2021 Optimistic Start

The only question – Is this an early or a late cycle?

Ok, every cycle is different so there is no simple road map to follow. However, the biggest question that will differentiate between investment success and failure (on a relative basis of course) is whether this is the start of a new cycle or if we are still in the late stages of the cycle that began in 2009. Spoiler alert: nobody knows.

Early in a new cycle

• 2020 does check several important boxes for the end of a cycle. There was a bear market, with global equities falling about 35%.There was, and still is, a recession with the global economy expected to have posted a -3.8% growth rate for 2020 (developed economies). This included negative GDP in Q1 (-3%) and Q2 (-26%) with a snapback in Q3 (+15%). Q4 and Q1 of 2021 are expected to be flat. 

• The U.S. economy saw unemployment peak at 15%, Canada at 14%. These have subsequently recovered to 7% and 9%, respectively. 

• No question this was a very different recession that really impacted services and didn’t have to burn through any excesses such as housing (2008) or tech spending (2000). With aggressive ‘proactive’ stimulus on both the fiscal and monetary front, the economic damage has been limited. And the recovery will gain even more speed when the vaccine enables industries negatively impacted by social distancing to return closer to pre-pandemic levels of activity. 

• It is this scenario that the equity markets appear to be increasingly pricing in. 

Late cycle still

• The pandemic was an exogenous shock that triggered a technical bear market and recession but did not end the current cycle. From a market perspective, some similarities can be drawn to 1987 or 1998. 

• Before the pandemic, the global economy did not appear to have any excesses, the economy was not running too hot, central banks were
  not tightening. 

• There did not appear to be widespread speculation or silly individual investor behaviour during the bull run from 2009 until the pandemic. However, over the past year the silly behaviour has come, big time. There were 480 IPOs in 2020, and retail option trading increased 8x 2019 levels. 

• Monetary policy and high liquidity have lifted asset prices. If the economic recovery isn’t a sure thing, there could be an air-pocket ahead. Perhaps when things do get back to more normal thanks to vaccines, the market may realize how much economic damage has been done. 

• We are not convinced one way or the other. However, there are more bubbles today than a year or two ago which is concerning and not indicative of a new cycle. That doesn’t mean it won’t keep going. From our perspective, the strategy is to trade into some of the lagging or less expansive assets or markets. This should help protect on the downside, and if this is the start of a new cycle, this approach should also benefit from the steady global economic recovery back to ‘normal’.
  

Equities – Has EM started the long road back?

• The final puzzle piece has fallen in place for International & Emerging Markets (EM). In our 2021 outlook we detailed why we believe in overweighting international equity exposure, including emerging markets (EM), over U.S. equities. Now that control of the U.S. Senate has flipped, we find it probable that President Joe Biden will be able to push through some of his additional fiscal spending plans. The dominant drivers of the ongoing risk rally will include stimulative monetary and fiscal policies as well as the prospects of mass vaccinations. These themes will be paramount for the continued economic recovery, but they likely will also mean that the ensuing growth rebound could also be a detriment to U.S. equities from a relative basis.



• The mega-cap tech rally of 2020 will likely be hard to replicate over the year ahead, especially with threats of potential regulations coming from Washington. Amazingly, Technology contributed more than half of the S&P 500’s return last year. While the clean-tech bubble continues to grow, it simply does not have the market-cap clout to drive index outperformance the same way. As you can see in Chart 5, EM have been underperforming for the past few years but have begun to outperform even U.S. equities. A lot of emerging economies have stronger secular growth rates and yet their valuations are cheap relative to the U.S. Investors have been hesitant to tilt towards EM as we were late cycle, but now the state of the cycle seems rather irrelevant. Developed international markets are also attractive from a valuation standpoint. Valuations on the S&P 500 are significantly above their five-year average, less so for international markets. 

• The predominant trend of the lower U.S. dollar, as investors bet on a continued economic rebound, will be a boon to EM and a headwind to domestic U.S companies and foreign investors. The U.S. dollar tends to serve as a risk haven, and while we continue to believe it will benefit from further episodes of volatility, overall we expect the current downward trend to continue with brief periods of counter-cyclical bounces. 

• European market lagged in 2020, but with Brexit now behind them there is also less of a distraction. The European market is dominated by cyclical shares, whereas the U.S. has grown increasingly tech-heavy. EM might have less industrial exposure, but many are still heavily exposed to commodities, which will benefit from the reflationary trade, as will Canada. Chart 5b details the index weight of economically sensitive sectors versus technology across various indices. The U.S. has by far the lowest economically sensitive exposure. With rates rising, and the yield curve steepening, the S&P 500 also has relatively low exposure to bank stocks, which could benefit during an economic recovery. Financials make up 18% of the MSCI emerging-markets index and nearly 16% of its Europe gauge, compared with 10% of the U.S. benchmark.

• Stocks and other risky assets outside the U.S. remain attractive, bolstered by cheaper valuations, solid growth prospects and aided by what we view as the end of the cyclical U.S. dollar bull market. There has been lots of interest in EM, but we continue to believe there is still more room to run. 
  

Fishing beyond the traditional 60/40

• The evolution of the balanced portfolio is leading to the implementation of alternative strategies to replace a portion of traditional fixed income components. The purpose of many of these strategies is to replicate fixed income characteristics –overall portfolio volatility reduction, increased diversification, and overall portfolio drawdown minimization –while also generating more income than traditional fixed income sources. 

• Equity markets are heading into 2021 at historically high valuations and bond yields have doubled off the summer lows. The latter may continue to do so if the reflation trade continues into next year. Add to that the fact that credit spreads have fallen to 14-year lows, and it seems that the risk does not appear to be symmetrical but instead more tilted to the downside for credit. 

• While we do not believe a complete abandonment of fixed income is warranted, shifting part of client portfolios to alternative credit strategies could be a solution for tackling this particular investment landscape. Bonds are not dead and traditional long government bonds still serve a strong point in portfolio diversification. 

• Long/short credit strategies are of particular interest in this environment. Managers typically have the opportunity toshort bonds and futures contracts. Shorting bonds is an interesting proposition because the credit at maturity settles at par, so downside is limited. The long/short nature of the fund also reduces the risk from rising rates.

Charts are sourced to Bloomberg L.P. unless otherwise noted.

The contents of this publication were researched, written and produced by Richardson Wealth Limited and are used herein under a non-exclusive license by Echelon Wealth Partners Inc. (“Echelon”) for information purposes only. The statements and statistics contained herein are based on material believed to be reliable but there is no guarantee they are accurate or complete. Particular investments or trading strategies should be evaluated relative to each individual's objectives in consultation with their Echelon representative. 

Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.

The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete. The information contained has not been approved by and are not those of Echelon Wealth Partners Inc. (“Echelon”), its subsidiaries, affiliates, or divisions including but not limited to Chevron Wealth Preservation Inc. This is not an official publication or research report of Echelon, the author is not an Echelon research analyst and this is not to be used as a solicitation in a jurisdiction where this Echelon representative is not registered.

The opinions expressed in this report are the opinions of its author, Richardson Wealth Limited (“Richardson”), used under a non-exclusive license and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. (“Echelon”) or its affiliates.

This is not an official publication or research report of Echelon, the author is not an Echelon research analyst and this is not to be used as a solicitation in a jurisdiction where this Echelon representative is not registered. The information contained has not been approved by and are not those of Echelon, its subsidiaries, affiliates, or divisions including but not limited to Chevron Wealth Preservation Inc. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete.

Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Echelon and Richardson do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.