1. Social and political divisions are not yet healed: Can Biden bring the nation together?
January 20, 2021 will mark a changeover in the White House. A new Administration will take office. Vice President Pence has now announced that he will attend the inauguration of President-elect Biden and Vice-President-elect Harris. And with Democratic control of the Senate assured — albeit with the thinnest of margins — the experienced and diverse team that President-elect Biden has assembled should be swiftly confirmed and in place. The only question is how hard it will be to restore peace and prosperity, and to prepare for other global challenges.
Last week may, in a strange way, have made this job easier. This will not happen overnight. Federal officials are braced for continued demonstrations around the country in coming days and weeks, with the possibility of violence. We have already seen extraordinary harassment of elected officials in airports and other public places. But the shock of a mob storming into the US Capitol, destroying and stealing property, and triggering the emergency evacuation to a secure location of elected Congressional leaders forced a reckoning last week. Bipartisan groups of American leaders, including business leaders and former secretaries of defense, denounced the perpetrators, and those who had encouraged and enabled their actions. We are hopeful that this may mark the beginning of a more bipartisan approach in Washington, enabling a speedy economic recovery based on more inclusive and equitable growth.
2. It does come back to the economy
A recovering economy will be critical. Rising populism in the US and elsewhere has deep systemic roots. Dashed expectations and stifled opportunity in many communities laid the groundwork for populist messages. The need for long-term solutions to these problems, and to the scourge of systemic racism in America, is widely recognized. But short-term measures to boost the economy can also help.
Circumstances are ripe for a combined fiscal and monetary boost to the US economy this year. Investors continue to differ on whether this boost risks igniting inflation. But the Federal Reserve and other major central banks remain unconcerned — they still see inflation as too low. As we have argued and written before, alongside other influential economists, deficits and debt are not as worrisome as many had long thought, widening the political scope for fiscal action. Importantly, this is the view of Janet Yellen, President-elect Biden’s nominee for Treasury Secretary.
President-elect Biden’s economic team understands the importance of moving quickly to shore up incomes and employment as well as taking action, while they have a legislative window, to address social ills. They will likely find some bipartisan support.
Look for a two-stage process: immediate steps to extend unemployment pay, perhaps give another round of stimulus checks and to fund state and local governments who urgently need help, not least to vaccinate their populations and finally reopen schools. A second stage would include longer-term investments to fulfill the promise to “build back better” —meaning greener. At some point, the Administration will look at tax reforms. The tax taken by the federal government fell to 16 percent of GDP in 2019, below the level during the rapid economic growth in the 1990s and less than when Ronald Reagan left office. But for 2021, both fiscal and monetary policy will be supportive. The last-minute passage of a $900 billion fiscal boost in the waning days of 2020 provides a tailwind as the year starts.
3. Roll on — and hurry up to roll out — the vaccine
As we saw last year, massive fiscal and monetary easing can hold up incomes and spending, and stall a recessionary spiral. But the Coronavirus Recession will only be over definitively once Covid-19 itself is controlled. Renewed widespread lockdowns in the UK and Europe are now curbing economic activity again. Signs of resilience in manufacturing late last year are overshadowed by inevitable weakness in most service industries — not e-commerce, of course.
Perhaps it is not surprising that the vaccine roll-out has been slow so far. In the early weeks of the pandemic, it seemed extraordinary that the US could not muster the means to control the virus, from the lack of widespread and effective testing to the failure to find and provide to essential workers the protective equipment they needed. Some of the same factors underlie the vaccine distribution problems: mixed messaging on priorities, lack of clarity about who is responsible for what between the public and private sectors, overwhelmed health systems and underfunded state and local governments. It turns out that inventing and producing a vaccine plays to US strengths, while administering mass distribution across the nation shows the country’s weakness. But these problems can and will be resolved. Addressing the pandemic is expected to be the first and paramount concern of the government after January 20.
4. Oh — and Brexit happened, just like that
Interestingly, the UK vaccine roll-out has been one of the most successful in Europe so far. The centralized National Health Service, with information on almost everyone, has organized appointments and set up efficient systems to get the vaccine into arms (yes, including that of this writer’s 93-year-old mother). With the new variant spreading infection across the country, Prime Minister Boris Johnson and his government have had no time to bask in the success of the vaccine. Nor have the consequences of the limited and disadvantageous Brexit deal yet played out. This deal was a bare minimum for the UK — ensuring smooth trade in goods for the time being, but not of the services in which Britain excels.
Already, the drain on London as a financial center has begun. Other professional services — architects, lawyers — will also suffer from being outside the single market. But as the Labor opposition recognized, it is time to get on with the next phase — four and half years after the Brexit vote.
5. Investor Takeaways — Markets Start 2021 on a High Note
The first week of 2021 saw an acceleration in the reflation trade in part due to the results of the Georgia run-off election. While markets are expecting stimulus from the Democratic Congress, the US economy is already flush with cash — the M2 money supply grew by 24 percent in 2020. For some investors, the prospect of more stimulus raises inflation concerns. But the inflation rate that markets are pricing in — 2.1 percent over the next five years — is unlikely to worry policymakers. The Fed last year laid out a view that some catch-up inflation above target would be acceptable after a period of below-target inflation and under-used capacity. Even with price pressures starting to emerge along the supply chain, most economists expect still-high unemployment and underused capacity will contain inflation.
What did last week’s seismic political developments mean for financial markets? The Treasury curve steepened markedly with the 30-year yield rising 23 bps, its biggest weekly move higher since mid-August. TIPS held up better with a rise in the 30-year real yields of 17 bps to -0.20 percent, but front-end TIPS actually rallied, with 5-year real yields declining 3 bps resulting in a rise in near-term breakeven rates of 15 bps.
Although typically a beneficiary of higher inflation expectations, gold prices finished lower on the week as the sharp rise in nominal yields put pressure on the yellow metal. “Digital gold,” i.e., Bitcoin, was undeterred as prices approached $42,000, rising from below $30,000 a week ago. While precious metals tapered off heading into the weekend, base metals finished the week higher by 3.7 percent and WTI crude oil gained 8.4 percent to close above $52 per barrel, its highest level since March. It wasn’t just reflationary forces moving oil though, as Saudi Arabia surprised markets on Tuesday announcing that it would unilaterally cut one million barrels a day of crude production starting next month while OPEC+ — concerned about longer-term demand for oil — indicated that it would keep production flat.
The reflation trade had equities reacting as expected with energy and materials sectors in the US outperforming all other sectors returning 9.3 percent and 5.7 percent, respectively. The bear steepening of the Treasury curve also bolstered the financials sector (4.8 percent) and small-cap value cohort which rallied 5.9 percent — outperforming mega-cap growth by 511 bps, unlike the trends we saw last year.
As we indicated for much of last year, investor enthusiasm for clean energy stocks has been building. It was further boosted last week in anticipation that the Biden-Harris Administration, combined with a Democratic-controlled Congress, will increase policy momentum for renewables. The iShares Global Clean Energy ETF gained over 17 percent for the week. Another beneficiary, Tesla, followed its 7x climb in 2020 with a nearly 25 percent gain last week, helping Elon Musk surpass Jeff Bezos as the world’s richest person for the time being.
Other stock markets around the world also had a good start to 2021. In Japan, the Nikkei 225 reached its highest levels in three decades before the government declared a new state of emergency in Tokyo to fight a resurgent outbreak of Covid-19.
The Stoxx Europe 600 ended the week up 2.7 percent, and London’s FTSE 100 ended more than 6 percent higher for the week, possibly in response to movement on Brexit implementation. The ripple effects of potentially larger US fiscal stimulus lifted commodity-linked and other cyclical stocks in Europe. Weak eurozone inflation data also put downward pressure on the euro to the benefit of European exporters.
Net inflows into both emerging market equity and fixed income markets continued for the fifteenth consecutive week. In equities, 2021 started off much like Q4 of 2020 with cyclically sensitive markets like Mexico, Chile and Russia leading the way. We expect the flow to emerging markets to continue in the first half of 2021 as the prospect of large-scale immunizations helps the global economy recover. Last year, making the correct country calls helped our emerging markets portfolios outperform. This year, we expect getting the country and sector call right will be critical to driving returns. Unlike in 2020, basic materials, energy (including clean energy), industrials, utilities, and financials — such as banks that cleaned up their distressed books and are poised to gain market share — could outperform defensive names in the first half of the year. Stock selection continues to be of paramount importance. Commodities that came into the Coronavirus Recession with a strong financial balance sheet, and whose costs of production have dropped precipitously because of domestic currency depreciation offset by USD-based revenue.
In addition, China, Korea and Taiwan continue to be standouts among major EM markets with a favorable mix of macro conditions. In these North Asian countries, domestic growth opportunities that are not exposed to currency risks and companies that are well placed to fulfill pent-up consumer demand — including technology-related retail, travel, gaming, healthcare, and education companies — are all potential 2021 winners. China’s actions in Hong Kong last week were serious reminders of a more complex geopolitical picture in the region. Nonetheless, investing in markets that are related to impactful sectors and domestic growth and exclude defense and strategic related companies will continue to grow.
It was a tough start to 2021 in the US for many reasons, but global markets continued to look through the short term to longer-term hope for a better economic and financial picture.