The market outlook in 2021 among investors and analysts is easy to describe: cautious optimism.
Almost universally, fund managers believe the year will bring a rebound in economic activity, supporting assets that have already gained momentum from the depths of the pandemic crisis in March, but also lifting sectors left behind. account. Bond yields are expected to remain low, which will further support equity valuations.
But the viral mutation found in the UK, which caused the markets to wobble briefly at the end of the month, shows just how smooth sailing is always.
We asked investors: what can go wrong?
The answers below have been edited for clarity and length.
co-president, Oaktree Capital management
The main threat is rising interest rates, unlikely to be in the medium term.
Current high asset prices depend heavily on low interest rates for their relevance. If rates went up, asset prices would likely fall. However, there is little reason to believe that rates will rise in the short term because there does not appear to be much inflation, and I think the Federal Reserve is not concerned about inflation.
Valentin de Nieuwenhuijzen
I don’t think central banks will have to look at inflation because I don’t think there will be. If I’m wrong and it picks up speed, it is a game-changer for the markets.
That would mean that many losers in markets that have been left behind could really catch up – think of banks and financials, but also the larger value factor that has suffered secular underperformance over the past year. decade. Growth stocks would suffer from rising interest rates. They could still increase but less than the value. And obviously government bonds would suffer.
Everyone has the same caring attitude. It is also a risk. We will be watching closely for any worrying concentration in the positions.
Global Fixed Income Co-CIO, Goldman Sachs Asset Management
Bond investors face two major risks as we enter 2021.
First, the extraordinary political response of Covid-19 has extended the challenge of low yields. Second, central banks have limited political ammunition in the event of a negative growth shock. In this context, we are focusing more on building balanced portfolios that withstand episodes of market volatility.
Deputy CIO, Amundi
The recent market rally is based on blind faith in the vaccine and the courageous assumption that very soon everything will be back to normal, if not better. It’s a risk: producing and distributing these vaccines on such a large scale will not be a walk in the park.
Fiscal and monetary support keeps economies afloat, but fair. These measures are increasingly difficult to implement. Expect greater monetization of debt and increased pressure on central banks – any withdrawal from the measures is unthinkable at this time, and the risk of policy error is underestimated by the market.
The third risk is the consensus itself. The search for yield with the surge in negative yielding debt will push the search for yield to the extreme: there are nearly $ 1.5 billion of bonds outstanding in “zombie companies”. The temptation for investors to accept lower quality in their portfolios is strong, as is the bet that interest rates will stay low forever. It’s dangerous.
Managing Director of the Caxton Associates hedge fund
The stage may well be set for a great reflation.
Lots of expressions [of this reflation] have been out of favor for the better part of the decade. Most market participants, and therefore their portfolios, are heavily conditioned by decades of disinflation or low inflation.
The change in the inflation regime and, subsequently, the mindset of investors, will likely have profound implications for asset allocation.
Liz Ann Sonders
Chief Investment Strategist, Charles Schwab
What concerns me most is the feeling. The market’s success itself has recently created what I think is its biggest risk, which is overly optimistic sentiment. By itself, a tense sentiment does not portend an imminent correction, but it does mean that the market is likely more vulnerable to the extent that there is a negative catalyst, which could take a number of forms.
Director of Global Investments, Guggenheim Partners
The pandemic has completely overhauled our free market economic system based on competition, risk management and fiscal prudence. It has been replaced by increasingly radical monetary intervention cycles, the socialization of credit risk and a national policy of moral hazard.
This is troubling, because beyond the wall of the eye lies a poor credit environment judging by credit defaults, rating migration and corporate fundamentals. Overall, the high yield [debt] the market has 4.5 times more debt than the profit before taxes and other items of the past 12 months, a ratio that is already above the peak of the 2008-2009 default cycle, and is likely to get worse from there .
Managing Director and Senior Portfolio Manager, PGIM Fixed Income
It’s amazing to me that the market has overtaken the idea of ”Blue Sweep”[of Democrats winning control of both houses of Congress and the White House]. . . I think we might see a “Blue Sneak” as Georgia Senate races are still very much on the line to go blue. This could open the fiscal tap even further.
I still believe it will be a golden age for credit, but I’m probably more worried about this thesis than I was in April. Everything is happening at breakneck speed, so maybe dividends, buyouts and mergers and acquisitions are coming back quickly too.
The biggest market risk remains inflation. I think it will only increase temporarily next year due to base effects and then come back down. But the risk is that it continues to rise, and that changes everything. We have a lot of confidence in the Fed to keep its positions and not respond to accelerating inflation. If the Fed loses its temper and worries about inflation earlier than it has hinted at, then this could be a problem for the markets, triggering a sort of “Tap Tantrum 2.0” scenario.
Founder of the Dymon Asia hedge fund
The US dollar has weakened this year, but could drop sharply at some point. If this happens, the Fed will lose the flexibility of [real] interest rate, and may even be forced to suspend asset purchases. This is the extreme risk scenario.
If there is no blue sweep [in January’s Georgia Senate elections], then the Fed is the replacement. But if you lose the save, the world could take a brutal shock. It’s plausible, it’s not such a crazy scenario. If the dollar drops significantly, the Fed could run out of easing options, leading to a sell off of shares.
Emerging Markets Debt Portfolio Manager, GAM
Financial markets held together due to low policy rates and low bond yields, and falling discount rates supported asset prices and reduced government debt costs.
Although the debt burden of emerging markets is (essentially much) lower than that of developed markets, yields are not, so debt servicing costs have not been reduced to the same. degree. Emerging market central banks cut rates as aggressively as DMs, but bond buyers have been more cautious. Unlike DM, central bankers in emerging countries have not had the benefit of the doubt.
Turkey is particularly instructive – a refusal by the government to recognize balance of payments constraints has led to the need for an aggressive almost single rate hike. This is the example of what we see as a broader risk: if EM policy makers do not continue to recognize that they face much more stringent constraints due to the balance of payments than their DM counterparts. , they risk a debt spiral which seems a very remote possibility in DM.