After a deadly global pandemic, a hotly contested US election, rising trade tensions and growing civil unrest, a better and brighter 2021 seems within reach. 

Year ahead

The Covid-19 pandemic has been like wartime, with nothing else on the news, less to spend money on, dramatic winners and losers in business, and rocketing national debt. If 2020 was the year of hostilities, then 2021 should — eventually — become the year of peace, beginning the slow process of economic restoration. It also offers an opportunity, as US president-elect Joe Biden might say, to build back better.

Back in April, with half the world’s population in lockdown, the International Monetary Fund predicted the worst recession since the Great Depression of the 1930s, with 2020 global growth contracting by 3%. In mid-September, when the Organisation for Economic Co-operation and Development (OECD) published its latest economic outlook, it took an even dimmer view, forecasting 4.5%. However, that view was less downbeat than its June outlook, thanks to better-than-expected first half of 2020 outcomes in China and the US, and the “massive scale” of governmental response.

The bar chart of growth estimates for the G20 in 2020 is a sea of red, with one small, ironic, green exception: China — the birthplace of the coronavirus — where the economy is forecast to grow by 1.8%. The OECD believes that the US economy will shrink by 3.8% this year and the euro area by 7.9%. The worst performers will be South Africa (–11.5%), Argentina (–11.2%), Italy (–10.5%), India and Mexico (–10.2% apiece), the UK (–10.1%) and France (–9.5%).

By contrast, the chart for 2021 is a sea of uninterrupted green as the effects of the pandemic recede and economies, it is hoped, bounce back. The numbers are positive, with global gross domestic product (GDP) growth of 5%. China’s economy is forecast to grow by 8%, the US by 4% and the euro area by 5.1%. Among the 2020 laggards, India and the UK are expected to rebound most strongly, growing by 10.7% and 7.6%, respectively.

But those positives depend on keeping Covid-19 in check. The November news of a vaccine breakthrough by pharma firms Pfizer and BioNTech sent markets, not to mention airline and bank shares, into a frenzy. Yet questions remain over its long-term efficacy and logistics, so, in the real world, this is not yet the silver bullet.

A silver bullet is required in one form or another. The OECD says that a stronger resurgence of the virus or more stringent lockdowns could cut 2–3 percentage points from its global forecast.

Recovery prospects

All forecasts are fabrications, of course, and right now more so than ever. Covid-19 remains a great fog, obscuring any clear view of the horizon. Recovery is conditional on victory over the virus, whether that entails a vaccine, better testing, wider immunity or simply ignoring it and soldiering on. Since opinions differ over scientific truth and invention here, the victory may have to be more psychological than medical.

“With a vaccine, the pricing of tail risk in the bond markets will shrink significantly,” says William De Vijlder, chief economist at BNP Paribas. “Then central bank messages will change; not to start normalising policy, but they will no longer say they will do more.” Mr De Vijlder says there is a “huge probability” that this will happen in the course of 2021, putting the world on the road to a more lasting recovery. News from the vaccine front supports his view.

With a vaccine, the pricing of tail risk in the bond markets will shrink significantly

Wiliam De Vijlder, BNP Paribas

An ‘end’ to the virus is pivotal to everyone’s economic prognostications. To help their own forecasting, Société Générale’s economists constructed three scenarios: base, upside and downside, depending on how long it took to find an effective treatment or vaccine.

“In different regions we can now see different scenarios,” says Klaus Baader, Société Générale’s global head of economics. In China, he notes, restrictions are a distant memory and life is back to normal. France, Germany, Spain and the UK look as if they are in the downside scenario.

“There was a powerful rebound in the US and the euro area in the third quarter [of 2020],” Mr Baader says. “That could reverse in France in the fourth quarter, and possibly in Spain and the UK, but this will be recovery delayed rather than abandoned. We will get on top of the virus.”

The rebound has been largely confined to manufactured goods. Services are suffering a more prolonged downturn as consumers have more or less stopped eating out, travelling, going to shows or buying clothes.

Mr Baader says that the recovery in trade in goods has been faster than post-2008. On the other hand, trade in services is barely improving, if at all. “It’s going to be a pretty long slog,” he reckons.

In other news...

In the UK, the virus has more or less elbowed Brexit out of the news. The final shape of a UK–EU deal is still unclear, but it will clearly have a negative effect on both economies once it takes full effect next year. One rule of thumb is that every percentage point of GDP it costs the UK will shave 0.25% off the euro area’s growth.

The only topic big enough to share the headlines with the virus this year has been the US presidential election. Even then, much commentary was on the candidates’ very different approaches to the pandemic. Soon-to-be former president Donald Trump seesawed between misinformation and denial, even as the US Covid-19 death toll rose to nearly twice that of the next worst-hit nation, India.

Mr Biden has promised, among other things, to fix test-and-trace, make masks mandatory, provide clear national guidance and immediately restore the “admittedly not perfect” US relationship with the World Health Organisation.

Though much of Wall Street was more naturally inclined towards a tax-cutting Mr Trump, a tax-raising Mr Biden would come, it was hoped, with a generous Democratic fiscal stimulus package, boosting equities, driving up inflation and bond yields.

Such generosity would have been more likely if the Democrats had won control of the Senate, which they have so far failed to do. However, they have a final shot at that in January, when elections for two Georgia senators will be rerun.

In Europe, continued fiscal support seems more assured. “Fiscal and monetary policy worked together this year,” says Walter Edelman, chief global strategist at Credit Suisse. “That will stay in place.”

Under Bidenomics, the domestic plan is to raise both the corporate tax rate, from 21% to 28%, and income tax for high earners. Mr Biden has promised to raise capital gains tax — which would hurt private equity firms, among others — and to increase spending on healthcare, education and benefits. He also wants to spend $2tn on green investments over four years. Unless his party secures the Senate, it will be harder for him to achieve all, or perhaps any, of these goals.

On the world stage, we can expect more multilateral co-operation and less pugnacity. The president-elect will take the US back into the Paris Agreement on climate change (which it just left in November). The trade stand-off with China may become less aggressive in tone, though the substance of US policy will stay much the same, with the new president staying tough on trade and security.

In the end, the election didn’t change the fundamental disposition of the capital markets. Equities continue to defy gravity, possibly because, with fixed income not providing any income, there is no alternative.

Market response

Counter-intuitively, Covid-19 generated record-breaking bond and equity issuance in the first nine months of this year. “Generally, equities do well in times of boom and distress,” observes Gareth McCartney, Europe, the Middle East and Africa (EMEA) head of equity capital markets (ECM) at UBS. “It’s the periods in the middle that are more challenging.”

Equities do well in times of boom and distress… It’s the periods in the middle that are more challenging

Gareth McCartney, UBS

Mr McCartney believes that clarity on some of the big event risk, including the US election, sets the stage for more of the same in the equity markets. “It will be a strong year,” he says. “The backdrop is likely to be similar to 2020, with a strong pipeline of growth opportunities and a lot of liquidity. Equities that deliver growth will still get a large premium.”

The second wave of lockdowns should support more strategic capital raises, through recapitalisations, rescue primary accelerated bookbuilds and rights issues, Mr McCartney adds.

After a slow six months, initial public offerings (IPOs) picked up during the third quarter of 2020 and are expected to gain momentum. “Fund managers were crying out for new ideas at the beginning of the year and remain keen today, so there is a demand for IPOs,” says Carlton Nelson, co-head of corporate broking at Investec. “Those that have benefited from Covid need to strike while the iron is hot.”

Many of them are, it seems. Mr Nelson says that his team recently had four separate introductory meetings in just one week for IPOs to go to market in 2021 or 2022. The sectors concerned are typically Covid-era favourites like IT, renewables and healthcare.

This year’s few IPOs have come largely from these Covid-resilient industries. Next year should see a broader group of IPO candidates coming to market, according to Renaud-Franck Falce, head of capital markets EMEA at BNP Paribas.

“Private equity will be looking keenly at ECM to exit some of their investments,” Mr Falce says. “They paused this year as companies acquired by leveraged buyout had to address their liquidity needs and funding requirements in the context of the crisis.” On top of that, this year’s volatility in equity markets has not been conducive to IPOs of any stripe.

end of year 2020

M&A revival

Private equity sponsors currently have what one banker calls “immense” liquidity, and will be in the market for any corporate carve-outs or spin-offs in the year ahead. Mergers and acquisitions (M&As) generally have been resurgent and are expected to return to pre-Covid levels in the course of 2021. That said, recent surveys suggest increased interest in alternatives to traditional M&As, such as alliances and joint ventures.

George Holst, head of corporate clients group at BNP Paribas, expects private finance to be more active next year, whether as private equity, sovereign wealth funds, pension funds or family businesses. “They have the capital to deploy, but have had a lack of opportunity,” Mr Holst says.

Relative competitive strengths have been amplified during the pandemic, enabling stronger companies to seize opportunities not there before — such as acquiring weakened competitors. “Or it could be a supplier or customer in need,” says Mr Holst, who sees more vertical integration ahead. “M&A will be driven not by financial engineering but by strategic industrial logic.”

Bankers expect another lively year in the bond markets, though perhaps not quite as lively as this one. “We expect lower volumes in 2021, perhaps 15% or 20% lower than 2020,” Mr Falce says. “But we will still see more than in a regular year because of the second lockdown.” Yields in the euro market will probably go down, he suspects. That’s because the market is dominated by the European Central Bank (ECB) still practicing “lower for longer”.

Covid-19 drove the flood of issuance in 2020 as corporates shored up their liquidity buffers. Investors absorbed everything on offer because the spreads were generous. Issuers paid up because it was strategically important to maintain market access. That has not always been the case in the euro market, which Felix Orsini, Société Générale’s global head of debt capital markets, sees as a sign of maturity.

“In the US market, it has always been ‘what’s the price today?’,” Mr Orsini says. “In the euro market, when spreads widen a lot, issuers have traditionally decided to wait.” He too believes that the second lockdown will trigger additional funding needs, not least from sovereign issuers.

“The [sovereign, supranational and agency] asset class has exploded,” Mr Orsini says, noting that sovereign issuance alone was up 111% year-to-date on 2019. “And it’s not going to be a one-off. The public sector’s funding needs will be extremely large in coming years.” From now on, that will include the EU, whose inaugural €17bn social bond recently drew a world record-breaking €233bn of demand.

A green focus

Environment, social and governance (ESG) will continue as a bond market theme in 2021, in Europe in particular, now that the ECB has declared sustainability-linked bonds eligible for its asset purchase programmes.

On a broader ESG level, BNP Paribas’s Mr Holst is pleasantly surprised at how the pandemic has accelerated companies’ adoption of more sustainable business models. “It has created so much disruption,” he says. “So rather than navigate through the disruption back to the status quo ante, here’s an opportunity to transform the business by factoring in more sustainability.” If Covid-19 has forced a business to review its supply chain, for example, that’s an opportunity to replace less sustainable activities.

Commodities have enjoyed mixed fortunes. Oil has had a grim year, with negative prices briefly in April, as virus-induced slowdowns sapped demand. Concerted production cuts forced prices back up to around $40/barrel at the time of the US election, but they have remained below break-even for many producers.

OPEC has done a remarkable job of stabilising oil markets, and will continue to do that next year

Michael Haigh, Société Générale

The vaccine news is good for oil, while Mr Biden is bad news, partly because of his green agenda and partly because he may come to an accommodation with Iran, whose oil is currently blackballed by the US. That would put more oil supply back on the table. Saudi Arabia occasionally turns on the taps to try and force US shale producers out of business, and a Biden presidency may prompt a repeat.

“OPEC has done a remarkable job of stabilising oil markets, and will continue to do that next year,” says Michael Haigh, global head of commodities research at Société Générale. “Oil will grind up to around $50 by the end of 2021.”

Copper prices recovered through 2020 along with recovery in China, which consumes half of all supply. They climbed further with the ‘green’ Biden victory — copper is used in wiring, a lot of which goes into renewable generation and electric cars — to more than $7000 a tonne. That may lead to oversupply and some see the price falling to less than $6000 by mid-2021.

Eastern energy

China aims to become fully carbon neutral by 2060, with electric cars comprising 20% of new sales by 2025 and a major boost to renewable energy generation. “That will have a pretty meaningful impact on the demand for copper,” says José Cogolludo, Citi’s global head of commodities. “It’s negative for demand in platinum and palladium, used as catalysts in internal combustion engine cars, and eventually in oil.”

Gold has had a good crisis, as it usually does, breaking the $2000-per-ounce barrier briefly in the summer and falling below $1900 on the vaccine news — a vaccine and president Biden are bad for gold. Mr Haigh sees monetary policy and a weaker dollar providing a floor at $1800 and thinks we may see $2200 by the end of 2021.

A weaker dollar is on most radar screens for 2021. Ebrahim Rahbari, Citi’s chief G10 currency strategist and global head of foreign exchange analysis and content, links this to three global drivers: getting the virus under control, continued broad global stimulus and a global recovery.

When investors look for currency value elsewhere, they may well look east. “This is the Asian century,” Mr Rahbari observes. “The single most popular currency is the renminbi.” That, he adds, may be because China dealt with the virus better, its growth is more solid and the central bank is less intent on pushing up inflation. Other Asian currencies such as the Korean won and the New Taiwan dollar should be supported by similar factors.

At NatWest Markets, the thinking is that the foundations for much higher inflation are falling into place. Global head of desk strategy Jim McCormick points out that a shift from monetary to fiscal policy has been accelerated and amplified by Covid-19, and that there has already been some steepening of the curve as yields rise at the long end.

Bond issuance is being pumped up by recovery funding and shows no sign of slowing. “This is only the beginning,” Mr McCormick says. “We think there is more inflation risk than people realise.” In case we had forgotten, in wartime you also get inflation.

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