Being boring is not an option investors should take in 2021

After such a tumultuous 2020, what does 2021 hold?

We believe there are four major factors that will determine the outlook for equity markets - the distribution of vaccines; government and central bank policies; the extent to which government bond yields will (be allowed to) rise; and the performance of the dollar.

On balance, we think these factors will continue to fuel the ongoing recovery of the global economy, equity markets and income-generating assets.

The news on the vaccine front looks positive. There are logistical challenges to producing and distributing vaccines on a sufficient scale, especially as the initially-approved vaccine needs to be stored at -70C. However, we believe in the power of human ingenuity to resolve these issues, which means we should be able to put this pandemic behind us in 2021.

Not easing off

While the vaccines are gradually rolled out, governments and central banks are likely to continue doing everything in their power to sustain the economic recovery and ward off the development of a credit default cycle. This means additional fiscal packages and continued debt monetisation, in all but name, in the coming months.

These measures should keep bond yields capped and drive the US dollar weaker still.

What does this mean for investors? Human beings, by nature, are generally a skittish bunch. We almost have to be worried about something – and when we are not, it is usually a time we should be worried.

Towards the end of March, it was the looming recession and the perceived impending collapse of the economy. Today, in the aftermath of the spectacular recovery since then, it is the worry that markets have risen too quickly, pushing valuations to stratospheric levels.

Onboard the bias

Acknowledging these biases in the first step to making an investment plan. These fears are natural and play a role in ensuring we do not fall too much in love with romantic stories about the next BIG thing. However, they should not get in the way of making a plan.

In 2018-19, we advised clients who were starting out on their investment journey to try and envision how they would want their portfolio to look like in three years. The next step – always the hardest part – was to start slowly accelerating investments should there be significant market correction.

Those who followed that plan assiduously would be very happy today. However, human nature means that fears likely dominated when markets were collapsing and this led people to freeze, or at least invest less than their plan would have suggested.

Growth pivot

So what should investors do now? Our view is that we are in a relatively early stage of a long-term equity bull market. There is still plenty of excess capacity in the global economy, which means inflationary pressures are likely to be generally muted, allowing central banks to continue focusing on supporting growth rather than fighting inflation.

Meanwhile, for 2021 itself, a weaker dollar is likely to be a strong tailwind for investors. Historically, a weak USD environment has been very positive for asset class returns pretty much across the board.

Check this correlation

For example, since 1999, when the dollar has weakened 5-10 per cent over a 12-month period, global equities have averaged a 14 per cent annual return and have delivered positive yearly returns 83 per cent of the time. This compares to an average 0.4 per cent return and 56 per cent hit rate, respectively, where the dollar has strengthened 5-10 per cent. A similar profile can be seen when looking at returns for bonds and gold.

In our opinion, the stage of the economic cycle and the dollar’s outlook both mean investors should be less wary when it comes to increasing investment allocations in 2021. A year ago, spare capacity was very limited and central banks were increasingly focused on making sure inflation would not take off, which raised the risk of overdoing it and inducing a recession. Today, we are past that recession already and we believe there are bluer skies ahead.

Of course, investor concern over the elevated level of equity market valuations – such as price-to-earnings or price-to-book ratios - is valid. It is possible that equity markets have moved ahead of fundamentals to some extent, making them vulnerable to intermittent pullbacks, especially if the recovery of those fundamentals turns out to be slower than expected.

Risk is on

However, investors are faced with high valuations almost everywhere they look. Deposit rates and bond yields are mostly below the level of inflation – meaning that we are losing our purchasing power. To us, this means investors looking to preserve and grow their wealth will increasingly be forced to look to riskier asset classes, such as equities, bonds issued by companies with lower credit quality and other alternatives such as real estate.

While we cannot rule out short-term equity market pullbacks, we believe such reversals are likely to be less severe and relatively short-lived, given the policymakers backstop. Against this backdrop, we believe avoiding an all-or-nothing investment approach will be critical to one’s long-term success.

Stick with it

Drip-feeding investments in a planned way into a diversified basket of financial and alternative assets may feel boring, but boring can be good if it gets you started. A systematic approach to investing would also reduce the risk of panic selling in the face of short-term market fluctuations. Of course, it means that you may wish you had invested more or less, but at least you will have skin in the game already if the market has gone up, and still have more cash to deploy at cheaper levels if the market has fallen.

These are easier emotions to deal with than being 100 per cent wrong by staying out of the market and watching your hard-earned savings being gradually depleted by inflation.

- Steve Brice is Chief Investment Strategist at Standard Chartered Wealth Management.