Editor’s Note: The full White Paper ‘Ten for 2021’ mid year update is available here. In this summary, we have extracted the first paragraph from each section on 'what we've seen'. The full paper contrasts this with what was expected in November 2020.
Last November, the heads of our four investment platforms identified the key themes they anticipated would guide investment decisions in 2021. With the year now half over, we revisited these concepts to see how they’ve played out thus far and assess our outlook for the second half of 2021.
Macro: The world after the coronavirus
1. A return to early-cycle dynamics - but no substantial reflation
We think inflation is likely to fall back, but we are more sensitive to upside risk than at the start of the year.
What we’ve seen: The big change since we met in November is the sheer boldness of U.S. President Biden’s fiscal plans. The $1.9 trillion American Rescue Plan was arguably baked into market expectations already, but there is a lot more to come. It’s unclear how much will survive the legislative process, but it seems likely to be the “significant continuing fiscal stimulus” that we thought necessary to generate structural rather than transient, low base-effect inflationary pressure.
2. Populism is here to stay
If anything, geopolitical tensions are up and economic policy is becoming more explicitly oriented toward social equality-related targets.
What we’ve seen: Accusations of “vaccine nationalism,” the frosty atmosphere at the first talks between China and the new U.S. administration in Alaska in March, and a hawkish NATO communiqué in June leave little doubt of the abiding and growing frictions in geopolitics and global economic relations. The U.S. has rejoined a number of multilateral agreements and institutions, as expected, but diplomatic efforts such as the end of the 17-year Airbus-Boeing trade dispute appear to be just as much about shoring up traditional alliances against China.
3. Accelerated digital transformation puts down roots
Evidence of longer-term investment in more and more sectors continues to build.
What we’ve seen: Evidence of a desire to continue working from home after the pandemic is mixed. 99% of 227 human resources leaders surveyed by Gartner during its Workplace Re-Opening Amid Vaccine Rollout webinar in March 2021 said that at least some of their workforce would be ‘hybrid’ after the pandemic, with 42% anticipating a majority to adopt hybrid working. Of the 4,264 employees in Gartner’s January 2021 Hybrid Work Employee Survey, 84% prefer remote or hybrid over onsite working, and more than half said that inflexibility from their employer would make them consider changing jobs. U.K. workers: a year in the pandemic, a Deloitte survey published in April, suggested that twice as many workers would like to work from home all or most of the time, compared with pre-pandemic. The same survey indicated that more than a third of under-35s felt ‘overwhelmed’ by working from home, however, and other studies appear to find a similar desire to get back to the office among younger employees, often for the social and career-advancement benefits. Policy statements from major employers are also mixed, with most appearing to embrace some kind of hybrid arrangement.
4. Supply chains become shorter and more diversified
Business leaders appear to be moving supply-chain resilience and transparency up their agenda, and not just in the semiconductor industry.
What we’ve seen: While it is too early to say how profound and lasting these forces will be, we are seeing new effects on supply: this year’s semiconductor shortage appears at least partly due to U.S. auto manufacturers shifting away from mainland China’s suppliers, for example. Rising demand and national security concerns are leading to large commitments to domestic production. U.S. President Biden has pledged $50 billion to the cause as part of his administration’s infrastructure spending proposals. Intel has committed $20 billion to build new fabrication facilities in Arizona. TSMC and Samsung have multibillion-dollar plans for new U.S. production capacity in Arizona and Texas, respectively. The European Union will use its pandemic response fund to target a doubling of its semiconductor manufacturing by 2030. South Korea has recently earmarked $450 billion for advanced chip manufacturing, India is offering more than $1 billion to companies that set up chip manufacturing facilities there, and chipmaking is a key element of China’s latest Five-Year Plan.
Fixed income: static yields, volatile currencies
5. Low yields and flat curves demand opportunism in credit markets
Flexibility and a tactical approach across the full range of credit markets has been a key source of return opportunities.
What we’ve seen: The mix of early- and late-cycle characteristics has arguably been clearest in fixed income markets so far this year, where a rapid, 80-basis-point rise in U.S. Treasury yields in the first three months left credit markets virtually unscathed. Spreads in both investment grade and high yield markets actually tightened as investors scrambled to offload interest rate risk. Tighter spreads do increase the need to seek out some extra capital appreciation through tactical allocation, however - and attractive opportunities have arisen.
6. Macroeconomic dynamics will be expressed through currencies
Currency markets have been subdued and Treasury yields have been the big story so far this year.
What we’ve seen: While central banks do appear to have stabilized real yields during the first few months of the year, they could not prevent a run-up in longer-dated nominal yields and therefore a rapid rise in bond market inflation expectations. That run-up in yields coincided with a New Year rally for the U.S. dollar and a continuation of the secular decline in currency market implied and realized volatility. That said, the decline in credit-spread volatility has been still more pronounced, and alongside the quietness of the majors there have been a number of mini-cycles in emerging markets currencies, as well as some unanticipated strength in the renminbi.
Equities: cyclical opportunities, long-term themes
7. Secular growth stocks ultimately prevail over cyclical rallies
We still expect the shadow of secular stagnation to help growth stocks eventually, but current dynamics could extend beyond this year.
What we’ve seen: As we expected, given the very strong early-cycle flavor of so much of the economic data, cyclical stocks have pulled ahead of both defensive and growth stocks so far this year. What has surprised us is the sheer strength of the economic data and the speed with which value stocks have re-priced: by mid-June, returns to U.S. large-cap value were more than twice those to U.S. large-cap growth.
8. A thematic approach can help to uncover long-term growth
Long duration and strong performance in 2020 have caused thematic stocks to lag the market.
What we’ve seen: While we would have acknowledged, at the end of 2020, that base effects would ensure that the world was unlikely to be “low-growth” over the next 12 months, the extent to which it has turned out to be high-growth has surprised us. The corollary to that has been marked outperformance by value and cyclical stocks. Moreover, stocks associated with portfolio strategies focused on secular, technology-related themes such as next generation connectivity and mobility have tended to underperform growth indices as well as value indices, in some cases due to the duration of their earnings expectations and in others due to the strong performance they experienced during the height of the pandemic crisis.
Alternatives: resilience for growth, nimbleness for value
9. Resilient growth will be in favor - but it won’t come cheap
Evidence of the quality-growth tilt in private equity portfolios continues to build.
What we’ve seen: The sector tilt of global private equity deals continues to favor traditionally higher-growth industries: according to Preqin, over the 12 months ending in April 2021, 48% of deal value was in information technology and health care, relative to a weighting of 36% for those sectors in the MSCI World Index. We see this tilt to higher growth in our own co-investment programs. During the first six months of 2021, and including investments still pending, 65% of the companies to which we committed co-investment capital were projecting annual revenue growth of 10% or more; six years ago that proportion was just 26%. When we look at earnings growth projections, which tell us more about opportunities for profit-boosting operational and strategic enhancements, we see even greater ambition: 83% of the companies we have invested in this year project EBITDA growth of 10% or more.
10. A continuing role for opportunistic and idiosyncratic strategies, liquid and illiquid
The year has started well for liquid alternatives strategies, particularly those reflecting themes of inflation, the value equity comeback and the search for yield.
What we’ve seen: The market dynamics described under theme numbers 6 and 7 - the sell-off in Treasuries, the up-then-down trends in the dollar, the complex push-and-pull between equity styles and sectors - provided a rich opportunity set for trading strategies and other liquid alternatives. Just as important, we believe they are also a reminder of how important it is to seek out new sources of diversification when Treasury yields are so low and inflation expectations are rising, rendering the traditional portfolio hedging asset potentially much less effective.
The full White Paper ‘Ten for 2021’ mid-year update is available here with more details on each of the above categories. Contributions include from:
- Joseph V. Amato, President and Chief Investment Officer - Equities
- Erik L. Knutzen, CFA, CAIA, Chief Investment Officer - Multi-Asset Class
- Brad Tank, Chief Investment Officer - Fixed Income
- Anthony Tutrone, Global Head of Alternatives
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