The Year That Was… And The Way Ahead
Markets entered 2020 on a calm note, with a continuation of the longest bull run in history expected and hoped for. But this was to change within a few weeks, with stock market volatility thrown into full-blown panic mode in March with the onset of the global pandemic. Perhaps the best reflection of a tumult is seen in Wall Street’s “fear gauge,” known as the Vix (volatility index), which reflects the ebb and flow of anxiety levels expected in the S&P500. Entering the year at 13, and with a long-term average around 21, the Vix skyrocketed to a record 85.
The speed and severity of the pandemic and global lockdowns were in many ways matched by the size of the central bank and government stimulus worldwide and the magnitude of the equity market rebounds. Interest rate cuts, bond buying (to the tune of $7.5 trillion in 2020, according to the IMF) and liquidity measures of central banks helped governments finance essential fiscal measures to support their economies. This reassured investors that policy would remain supportive until vaccines pave the way for a return to normality. It also helped support equity and credit valuations. By the start of June, Vix returned to its 200-day moving average.
During this time oil prices collapsed. The cost of such a symbolic physical asset going below zero was astounding. The interplay between financial and physical markets is always complex, but in 2020 we saw its extreme—a toxic mix of unchecked production, zero storage capacity, and zero demand lured speculators into pushing the price to -$37 per barrel. It is almost absolutely unlikely that we will see this happen again.
When will we get normality in a post-pandemic environment? Economic scarring will remain a concern, while new ways of work and play may have to be continued. On a global level, the emergence of a tripolar world of the U.S., Europe and Asia will continue, increasingly creating their own economic ecosystems and supply chains. Total fragmentation is not likely but the return of globalization will also not be on the cards.
The new President in the White House will have a huge bearing on the re-forming of global alliances. The blue sweep has been the catalyst for U.S. 10-year bond yields to climb above 1%. The sharp rally in risk markets since the vaccine news in early November, more government stimuli and a Brexit deal, all caused yields to double. With inflation expectations also moving higher, the dollar is expected to continue suffering, having already lost nearly 7% of its value in 2020. Falls of between 5-10% this year are forecast by many on Wall Street as the safe haven nature of the greenback fades, while higher inflation and ultra-loose monetary policy erodes the value of the global reserve currency.
Traders rarely see a straight-line selloff of the dollar; a stalling world economy or vaccination distribution issues are likely to delay the great greenback sale. Undoubtedly, the U.S. Federal Reserve will have a big say, especially if it takes away the stimulus punchbowl too early. The central bank may well be prepared to tolerate core prices running above their target of 2%, but it is also cognizant of a long period of ultra-low interest rates and slumbering inflation. Underlying economic growth should support equities but higher interest rates will weigh on growth and tech stocks in particular. Investors will be wise to watch how high the Fed allows rates to drift, as withdrawal of emergency measures will generate potentially significant market volatility.