2021 YEAR AHEAD Claudio Brocado Anthony Brocado January 29, 2021 1 2020 turned out to be quite unusual. What may the year ahead and beyond bring? As the year got started, the consensus was that a strong 2019 for equities would be followed by a positive first half, after which meaningful volatility would kick in due to the US presidential election. In the spirit of our prefer- ence for a contrarian stance, we had expected somewhat the opposite: some profit-taking in the first half of 2020, followed by a rally that would result in a positive balance at year-end. But in the way of the markets – which always tend to catch the largest number of participants off guard – we had what some would argue was one of the strangest years in recent memory. 2 2020 turned out to be a very eventful year. The global virus crisis (GVC) brought about by the coronavirus COVID-19 pandemic was something no serious market observer had anticipated as 2020 got started. Volatility had been all but nonexistent early in what we call ‘the new 20s’, which had led us to expect the few remaining volatile asset classes, such as cryptocurrencies, to benefit from the search for more extreme price swings. We had expected volatilities across asset classes to show some convergence. The markets delivered, but not in the direction we had expected. Volatilities surged higher across many assets, with the CBOE volatility index (VIX) reaching some of the highest readings in many years. As it became clear that what was commonly called the novel coronavirus would bring about a pandemic as it spread to the remotest corners of the world at record speeds, the markets feared the worst. Risk assets plunged along with the surge in volatility, and the US stock market abruptly ended what had been the longest bull phase in recent memory. In early spring the US Federal Reserve Board (Fed) led other key glob- al central banks in preemptively and forcefully delivering monetary policy stimulus, which contributed to the fast- est recovery from trough to peak in risk assets, let by US stocks. Even the Oracle of Omaha Warren Buffett, who often in previous crises was able to snap up bargains -- as he used his enormous reputation and credibility to signal the selloff was overdone -- was unable this time around to make any meaningful investments. The Fed in a way usurped the Oracle’s traditional role, injecting a large amount of confidence and reawakening animal spirits. In the end, the US central bank did not end up making significant purchases of fixed income ETFs. The Fed had indicated it would be willing to invest in the securities in order to restore confidence in the credit markets. Similarly, Boeing (BA -- a major global corporation based out of the US) arguably among the most af- fected companies by the first phase of the pandemic -- was soon enough able to finance itself in the markets, eliminating the need for either fiscal or monetary authorities to step in directly. Developments such as this left Buffett’s Berkshire Hathaway as actually a net seller of stocks near the bottom. At the May 3 virtual annual shareholders meeting led by the Oracle of Omaha, the legendary investor disclosed that his conglomerate had liquidated its once sizable holdings in airline stocks. Berkshire Hathaway had also made large cuts to its JPMorgan (JPM) and Goldman Sachs (GS) stakes by then. Mr. Buffett actually sounded quite downbeat (particularly for his standards) during the Q&A portion of the annual shareholders meeting. 3 Therefore, the decisive action by the world’s major ing the large impact on economic activity from the central banks, led by the Fed, can be said to rather global virus crisis. single-handedly have engineered a meaningful recov- Even prior to the pandemic, global demographic ery in financial conditions, and US stocks led global trends had contributed to what we have long been risk assets to a major recovery. When all was said and calling the global savings glut. The resulting surplus of done, major US equities indices ended 2020 at record liquidity helped to push interest rates across most of -high levels. Many professional investors stood by in the so-called advanced economies to record lows. disbelief, and many analysts and commentators high- Negative interest rates (even in nominal, and not only lighted much of the year starting in late March the in real – inflation-adjusted -- terms) have become wide discrepancy between the markets and the real common in Europe and Japan. In the US, the key 10- economy. year Treasury note now offers yields of around 1% One of the largest surprises in terms of the stock mar- (after having gone down to roughly half that). ket brought about by the pandemic was the surge in As a result of such a low-yield environment, investors retail investor participation in US equities (and even have been compelled to take on more risk. US Treas- options). US retail investors have historically been ury securities have traditionally been viewed as virtu- more active in their stock market than many of their ally risk-free, but as they are now also essentially re- peers in other countries. Over the last couple of dec- turn free, investors must move up the proverbial risk ades, nevertheless, US retail investors had generally curve if they aspire to obtain any real return. This has stepped away from individual stocks, focusing increas- contributed to what many call the environment of TI- ingly instead on exchange-traded funds (ETFs), and NA (there is no alternative) to stocks. We have been emphasized other asset classes, such as fixed income making the case for quite a while now that the new mutual funds, in their personal investment portfolios. safe haven is represented by US large-capitalization However, widely attributed to so-called lockdowns stocks, particularly those which provide a secure and implemented in many jurisdictions around the globe - growing dividend yield. - and the related work-from-home (WFM) resulting from the pandemic -- retail participation in the stock market made a strong comeback. Led by young peo- ple -- many belonging to the so-called Millennial gen- eration -- investing apps such as Robinhood opened millions of new accounts (estimated at some 10 mil- lion new brokerage accounts in total in the US during 2020). Free equity trades now have become common- place in the US, along with the possibility of buying stocks in fractions, thus enabling even the smallest of investors to trade in high-priced stocks, such as Ama- zon’s (AMZN). Amazon was an obvious net beneficiary from the trends which had been already in place prior to the pandemic -- and which only accelerated due to what became the new normal of 2020. Even people who had never made an online purchase were in many cases compelled to do so as lockdowns spread around the world. Massive monetary and fiscal policy stimulus measures applied in a number of countries and entities such as the European Union/Eurozone were aimed at cushion- 4 For 2021, our base-case scenario is that the global interest rate environment will remain quite supportive for such equities. The Fed has made it patently clear that it will not preemptively tackle inflation. The US central bank is quite willing to see inflation move above its 2% target, not making that a hard ceiling but rather a range in which it can subsequently settle. In other words, because inflation has been so long under 2%, it can then exceed that mark, and it would take meaningful time for it to average about 2%. The global economy is generally expected to take quite a while to recover from the damage caused by the pandemic, so global interest rates should remain low for much longer than they had been expected prior to the GVC. The global savings glut remains firmly in place. In fact, even the US, where savings rates had long been well under the levels seen across many advanced economies, is seeing much higher levels of savings. In countries such as Germany, bank account balances are at record-high levels, despite the fact that large depos- its are now widely subjected to negative interest rates. Even in Germany, where -- as we explained in our mid-year outlook report last summer -- there generally has been little interest by the public to invest in stocks, the same trends which seemed to nudge US Millennials and even younger investors back into the equity market had the closest to the same effect. Many hundreds of thousands of new brokerage accounts were open by Germans, led by new young people suddenly interested in the stock market! The global savings glut just discussed gives us confidence that interest rates will remain broadly supportive of equity valuations, at least through the upcoming year. Volatilities have settled back into rather ‘normal’ ranges, more in line with their historical averages, as is the case for example in the key VIX measure of volatility for US large-cap equities. Still, there has been a sufficient resurgence in animal spirits so that there are plenty of what are at least pockets of speculative activity. In fact, many market commentators now talk about widespread in- vestment bubbles. We have been calling this “the bubble in bubble calling.” 5 We remain of the view that bubbles can only be confidently called in hindsight, but we acknowledge that there are pockets of speculation. In the terminology which we coined in last year’s analog to this report, we see plen- ty of balloons, but not outright bubbles, though only time will tell.