Although hopes of a V-shaped recovery have proved misplaced, there may be reasons to be more confident on the economic outlook moving in 2021.
Even if the virus has lost none of its potency, progress towards a vaccine appears to be gathering pace and most governments seem to have decided against resuming extreme lockdown measures.
For most countries, consumer spending has recovered; even if it remains between 10% (Germany) and 25% (Spain, Brazil, UK) of its pre-covid levels.
The same is true for GDP growth, which has snapped back but is still some way below levels at the start of the year and some sectors such as tourism have, for obvious reasons, failed to recover at all.
Nevertheless, it is clear that we are closer to the end than the beginning and investors should perhaps start to consider that a recovery is, if not likely, then at least plausible.
Noel O’Halloran, chief investment officer at KBI Global Investors, says: “Looking to 2021, there are reasons to be more confident. In an environment where confidence improves and the macro and earnings growth outlook become more apparent, combined with distribution of a covid vaccine, there is the potential for 2021 to be the opposite of 2020.”
But which areas are likely to benefit most?
In a ‘normal’ recovery, investors might expect cyclical areas such as energy, mining, airlines to recover first.
Certainly, these areas have become extremely cheap, which should increase their appeal.
But Dan Kemp, chief investment officer for Emea at Morningstar, says investors need to ask whether we return to ‘normal’ or a new normal: “Are we expecting a recovery where things go back to the way they were pre-covid, working from an office, commuting in on the train?
“Or will we see a new wave of economic growth and a new way of living and working?”
A new normal would mean areas such as travel, commercial property, retail and leisure never return to pre-pandemic revenue levels.
He believes it is also important to look at the time scale for recovery.
“This is a really important question. There will a relief for some sectors that things aren’t getting any worse and this may prompt a share price rise, but is this the best place to invest for a longer-term structural recovery? Certainly, if there is an economic recovery some cyclical areas will do well, but over the longer-term, growth stocks may do even better.”
O’Halloran agrees: “Even if there is a bounce in some of the unloved areas, is it sustainable?”
Already baked into the price
As it stands, the shape of the recovery is largely unknowable. However, valuations also need to be considered. Kemp says: “Before making any sort of prediction, it is important to consider whether that fundamental growth is already in the price. If we look at capital markets at the moment, companies that look set to do well in the ‘new normal’ have this baked into their prices.
“Cyclical stocks, in contrast, are very cheap. It comes down to how confident investors are in predicting what the future looks like post-covid.”
O’Halloran favours selective cyclical areas for this reason: “My strong conviction looking forward is that a return to ‘normality’ will be the catalyst for markets reconnecting with fundamentals again. Portfolio wise this absolutely favours the beaten up, more value or cyclical oriented areas of the market such as the consumer discretionary sectors of hotels, airlines, retail as well as autos and industrials.
“The ‘work from home’ market darlings in the technology and healthcare sectors, who have benefitted from the staggering market momentum trade, will I believe be vulnerable.”
He believes that many more value or cyclical-oriented stocks and industries, which do not look particularly cheap on 2020 or even 2021 earnings, have room to grow as the next cycle develops out into 2022/23 and beyond. He believes equity markets have reached extremes of valuation and are at a point where value and cyclicality should prevail over growth and defensiveness.
Not clear cut
Having said this, it may not come down to a straight cheap cyclical versus expensive growth debate. Some areas appear to offer relatively strong growth at lower prices.
This is true selectively of regions such as the UK and Europe, where the majority of companies trade at a discount to their international peers because of the concerns over Brexit, or frontier markets, which have remained unloved because of their poor liquidity.
While it is by no means the case that all European or frontier market equities display strong growth, in the scramble for US technology stocks, those that do have been almost completely over-looked by investors.
O’Halloran adds: “Investors need to be patient and judicious. Bottom up stock picking will be rewarded. The new version of normality will likely see a moderate rather than rapid growth trajectory. In every industry there will continue to be winners and losers.
“In this pandemic environment, it is the stronger names I would focus on across all these industries as there will be casualties. As markets reconnect with fundamentals a renewed focus on earnings, cash flows and dividends will again matter.”
Kemp believes it is important any portfolio covers a range of possibly outcomes rather than betting everything on one outcome. At this stage, it is still difficult to judge how new the new normal will be and the recovery may take a number of different forms. Investors need to be prepared for the best and the worst.