The U.S. and other major economies have recouped a significant portion of the output lost during the COVID-19 recession of 2020, and China’s economy has moved to new output highs. We believe the V-shaped recovery that began in May of 2020 for most economies will give way to a less dynamic, possibly bumpier phase of growth. But all major economies seem set to reach their previous peak output levels much faster than they did following the global financial crisis. The continuation of ultralow interest rates should support higher stock prices while making fixed income investing more challenging. Following are our thoughts about portfolio positioning for 2021 by asset class and region, and our forecasts for currencies and commodities.
RBC’s annual real GDP growth forecasts (y/y)
Source - RBC Global Asset Management; data as of Nov 2020
The major global central banks will likely keep the stimulus pedal to the metal in 2021, but amid concerns policy tools are already nearing speed limits, look for policymakers to fine-tune current programs in order to deliver the most efficient and focused aid to support the economic recovery. Negative rates will likely remain off the table for the Federal Reserve even as the Bank of England explores their efficacy. We believe expanded asset purchase and lending programs will remain the primary economic support vehicles.
Yield forecasts signal a long road to recovery
Source - RBC Wealth Management, Nov. 2020 Bloomberg Survey; data through 11/20/20; forecast period of Q4 2020 to Q4 2022 shows median estimates, shaded regions represent central range of forecasts
- Fiscal support will likely be lacking in 2021 amid political gridlock, with the burden of the economic recovery again falling on the Fed. Regardless of any COVID-19 vaccine rollouts or the pace of the economic recovery, we believe the Fed will need to keep policy rates at zero percent for years to come. Asset purchases are likely to continue, but we see the Fed shifting the composition toward longer-dated Treasuries in an effort to anchor rates and provide more stimulus.
- Though Fed policies should act as an anchor on Treasury yields, we still see yields rising and curves steepening on improving growth and inflation expectations over the course of 2021, though at a shallow and glacial pace, meaning the 10-year Treasury yield is likely to hold below approximately 1.25 percent for the balance of 2021.
- We believe credit markets will remain well-supported throughout the year as the Fed’s lending programs are likely to remain in place, with additional support from high equity market valuations and an ongoing economic recovery. However, current fixed income valuations already reflect this as credit spreads—or the additional yield compensation for credit risks over Treasuries—are below historical averages. With little threat of sharply higher Treasury yields, we think investors should look to preferred shares for additional income within portfolios in a low-yield environment.
- The Canadian sovereign yield curve remains at record lows in the front end due to central bank policy rates while yields further out the maturity spectrum fluctuated more as 2020 progressed. In an unappealing yield environment like this, we recommend traditional Government of Canada bonds for their liquidity characteristics in portfolios but look away for income generation. We maintain a focus on Real Return Bonds given the cost of inflation protection remains relatively cheap in Canada.
- Corporate bonds became less appealing for investors as 2020 evolved. The Bloomberg Barclays Corporate Bond Index in Canada has a sub-2 percent yield and an average maturity of approximately nine years, which is better than is available in government bonds, but leaves us less enthused about this segment as we head into 2021.
- Preferred shares remain one of the few areas of the Canadian fixed income space where investors can find four percent to six percent yields. We believe the combination of a steady demand for income and a reduced supply of preferred shares due to refinancing will support prices over 2021. However, our excitement must be tempered with the knowledge that preferred shares are highly sensitive to changes in market sentiment. A higher-than-normal allocation to preferred shares should be combined with defensive securities to produce a portfolio of income and safety.
Europe & UK
- Substantial central bank action by the European Central Bank (ECB) and Bank of England (BoE), with corresponding strong fiscal support from national governments and at the EU level, has been effective at anchoring interest rate expectations, while supporting government spending, corporate refinancing, and households during 2020.
- Europe still has to contend with the uneven recovery and re-opening of some countries’ economies over the months ahead. However, the outlook is constructive given the considerable joint fiscal and monetary stimulus across the euro area, with a further extension expected to come from the ECB.
- In the UK, the end of the transition period means the country leaving the EU single market for good. This heralds a challenging growth outlook which could see the BoE potentially doing more to support the economy. At best, we would expect range-bound market moves; however, we could see the low yields of 2020 being revisited.
- This leaves investors in an environment of low yields and flat yield curves heading into 2021. Given this backdrop, we continue to favour corporate credit over government bonds, and adopt a flexible and tactical approach in our credit selection. We see cyclical sectors benefiting from the recovery as it slowly starts to gain momentum during the first half of next year. However, the more defensive sectors that performed well throughout the pandemic may start to lag.
- We believe Asian bonds are particularly attractive for 2021 including their balance between rewards and risks. Asia’s economic recovery has been led by China, where an impressive V-shaped rebound is underway. GDP rose sharply by 3.2 percent y/y and 4.9 percent y/y in Q2 and Q3, respectively, after a contraction of 6.8 percent in Q1. At the Fifth Plenum of the 19th Party Congress held at the end of October, the Chinese government emphasized its aim of sustaining quality growth under its 2021–25 national economic and social development plan.
- In the current zero interest rate environment, we think the search for yield is here to stay. Asian bonds provide what we believe is an attractive yield pickup versus developed markets. At the same time, Asia is economically better positioned compared to the other emerging market regions of Latin America and Central and Eastern Europe Middle East and Africa.
- In Asia, we prefer high-yield to investment-grade bonds. The 7 percent–8 percent yield in the high-yield market is attractive but we caution clients the ride may not be a smooth one. Investors need to be nimble and selective as heightened idiosyncratic risks amid COVID-19 challenges, trade tensions, and debt burdens remain. However, we believe the risks should be contained.
Our view for 2021 features worthwhile equity returns and strong earnings growth as the COVID-19 economic headwinds diminish. For 12–18 months following the end of a recession there is usually very rapid catch-up earnings growth. Stocks in the major markets have priced in some of this anticipated better profits trajectory, but not all. The persistence of ultralow interest rates should support above-average valuations and make equities the asset class of choice in 2021. We recommend holding an Overweight position in equities.
Price-to-earnings (P/E) ratios of major equity indexes
|Index||Forward P/E||10-year average|
|S&P Small Cap 600||20.8x||18.4x|
|STOXX Europe 600||17.7x||13.7x|
Source - Bloomberg, Refinitiv I/B/E/S (S&P 500); data as of 11/23/20; represents forward P/E ratios based on consensus earnings forecasts for the next 12 months
- A number of economic indicators continue to move in the right direction, albeit at an uneven pace, despite lingering COVID-19 challenges. We expect corporate profits and U.S. equity indexes to gain more ground as the economic foundation becomes sturdier with the help of ongoing ultraloose monetary policies, another round of fiscal stimulus, and the taming of COVID-19 headwinds.
- The S&P 500 consensus earnings forecast of $168 per share for 2021 seems reasonable to us, and would represent roughly 20 percent y/y growth after the final 2020 results shake out. If this is achieved, it would push profits to a record level, beyond the pre-COVID-19 high of $163 per share reached in 2019.
- The S&P 500’s valuation of 21.2x the forward consensus earnings estimate is uncomfortably above average, but should not prohibit the index from advancing given that interest rates are likely to remain extraordinarily low. We think equity valuations will stay elevated as more investors come to realize that returns in fixed income are limited. To start 2021, we would position equity portfolios with a mix of cyclical (economically-sensitive) and defensive dividend-paying sectors. We would Overweight U.S. equities.
- A greater return to normalcy such as that afforded by a successful COVID-19 vaccine could be a powerful tonic for Canadian equity market performance in 2021. The S&P/TSX Composite trades at a marked valuation discount relative to some developed markets. An improvement in the perceived durability of the economic recovery could boost sentiment toward key sectors of the domestic market and help shrink its relative discount.
- Big Six banks have amassed CA$21 billion in credit loss provisions through three quarters of fiscal 2020. If the economic outlook brightens, actual credit losses could prove to be less than feared, and we could see a portion of these provisions released back into earnings. This is not our base case but is illustrative of what further evidence of sustained economic growth could provide to Canada’s largest industry group.
- Energy’s weight in the benchmark has eroded in recent years, but improved performance could further propel Canadian equities. RBC Capital Markets forecasts higher crude prices in 2021, which we believe is reasonable if a sustainable improvement in demand helps drain both oil and refined product inventories. We recommend a Market Weight position in Canadian equities.
Europe & UK
- We would hold a Market Weight position in both Europe and UK equities. Both economies face a difficult winter due to COVID-19, but based on a 12-month outlook, they should recover as infection rates subside and monetary and fiscal support work their way through.
- For Europe, the landmark €750 billion rescue package backed by joint EU debt should ensure aid is available in H1 2021. We believe an improving economic outlook would favour cyclicals, such as select Industrials companies underpinned by secular trends, and luxury and sporting goods categories where long-term fundamentals appear structurally attractive. Long term, we favour Health Care, a sector supported by demographics and rising global health care expenditures, and renewables-focused companies in the Utilities sector as governments target green and sustainable investments.
- The UK is continuing to adjust to leaving the EU single market, and we believe its economy will adapt to these challenging times.
- The FTSE All-Share Index has been a perennial underperformer since the 2016 Brexit referendum, and valuations are attractive relative to other developed markets. Moreover, we expect a notable rebound in dividends over the coming year as many companies are likely to reinstate their payouts as the outlook improves.
- We prefer UK companies that are well positioned to benefit from long-term structural growth tailwinds or possess internal levers to grow, particularly in the Consumer Staples, Health Care, and Industrials sectors.
- We remain Overweight on China equities. We believe the Chinese economy and corporate earnings are likely to record stronger growth in H1 2021 than in H2 2021 due to easy comparisons to 2020. The liquidity situation could be tighter compared to 2020 as the economy continues to recover. The renminbi may continue to strengthen versus the U.S. dollar, which could benefit sectors with large U.S. dollar debt exposure or whose raw materials costs are settled in dollars.
- The market generally believes the U.S.-China relationship would marginally improve under a Biden presidency. On the positive side, Biden views China as a “serious competitor” instead of a rival, and he believes imposing extra tariffs on Chinese goods is unwarranted. However, curbing Chinese tech firms could remain a key U.S. strategy, but this may be undertaken via a more traditional approach.
- For Japan, we expect economic growth to recover moderately in 2021 after a weak 2020 (the Bank of Japan estimates GDP for FY2020–21 at -5.5 percent and +3.6 percent y/y, respectively). With the global economy recovering, we expect the downward revisions to Japan’s corporate earnings to reverse. The term of Japan’s House of Representatives will expire in October 2021, and we expect the current administration to call a snap election. A strong mandate for Prime Minister Yoshihide Suga could be a catalyst for Japan’s equity market. We expect the stronger yen to persist, which would weigh on Japan’s key export sector. All in, we are neutral on Japan equities in 2021.
USD – Mixed performance. The dollar’s highly anti-cyclical characteristics could point to underperformance against more growth-oriented currencies as the global economy recovers and investors seek higher-yielding assets, particularly with ultra-loose Fed policy poised to persist. However, risk appetite remains a key driver of the dollar’s performance, and bouts of “safe-haven” demand could provide support amid ongoing tail risks.
EUR – Limited upside. The outlook for the euro has turned more constructive with the passing of the EU recovery fund and joint fiscal-monetary response to COVID-19. However, with positive catalysts largely priced in and concerns of slowing growth momentum amid the latest COVID-19-related lockdowns, gains could be limited for the euro in 2021.
CAD – Supportive risk backdrop. Although the Canadian dollar faces challenges with the growth rebound stalling and a rising fiscal deficit, we expect risk sentiment will continue to be the primary driver of the currency. A more positive risk backdrop and increased demand for commodities could keep the Canadian dollar supported.
GBP – After Brexit. Looking past the transition period when the Brexit process concludes, we still have reason to be cautious on the British pound through 2021. The UK’s weak financial position, challenging domestic growth outlook, and the possibility of negative rates could point to sterling underperformance.
JPY – Domestic flows. Alongside risk appetite catalysts, the yen will likely be driven by flows from Japanese investors. Due to low global rates, Japanese investors are repatriating foreign investments and adding hedges to foreign holdings, keeping domestic demand strong for the yen. These flows could provide support regardless of risk appetite.
2021 forecasts for currencies
|U.S. Dollar Index||94.71|
Source - RBC Capital Markets; for prices at year-end
WTI – Fuel the economy. Global lockdowns led to sharp double-digit losses for West Texas Intermediate crude in 2020. While vaccine news is positive for crude, RBC Capital Markets suggests further upside would require a resurgence in consumer demand and an improvement in refining margins. We expect further volatility but also upside participation alongside an economic recovery in 2021.
Natural gas – Economic drawdown. Natural gas surprised to the upside in 2020, and RBC Capital Markets believes the supply-demand dynamic should improve heading into 2021 driven by moderating gas production and increased liquefied natural gas export activity. Inventories remain elevated due to government shutdowns, and we expect drawdowns to pick up as restrictions are lifted.
Copper – Surplus position. Copper experienced a V-shaped recovery, bouncing 45 percent+ off its 2020 lows and is trading near the top end of its 18-month range. As China consumes roughly 50 percent of global demand, swift action by its government to curb the pandemic has benefited copper. Going into 2021, we expect the copper market to remain in a surplus position.
Gold – Resetting expectations. Gold has pulled back from its 2020 high driven by news of potential vaccines and therefore improved risk appetite. While a “normalized” economy may be a headwind for assets considered to be “safe havens,” we believe the environment remains conducive for gold due to low real rates and political/economic uncertainties going into 2021.
Soybeans – Soy-ing higher. Soybean prices rallied to an 18-month high on the back of growing Chinese demand and lower global production as a result of unfavourable weather conditions. Global ending stock for the 2020/21 season is well below the previous two seasons. We would expect a rebound in production and prices to normalize.
Wheat – Another record. Wheat prices have benefited from sustained purchases from China as part of the U.S.-China Phase 1 trade agreement and were up about 9 percent in 2020. The U.S. Department of Agriculture expects global ending stock to reach another record high in the 2020/21 season.
2021 forecasts for commodities
|Oil (WTI $/bbl)||$46.15|
|Natural gas ($/mmBtu)||$2.60|
Source - RBC Capital Markets forecasts (oil, natural gas, copper and gold), Bloomberg consensus forecasts (soybean and wheat); for prices at year-end
Non-U.S. Analyst Disclosure: Christopher Girdler, Patrick McAllister, and Richard Tan, employees of RBC Wealth Management USA’s foreign affiliate RBC Dominion Securities Inc.; Frédérique Carrier, Blaine Karbonik, and Alastair Whitfield, employees of RBC Wealth Management USA’s foreign affiliate RBC Europe Limited; Jasmine Duan, an employee of RBC Investment Services (Asia) Limited; and Nicholas Gwee and Chun-Him Tam, employees of Royal Bank of Canada, Singapore Branch, contributed to the preparation of this publication. These individuals are not registered with or qualified as research analysts with the U.S. Financial Industry Regulatory Authority (“FINRA”) and, since they are not associated persons of RBC Wealth Management, they may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts.