Updated: Jan. 14, 2021
2020 is ending with a second wave of COVID-19, following the largest exogenous shock in modern history, extreme market volatility that was followed by an unprecedented fiscal and monetary response and a tumultuous U.S. election cycle. This year also comes to a close with the S&P 500 hitting record highs and as credit spreads close in on their pre-pandemic levels despite the unprecedented shocks.
2021 should bring stabilization and a reset for a number of disruptions experienced this year, with front-loaded market momentum and an economic recovery to follow. J.P. Morgan Global Research forecasts volatile but strong global growth as economies reopen. Heading into the New Year, J.P. Morgan Global Research analysts believe recovery, reflation and rotation against the backdrop of accommodative monetary and fiscal support will set the backdrop for key market and economic calls for 2021. “Global growth will be below trend in early 2021, but the strongest global recovery in a decade will play out by the end of 2021 if the vaccine prospects play out as expected,” said Joyce Chang, Chair of Global Research.
J.P. Morgan Chief Economist Bruce Kasman forecasts global GDP growth reaching 5.8% and notes that optimism about 2021 global growth is building on the back of news that vaccines are now being rolled out to permanently sever the link between the COVID-19 virus and mobility. Widespread distribution of the vaccines should be forthcoming by Q321, however, Kasman cautions that “the legacy is an incomplete recovery with a 2.0% output gap that is larger than any similar recovery stage at any cycle over the past 50 years.” Policymakers remain committed to limiting spillovers, and there will not be a move away from accommodative monetary policy in 2021. Next year’s expansion of central banks’ balance sheets is expected to be half the size seen in 2020 and as a result, global fiscal policy should turn to a modest 1.5% drag after the 4.7% record fiscal thrust provided in 2020. Michael Feroli, Chief U.S. Economist, sees the U.S. economy growing at a 2.3% pace in Q1 but expects growth to lift on the recently approved $900 billion COVID-19 relief package, with additional fiscal stimulus potentially forthcoming in 2021, although the Federal Reserve will be mostly out of the picture. “The Fed will likely be on the sidelines for at least the next two years, while lingering labor market slack should keep inflation stuck in its 2010s range between 1.5% and 2.0%,” said Feroli.
The Fed will likely be on the sidelines for at least the next two years, while lingering labor market slack should keep inflation stuck in its 2010s range between 1.5% and 2.0%.
S&P 500 companies hold record balance sheet cash and offer high earnings yields vs bond yields
The financial market recovery is well advanced compared to the economic recovery, but John Normand, Head of Cross-Asset Fundamental Strategy, points out that some segments of equities and fixed income, commodities and currencies still remain as much as 10%, or as much as 200 basis points, cheap to pre-pandemic levels. “Stocks will outperform bonds but our total return forecasts are below average for almost every fixed income sector due to low entry yields and spreads,” noted Normand. J.P. Morgan strategists are forecasting above-average returns on equities (10-20% across regions) compared to small losses for fixed income (-2% on Developed Market bonds) or below-average gains (1% to 4% on parts of credit). For the S&P 500, equity risk premium, defined as the spread between the forward earnings yield (reciprocal of P/E) and bond yield, is currently at ~3.3%, while non-U.S. Developing Equity Markets appear even cheaper on this metric at a 5.4% spread. The S&P 500 finished 2020 as the top-performing asset class, returning 16%, but Dubravko Lakos-Bujas, Chief U.S. Equity Strategist, sees the rally continuing, supported by the economic recovery, earnings, inflows and lower volatility. “Our base case is an S&P 500 price target of 4,400 and our EPS estimate is $178 in 2021 and rises to $200 in 2022. The Equity price-to-earnings multiple is expensive in absolute terms but not when low rates and reasonable growth prospects are taken into account. The largest beneficiaries will be stocks at the epicenter of the pandemic, such as Consumer Discretionary, Financials and Energy.”
Our base case is an S&P 500 price target of 4,400 and our EPS estimate is $178 in 2021 and rises to $200 in 2022. The Equity price-to-earnings multiple is expensive in absolute terms but not when low rates and reasonable growth prospects are taken into account. The largest beneficiaries will be stocks at the epicenter of the pandemic, such as Consumer Discretionary, Financials and Energy.
The technical backdrop also remains supportive, characterized by an abundance of cash and declining volatility. Marko Kolanovic, Global Head of Macro Quantitative and Derivatives Strategy, expects $1 trillion of equity inflows/demand driven by systematic flows, hedge funding positioning, retail buying and share buybacks. He also sees a structural decline in the Volatility Index (VIX) to the high teens compared to the 2020 average of 28. Globally, he believes the positive drivers for equity markets are in place. Mislav Matejka, Head of Global and European Equity Strategy, now recommends holding positions in Eurozone, Emerging Markets and Japan equities. “A potential rebound in relative earnings of Eurozone could be on the cards, and the region could benefit from the style switch into Value,” said Matejka, “and Japan appears well-positioned as a traditional global cycle play.”
In fixed income markets, Matthew Jozoff, Co-Head of Fixed Income Research, favors spread product heading into 2021 as fundamentals and technicals are supportive. J.P. Morgan’s 2021 Year Ahead U.S. fixed income investor survey shows that ESG, high yield and high grade credit and EM are seen as the top asset classes to increase risk. Jozoff believes fixed income net issuance will remain at record levels and approach $4 trillion led by U.S. Treasuries, but the share of spread product will fall from 50% to just 30% or to $1.2 trillion compared to $1.9 trillion in 2020.
Duration supply excluding Fed purchases is set to more than double in 2021 to exceed $2 trillion. Jay Barry, Head of USD Government Bond Strategy, expects 10-year U.S. Treasury yields to rise to 1.25% by Q221 and to end the year at 1.45%. Steve Dulake, Global Head of Credit Research, sees spreads possibly overshooting near term but ending 2021 flatter or slightly tighter across the board although current spreads (125 basis points for U.S. high grade corporates) have already tightened past January 2020 levels. Even without further spread tightening, corporate carry plus roll-down on the spread curve should generate about 50 basis points per quarter. Record cash accumulation by high grade companies in Q220-Q320 could end up being used for M&A, share buybacks and dividends instead of deleveraging. U.S. dollar downside is likely to be limited as the great interest rate convergence of 2020 that accompanied much of this past year’s dollar weakness is now complete. EUR/USD should end-2021 near 1.18, where it has been trading in recent months.
“Fundamental balance of payments positions matter more, and surplus currencies should trend strengthen,” according to Paul Meggyesi, Head of Global FX Strategy. A wildcard risk for 2H21 is of an even stronger rebound in growth and inflation that could lift the U.S. dollar on the fears of an early policy exit. Natasha Kaneva, Commodities Strategy, sees global oil demand only reaching its pre-pandemic run-rate by mid-2022, with OPEC+ likely to stick to the terms of the existing agreement for the entirety of 2021, keeping a 1.3 million barrels per day deficit. OECD inventories won’t normalize until late 2021, boosting Brent prices to $68 per barrel.
Fundamental balance of payments positions matter more, and surplus currencies should trend strengthen.
Emerging markets (EM) growth is poised to rebound to 7.3% from 2.1%, led by China’s 9.2% growth providing an anchor, despite the lasting damage from COVID-19. But only a handful of North Asian economies are expected to recover to J.P. Morgan’s pre-pandemic projections while EM high yield economies should end 2021 at an average 5.0% in GDP shortfall relative to pre-pandemic projections. There are even larger shortfalls in parts of Latin America and Southern Asia. However, according to Luis Oganes, Head of Currencies, Emerging Markets and Commodities, “EM valuations remain attractive and EM assets are under-owned compared to global asset classes. 2021 returns for EM fixed income across EM FX local bonds, sovereign and corporate credit, should be in the 4-5% range, while EM equities could gain as much as 20% over developed market equities.”
Turning to alternative asset classes, Bitcoin has gained a following with millennials who see it as an “alternative” currency competing with gold, while corporate support has been growing via Square, MicroStrategy and Paypal. Nikolaos Panigirtzoglou, Senior Global Markets Strategist, believes that the adoption of Bitcoin by institutional investors has only begun compared to holdings of gold and sees Bitcoin’s intrinsic value rising significantly over the coming months as mining activity improves although near-term risks are skewed to the downside.
EM valuations remain attractive and EM assets are under-owned compared to global asset classes. 2021 returns for EM fixed income across EM FX local bonds, sovereign and corporate credit, should be in the 5-6% range, while EM equities could gain as much as 20% over developed market equities.
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