Three key themes – ‘the new nominal’, ‘globalisation rewired’, and ‘turbocharged transformations’ are going to drive markets in 2021, according to the BlackRock Investment Institute team, after a year dominated by the Covid-19 pandemic.
The coronavirus has brought about a “new investment order”, according to the investment think tank, having caused a “profound shift in how economies and societies operate”.
These shifts in various areas such as sustainability, inequality, geopolitics and macro policy fall under the three umbrella themes they think will dominate markets in 2021: ‘the new nominal’, ‘globalisation rewired’, and ‘turbocharged transformations’.
Below, the BlackRock Investment Institute team break down next year’s themes and how they’re impacting portfolio allocation decisions.
‘The new nominal’
The first theme is a ‘new nominal’ in markets, which will see stronger growth in the near term that eventually leads to higher inflation.
But this round of inflation will be different, the team said, because it will be without the typical rise in nominal bond yields, which have been limited by monetary policy.
“As a result, we see very different market implications than in the past,” the team said. “Previous episodes of rising inflation were costly for investors, leading to higher interest rates that pressured valuations across asset classes via rising discount rates.
“Yet the policy revolution means any rise in inflation from today’s levels will be better for risk assets than in past episodes, in our view.”
The team said central banks are more willing to let economies run at above-target inflation to make up for years of low inflation.
This change in policy comes alongside what the team called the “fiscal-monetary policy revolution”, the pumping of billions in liquidity to help alleviate the financial and economic impacts of the pandemic.
While the team said such fiscal measures were necessary, they claimed it risks “greater political constraints on central banks’ ability to lean against inflation”.
As such, markets are likely to see central banks limiting nominal yield rises in order to prevent unwanted tightening.
But there are other reasons for higher inflation.
Following the disruption to supply chains during the pandemic, BlackRock said a “rewiring of global supply chains” was likely. This will drive-up production costs, contributing to higher inflation, although corporate cost-cutting might mitigate this in the short term.
“But even the moderately higher inflation in our base case – around 2.5-3 per cent annually – would surprise markets after a decade of undershoots,” they said.
Regarding asset allocation, the BlackRock team said developed market government bonds will be less effective as portfolio diversifiers due to the low yields and central banks limiting its rise. Instead, the team favoured inflation-linked securities.
“Importantly, we believe ‘new nominal’ of constrained nominal bond yields will support risk assets,” they said. “As a result, we are tactically more pro-risk and maintain a higher strategic allocation to equities than we would if higher inflation were to have its historical impact on nominal yields.”
‘Globalisation rewired’
Another theme that Covid-19 accelerated were geopolitical trends of a continuing US-China trade war and rewiring of global supply chains.
The US-China trade war has been a source of tension for global markets since 2018 when outgoing president Donald Trump first accused China of being unfair in how it traded with the US.
Going forward, the BlackRock team said it was unlikely that tension between the two superpowers will end. What might change, however, is the political rhetoric, with the US focusing more on climate and human rights than trade issues.
Yet, control of the tech sector will remain at the core of the debate, BlackRock said.
“We are likely to see an increased emphasis in both countries on seeking self-sufficiency in critical industries of the future,” the think tank said. “China is looking to master foundational technologies such as semiconductors, in which it has traditionally lagged the US.
“This is why we believe investors need exposure to both poles of global growth.”
The US-China spat is more than a simple deglobalisation story, the BlackRock analysts claimed, as China is opening itself up as a desirable place for global investors.
They noted China’s share of global GDP has been steadily rising despite a slowdown in the pace of its economic expansion.
However, growth is now ‘on track’ to return to pre-Covid levels, according to BlackRock, “just as it bounced back quickly in the post-global financial crisis period”.
“We see assets exposed to Chinese growth as core strategic holdings that are distinct from emerging market exposures,” the think tank’s analysts said. “There is a clear case for greater portfolio allocations to China-exposed assets for returns and diversification, in our view.”
“We expect persistent inflows to Asian assets as many global investors remain underinvested and China’s weight in global indexes grows.”
‘Turbocharged transformations’
The final theme for 2021 is ‘turbocharged transformations’, covering areas such as sustainability; widening wealth; income and health inequality; and, the dominance of e-commerce.
Just as the pandemic as accelerated geopolitical shifts it has also fast-tracked structural trends which were already in place, according to the team.
Looking first at sustainability which was a major theme in markets this year.
It’s not just increased awareness of environmental and social issues, the team noted, but investor inflows into sustainability options.
Sustainably is also being built into the coronavirus recovery, especially in Europe where the team highlighted a focus on “green infrastructure and digitalisation spending at the centre of its economic restart efforts”.
Moving on to widening wealth, the BlackRock team said the pandemic has heightened the focus on inequalities within and across countries “due to the varying quality of public health infrastructure – particularly across emerging markets – and access to healthcare”.
Another trend was e-commerce, which had been building investment momentum for several years before the onset of Covid-19. The national lockdowns and closure of non-essential businesses forcing people to shop online only increased the trend at the expense of traditional bricks & mortar retailers, the team added.
“The pandemic has accelerated ‘winner takes all’ dynamics that have led a handful of tech giants to dominate equity market index performance in recent years,” the team said.
“Despite this year’s runup in valuations, we see tech exposures as having long-term structural tailwinds. The quality factor, US equities and Asia ex-Japan equities are ways of gaining such exposure.”
As such, the team said they prefer to use sustainable assets “as portfolio building blocks”.
“We see persistent flows into sustainable assets in the long transition to a less carbon-intensive world,” the analysts explained, and was taking a barbell approach, with a bias towards tech and healthcare alongside some cyclical exposures.