The prevailing narrative

In our most recent tactical conversations, it was very clear from our own data, various individual viewpoints and our team discussions that we were thinking very similarly to the broader market cohort (bank research, asset management contacts and independent research subscription services that we utilise).

The broad consensus narrative is that:

1. Interest rates will stay low for the foreseeable future.
2. 2021 is expected to be a year of decent economic growth relative to 2020 and lockdown-driven economic contraction.
3. Market participants re-based corporate earnings to very low levels in 2020, so base effects and some top-line expansion as economies re-open and normalise should result in material earnings growth trajectories for equities.
4. Bond markets will continue to behave and, while some inflation will return, central banks will continue to support their own bond markets with Quantitative Easing processes. However, the rising term premium will act as a tailwind for the value factor in equities, as opposed to the growth factor, which has outperformed value by an enormous margin over the last few years.
5. The weaker dollar theme is driven by increased risk appetite, perception of better opportunities outside the US (growth and interest rate differentials) and growing deficits in the US.

A weak dollar should lead to a decent performance from risk assets (emerging markets, commodities and carry trades alongside falling or stable volatility). Many strategists and asset managers have labelled this broad context as the “reflation” trade.

STANLIB Absolute Return asset allocation perspectives

We have very few points or areas of major disagreement with the consensus. This require us to interrogate our viewpoints more aggressively than we normally would and lean heavily on our tried and tested process.

 Our stand-alone, six-lens approach to our TAA can be summarised as follows:

1. Economics

As we move into 2021, growth will be much higher than in 2020 and, according to Kevin Lings, STANLIB Chief Economist and his team, local and global inflation will remain muted, apart from base effects. We fully agree with Kevin.

The view on extending fiscal support directly to the global consumer is, we acknowledge, a very important evolution in the inflation and monetary debasement argument and this could be a potential gamechanger.  At the same time, the US Federal Reserve has changed its forward guidance to encompass a focus on an aggregate inflation rate of above 2%, so a reaction from US central bankers to subdue inflationary impulses, even when inflation breaches 2%, is unlikely.

The structural issues driving global disinflation remain in play.  We believe that excess capacity remains in the system and so-called output gaps due to unemployment and excess capacity will keep broad-based inflation in check. So, the “reflation narrative” should be seen for what it truly is, a broadening of economic growth driven by base effects and a pick-up in demand off a low base. It is a re-opening trade, not a reflation trade.

2. Liquidity

COVID-19 and the subsequent response has dramatically accentuated the liquidity environment. The effects have positively impacted asset markets, yet the enormous liquidity generated by huge rate-cutting cycles, fixed Income purchases and direct fiscal support is not yet translating into above-trend economic growth or, more importantly, a steady improvement in the velocity of money.

It remains to be seen whether fiscal support and a savings transfer will lead to spending patterns that drive inflation meaningfully higher, however liquidity supports asset markets at present. Whether it will be enough to drive markets meaningfully higher is uncertain. We are very much aware of the risks of inflation rising, showing its teeth and hence impacting portfolios. However, we do not believe inflation will be a bogeyman within our tactical horizon, even with this huge liquidity tailwind.

3. Valuations

Across the board, in absolute terms, we would not classify asset markets as cheap. Relative valuations are, however, interesting. For the first time in a number of years, South African equities stack up comparably with South African bonds. We continue to believe a longer-term structural issue exists with SA equities, but they do not fully reflect the South African economy. While the world improves, so will South African equity markets and the multiples people are willing to pay.

Very few bond markets are compensating an investor for the credit, duration or inflationary risk being taken, especially those with negative nominal yields. South African bonds are very appealing relative to South African fixed income history, global bonds, emerging market bonds and South African cash. As a global investor, we continue to advocate South African bonds on a currency-hedged basis.

Listed property in SA remains a difficult asset.  The bad news is well known, and balance sheet issues are slowly being addressed. As a team leaning heavily on tactical asset allocation, we continue to look unfavourably upon the sector, but there is no doubt that the advent of a vaccine requires a less bearish stance toward listed property than a few months ago.

4. Momentum

Our current outlook is broadly positive across major asset risk classes and reinforces the economic and liquidity arguments summarised earlier.

5. Volatility

Our volatility signals paint a mixed picture for different asset classes. Equity, commodity and longer-term fixed income volatility remains higher than normal and what we would term “sticky”. We expect both realised and forward-looking equity volatility will drift lower from here. While the risk/reward of increasing asset exposure here is less compelling than a few months ago, at these volatility levels we would still lean towards risk over the medium term.

6. Sentiment

There has been a notable shift in sentiment since the last quarter. Equity and credit sentiment is very strong, with currency sentiment more in the middle of the range but skewed away from the dollar. This is urging some shorter-term caution, with better opportunities for adding to our tactical view lying ahead.

Where we differ from the consensus

1. We do not believe in “reflation”, but in re-opening. We think that inflation is a potential risk but it is a low-probability evolution in our tactical scenarios.
2. We are not yet big believers in the Equity Value Factor over Equity Growth factor. We think the cash flow dynamics of growth continue to outweigh value for now.
3. We do not yet believe that US assets are less appealing than global assets. It is true that from a valuation perspective US markets are more expensive than most other global markets and if the dollar weakens other assets may do better (if history is a guide).  We postulate that US margins remain world class and return on equity numbers remain high relative to the rest of the world. We would still make substantial allocations to the region in unconstrained portfolios.

Risks

The single biggest risk, identified by both the Absolute Return team and subsequently by the STANLIB Tactical Asset Allocation discussion group, is related to the vaccine, its potential side effects, logistical challenges (storage, transport, lack of sufficient dosages etc) and the speed of the vaccination process (logistical and safety or behavioural issues). Should vaccine efficacy be questioned, all of the positive macro dynamic discussed above would have to adjust.

Other risks that the team consider to be under-appreciated are the stubbornly high unemployment rate and low participation rate, given ongoing (expected) stimulus cheques.

Similarly, the team felt that a policy mistake of providing too little fiscal and monetary support to economies, businesses, consumers (and markets) would leave the market susceptible to disappointment, especially given the continued state of various stages of lockdown around the world.