Boost your portfolio’s yield, prepare for a weaker US dollar and reposition for ‘The Next Big Thing’ in 2021
2021 resolution No. 3: Look to boost the portfolio’s yield
Cash rates and high grade bond yields are unlikely to rise meaningfully for the foreseeable future, so investors will need to seek assets other than cash and high grade bonds to find income. Credit, selling volatility, and employing leverage are potential options for yield-seekers. In our third part of our New Years Resolutions for your portfolio, we discuss how investors can try to boost the yield of their investments in 2021.
US inflation breakevens have normalized to pre-COVID-19 levels at around 1.8%, but remain below the Federal Reserve’s 2% target. This suggests that even with current expectations for unprecedented stimulus, investors do not believe the Fed will reach its inflation target over the next decade. Indeed, markets aren’t pricing any US rate hike for nearly three years, and are only pricing in three hikes over the next five years.
Inflation expectations in Europe and Japan are at even lower levels. The ECB has increased the size of its bond purchase program, while the Bank of Japan said it will ease policy further “without hesitation” if downside risks were realized.
Investors looking to boost the yield of portfolios can seek additional income from credit. As earnings recover in 2021, we think credit fundamentals and credit ratings will also start to improve. Yet the disruption caused by the pandemic will have divergent effects, which could boost returns for more active investors. For example, risk-tolerant investors can earn potentially significant returns by anticipating key rating agency action, and investing in select euro- or US dollar- denominated bonds in the crossover zone (hence, the term crossover bonds) between investment grade and subinvestment grade.
We also like emerging market USD-denominated sovereign bonds. With yields of over 4.5% (or 350bps spreads over US Treasuries), emerging market USD-denominated sovereign bonds compensate well for their risks, in our view. We think spreads could tighten to 340bps as global demand returns and oil prices recover.
Separately, Asia HY offers some of the most attractive yields in the credit space, at over 7%. The asset class is backed by a positive outlook for Chinese property bonds that benefit from easy domestic liquidity conditions. Dividend stocks can potentially offer an attractive source of income. Dividend payments are still attractive at current levels, particularly compared to government bond yields. While we expect dividend cuts as a result of COVID-19 (more so in Europe than the US), dividend-paying stocks tend to have defensive characteristics. We recommend selecting companies that can sustainably pay attractive dividends.
Finally, investors could also consider alternative strategies to boost income, like selling volatility or employing leverage. This might include strategies like put writing, for those who can implement options, or structured solutions that offer a fixed coupon payment until maturity, based on movements in underlying equity or commodity markets. We also view direct lending and core real asset strategies as attractive long-term income generating instruments.
2021 resolution No. 4 – Prepare for a weaker US dollar
The US dollar index has fallen by 12% since its peak in March, but we think the weakness has further to run.
Investors should consider the impact of a weaker dollar on their portfolios and financial plans, and reposition accordingly.
From 2017 until earlier this year, the dollar offered both yield and safe haven appeal, an exclusive proposition among currencies. Consequently, international investors built up the largest USD exposure in 25 years, which led the US dollar to become overvalued relative to most other G10 currencies.
Today, the dollar’s interest rate differential has diminished. The spread between US and German twoyear yields has shrunk from 215bps to less than 100bps this year alone and from a wide point of 358bps in November 2018. At the same time, the US budget and current account deficits, taken together, equal 18% of GDP. The normalization of safe haven demand and US savings rates could also put further pressure on the dollar.
We expect the US dollar to weaken against a broad basket of G10 peers with medium- to long-term upside potential in the EUR, GBP, CHF, and AUD vs the greenback.
The euro in particular is well-placed to benefit from a recovery in global export demand as the pandemic fades and US stimulus boosts growth. We think the euro is also attractive, as the ECB has not pushed rates further into negative territory and seems willing to accept further euro strength. It is also pursuing efforts to stabilize the cost of credit in the EU periphery. We forecast EURUSD to rise into the 1.25 – 1.30 range by the end of 2021.
We also view the Swiss franc as a superior safe haven to the US dollar, given that investors could become more concerned about the US’s indebtedness at the same time that the Swiss National Bank relaxes its intervention in the franc, and Asia’s economy rebounds.
Among emerging markets, within Asian currencies, we like those with a high yield, such as the Indian rupee and Indonesian rupiah, and those with cyclical exposure, such as the Singapore dollar and Chinese yuan. The yuan could additionally benefit from capital inflows as access to Chinese capital markets eases further. Elsewhere, we think the Russian ruble will benefit from a global economic recovery, especially if oil prices increase, as we forecast.
2021 resolution No. 5 – Reposition for “The Next Big Thing”
Mega-cap tech performance has been one of the big stories of 2020 and the past decade. But since 1973, if a US equity sector was a top-two performer over the previous 10 years, it had only an 8% chance of staying there over the subsequent 10 years, and a 25% chance of falling into the bottom two. We think investors should position for “The Next Big Thing,” which we think will materialize in fintech, greentech, healthtech, and the deployment of 5G technology.
If the last decade was about investing in the technology sector itself, we think the next decade will reward investments in the disruptors of sectors undergoing technological transformation. These would include areas of fintech, healthtech, or greentech spaces, or sectors to be enabled and accelerated by the global rollout of 5G technology.
Fintech. We see scope for continued growth in digital payments, driven both by increased use of contactless and mobile payment systems, and by higher online spending. According to Adobe Analytics data, shoppers spent USD 10.8 billion on Cyber Monday at the end of the Thanksgiving weekend last month, making it the highest-grossing US online shopping day on record. Overall, we expect fintech firms to enjoy earnings growth rates in the midto- high teens over the next decade, making the industry one of the fastest-growing globally.
Greentech: The green transformation of some of the world’s biggest industries is just beginning, as policymakers direct regulations, investments, and subsidies toward reaching carbon-neutral targets. We think achieving this will require significant government subsidy and corporate capital investment in key new technologies, such as batteries, renewable energy, and hydrogen.
Healthtech: The global over-65 population is expected to grow 60% to reach 1 billion by 2030. As a result, technology will need to play a critical role in meeting increased health care demand, driving efficiency gains that will facilitate improved outcomes while controlling costs. We expect the healthtech industry to expand rapidly, with a growth rate that we estimate could reach the upper single digits or even higher over the next decade.
5G+: 5G enables a myriad of business models and could spur the growth of a new generation of platform leaders, in our view. Industry body GSMA estimates that investment in 5G technology will account for 78% of a projected USD 1.14tr in capital expenditure by mobile telecom operators globally over the next five years.