BeeWyzer Thoughts on 2021Jan 04, 2021
Following a very bumpy year 2020 with a decline in stock markets in March 2020 of around 30% and a pick-up of valuations to new highs within a short time of around 6 months, it seems difficult to make any projections for the coming year 2021 at all. At the end of the year 2020 for example the German DAX index has reached an amazing near all-time high above 13.700 points in the midst of the Covid-19 pandemic.
But interestingly, almost all analysts and economists are still in a positive mood and even the estimates for GDP growth and equity valuations 12 months from now are very positive and closely aligned. This unanimous position is unusual at the turn of the year and offers two ways of dealing with it: Either you follow the crowd - expecting the experts to be correct and the markets to follow the self-fulfilling-prophecy pattern.
Or – alternatively - you decide to see the unanimous attitude as suspicious and use it as a counter-indicator.
What are reasonable arguments in this context ?
Of course, there is the outlook of reaching herd immunity following vaccination and a return to a more normal life during the next year 2021. Let us simply assume the vaccines are working and the logistical challenges of rolling them out are handled well. Then economic and social life will return to a more active status, probably in the second half of the year. The mere expectation of things getting better will trigger spending and investment already in the first half of 2021. So, the global economy is likely to grow and in combination with more cheap money and continuing high liquidity levels the stock markets would continue to be fueled with the “drugs” they need…
Behind this reasoning there is not only the hope for a ‘things-get-better’ assumption, that seems to be quite realistic. There is also the ‘things-will-be-almost-as-before’ assumption which is more difficult to accept. Entire industries have been devastated and not all of them are likely to come back to their previous strength. Also, there are clearly more large and small bankruptcies to come following the Covid-19 pandemic. For example, nobody expects business or touristic travel to resume at a pre-Covid-19 level. Now digital conferencing companies are probably very likely to continue growing instead, but in terms of manpower and investments these will never compensate the loss on the side of the traditional industry. Just this one example underpins that the ongoing restructuring of the way we live and work will dampen employment, consumer spending, material investing and GDP growth in this transition period for an unknown duration. Countries and economies that were already in a restructuring mode before the pandemic shock are likely to dive more - or to take more time before entering a normal growth path again. To some investors stock prices seemed to be high already before COVID - now, imagine company results at the end of 2021 are significantly off analyst estimates and you spot serious risk out there.
There is also the ‘financial-markets-will-stay-in-post-Lehman-pattern’ assumption. This means money is cheap, central banks buy everything nobody else wants to buy at any given price, public debt continues to rise to unthinkable zillion-levels and financial repression (negative real interest rates) helps governments to get by with it. It may well work this way for the short term. But patterns never hold forever and change often comes from where nobody expects it. Just a few thoughts on this:
- Investors have already started to distrust official fiat-money as a means to preserve value - see their diversification into gold and cyber currencies
- At a certain level of central banks holding government bonds, many countries have institutional bans on financing public spending by printing money will kick in, putting a ceiling on dealing the drug of cheap money
- Institutional buyers will over time ask for a positive real return on longer maturities, if they have to step in
- Higher taxes, increasing interest rates or partial and hidden defaults may be consequences
- Competitive devaluations and attempts to weaken the external value of currencies may foster imported inflation
Nothing of this may come true. We have merely listed these scenarios in order to make only one thing clear: Markets are never a one-way street, so be aware of black swans in the future.
How should investors prepare for the current scenario?
First of all, get your understanding of risk up to date. Look at overall and holistic risk for your entire wealth (you may use the BeeWyzer robustness indicator, if you have not already done so: get a free download on www.beewyzer.com).
Define your (maximum) risk budget and possibly invest it into real assets that are likely to be boosted by post-pandemic trends. But look for exit horizons that are not too far out in the future.
Invest liquid assets in a flexible way that has risk management measures integrated from the start. Use protective hedging tools or risk-adjusted management techniques. And keep some liquidity: if analysts turn out to be wrong, you will be there to benefit from it, when markets correct downwards. Manage liquidity in an innovative way in order to get some return on it, e.g. via put options sold on stocks that would fit your portfolio. Think out of the box but do only things you understand. That should do for the moment.
Have a look at this chart:
Source: Berenberg Economics, Joh. Berenberg, Gossler & Co. KG, Hamburg
The concept of reversion to the mean expresses the experience, that discrepancies, that are way off historical boundaries tend to get back to normal. On this chart you have three options for reversion to the mean: GDP goes up, Equities come down or the curves move towards each other and meet somewhere in the middle. Did you notice, that only one of these scenarios shows a bullish stock market? Two out of three ain’t bad….
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