2020 was a landmark year for financial markets, in March the world witnessed one of the sharpest declines in market history which was followed by one of the swiftest rebounds and a rally that sustained to the end of the year.
Outlooks for 2021 most certainly have to be informed by the events of 2020. Structural trends such as digitalisation accelerated at an unpreceded rate, and governments and central banks embarked on large levels of fiscal and monetary spending to support those impacted by enforced lockdowns and subsequent unemployment.
Jean Bolvin, head of the BlackRock Investment Institute, and members of the team said there were three key lessons to learn from navigating markets in 2020.
“The nature of the Covid shock and the policy revolution triggered by the pandemic were core to the performance of risk assets and our overall asset views,” he said.
Bolvin explained that early on in the crisis the team assessed that the ultimate cumulative economic losses would likely prove to be a fraction of those seen in the wake of the 2008 global financial crisis.
“We saw the Covid shock as more akin to a large-scale natural disaster that would be followed by a swift economic restart – if policy support could provide a bridge,” he said.
“We then witnessed the extraordinary policy response and saw it as an opportune time to raise our strategic allocation to equities.
“On a tactical horizon, we upgraded credit and increased our preference for quality assets – and held our moderate pro-risk stance over the rest of 2020.”
Bolvin said ongoing fiscal and monetary support in 2021 will help prevent economic scarring as Covid-19 vaccines create a bridge to a post-pandemic economy, as detailed in the chart below.
Source: BlackRock Investment Institute
Below, Bolvin explores the lessons in greater detail.
‘The new nominal’
The first lesson highlighted by Bolvin and the team is inspired by the potential for a more muted response of nominal yields to higher inflation. They expect nominal yields to be capped by central banks, who have signalled they would be willing to let economies run with above-target inflation.
“We see stronger growth and lower real yields ahead as the vaccine-led restart accelerates and central banks limit the rise of nominal yields,” he said. “Even as inflation expectations climb it will have different implications to the past.”
Bolvin said medium-term inflation risk looks underappreciated and argued that the reason central banks appear to be more willing to let economies run hot with above-target inflation is to make up for past inflation undershoots.
“However, they may also face greater political constraints that make it harder to lean against inflation,” he added.
The result, according to the BlackRock Investment Institute is stronger growth and declining real yields.
“We see this combination as underappreciated by markets, and a potential booster to risk assets even as the prospect of a widespread Covid vaccination campaign has buoyed markets in recent months,” said Bolvin.
The importance of long-term structural trends
BlackRock’s second investment lesson of 2020 was the importance of long-term structural trends as drivers of asset performance. Bolvin referred to the dominance of e-commerce at the expense of traditional retail and the increased focus on sustainability as the key areas.
“This helps inform our barbell approach to risk assets over the next six to 12 months,” said Bolvin. “Quality assets such as tech and healthcare stocks on one end and selected cyclical exposures on the other.
“Quality assets with strong balance sheets and cash flows also offer resilience against potential bumps on the road to a full activity restart.”
The team maintained their overweight in the quality style position and cannot see the substantial structural challenges facing traditional “value” sectors abating anytime soon.
Being selective in cyclical exposures
Cyclicality has been a predominant theme of the Covid-19 crisis and Bolvin explained the importance of being selective in exposure to cyclical areas.
“In our mid-year 2020 outlook we recognised the importance of titling back into cyclicality,” said Bolvin. “We closed our overweight positions in US and Asia ex -Japan equities and upgraded European equities to overweight.
“These calls turned out to be less successful than some of our other views, such as overweight in high yield credit and the quality style factor,” he added. “We’ve since turned neutral on emerging market debt, and positive on emerging market equities.”
Bolvin concluded by saying BlackRock’s directional risk views – driven by the nature of the Covid shock and the policy revolution – were critical in navigating turbulent market conditions in 2020.
“A key takeaway is how swiftly macro policies can evolve and the lasting impact this can have on market dynamics,” he said.