investment viewpoints

Outlook 2021 – equities

Outlook 2021 – equities
Didier Rabattu - Head of Equities

Didier Rabattu

Head of Equities
Pascal Menges - Head of Equity Investment Process and Research, Client Portfolio Manager

Pascal Menges

Head of Equity Investment Process and Research, Client Portfolio Manager

The sustainability transition to a Circular, Lean, Inclusive and Clean (CLIC™) economy

Long-term trends and structural themes are key determinants in creating alpha, as they provide growth opportunities for companies. Historically these trends have reflected themes such as increased globalisation or the rising middle class in emerging markets. When analysing companies’ growth prospects, these trends tended to be approached in a rather simplistic, volume-based way without considering the consequences or second order effects. Policy makers, regulators and, significantly, consumers now see these effects as less acceptable. The shift toward sustainability is, therefore, a fundamental structural change in the way we need to analyse companies’ growth prospects. A license-to-operate is, implicitly, more challenged than ever.

For instance, fast fashion, a trend permitted by the deflation offered by globalisation, has now had to face some key questions regarding topics such as its environmental impact or use of fair labour practices. Some argue that we may have even reached “peak clothing”, as more conscious consumers alter their behaviour and see limited marginal utility in buying new clothes – this has also been augmented by an increased awareness of negative externalities. 

Global healthcare systems are also under intense pressure. As a percentage of GDP, healthcare spending has already reached elevated levels for indebted governments, but in many regions consumers are also facing both increased premiums and out-of-pocket spending. This situation has the potential to deteriorate further as the consequences of an ageing society – combining a shrinking workforce with increased health needs – are still on the horizon. When analysing growth prospects within the healthcare sector, we believe companies that bring value to patients and efficiency to the entire system will likely be in the best position, while those layering-in costs will be challenged. 

Some areas of change have a higher media profile, for example the on-going transition of the energy sector towards cleaner sources of power. This transition is driving a massive trend towards the electrification of processes and habits around the world, impacting an array of spheres from steel to mobility and has multiple ramifications across industries – including electric cars, batteries, renewable energy sources (solar, offshore wind, hydrogen), grid infrastructure, demand management etc. Rewiring how the world is powered will be a massive endeavour, lasting decades.  

Sustainability and growth are now intertwined. This a structural paradigm shift. It cannot be narrowed just to “greening”, this is pervasive across all sectors and needs to be a key priority for equity investors.

Further clarity on a return to normality should also be positive for insurers and banks.

What will a post-coronavirus world look like?

To some extent the Covid-19 pandemic has been a catalyst for many burgeoning trends already harnessing the power of digitalisation.  For years, experts have warned about the rising risk of a global pandemic. Social and economic risk factors have been at play such as population growth, increased urbanisation, globalisation and international mobility. Environmental risk factors have also favoured a pandemic scenario, as climate change blurred geographical and seasonal boundaries, for instance. While it is expected that vaccines will solve the current situation in the near-term, more structural decisions will need to be taken to address the risk factors behind further global pandemic outbreaks. This fight against the root cause of pandemics is an additional impetus to address forces that are already at play, and has been empowered by even more public and monetary support than expected, as well as the rapid application of wide-scale digitalisation.

By virtue of the containment measures associated with the fight against COVID-19, the digitalisation of consumption, corporate life, financial services and healthcare is in full effect. The pandemic has also underscored the need for more flexible business models. Digitalisation will also support the reorientation of elongated supply chains, towards a re-shoring of production in developed markets where emphasis is likely to shift to ‘just-in-case’ rather than ‘just-in-time’. In our view, such re-localisation practices are likely to result in more flexible, automated, robotised production processes in countries where the working population is shrinking as a consequence of an ageing society.  An energy transition will further support this industrial renaissance, providing cleaner, cheaper, decentralised and independent sources of power. A number of governments who view ‘green deal’ proposals as a powerful tool to boost weak economies, also support this transition to more circular economic structures. 

In the short-term, three steps are still needed for the COVID-19 vaccine to be effective: efficacy, distribution and population acceptance. News flow associated with each step is still a potential source of volatility. Assuming a successful path is established, the most obvious near-term beneficiaries will be those industries released from lockdown restrictions, such as physical retail, hotels, restaurants, international travel and tourism etc. Such a revival in transportation will then favour traditional energy. A more dovish US-administration could also help dampen the impact on the commodity market if Iran oil production is allowed to come back. 

Further clarity on a return to normality should also be positive for insurers and banks.  Insurers will benefit from the decreased risk for business interruption claims. Traditional banks might benefit from a decreased risk of non-performing loans and a likely steepening of yield curves (as increased activity spurs the anticipation of rising rates) which would be beneficial for banks’ net margins. Such yield-curve steepening might weigh on high growth companies, however, as these tend to be tech-driven and are often considered “long duration stocks”. These companies also have a disproportionate share of their value dependant on long-term growth prospects and, hence, the perceived impact of higher long-term rates could affect valuations.

In our view, equities remain an attractively priced asset class, particularly when considering the potential for a re-acceleration of activity and interest rates still remaining low in absolute terms. The case for a potential return of inflation, given central banks have indicated a willingness to only tighten late into the cycle, could also create the right conditions for investors to consider increasing their allocation to equities. 

However, 2021 will be a delicate year with markets remaining vulnerable to sentiment and rotation. Equity portfolios will need to be agile and capable of balancing between short-term bursts of performance in certain traditional sectors and the long-term vision of capturing growth opportunities focused on sustainability. 
Capturing such opportunities requires an ability to select companies able to harness and compound the economic value of growth. Too many companies are expected to grow too quickly, especially given access to capital is cheap and easy. Therefore, assessing the creation of superior excess economic return (EER) of companies remains at the forefront of our selection process and is a key determinant of alpha creation that should be resilient across business cycles. 

 

What are the likely consequences of a Biden Presidency?

Our general view is that economic and business cycles tend to trump political cycles in the medium term, while the latter can create near-term volatility.

On the US domestic front, a Biden presidency will likely implement more fiscal support measures, the intensity of which will be a function of successful vaccines (less spending required) or Senate control (more support). This, in turn, will potentially influence reaction-effects from the US Federal Reserve. For instance, it is believed that material fiscal measures could bring forward anticipation of a pick-up in inflation and, therefore, prompt an increase in rates to cool the economy.  Eventually, the implementation of corporate tax increases and higher taxes for the wealthiest – policies that are expected under a Democrat administration – would potentially also dampen the cycle if introduced at a later stage. The sequence of events will be important to follow. However, the de-locking of the economy in the near-term is a much more powerful cyclical force that nobody really aspires to de-rail. 

On the international front, there are several key areas of potential influence for the new US president. Should the Biden administration re-join the nuclear agreement with Iran, with a conciliatory outcome, there is potential scope for the expected rebalancing of the oil market to lag the broader economic cyclical upturn, as Iranian oil supply would re-enter the global market. In addition, the US might also re-join the Paris Agreement. However, a divided government will likely have far less financial latitude to implement the USD 2 trillion “green stimulus” promoted during Biden’s campaign or introduce stricter environmental legislation. This might limit the near-term boost expected for some environmentally-friendly industries (renewables, infrastructure, renovation, etc.), but it should clearly entrench the longer-term outlook to a more sustainable growth path. 

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