I feel cautiously optimistic as I look to 2021 – and “cautiously” is the operative word.
The US economy has demonstrated a remarkable resilience, showing it still has the stamina to bounce back from the COVID-induced recession. As states eased lockdown restrictions earlier this year, consumer spending rebounded, driving a V-shaped recovery in gross domestic product (GDP) and employment. Fiscal and monetary support has proved crucial, and the benefits will continue to accrue: the personal savings rate remains high, at close to 15 per cent, and households have improved their credit standing with average credit scores at their highest levels since records began in 2005 – building firepower for future spending.
This recovery in spending and jobs growth has already withstood two adverse shocks: the second wave of COVID-19 contagion during the summer, and the expiration of the first extraordinary fiscal support package in July. This provides some optimism for how economic activity will respond to a potential winter seasonal surge in new infections. There has also been a positive trend of the contagion becoming relatively more benign, with hospitalisations and deaths rising less than new cases. This is partly because more new cases involve younger and less vulnerable age brackets, and also thanks to improved knowledge on effective therapeutics.
Navigating the path to recovery
Our Franklin Templeton–Gallup Economics of Recovery Study has confirmed that Americans’ willingness to engage in a range of economic activities – from traveling to visiting restaurants and shops, to working outside the home – has similarly proved resilient to the second and third waves of COVID-19 contagion, but it also revealed that the launch of an effective vaccine could prove essential for a majority of people to feel comfortable enough to go back to fully normal patterns of behavior.
And the latest news on the vaccine front has been encouraging: shortly after the US presidential election, pharmaceutical companies Pfizer and Moderna separately announced that their vaccines have shown around 95 per cent effectiveness in clinical trials. There now seems to be a good chance that we could have a highly effective vaccine on the market by the spring.
The November US elections are now behind us. While not all official results have been determined at the time of this writing, it seems extremely likely that Joe Biden will be the next president. At the same time, however, the Democratic Party has seen its majority in the House of Representatives diminished, and Republicans may well maintain their majority in the Senate, as long as they win at least one of the two runoffs scheduled for January in Georgia.
A divided government might bring some benefits for the economic outlook, by reducing the probability of major changes in policies and regulations that might otherwise risk having an adverse impact on the overall economy or on specific sectors.
I expect additional sizeable fiscal support measures to be passed between the end of this year and the first quarter of 2021. If the Republicans keep a majority in the Senate, the fiscal package might be somewhat smaller than was expected in a “blue sweep” scenario – where Democrats controlled the House and Senate along with the presidency – but it would still be very significant.
A vaccine would also brighten the economic outlook in the rest of the world, notably in Europe where a resurgence of COVID-19 cases is currently pushing several governments to reimpose serious restrictions on social and economic activity.
I said the operative word was “cautiously”. If the vaccines see their effectiveness and safety confirmed, they will then have to be produced and distributed at massive scale, which is no small challenge. Moreover, our joint study with Gallup has shown that only between one-third and one-half of Americans would be ready to take a vaccine. Unless a large enough majority of the population is willing to be vaccinated, even a highly effective vaccine will not be able to rapidly reduce contagion and allow economic activity to return to normal.
Meanwhile, even the very resilient US economy has suffered some significant damage, some of which might prove long-lasting. Permanent job losses are up by 2.4 million since February and account for nearly half of the increase in unemployment since then, even though job openings have already risen above pre-COVID levels. This might signal an emerging structural mismatch of skills, possibly tied to the fact that the COVID-19 recession has hit some sectors a lot harder than others. Prolonged school closures might also have significant adverse long-term effects. Remote learning has proved a very inferior substitute for in-person education, especially for younger students and particularly for those from lower-income backgrounds; the long-term damage in terms of lower skills, reduced earning potential for the students and lower productivity for the economy might prove heavier than we currently realise.
These adverse consequences would be magnified if the country were to head into a new phase of widespread lockdowns, which could also potentially result in a double-dip recession.
How policymakers manage the next several months therefore matters a lot, not just for the immediate recovery and the 2021 outlook, but also – and perhaps even more so – for the longer term. We are thus still heading into 2021 with a lot of uncertainty, some massive economic imbalances and policy measures of unprecedented magnitude on both the monetary and fiscal sides. It’s not surprising that stock prices and bond yields have already shown massive swings in response to headlines on the political or healthcare fronts.
The market may also be underestimating the potential inflationary effect of the unprecedented fiscal and monetary stimulus and rescue packages, in addition to the likelihood of increased in-sourcing and shifts in supply chains that may result from the current crisis and ongoing tensions with trading partners. (I believe tensions between the United States and China are here to stay even with a change in US administration.) With the economy already demonstrating a healthy capacity to rebound, and given the amount of fiscal and monetary stimulus already delivered and under consideration, an earlier-than-expected rebound in growth and price dynamics cannot be ruled out.
I am not predicting a major rise in inflation, but even a moderate acceleration in price dynamics would be enough to exceed the sanguine expectations of most market participants and cause further yield curve steepening in US Treasuries over the course of 2021.
Finally, the combination of large potential macroeconomic swings with some long-term structural shifts triggered or accelerated by the pandemic strengthens my view that active asset selection based on high-quality fundamental analysis will be crucial to any successful investment strategy. Fixed income allocations will continue to play an important role in many investor portfolios as a diversifier, as well as a historically lower-volatility asset compared with equities. But from the perspective of credit, bottom-up selection has never been more important, in my view.
Valuations are a concern in many sectors, as the market is not properly priced for the level of uncertainty. We see no obvious areas of undervaluation remaining; to the contrary, some sectors like commercial real estate remain vulnerable. As a number of states will likely need to increase taxes to get their finances on a more sustainable footing, the tax-free municipal bonds sector will likely become an even more valuable source of investment opportunities. Non-US fixed income assets also present selected opportunities. The massive stimulus program in Europe, combined with the European Central Bank’s accommodative monetary policy, offers support for European government bonds.
2021 will be challenging, but it could be equally rewarding.
Sonal Desai, chief investment officer, Franklin Templeton Fixed Income