The estimated (year-over-year) earnings growth rate for the S&P 500 for CY 2021 is 21.8%, which is above the 10-year average (annual) earnings growth rate of 10.0%. If 21.8% is the actual growth rate for the year, it will mark the largest annual earnings growth rate for the index since CY 2010 (39.6%). The unusually large growth rate can be attributed to both an easy comparison to weak earnings in CY 2020 (due to the impact of COVID-19) and expected improvement in earnings in 2021. At the sector level, all 11 sectors are projected to report year-over-year growth in earnings, led by the Energy (growth rate N/A due to a loss for the sector in CY 2020), Industrials (78.0%), and Consumer Discretionary (58%) sectors.
2021 Prediction 1: Mutual-fund-to-ETF conversions become popular among asset managers, but not among investors. Asset managers Guinness Atkinson and Dimensional Fund Advisors are preparing to convert existing mutual funds to ETFs. The asset managers are hoping to lower holding costs and stem the tide of outflows from their actively managed portfolios. It's clear that they will be entering a highly competitive marketplace. Are they ready? The data suggests that the competition will be brutal.
As of this writing in mid-December, I think that much of the fixed-interest universe is trading incredibly rich. With that in mind, my crystal ball has revealed several areas to watch in 2021:
Inflation hits developed markets hard, trending in a V-shape (corresponding with a late-spring to early-summer re-opening at scale) and increasing pressure on central banks worldwide to limit easing and even explore raising rates by the end of Q3 to placate hawkish legislators.
Investors of all shapes and sizes continue to move down the capital structure, effectively extending duration by moving into preferred and/or perpetual issues in a never-ending search for yield. Investors not constrained by reserve or capital charges pivot to alternatives like real estate or dividend-paying stocks.
ESG continues to be the flavor du jour. Green bond issuance hits a record high. SASB or SDG-linked bonds popularize new term structure, redemption, and coupon schedule features, requiring a re-think of underwriting and analytics generation.
The United States explores another Build America Bonds-like program to support local and state debt issuance.
The impact of COVID-19 on economies could prompt further temporary or even permanent regulatory reform. ESG will dominate again with EU firms grappling with a deluge of level-two technical details under the SFDR and taxonomy regulation. Elsewhere, other jurisdictions including China, the U.S., and U.K. will further develop their own models that may compete with or co-opt the various consolidating voluntary regime projects that commenced in 2020.
The LIBOR transition will continue to capture column inches as its retirement at the end of 2021 approaches, while further developments can be expected in market data and transparency in the EU, UK, and U.S.
Brexit will also be a big theme and will trigger broader developments as the UK looks to reconsider its entire regulatory rule book and the EU considers overhauling MiFID II, rewriting its UCITS/AIFMD funds rules, and possibly erecting further trade barriers should a Brexit deal not be forthcoming.
Debt and Markets: In the Wake of Massive Government Subsidies, How Long Until We Revert to Fair Value?
Obvious statements: Due to the subsidies of national governments in response to the pandemic, there are a lot of investment opportunities where the fair value of the investment is significantly different than the current market price. The reversion of the current market value to the fair value will depend solely on the as-yet-unknown duration of these subsidies.
Not-so-obvious implication: value-based investment strategies exploit this reversion to fair value and exist in both explicit and subtle forms in nearly every investment hypothesis. Simply put, success will depend on the timing of when these subsidies cease. The only viable alternative is momentum, which typically works well until it ends badly. Good luck!
Alternative Data: Invaluable During the Pandemic…And Beyond
COVID-19 brought with it unpredictable economic behavior. Fundamental data was not timely enough to capture consumer or market behavior. This led to an unprecedented rise in the use of alternative data that can be leveraged to nowcast consumer sentiment; content sets like point-of-sale, job posting data, and foot traffic saw a huge rise in usage and thusly, were integrated in many investors’ models. Post-COVID, it will be interesting to see if those modified models and newly acquired datasets are still as predictive and as valuable. My hunch is that COVID-19 only forced investors that were lagging in the alt data space to see what many of the investors that already leverage this data knew. Whether this increased usage results in signal decay is also something to keep a close eye on.
Economics and Markets: The Ultra-Low Yield Environment Persists
While most of the world’s GDP growth will finish the year in contraction territory (except for a few countries), 2021 is looking to be the year of slow recovery with a shape more like a “K.” The dislocation of the hype in financial markets vs. tepid resumption of activities on main street draws a huge contrast, like the “Tale of Two Cities.” COVID-19 brought about a further bifurcation of wealth and inequality. This is likely to be further materialized as defaults are set to continue, especially for small- and medium-sized enterprises; in the U.S., it appears that Paycheck Protection Program loans have not been adequately allocated to small businesses.
The market volatility witnessed in the markets during COVID-19 and the ultra-low yield environment, along with expectations that rates will stay low for the foreseeable future due to lackluster economic growth, have been the main drivers that accelerated the demand for yield in private markets globally.
Private equity and venture capital (PEVC) have gained substantial momentum during 2020. Capitalizing on low financing costs, large pots of dry powder brought in plentiful fundraising and M&A activities. We saw this in data centers, distribution/warehouses, and renewables investments worldwide, especially in the U.S. and Asia. As banks tighten lending standards, private credit has also experienced considerable growth. While it is capital adequacy protection for the banks, it becomes a value hunting ground for the private debt and distressed funds.
Growth in the private space appears poised to continue as it becomes a more substantial part of asset allocation for multi-asset class investors looking for source of yield and diversification. This drives further demand for data and analytics that can coherently cater to multi-asset class investment analysis including private assets with a focus on an ESG lens.
Private Markets: High Levels of Dry Powder Will Fuel Deal Activity
We believe that PEVC deal activity will rebound as a vaccine becomes available, and we’re hopeful that life/business goes back to normal. General Partners’ dry powder levels remain extremely high globally, which will continue to make the PEVC environment extremely competitive. From an overall private markets’ strategy lens, we continue to expect significant consolidation of private market data/technology providers. There is a clear data arms race occurring as corporates and PEVC firms continue to acquire and/or invest aggressively in private market players.
South Africa: Slow Growth, High Inequality, and High Government Debt
On March 27, 2020, Moody’s downgraded South Africa from an investment-grade rating to Ba1, maintaining a negative outlook. On November 20, 2020, Fitch Ratings downgraded South Africa's Long-Term Foreign-Currency Issuer Default Rating (IDR) to BB- from BB, maintaining a negative outlook. Low trend growth and de-stabilizing high inequality will continue to complicate rating sensitivities and macroeconomic performance of the country into CY 2021.
Biden a Boon for the Rand
The rand has appreciated by more than 20% against the dollar since the end of the first quarter of 2020 amid a softening of U.S. stock markets and post-election lows. A stronger rand has aided importers, while still assisting exporters because the currency is undervalued compared to other emerging markets. It is predicted the U.S. dollar will follow a downward trend into 2021, and the rand will stay at its current high dependent on higher yield-driven investor flows to South Africa and the release of the COVID vaccine by Q2 2021.
Repo Rate to be Maintained by the SARB
The Monetary Policy Committee within the SARB lowered the repurchase rate by a full percentage point in March 2020 to decrease the burden on consumers; this brought the bank’s policy rate to a six-year low of 5.25%. The rate was further eased in November 2020, to 3.5%. This decision was mostly due to uncertainties over the outlook for economic growth and inflation. It is predicted the SARB will take a cautious approach by maintaining the current repo rate into CY 2021 given the recent downgrade by Fitch, high government debt, as well as the continued deterioration in South Africa’s sovereign risk profile.
An Optimistic GDP Outlook
South Africa is projected to see real GDP (%y/y) growth rate of 3.5% for CY 2021 mostly aided by the resources sector. A projected decline in the unemployment rate to 29.9% is envisioned, but the country will continue to be weighed down by projected government debt (% of GDP) of 82% for CY 2021 as the country has historically struggled to meet government debt targets due to a lack of fiscal discipline and the inability of the government to control spending.