Market Comment January 2021 - A New Year - Is 2021 The Year of Wealth
The single most striking phenomenon about the stock markets in 2020 was that they rose relentlessly, interrupted only briefly by a steep decline in March, even though a deadly pandemic was sweeping the globe. This apparent contradiction has raised deep and troubling questions about the relationship between financial markets and the real economy, and about the relationship between economic growth and the welfare of actual human beings. Much of this apparent riddle has to do with interest rates.
All else being equal, when interest rates fall, this means a lower discount rate on, and therefore a higher value of, the future cash flows from stocks. Consequently, the biggest trade by far of 2020 was buying companies that had the biggest cash flows far out into the future. That meant tech stocks, which saw their values multiply from the March lows.
Long-term interest rates crashed as the pandemic took hold. As economies went into lock-down, expectations of growth evaporated, and central banks rushed into the market to buy up government, and in some cases, corporate bonds, precipitating a further drop in rates. Consequently, borrowing costs available to sound companies that wished to borrow dropped even lower.
Thousands of small companies will not survive the financial stress caused by the pandemic, no matter what the level of interest rates is. One of the ironies of the pandemic, however, is that other companies will emerge from the crisis with more cash resources than before the virus struck. A splurge in debt and equity issuance for bigger companies raised more than USD 6.35tn globally this year.
To withstand a collapse in earnings, companies rushed to issue debt which helped nudge overall US corporate bond issuance to USD 1.919tn, surpassing the previous annual record of USD 1.916tn set in 2017. Similarly, companies everywhere suspended or cut payouts to conserve cash, depriving millions of retail investors of income and hitting retirement savings. On the other side of the balance sheet, businesses raised almost USD 300bn inequity through flotations globally in 2020, including a record USD 159bn in the US and thereby bolstering their equity position.
If everything hinges on interest rates, the big question for 2021 is whether rates will rise and upend the general market consensus of a benign market environment of low-interest rates, higher corporate earnings and multi-trillion stimuli packages to finally being disbursed in support of the small businesses and actual human beings of the real economy. The answer to this question will depend very much on how smoothly the vaccination process goes and on how much pent up economic demand will be released when all of us get back to living a normal life. Considering that the production of vaccines and the vaccination process can only be ramped out gradually, the pandemic is in all likelihood going to be with us throughout the entire year. There is little reason to believe that central banks will act on interest rates any time soon.
If Chinese statistics are anything to go by – after all China was the first country to emerge from the lockdown – 2021 should see its economy grow by some 8%.
Remembering that the number 8 means ‘wealth’ in Mandarin, this points to a promising year of the golden bull ahead. Here’s to a smarter, happier, and richer New Year.
Switzerland, January 1st 2021