Save, make, understand money


BLOG: The outlook for financial markets in 2021

Paloma Kubiak
Written By:
Paloma Kubiak

The damage has been done in 2020 but with the dawn of a vaccine, many are hoping for a return to normal. But will coronavirus keep its hold on economic growth and financial markets in 2021?

2020 is a year that will go down in history as one defined by extreme market volatility as a result of the Covid-19 virus, which inflicted further untold havoc on people’s health, livelihoods and freedoms. Now, as we begin to make more confident strides towards an economic and social recovery, we look at the key drivers for financial markets in 2021.

The UK is emerging from the end of its second national lockdown, and we are all hoping that enough has been done to avoid too much disruption to our Christmas plans. The imminent roll-out of the Pfizer-Biontech vaccine has also allowed for cautious optimism that if enough doses are administered by the Spring, we may see the back of widespread lockdowns. Many businesses will be keeping a close eye on this news, in the hope that society may be on the home straight towards a return to normality.

In terms of the good news, that’s about it. The damage done in 2020, which saw the biggest ever quarterly plunge in economic activity in most of our lifetimes, has left many major economies some way short of their pre-pandemic forecasts. That’s despite us observing the biggest ever rebound in activity in the third quarter. The global economy is set to contract by around 4%, and the UK is expecting a shrink of 10-11%. This means the influence of Covid-19 on economic growth and financial markets is likely to remain in the coming year.

Politics and Brexit

For once, recent political developments in the US are expected to have a calming effect on global markets. Why? Because President Trump, whose headline-grabbing tendencies have led to much instability in the last four years, will no longer be in office from January. The incoming Biden administration is expected to reinstate the much-needed international relations that will lead global economies out of the crisis together. This, combined with the end of incoherent economic policies and the limited likelihood of tax rises and further regulation, has given markets a state of euphoria at the prospect of a less volatile future.

With all that’s happened in the past year, Brexit developments have understandably fallen off people’s radars. As the end of the transition period approaches, attention is now turning to whether or not a deal will be struck on the UK’s future trading relationship with Europe.

However, we have already had a fairly ‘hard’ Brexit experience so far, meaning precursory arrangements have already been put in place on both sides. Negotiations, and subsequent outcomes, are therefore not as profound as in the past.

Short-term prospects will be more significantly impacted by monetary and fiscal policies, along with how the UK continues to tackle the fall-out of the pandemic. That said, negotiators must ensure adequate protections for traded goods and services, at the risk of the UK being disproportionately affected compared to other European countries.

The chancellor’s latest spending review communicated a rather bleak outlook for the economy, on account of fiscal spending, rising debt and unemployment, public sector pay freezes and long-term tax hikes. Despite this, 2021 should be somewhat rosier than this past year. We can reasonably expect to see a bounce in the first half of the year, followed by some reflection on the impact of the virus in the second. We shouldn’t count our chickens just yet though – as the chancellor says this is only the start of the economic fall-out.

Predicting market outcomes remains difficult, given the ongoing risk of dislocation from the economic reality, as has been evident during the pandemic. For example, some stock markets, particularly in the US, have reached record highs, despite the fact that millions are out of work and a tidal wave of corporate failures is on the horizon. Looking ahead, Brexit remains a significant dark cloud for UK markets, while the longevity of the global tech bubble is also questionable.

Opportunities for investors

This is unlikely to be the positive outlook many investors were hoping for, but it doesn’t mean opportunities are disappearing. Investors should focus on structuring their portfolios according to the dominant market trends. There is good long-term value in equities, and while we may see further market wobbles, central banks’ ultra-accommodative monetary policies are here to stay. In the short to medium term, fiscal policy should also continue to be supportive, though will eventually be removed.

UK equities have traditionally seen great yields, and we can realistically expect dividends to make a steady return in 2021, having been ravaged during the crisis. Large cap companies with an international exposure will also provide a natural hedge against political uncertainties in the UK, through overseas sales and currency movements.

For those with a disposition to US markets, exercising caution will be important, given that valuations are currently high. However, with US companies already at the forefront of innovation in its various forms, investors can afford to be selective, rather than seeking to gain overall market exposure. Equities, on balance, are the place to be.

Finally, following a transformational year for ESG investing, interest is likely to remain, if not rise, in 2021. Events of 2020 have heavily influenced investors’ mindsets, making us think more about our planet and social needs. In addition, market conditions have led to a rise in activity from young investors, for whom ethical and sustainable stocks are preferred.

Government policy is due to bring electrification of transport to the fore in the coming years, and technologies to facilitate e-mobility are already advancing. Businesses that capture these trends, and investment products that follow them, can expect to have another rewarding year.

Helal Miah is investment research analyst at The Share Centre