Issue date: 2020-12-31
Amid the ongoing global economic recovery, investors may need to use a broader toolkit – beyond the regions that have recently done well. Equities in Europe and emerging Asia may offer better value than the US winners of 2020, while a continued low-yield environment could create attractive opportunities in Asian debt and corporate bonds globally.
After a historic rebound in economic activity in the third quarter of 2020, the US growth outlook grew more moderate (see Exhibit 1). We expect this trend to continue throughout 2021, albeit with some surges and dips. Growth will likely still be above potential – meaning overall demand may outpace supply due to strong employment, high government expenditures and other factors – which may eventually spark inflation. Where the US economy ultimately ends up will likely depend on a few factors:
If US economic activity gradually returns to where it was before the coronavirus crisis hit, it may set up a generally benign backdrop for US risk assets such as equities and non-government bonds – though it will be important to choose carefully. In the case of another slowdown, markets will likely anticipate more fiscal and monetary stimulus – which could be supportive for risk assets as well. Either way, we may see a shift in which sectors are leading, and we expect market participation to broaden – meaning different sectors of the market may begin to outperform.
In the European Union, the Covid-19 pandemic is being battled by 27 different member states. This makes the path of containment, the reaction of market participants and the speed of any rebound very difficult to predict. Continued lockdowns and social distancing would have a particularly strong impact on the service sector, and we would likely see insolvencies rise and employment fall across the EU. The markets would anticipate some uptick in insolvencies; what matters is whether they rise beyond expectations. We also assume that fiscal and monetary policy measures will help preserve the region’s economic fabric and avoid large-scale bankruptcies and layoffs.
The 19 countries in the euro zone carry the greatest weight – particularly Germany, France, Italy, Spain, the Netherlands, Belgium and Austria, which account for around 90% of the euro zone’s aggregated GDP. Overall, we expect the euro zone to grow by around 5.5% in 2021 after a projected collapse of 7.7% in 2020. This will be helped by several factors:
The inflation outlook remains relaxed for the time being, with euro-zone headline inflation expected to accelerate to a still-moderate 1.3% in 2021, up from 0.4% in 2020. Higher food and oil prices will exert a gradual upward push. Against this backdrop, the European Central Bank will likely stick to its extremely expansionary policy stance of low interest rates and continued asset purchases (see Exhibit 2). Within fixed income, we continue to prefer bonds in the euro-zone periphery, including Italy and Spain, over German government bonds. We also have a positive view of investment-grade corporate bonds. Both segments benefit from ECB purchase programmes.
We have a constructive outlook for European equities over the long term, thanks to their moderate valuations and our expectation that today’s promising vaccines, if broadly adopted, will help contain the virus’s spread.
We expect China’s economy to keep up its strong recovery from Covid-19, which had a hugely negative impact early in 2020 even though the authorities quickly got the pandemic under control. Year-on-year GDP growth could be impressive in the early part of 2021 – in large part because the same period in 2020 was so deeply depressed (see Exhibit 3) – before slowing somewhat through the rest of the year.
China’s service sector seems set to continue its upward climb, assuming the government can suppress renewed outbreaks of the coronavirus. The manufacturing sector also seems likely to keep growing, helped by public investment projects and a gradual recovery of global demand as Covid-19 passes. And China is still positioning itself to win over the long-term by nurturing its own high-tech industries – particularly in the fields of robotics, aviation and other advanced-manufacturing areas.
We think this environment will lead China’s authorities to continue normalising the fiscal and monetary stimulus they provided in 2020. This means the government may start spending less, and the People’s Bank of China (PBoC) seems unlikely to make any major monetary easing moves – including rate cuts – in 2021. On the contrary, we could even see the PBoC start to tighten towards the end of the year if growth returns and core inflation picks up.
We are somewhat cautious on China’s investment outlook in the near term, given that fiscal and monetary policy are on a path of being normalised against an improving macroeconomic backdrop. Over the long term, however, China’s economic story is a compelling one. We think investors should continue to think of China as an asset class in and of itself – meaning it’s not so much a question of whether to invest in China, but how much to invest.
Emerging markets Emerging Markets
Emerging economies generally rebounded sharply after substantial losses in March 2020 – in large part thanks to extremely accommodative support from central banks (Exhibit 4). Over the long term, we may see this support contribute to higher inflation globally. In the short run, however, we expect that factors such as weaker commodity prices will likely help avoid meaningful inflation pressures in the developing world. This will allow their central banks to cut rates to record low levels and experiment with some forms of asset purchase programmes (known as “quantitative easing”).
But the massive amount of monetary and fiscal stimulus measures at work in emerging economies won’t last forever. For example, there is a limit to how low interest rates may go, given concerns about inflation, exchange rates and financial stability. Indeed, Turkey and Hungary already increased their policy rates in 2020. And fiscal stimulus measures – including increased spending – may soon become simultaneously less effective and increasingly scrutinised as investors assess whether too much spending hurts creditworthiness.
In the immediate future, Covid-19 continues to be the main risk for emerging-market growth. As viable vaccines become available, economic conditions around the world could normalise – which would help emerging and developed nations alike. But rising infection rates pose significant risk to vulnerable nations that have already spent much of their ammunition fighting the disease. As a result, we expect the recovery in emerging markets to be both fragile and diverse:
Overall, some emerging economies could enjoy robust quarterly GDP growth rates in 2021 given how low they were in the spring of 2020. But in many nations, economic activity is still below pre-Covid levels even as other challenges persist – from increased geopolitical tensions to broken supply chains and higher protectionism. However, with core emerging-market central banks signalling that their accommodative policies will not be reversed anytime soon, and with multilateral support ramping up from developed nations, emerging economies should feel external financial pressures ease somewhat.
Among emerging-market sovereign bonds, investors may want to consider high-yield over investment-grade securities, in part thanks to the external support the Fed and IMF are providing to developing nations.
In emerging Asia, fiscal and monetary support – along with positive developments in the fight against coronavirus -- should help fuel the appetite for yield and risk assets. Across the region, we generally prefer fixed-income investments with shorter durations, and generally favour high-yield over investment-grade securities. In addition, a challenging environment for the US dollar could help India, Indonesia, the Philippines and other economies in South and South-East Asia. A weaker dollar means these countries’ central banks may not need to raise rates to help their currencies. It also makes it cheaper to hold debt denominated in US dollars and could result in more foreign inflows into the region.
Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to revise any information herein at any time without notice. Past performance, or any prediction, projection or forecast, is not indicative of future performance. No offer or solicitation to buy or sell securities and no investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice.
Investment involves risks, in particular, risks associated with investment in emerging and less developed markets. This material and website have not been reviewed by the Securities and Futures Commission of Hong Kong. Issued by Allianz Global Investors Asia Pacific Limited.