Six Predictions for 2021

There is little doubt that 2020 marks an exceptional year for many, one that the annals of history will look back on with a degree of scrutiny, but to what extent did it disrupt pre-existing trends and change the course of medium- to long-term evolutions and developments?

Predictions these days are a risky business and he who attempts to stake his reputation on predicting the future is often left with egg on his face.

I make no attempt to underwrite the following predictions with anything substantive and these are not intended as investment advice or the like - I wish merely to provide some food for thought and discussion.

Prediction 1: Economic growth and Vaccination Coverage will be Highly Correlated

The most significant economic impacts from Covid-19 have been due to fear of the virus more than the virus itself. The widespread rollout and (importantly) uptake of the various vaccines around the world is the surest way to curb the fear of Covid-19.

Until a high enough proportion of the population has been vaccinated, this fear is likely to remain. The exact threshold for this level of coverage is hard to estimate, though considered to be "substantial" by the WHO.

Goldman Sachs forecasts vaccination coverage of about 50% across most western nations' populations by Q2 2021, acting as a boon to world economic growth and complementing China's recovery.

Global growth remains around 8% below trend and if vaccine production cannot meet the desired levels or if populations are unwilling to be vaccinated, the fear may persist, countries may be in and out of lockdowns, and economic growth in 2021 may be low and sluggish, delayed until later in the year, or a mixture of both.

Prediction 2: The Investment Potential of Equities over Bonds

The traditional 60:40 balanced portfolio (60% equities, 40% bonds) has been a staple investment combination for decades, yielding 8.1% annually for the past decade, yet there are reasons to suppose its suitability for the future investment landscape is limited.

The merits of the 60:40 portfolio include growth potential from equities, whose volatility is tempered by the more stable 40% bond contingent, which acts as a hedge during times of market stress.

The main reason why the potential for bonds to provide investment performance in the years ahead is due to years of rock-bottom interest rates.

There is an inverse relationship between bond prices and interest rates. A decrease in interest rates leads to an increase in the price of bonds. The persistent decline in short and long-term interest rates since the 2008 financial crisis and advent of Quantitative Easing has put upward pressure on bond prices and granted investors steady returns.

Whilst it is still possible that interest rates could decrease and even be negative (particularly in Switzerland), interest rates may increase in the near future, particularly if inflationary pressures appear across the economy (refer to Prediction 3).

The low yield of bonds (US 10 year Treasuries currently yield 0.93%), together with the risk of price declines if inflation and interest rates rise, suggests that there is still great potential for equity investments to drive value for investors.

Prediction 3: The Return of Inflation

Following falls in inflation during 2020, most developed economies are forecasting upticks in inflation for 2021 and beyond.

Inflation is likely to go hand in hand with economic growth and whilst interest rate rises often follow inflationary spurts, with many economies crying out for a bit of inflation, central banks may let consumer prices rise for longer than they have done historically.

It's also important to recall that headline inflation figures such as CPI mask significant variation in which products are increasing/decreasing in price, meaning the actual increase in cost to consumers could be much higher than advertised. The price of air travel may have plummeted, but who these days is taking a European city break every other weekend?

As inflation returns, investors should look to ensure their portfolios are as inflation-proofed as possible, which may further increase the attractiveness of including equities vs bonds, as per Prediction 2.

Prediction 4: Tax Rises to pay for Government Borrowing

Very few governments have escaped the Covid-19 pandemic without significant increases in their borrowing. This debt will have to be paid for one way or another.

As economies recover in H2 2021, governments with significant black holes in their budgets will soon be found out. The borrowing is likely to continue through to Q2 and, even when economic growth comes back, most Finance Ministries will think twice about onerous taxation initiatives that extract economic value, thereby risking the recovery.

However, like any pendulum swing, pressure will soon emerge on those states unprepared to demonstrate their ability to repay what was borrowed and taxes must inevitably form part of any repayment plan.

Whilst headline-catching ideas such as a UK wealth tax may cause shivers up and down the spines of Britain's wealthiest, I expect it is more likely that revenue will be generated for the state by marginally increasing a wide number of smaller, less politically-stormy taxes whose infrastructure for collection already exists.

Understanding how best to optimise one's wealth in light of these changes will become paramount for all investors in 2021.

Prediction 5: The Growth of New Sub-Industries within the Technology Sector

If there's one sector that's done especially well during the pandemic, it's been technology. FAMAG stocks (Facebook, Amazon, Microsoft, Apple, Google) were up 44% in December from their opening value of 2020. Some return.

Depending on the success of vaccination rollout, the acceleration of forces underlying the technological transformation also known as the Fourth Industrial Revolution will continue into the new year.

Multinational companies will rethink cross-border supply chains. Firms will embrace agile staff and flexible working practices that avoid high fixed costs such as office rental. The systematic ways in which Covid-19 has targeted specific demographics will encourage the move towards personalised medicine.

Many of the social practices taken for granted (handshaking, kissing each cheek in French-speaking regions) now cause us to hesitate, a symptom of an increased atomisation of society that will also be reflected in increasingly insecure employment. More workers will become entrepreneurs, jumping in and out of industries and few graduates these days will join a company and stay there for decades until retirement.

Each of these changes involves technology in one way or another. Together with a new growth of ideas and an enthusiasm to address big problems, innovation in the tech sector will continue, leading to the creation of new sub-industries.

It is hard to predict how these industries will perform, though as political pressure grows to reduce the individual power of the FAMAG behemoths, space may develop for small adaptive start-ups with disrupting potential to thrive, providing a new wave of productivity growth in those economies capable of nurturing such sub-industries.

Prediction 6: The Growth of ESG Investing

The other side to this coin is the increased interest of retail investors in the values underlying investment opportunities. Consumers are now more interested in what and where they are investing, in addition to financial factors such as economic returns.

This has led to the growth of a new type of investment option, Environment, Social, Governance investing (ESG).

ESG aims to build investment portfolios comprising companies whose business models meet the values of ESG, with particular focus on ethical and sustainable investing.

ESG has taken off in recent years, a trend that will surely continue into 2021. It now accounts for one third of total US assets under management.

A number of new ESG funds have opened in the past couple of years and investors should always guard against "greenwashing", but there is encouraging signs in terms of performance, as ESG funds outperformed the S&P 500 during Covid-19.

In Summary

2021 will prove to be an exciting year as macroeconomies recover from the Covid-19 pandemic disruption, governments find new ways to balance the books, industries arise to take advantage of new opportunities, and we continue along the transformation to the new world of tomorrow, whatever that may look like.

As ever, if you are interested in any of the topics covered in this article or would like to understand how they may impact you and your families, please do reach out.