Insights for 2021

 

Talking about forecasts, what comes to my mind is what Ruchir Sharma famously quipped in 'Breakout Nations' -  you either forecast too many and publish the ones you got right, or you forecast so far into the future, that no one will remember.

But I'll try to take a potshot at some of the major fundamentals that could evolve over the next year. I wouldn't dare much and would try to be aligned to consensus on most, so as to play safe. But it would still be a refresher, to have this all in one place. 

1. A Global Recovery: US to grow at around 3% while EM may pick up by around 6%. 
   
   
   It is expected that the economies across the world  would record a recovery this year. There wont be a structural growth, but mathematically at least, given the lower base of last year, the direction would at least be up (global economy contracted by 4% in 2020). 
   
   
   Major drivers would be 
• The mass vaccination programs, that would help boost consumer spending, 
• Stimulus packages aimed at driving growth.  For ex. US would have Biden's $1.9trillion economic stimulus, Pakistan would see the impact from its Temporary Economic Relief Program of finance at max 5% aimed at driving investments in large scale manufacturing, EU has its EUR 750bn Recovery Fund, China with a $740bn fiscal measures, India will have impact of its USD 266bn economic stimulus package announced last year, etc. 
• The faster than expected recovery in China driven by pandemic related demand (medical equipment, electronics, machinery), government spending and innovation investment. However, more than ever before, China is facing certain hard headwinds, including restrictions on doing business overseas and global giants trying do diversify away from Chinese based supply chains. 
  
  
2. Equity Markets - S&P500 still has positive dynamics to propel it from $3,800 to breach $4,000, before settling back at around $3,500
   Boy, isn't this a story already? Equity markets are already in such a risk-on state and at record highs, that they don't remember April of 2020. The market is already heating up and the US stimulus will add a 1,400 dollar paycheck to all citizens. As earnings release comes in, there would be more optimism as work from home and streaming stocks comes out with record earnings, investment banks make more money and customer facing banks putting up a brave stand, backed by all the regulatory forbearances allowing them to manage their results.  Emerging markets would outperform the developed nations as there would be better valuations available there. 
   
   The above would be the general theme for the market, but I would like to throw a word of caution here. The markets are currently showing some definitive signs of heating up and an onward correction (1) Its a herd mentality. The markets are all moving in one direction, aided by a macro push, rather than individual fundamentals. When the individual characteristics come out to play, these valuation levels may not hold. Current rally is more about TINA - there is no (other) alternative, with greed in play to a large extent - cash levels are lower with a long tech stock strategy (2) Easy money or rather free money part of stimulus chasing too few assets, which naturally pushes the markets higher and (3) rising bond yields which shows a risk on proposition, when investors move away from bond markets and focus too much on equities. A curve steepening due to long term yields rising faster than short term is normally a bear-steepening, driven by expectation of inflation, rate hikes and eventual economic slowdown. This too signals to a corrections soon.
   
   Overtime, markets would become jittery and may over-emphasise the first sign of major weakness, sending the market to a spiral and profit booking. The rebound has been quick and my end up facing some resistance soon, when fundamentals come into play. 
   
   
3. Currencies - A weaker USD for 2021
   The general theme evolving from market fundamentals is that the dollar would weaken in 2021, due to (1) the stimulus and COVID fights pushing debt and deficits higher, (2) expected pick up in inflation (given the massive stimulus, too much money chasing few assets) and a negative yield that may happen by virtue of the same, and (3) expected better valuations in emerging markets that would result in massive outflow of funds from US to EM world. 
   
   A short dollar and long tech stock is the most consensus driven trades coming into 2021. Couple of currency pairs as follows:
• USDINR - the INR has already strengthened by around 2.3% over the last 6 months.
• USDCNY - The Chinese currency has seen a close to 8% strengthening over the last 6 months and we have not seen any policy action from Beijing. This is partly because the 2020 US-China agreement insists on market driven FX pricing and no intervention. 
• USDTRY: Compared to other EMs, the lira still has a lot of ground to catch up, as its still around 9% weaker than 6 month levels. As the general theme of USD weakening catches up, there is lot of bandwidth here. With Erdogan promising more CB independence and a well received USD issuance recently, further strengthening may be on cards. 
  
  
4. Commodities - A general upward trend, while oil would face resistance. 
• Oil: Definitely getting support from the OPEC production cuts. Currently moving around the $50 mark, as the recovery picks and consumer confidence returns, we may be looking at around $55 levels by year end.  OPEC is expected to produce 27.2 mbd in 2021, up from 25.6mbd in 2020, even with the production cuts in place. Saudi Arabia is planning to reduce supply by 1 million b/d until April 2021 and data suggests that the inventory levels are slowly coming down, aided by lower US production. There is strong upward potential at least in the 1Q which is expected to prevail for the rest of the year as vaccinations lead to relaxations and further economic activity. 
• Gold: Not everybody is interested in a safe haven now, given the risk-on market. But gold is always viewed as an inflation hedge. If we agree to the global recovery scenario and if stimulus results in inflation, then there should be strong demand for gold. Retreating from 2,000 levels seen during the height of pandemic when a flight to quality happened, gold is around 1,800 levels now, but its still high which may attributed to the inflation expectation. Hence, its a tussle between risk-on proposition and inflation expectation for now. But another variable may soon come in to play, which is a recovery in emerging markets, which would push demand higher. Say a recovery in India and a restart of gold purchases. So, inflation expectation and a purchase push vs. risk on appetite. This one's tough, I would just say it would remain below $2,000 levels. 
• Copper: Currently at historic highs (LME copper at $7,800/t vs. $5,000/t seen in mid 2020) aided by strong recovery from China, the major consumer. Now once the US stimulus comes in, the price support would be much better, mitigating the lower demand previously seen in EU and US. Also, if we agree to the weakening dollar story, then copper imports to EMs would be cheaper, further driving its demand and prices. Hence, it is more or less an upward trend expected for this metal. We wouldn't be surprised to see around $9,000/t towards end 2021. 
• Steel: China, the major supplier had increased its production substantially in 2020 to support its export driven economy, when other major producers had curtailed production. LME Rebar prices have moved from $430/t seen in mid 2020 to around $630/t in early 2021. A global recovery and improvement in construction activity will push the prices further up. A correction is unlikely in the near term and may remain elevated all through 2021. 
  
  
5. Bonds: A steepening curve - 10Yr Treasury at 1.5%
   The yield curve had shifted down substantially since the beginning of the pandemic given the flight to quality, with yields at sub-1% level for all but the 20&30Yr bucket. The curve was pretty flat as well during 2019 and beginning of 2020 - however the recent inflation expectations have slowly started pushing the curve steeper, with 10Yr bonds breaching the 1% mark. With inflation management not a priority for the governments any more, investors would look into safer bets to protect against inflation and hence the longer term yields are expected to remain strong. The short end of the yield curve is driven by rate hike expectations and longer end by inflation expectations and investor demand. With record stimulus and government debt out there, an increase in interest rate would be detrimental (if GDP can't grow faster than cost of debt, there is no point in stimulating economy with debt). Hence it is expected that the curve will steepen further as we go along into 2021. This would definitely give a breather to consumer facing banks, as borrowing short term and lending long term is the inherent business of a bank. But such steepening is normally called 'bear steepening' and it normally leads to an equity sell off, in anticipation of a rate hike. A lot would depend on policy announcements going forward. The Fed will have to specifically play down 'taper' expectations to support the current market environment. 
   
   
   
   
   
   
   
   

Overall, its a cautious recovery play being unwound for 2021, while the economy continues to grapple with rising infections with optimism of a vaccine rollout and EM recovery. It's going to be an interesting year ahead, one to survive and stabilize.