By: Sanisha Packirisamy, Economist at Momentum Investments and Herman van Papendorp, Head of Investment Research & Asset Allocation at Momentum Investments
- Global financial markets whipsawed in 2020 in reaction to a devastating COVID-19 pandemic and the subsequent decisions taken by governments and policymakers to protect citizens and keep economies afloat.
- Outside of Europe, global equity markets experienced strong returns in 2020. Easier monetary policy and additional fiscal support drove robust returns in equity markets in the United States (US), while European shares lost ground.
- The South African (SA) equity market trailed global equity markets in 2020. Resource shares were the standout performers for 2020, while financial shares fared poorly.
- In our view, whether or not the COVID-19 virus can be tempered successfully in 2021 will largely determine risk appetite in global financial markets. Improved global growth, still ultra-easy policy settings and a positive vaccine outcome should provide general support for more risky assets like global equities. Safe-haven asset classes, like global bonds, are nevertheless likely to face headwinds in a cyclical recovery phase, with bonds facing the additional challenge of somewhat higher inflation.
- It looks like the stars are finally aligning for the SA equity market, with a strong expected profit recovery in 2021 providing fundamental support on top of an envisaged conducive global risk-on environment, while a more favourable valuation underpin after years of poor performance should enhance potential return upside.
- SA real bond yields remain compelling, in sharp contrast to zero real cash yields. In the inflation-linked bond (ILB) space, the expected rise in SA inflation, as 2021 progresses, should provide a positive fundamental underpin.
- Listed property share prices have been decimated, with valuations at rock-bottom levels relative to history. It is likely that the weaker fundamental environment has already been discounted by share prices in the sector.
- The strength of the global economic upturn will be reliant on the success of vaccination campaigns and greater global co-operation to guarantee efficient distribution of vaccines worldwide. However, the road to recovery remains uneven and uncertain, particularly in light of renewed lockdown restrictions and new COVID-19 strains.
- More diversified economies that are less exposed to contact-intensive activity will likely fare better in the coming quarters. Meanwhile, more concentrated economies that are reliant on services, oil or small business activity are likely to require further support and will take longer to recover.
- Continued fiscal support and an ultra-accommodative monetary policy stance are crucial in keeping the economy afloat and will lessen lasting economic damage from the crisis. A premature withdrawal of stimulus could pull the rug out from under the nascent recovery if the private sector cannot pick up the economic growth baton.
- Meanwhile in SA, muted confidence, a likely rise in bankruptcies, a strained fiscus and ongoing electricity shortages will contain the anticipated recovery in 2021, more so given the recent tightening in lockdown restrictions. After contracting at an expected 8.1% in 2020, SA growth is likely to increase to a below-consensus 2% in 2021, before slowing to 1.6% in 2022.
- Efforts to arrest the increase in government’s debt burden through achieving higher growth will likely be constrained and could lead to further negative rating actions later in 2021, in our view.
- While near term inflation pressures are likely tilted to the downside, we see inflation rising in the medium term from an expected average of 3.2% in 2020 to 3.9% in 2021 and 4.7% in 2022.
- We are projecting a shift higher in interest rates in the second half of 2021 given the SA Reserve Bank’s (Sarb) warning against the constraints of fiscal dominance and the dangers of running negative real interest rates for a protracted period.