2021 Outlooks

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Januar 10, 2021

The Haze of Uncertainty Is Lifting

2021 Outlooks

The Haze of Uncertainty Is Lifting

Januar 10, 2021

Going into 2021, we expect the haze of uncertainty wrought by COVID-19 and U.S. politics to lift. For the global economy, this could translate into meaningful growth catalysts.

GLOBALLY: We believe the most promising of those catalysts is likely to be the introduction of effective and widely available COVID-19 vaccines around the world. Clearly, the eradication of COVID-19 would be a major factor in facilitating a quicker pace of economic normalisation in 2021.

UNITED STATES: Joe Biden is set to become the 46th U.S. president in January, with critical ramifications worldwide. In the near term, we expect the Biden team to provide a credible approach to managing COVID-19, coupled with an increase in fiscal stimulus to soften the ongoing economic impact of the virus. Longer term, we expect to see significant infrastructure spending, tied to innovative green technology, thus aligning the U.S. with the global “Schumpeterian” shake-up of the energy industry.

The Biden administration should ultimately be a boon to both domestic and international policy, in which greater certainty, consistency and co-operation with respect to U.S. global trade policy would be a game changer. This is not to imply that we expect Biden to turn “soft” on China, but more that the “rules of the road” will be clearer, with fewer unpredictable changes in direction, and greater alignment with traditional allies.

CHINA: The New Year will mark the start of China’s new five-year plan, which has a clear “growth” agenda — a reversal of the “deleveraging” goal of the previous five-year plan. While China’s focus is their domestic economy, their plan will nevertheless support global economies that export raw materials and equipment needed by China, helping to fuel growth in many of the world’s cyclical sectors.

As the world gratefully moves into 2021, we see plenty of reasons to be optimistic.

A more synchronised economic recovery

The global economy is likely to see both developed market (DM) and emerging market (EM) growth accelerate in 2021. This has not occurred since 2017, which marked the beginning of a period of divergent economic outcomes due to Chinese financial deleveraging, a manufacturing recession, global trade disruption and tightening financial conditions, as the Federal Reserve raised interest rates and the U.S. dollar surged.

Critically, the world’s two largest economies are both focused on increasing domestic demand and implementing an agenda for structural medium-term investment.

Consumers will reach a crossroads in the spring of 2021

POSITIVES FOR CONSUMPTION GOING INTO 2021, ESPECIALLY COMPARED TO THE 2008-2009 RECESSION:

VACCINES: The distribution of vaccines should coincide with spring, thus providing a healthy backdrop for the pace of economic activity to pick up in late Q1 2021.
PENT-UP DEMAND AND EXCESS SAVINGS: Forced lockdowns and generous government support programmes have resulted in consumer savings rising substantially above the historical average. As at the end of September, U.S. personal income was still 3.9% above pre-COVID-19 levels.¹ However, the follow-on fiscal stimulus from the U.S. may need to be greater than it has been so far to keep income high enough to sustain spending levels.
STRONGER HOUSEHOLD BALANCE SHEETS: Household balance sheets are considerably more robust than in the 2008/2009 recession, and there is evidence of consumers reducing leverage ratios in 2020, by using excess savings to pay down debt, particularly credit card debt.
SURGE IN NEW BUSINESS FORMATION IN 1H 2020: While further job losses are unavoidable (especially as the crisis accelerates trends towards automation), current unemployment is less broad-based and less sticky than during the previous global recession (Display 1). Moreover, new business formations in the U.S. surged in 1H 2020, and despite a pull-back in Q3, remain elevated relative to recent history, a trend that bodes well for the employment outlook in the U.S. (Display 2).

DISPLAY 1: Unemployment has been maintained well below 2009 highs

Source: Haver, 20 November 2020.

DISPLAY 2: A 2020 surge in U.S. small-business formations bodes well for the 2021 employment outlook

Source: Bloomberg, Macrobond, US Census Bureau. Data as of 3 December 2020.

NEGATIVES FOR CONSUMPTION GOING INTO 2021

Surging cases of the virus in western developed nations, combined with a lack of further fiscal stimulus in the U.S., may reverse the positive trends for consumers, especially as unemployment remains elevated.

A more intangible variable is consumer sentiment or, as Keynes put it, “Animal Spirits.” After the initial shock from the virus in March and April, U.S. consumer sentiment remained robust as people saw continued improvement in the economy and enjoyed massive income support from the government. The question is whether the recent surge in the virus and Donald Trump’s loss in the U.S. presidential election are weakening these spirits. The latest Michigan Consumer Survey data showed a sharp drop in expectations among Republicans and only a negligible rise in expectations among Democrats. Since the country is roughly evenly split, a deterioration in sentiment among Republicans—if it results in less robust spending—could lead to a softening in U.S. consumer spending.

Business activity and capex to pick up in 2021

As with the consumer, there are a number of reasons why we expect both manufacturing and capex activity to accelerate in 2021.

INVENTORY REBUILD POINTS TO ONGOING MANUFACTURING: Unlike during previous cycles (2000, 2008, 2014), both inventories and new orders had been slowing well ahead of the COVID-19 crisis. Businesses did not have a large buildup of excessive inventories, as would have been the case in a booming economy, because growth momentum had already been softening in 2019. The combination of a lower inventory starting level, combined with unexpectedly robust post-lockdown demand, meant that businesses found themselves short of stock that was in high demand. With new orders for durable goods and inventories now moving in opposite directions, the restocking of warehouses should continue into 2021.
CAPEX RECOVERY EXPECTED IN 2021: There are already clear signs of a capex recovery playing out. Chinese orders for machine tools from Japan were up 20% YoY in September; the last time growth was at similar levels was in March 2019.² In the U.S., core capital goods orders have surged in recent months and are not only above pre-COVID-19 levels, but are back at highs last seen in 2014 (Display 3). A similar positive trend can be observed in capital goods orders in Korea, whose economy is considered a bellwether for world trade (Display 4).

DISPLAYS 3 AND 4: Capital expenditures at strong levels across the U.S., Japan and South Korea

Source: Datastream, MSIM, Bloomberg. 3 December 2020.

China’s 14th Five-Year Plan focuses on domestic growth

HEAVY CAPEX SHOULD SPUR SHORT-TERM GROWTH

China’s 14th five-year plan for the 2020-2025 period outlines a road map for growth in the medium term, but also provides insights into how China is likely to stimulate growth over the next 12-24 months. Capex will form the base of that strategy, as China looks to scale up investment in transport (intercity rail and urban transit), technology (5G networks, artificial intelligence and data centres, industrial internet, inter-city high-speed rail) and new energy (ultra-high voltage power and electric vehicle charging stations).³ The size of this package is expected to total around US$1.4 to US$2.5 trillion (RMB 10 to 17 trillion), invested over the next five years through 2025, according to CCID Consulting.⁴

CHINA’S MEDIUM-TERM FOCUS: A SHIFT TO QUALITY GROWTH

The 14th five-year plan emphasises a shift from quantity to quality of growth, to the point where the long-standing quantitative guidance on growth has been removed from the statement, creating a stronger focus on productivity and self-sufficiency. We outline the five (out of six) key pillars that are likely to serve as the clearest near-term economic growth engines.

TECH LOCALISATION—SELF-SUFFICIENCY IN KEY TECHNOLOGIES: China’s aim is to become self-sufficient in key technologies such as semiconductors and software. China recognises that this is a transition that will take time, with self-sufficiency only targeted for 2035, but it implies that U.S. technology imports are set to decline in the long term.
MODERNISING CHINA’S MANUFACTURING SECTOR: China remains the world’s key manufacturing superpower, with close to a 30% share of global manufacturing output.⁵ However, China seems intent on maintaining manufacturing’s share in GDP by moving up the value chain within the manufacturing industry, slowly shifting from lower- to higher-value manufacturing and from old to new infrastructure, via strategies, including digitalisation, cloud computing, automation and robotics.
OPENING UP AND ATTRACTING FOREIGN CAPITAL: China will continue its push to liberalise trade and investment and ultimately attract foreign capital. In line with its goal of improved self-sufficiency, we can expect a simultaneous effort to promote RMB internationalisation, reduce funding risks, secure capital and decrease the “dollar-centric” nature of international financial systems.
A STRUCTURAL BOOST TO DOMESTIC CONSUMPTION: While China is gradually liberalising its external markets, its key focus will be on stimulating domestic consumption in order to regain self-sufficiency and avoid vulnerability to trade tensions. We see two main mechanisms to do so. Firstly, China could stimulate domestic consumption via investments, where the New Infrastructure fiscal plan will be the main growth catalyst for the economy. Secondly, China could focus on spurring domestic demand by implementing safety-net policies to reduce income inequality, such as social security, education, housing and affordable health care for lower income groups, or fiscal support via income transfer and taxes.
GREEN ECONOMY: In September, President Xi pledged that China would achieve carbon neutrality, or net-zero carbon emissions, by 2060. Likely policies include a carbon cap by 2030, the launch of China’s emissions-trading system and green financing. Moreover, the level of carbon emissions could become a key performance indicator for evaluating local government officials.

DISPLAY 5: Six key investment areas in the new infrastructure spending plan⁶

Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass.

Outlook: We expect equities to outperform in 2021

With diminishing global policy uncertainty and a constructive outlook on growth, we expect equities to outperform fixed income in 2021. We think this background will support the VIX moving back into a more subdued range, with implied volatility likely to fall back below 20 in 2021.

Within our equity allocation, our portfolio has a tilt towards cyclicals and value—we are overweight the Russell 2000, the DAX, financials and Latin America—while in fixed income, we are underweight rates.

One risk we are keeping an eye on is high-equity valuations. By traditional metrics, equities are overvalued. If they were to adjust to more normal levels, the timing would be very difficult to anticipate. Moreover, history shows that when it occurs, it can lead to substantial negative volatility.

DISPLAY 6: Latest tactical views

Source: MSIM GBaR team, as of 5 January 2021. For informational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The tactical views expressed above are a broad reflection of our team’s views and implementations, expressed for client communication purposes. The information herein does not contend to address the financial objectives, situation or specific needs of any individual investor.

APPENDIX: Asset class views in detail

¹ Bloomberg, 30 September 2020

² Bloomberg, November 2020

³ www.bloomberg.com/news/articles/2020-05-20/china-has-a-new-1-4-trillion-plan-to-overtake-the-u-s-in-tech

⁴ www.global.chinadaily.com.cn/a/202005/14/WS5ebcdf01a310a8b241155b32.html

⁵ www.weforum.org/agenda/2020/02/countriesmanufacturing-trade-exports-economics/ World Economic Forum, February 2020

⁶ China’s Urbanization 2.0: New Infrastructure Opportunities Handbook, Morgan Stanley Research, March 2020

⁷ Bloomberg, 19 November 2020

⁸ Morgan Stanley Research, Bloomberg, 4 November 2020

⁹ SCMP, Bloomberg, 14 December 2020

¹⁰ Bloomberg, 30 November 2020

¹¹ IBES, 2 December 2020

¹² Datastream, 20 November 2020

¹³ Goldman Sachs, 14 December 2020

¹⁴ Morgan Stanley, 12 November 2020

¹⁵ J.P. Morgan, 1 November 2020

Risk Considerations

There is no assurance that the strategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. In general, equities securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks, such as currency, political, economic and market risks. Stocks of small-capitalisation companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. The use of leverage may increase volatility in the Portfolio. Diversification does not protect you against a loss in a particular market; however, it allows you to spread that risk across various asset classes.

Andrew Harmstone

Managing Director

Global Balanced Risk Control Team

2021 60 Second Market Outlook: Andrew Harmstone - Global Balanced Risk Control Team

Economic uncertainty wrought by COVID-19 and U.S. politics is dissipating. Andrew Harmstone, Head of the Global Balanced Risk Control Team, discusses several likely growth catalysts in 2021 and what they mean for our positioning.

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DEFINITIONS

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. It includes all private and public consumption, government outlays, investments and net exports. The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. The MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. The MSCI All Country Asia Ex-Japan Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of Asia, excluding Japan. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends. The MSCI Emerging Markets Index (MSCI EM) is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Latin America Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets within Latin America. The MSCI Emerging Markets Latin America Index consists of the following 5 emerging market country indices: Brazil, Chile, Colombia, Mexico and Peru. The Bloomberg Barclays Global High Yield Index provides a broad-based measure of the global high-yield fixed income markets. It is comprised of the Bloomberg Barclays U.S. High Yield, Pan-European High Yield, U.S. Emerging Markets High Yield and Pan-European Emerging Markets High Yield indices.

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There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Prior to investing, investors should carefully review the strategy’s/product’s relevant offering document. There are important differences in how the strategy is carried out in each of the investment vehicles.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing.

This material is a general communication, which is not impartial and has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Except as otherwise indicated herein, the views and opinions expressed herein are those of the portfolio management team, are based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

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