By: Sanisha Packirisamy, Economist at Momentum Investments
Pharmaceutical breakthroughs have fed optimism for a faster global snapback, though we still view the road to recovery as uneven and uncertain.
The ebb and flow of COVID-19 infections around the world, the success of vaccination campaigns and greater global co-operation to guarantee an efficient distribution of vaccines worldwide are likely to be hugely influential in determining the outlook for the economy and financial markets in 2021.
Although the balance of probabilities is in favour of a positive vaccine outcome and hence a conducive environment for riskier asset classes like equities in 2021, we acknowledge that there could be sporadic downside risks for these assets during the year in case of disappointments on the vaccine implementation front.
Continued fiscal support and an ultra-accommodative monetary policy stance are crucial in keeping the economy afloat and will lessen lasting economic damage from the crisis. A premature withdrawal of stimulus could, however, pull the rug out from under the nascent recovery if the private sector cannot pick up the economic growth baton. In general, a better global growth picture should reward less risk-averse investment behaviour in 2021.
In such a risk-on environment, investors should be positioned for a weaker United States (US) dollar and drift higher in US bond yields. Investors should also expect support for more risky asset classes such as equities and credit and should further be prepared for some equity style rotation from growth to value and from a more defensive US equity market to non-US and emerging equity markets. In contrast, safe-haven asset classes like global bonds, cash and gold are likely to face headwinds in a cyclical recovery phase, with bonds facing the additional challenge of mildly higher inflation.
Meanwhile in South Africa (SA), a likely rise in bankruptcies, electricity supply constraints, a poor jobs outlook, and material fiscal constraints lower the ceiling on SA’s expected recovery. After contracting at around 8% in 2020, SA growth is expected to increase to a below-consensus 2% in 2021 before slowing to 1.6% in 2022. Against this tepid growth backdrop, the major rating agencies have flagged that fiscal consolidation and the Economic Reconstruction and Recovery Plan face high implementation risk. Further negative rating action can be expected later in 2021 if the government fails to arrest the increase in its debt burden through extensive wage bill cuts and capping additional financial support to poorly performing parastatals.
A more favourable terms-of-trade and positive momentum behind global vaccine hopes should support the rand in the interim. Nevertheless, we continue to see a depreciating bias in the local currency in the medium term given SA’s deteriorating macro-fundamentals on a relative emerging market comparison. We see inflation rising in the medium term from an expected 3.2% in 2020 to 3.9% in 2021 and 4.7% in 2022. As such, additional monetary policy easing is less likely from here unless SA suffers another growth setback induced by a renewed country-wide tightening in lockdown restrictions or if there is another sharp dip in inflation. We project a shift higher in interest rates in the second half of 2021 given the SA Reserve Bank’s warning against the dangers of running negative real interest rates for a protracted period.
The fortunate reality for investors in the SA equity market is that the local economy is only a secondary driver, with less than a third of operating performance coming from SA. Moreover, it looks like the stars are finally aligning for the SA equity market, with a strong expected profit recovery in 2021 providing fundamental support on top of an envisaged conducive global risk-on environment, while a more favourable valuation underpins after years of poor performance should enhance potential upside.
The almost zero real return available to investors from local cash looks unappealing, in contrast to the high real yields offered by SA inflation-linked bonds (ILBs) and vanilla bonds. The expected rise in SA inflation as 2021 progresses should provide a positive fundamental underpin for ILBs. Although listed property fundamentals have weakened considerably in recent years, this is already discounted by share prices. To bolster weak balance sheets, some property companies will be forced to do capital raises.
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Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services (FSP6406) and registered credit (NCRCP173) provider.