December was bittersweet in terms of the pandemic. The number of infected people in Europe and the US surged, including from a mutated version of the virus. Yet market optimism rose as vaccination campaigns began amid plans to significantly increase the pace of jabs in the first few months of 2021.
Investors were also reassured as a number of long-running issues were wrapped up, including the signing of a Brexit deal and budget agreements in Europe and the US.
The commitment from the main central banks to keep their monetary policies highly accommodative in 2021 as well was a further positive. It ensured that long-term rates will remain low at a time when budget deficits are rising due to the additional economic support packages.
In the short term, the tightening of lockdown conditions will inevitably weigh on activity. Hopes of a global cyclical recovery beginning in 2021 were reinforced by the start of vaccination campaigns and the prospect that these will accelerate soon.
Emerging market equities outperformed: +7.2% for the MSCI Emerging index in US dollar terms. To some extent, this reflected COVID-19 being under better control in emerging markets than in most developed countries. In addition, China's economic recovery is attracting exports from many EM countries. The 26% rise in Asian equity markets was a major component in the 15.9% year-on-year return of EM equities.
US equities continued to outperform the less dynamic European markets. The S&P 500 index finished 2020 at an all-time high, up by 3.7% in December. The Dow Jones 30 gained 3.3% in December and 7.2% over 2020. Investor appetite for US technology stocks persisted: The NASDAQ Composite’s December rise of 5.7% brought its gain over 12 months to 43.6% (compared to 16.3% for the S&P 500).
In Japan, death rates from COVID-19 have been much lower than those in other major developed economies. However, the acceleration in the number of new cases at the end of the year was serious enough for the government to make anti-pandemic measures mandatory for the first time. Despite this being likely to weigh on still-weak domestic demand, Tokyo stocks still managed to rise in December as the government announced a new stimulus package. The Topix index rose by 2.8% to a two-year high.
In the eurozone, the EuroSTOXX 50 gained 1.7% in December; even so, it was 5.1% lower than at the end of 2019. The underperformance of the financials sector, which may have been exacerbated by the euro’s 9% rise against the US dollar in 2020, partly explains this year-on-year decline.
December’s favourable environment for risky assets caused the US dollar to fall further. The euro broke out of the 1.16-1.20 USD range it had been in since late July and rose to 1.22 by mid-December, its highest since April 2018. It finished at 1.2229, up by 2.4% on the end of November.
The ECB repeatedly said it was not targeting a particular exchange rate, but was closely watching the impact of the stronger euro on inflation. These comments may have contributed to the US dollar stabilising at the end of the month. The dollar declined against developed market currencies and emerging market currencies.
The US government bond market was largely driven by fiscal policy expectations. Disappointing news on the number of jobs created in November drove the 10-year T-note yield to its highest since 11 November at 0.97%. The report suggested to investors that fiscal stimulus could be highly significant in supporting an economy that is suffering from wave after wave of the pandemic. The 10-year yield ended December at 0.91%.
After long negotiations, the US Congress approved around USD 900 billion in aid to businesses and households affected by the pandemic.
The Fed said its asset purchases would continue at the current pace, thus ensuring a long period of highly accommodative monetary policy. It signalled that it will act to limit long-term interest rate rises when the expected cyclical recovery for 2021 begins to materialise.
Breakeven and 5-year inflation expectations (5Y5Y forward swap inflation) rose further, the latter to close to 2.30% at the end of December, its highest since May 2019. Consumer price inflation held at 1.2% YoY in November.
The new restrictions put in place to combat the continuing surge of COVID-19 infections, particularly in Europe and the US, will doubtless weigh on economic activity. However, governments’ efforts to help their economies get through the next few months are likely to reassure investors, as are the vaccination campaigns. There should come a point in 2021 when the lockdown-on/lockdown-off see-saw that is hitting consumption and household and business confidence ends.
In the meantime, financial markets should continue to benefit from highly accommodative monetary policies, persistently low long-term rates and additional fiscal support.
While in 2020, investors were often reluctant to participate in the equity rally, the consensus now looks strongly bullish on equities, as shown by the large inflows of recent weeks. Any market consolidation in the short term can be seen as a buying opportunity given the favourable medium-term outlook.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
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