OCBC OneWealth App– The longest year

Equities

Global

Outlook

One-year Covid-versary

Carmen Lee

Head, OCBC Investment Research, OCBC Bank

The longest year

24 March 2021

The best is yet to be?

“The best is yet to be” is not just a line from a poem by Robert Browning, but an apt description of the financial market’s optimistic attitude that has driven a remarkable turnaround 12 months after suffering the brunt of the Covid-19 pandemic.

Indeed, the global pandemic has affected many of us personally, professionally and economically. The widespread impact is of a magnitude not many of us have experienced in our lifetimes. It has been an economic disruption of historic proportions.

Equally astounding was the way global markets reacted. After reaching the trough of the sell-off in late May, markets were somehow able to cast away the uncertainties and adverse impact on economic growth and social well-being and look beyond to other future opportunities and areas of growth.

After a strong run in 2020, the question is: Is the best yet to be or has the good times for equity markets come and gone?

2020: The longest year

When the pandemic escalated in March last year, global equities took a huge hit as all major equity indices plunged. Specifically, 23 March marked the anniversary of 2020’s panicked nadir.

The MSCI World Index fell 32% from the start of the year to the trough of the sell-off, as investors exited the market in rapid succession, fearing the global spread of the pandemic. Yet, by the end of a momentous 2020, equity markets had staged a stunning turnaround to end the year with fresh record highs. Specifically, the MSCI World Index ended up 14.1%, recovering all the losses seen in March when global equities fell as panicked investors sold off risk assets on the back of a spreading global pandemic that forced governments to lockdown borders and temporarily shutter businesses and schools.

According to the MSCI World Value Index, value stocks took a major hit. The index fell a stunning 38% from the start of 2020 to the lowest point reached in March. Meanwhile, growth stocks, as measured by the MSCI World Growth Index, fell by a smaller 26% over the same time period.

Many key sectors were severely impacted by lockdowns across the globe, and these included airlines, aerospace, tourism, retail, luxury goods, hotels, banks and financial institutions. Smaller-cap stocks, as measured by the MSCI World Small Cap Index, were more vulnerable to the panicked sell-off and fell a sharp 40% from the start of 2020 to the lows in March. Larger-cap stocks fared better, with the MSCI World Large Cap Index falling 31% over the same time period.

Back then, in a rare and concerted effort, governments and central banks worldwide provided unprecedented liquidity and fiscal aid to financial markets and affected businesses and households. The Federal Reserve launched an alphabet soup of lending programmes to thaw frozen credit markets while the US Congress passed a historic US$2.2 trillion fiscal package that, quite literally, placed cash in the hands of affected households. As a result, equities rallied strongly as optimism returned despite the rapid rise in Covid-19 cases globally.

By the end of March last year, the MSCI World Index was up 16% from the low reached on 23 March. And by the end of April, the index had recovered 28% from the trough. The remarkable turnaround picked up pace over the next few months and the index ended the year with stellar gains.

Growth stocks were the stars, value was a sideshow

Gains were largely powered by growth stocks, with the MSCI World Growth Index up 33% in 2020. Extraordinary gains were seen for both small-and large-cap players in growth-related sectors. However, gains were not uniform across the board. The market recovery was patchy, and the impact was uneven across sectors and markets.

Value and cyclical stocks were largely overlooked as persistent concerns remained on the pace of earnings recovery for these sectors and companies.

Closer to the light at the end of the tunnel

One year later, we find ourselves closer to the light at the end of the tunnel even with a potential setback to recovery amid an extended lockdown in Europe. With several vaccines in the market and with more countries committed to rolling out vaccines in 2021, the outlook remains promising.

The global economic recovery is on track and global GDP is projected to turnaround from -3.5% in 2020 to 5.6% in 2021 and 4.1% in 2022, based on consensus estimate from Bloomberg.

The Asia ex-Japan region is projected to grow from 1.4% in 2020 to 5.8% in 2021 and 5.7% in 2022. For China, which is the first country to be hit by the pandemic and the first country to contain it, growth is projected to accelerate from 2.3% in 2020 to 8.5% in 2021.

The world is healing

On 1 March 2020, there were a total of 88,369 confirmed coronavirus cases. A year later, there were 114.4 million cases globally and the number of confirmed deaths stood at 2.54 million. The US reported a total of 28.7 million cases, and this accounted for about 25% of the total number of cases. This is followed by India with 11.1 million cases (9.7%) and Brazil with 10.6 million cases (9.2%).

The pace of new daily cases, which peaked in February and March 2020 at a double-digit rate, has since come off to around 0.3% per day.

Even amid concerns of a new wave, widespread vaccinations will allow countries to ease restrictions and reopen economies gradually. Over time, we are optimistic that economic activities will gradually return to pre-pandemic levels.

Value and cyclical stocks are well positioned to see a recovery in earnings as the global economy stabilises and gradually reopens. These stocks may also benefit from renewed interest from investors looking for opportunities that are attractively valued against an increasingly expensive market. The hunt for yield amid the lower for longer interest rate environment will also buoy demand for dividend yielding stocks that typically operate in these value sectors including REITs, financials and energy.

In fact, several sectors that had largely underperformed in 2020, including aerospace and airlines, banks and financial institutions, energy, transportation and real estate, have started to perk up as investors increasingly rotate away from growth and momentum plays to value and cyclicals on the back of rising bond yields and a brighter outlook, principally driven by a vaccine-fuelled economic recovery.

Cyclical and value stocks should benefit from economic recovery

While we are largely positive on the global economic recovery, we also note that equities have performed surprisingly well despite the economic downturn last year. This tells us that most major equity indices have already priced in a great deal of optimism about the current economic recovery. After all, markets are forward looking, and prices reflect expectations of what might be rather than what was.

Much of the gains were concentrated in growth sectors that rode on the work-from-home themes including digital, e-commerce and other enabling technologies. The recovery and reopening play since the discovery of vaccines have triggered a rotation out of these sectors into value and cyclicals that are more sensitive to economic winds.

We see this rotation continuing for a while, especially as the economy recovers and long-term bond yields increase. Investors who are overexposed in growth sectors may consider improving the balance between growth and cyclicals within their portfolio by trimming some of their exposure to momentum plays that have done exceptionally well. Moving forward, we believe a carefully constructed and balanced portfolio of value and growth stocks should be the way to ride out both the challenges and opportunities of the next 12 months.

Despite stretched valuations in certain sectors like tech, the recent US earnings season has left us feeling somewhat encouraged. Earnings report cards have shown companies delivering in-line or better-than-expected performance despite high expectations that have already been baked into the price. Based on the S&P 500 companies that have reported earnings for the fourth quarter of last year, 80% beat analyst earnings per share estimates. This is a positive indicator and could mean that earnings revisions are likely. This suggests there could be more upside for US equities.

Understandably, the recent sell-off in the bond markets have caused some jitters among investors. Volatility is indeed par for the course as markets recalibrate expectations of inflation and policy as the economic recovery gains pace, aided by significant fiscal support. Despite the turbulence, we continue to stay the course with our positive view on equities.

For perspective, the S&P 500, one of the oldest indices with data dating back to 1928, shows that the compounded average growth rate over the last 93 years was a very decent 6%. History has shown that over a long period of time, equity is indeed one of the better asset classes to own. For long-term investors, this should be a guiding principle.

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