The great reset

Jean Chia December 16, 2020 10:03

2020 has been much maligned as the year we want to forget. The regrettable events of the year notwithstanding, the year deserves to be recognised for being the harbinger of change and the trigger for the great reset that will mark this decade.

The final weeks of this momentous year has been marked by a welcome boost to market sentiment, riding on the tail of a slew of recent positive vaccine developments; easing uncertainty over the US Presidential election outcomes and rising expectations of a US fiscal package.

Our view is that 2021 will be a year of economic recovery, despite near-term headwinds from surging new Covid-19 cases in some parts of the world and waning global economic momentum. Global central banks remain committed to ultra-loose monetary policy and continued fiscal support for the nascent recovery. These reflationary forces form a conducive backdrop, but investors will need to recognise the new realities caused by significant resets in three key areas.

Reset #1: The Economic Reset - Beyond Shots in the Arm

Breakthroughs in vaccine developments against Covid-19 and fast-tracked approvals in countries like the UK, have powered capital markets and risky assets to record levels since early November.

The capital market is not an honest mirror of today’s reality, but reflects an alternate reality viewed through lenses of investor expectations.

With cumulative vaccine manufacturing capacity of an estimated 8 billion doses by end-2021, the unprecedented global race by pharmaceutical firms, various positive results at trials, government support and the willingness of regulators to reduce red-tape and fast-track approvals, optimism appears justified.

Vaccines and government policies are mere shots in the arm for the world economy and markets.

The dark reality is this. Will the headline GDP growth figures and record stock market valuations mask the uneven nature of this recovery, and will the massive stimulus packages filter down to improve livelihoods?

Structural unemployment due to the obsolescence of entire industries or a shift in business models is a real and present threat, once the fast-forward button has been pressed. The onus on governments around the world will be to re-calibrate economic models to respond to the transformative impact of 2020.

Reset #2: Geo-Political Reset - China & Asia’s ascent

The rise of Asia, driven by China, is one of the most powerful forces reshaping the world economy and geopolitics today. China’s rapid rebound from the Covid-19 pandemic puts it in pole position to lead the global economic recovery with over 8 per cent growth in 2021.

The country’s bruising experience over the past four years during the Trump administration over US tariffs and restrictions on its technology sector has accelerated its pursuit of self-sufficiency in key sectors.

Emphasis in its 14th Five-Year Plan on quality growth, innovation, market reform and its “dual-circulation” strategy bode well for industry pillars that support clean and renewable energy, domestic consumption, high-end industrials, internet and “new infrastructure”.

China’s strategic intent to crack open its gates to international investors (which started 20 years ago) saw a renewed sense of urgency in 2020.

This was ostensibly sparked by a confluence of factors including escalating US-China relations, and rising hurdles in Chinese companies’ access to US capital markets.

Liberalisation of foreign ownership requirements of financial institutions and access to China capital markets were announced this year.

Chinese government bonds (CGBs) will likely be added to the benchmark FTSE World Government Bond Index (WGBI) starting October 2021 and estimated buying by global bond fund managers who track the index is around USD120 billion of CGBs.

Linkages to China via Stock Connect and Bond Connect were extended to Wealth Management Connect, a cross-boundary wealth management connect pilot scheme, for the Guangdong-Hong Kong-Macao Greater Bay Area (GBA).

Individual residents of GBA cities can invest Southbound in eligible wealth management products distributed by HK and Macao banks, while a reciprocal Northbound channel allows HK and Macao residents with designated investment accounts to invest in wealth management products from China banks.

Reset #3: Watershed Year for ESG

2020 was a wake-up call for the world to address the climate crisis, which is a known unknown for the world.

To stabilise global temperatures and avoid the potentially catastrophic effects of climate change, the Intergovernmental Panel on Climate Change (IPCC) concluded that net carbon dioxide (CO2) emissions must be reduced to zero by around 2050.

Successful and rapid decarbonisation of the world economy can limit global warming to 1.5°C above pre-industrial levels by the end of the century – the ultimate target of the 2015 Paris Agreement.

The shift that institutional investors have made into sustainable and environmental, social & governance (ESG) investing will likely gather momentum in the wealth management area, with tailwinds from intergenerational wealth transfer in wealth management and the regulatory impetus that has commenced in Europe.

The Global Sustainable Investment Alliance (2019) reported assets under management (AUM) of over US$30 trillion, managed according to responsible investment criteria worldwide in 2018.

Today, next generation and millennial investors are more inclined to allocate investments with ESG considerations. Our “Sustainability Made Simple” report, which was developed in partnership with EY, cited a 2019 survey which revealed that millennial investors’ interest in social impact investing had risen to 95 per cent, a 9 per cent increase from 2017.

Investment Implications: The Zero Fix – where are the opportunities for returns?

As we move into 2021, broad-based economic recovery, supportive macro policies, weaker US dollar and a lower rate environment support our risk-on asset allocation decision. We are overweight equities, particularly in Asia ex-Japan on positive fundamental and technical factors.

Investment opportunities in beneficiaries of structural shifts accelerated by the pandemic (such as digitalisation innovation and online consumption) remain attractive, as well as companies exposed to a cyclical recovery and resumption of economic activity on positive vaccine developments.

We have been overweight EM fixed income in 2020 and remain positive on Asian high yield with a preference for China credit, which is supported by valuations and the relative weight of China in credit benchmarks.

With interest rates pinned at ultra-low levels, we see limited capacity for nominal government bonds to offer a buffer against sharp drawdowns in risk assets within portfolios. Investors will need to seek alternative ways to increase portfolio resilience, including allocating to precious metals, hedge funds, private equity, and private debt.

While income expectations need to be reset lower, we expect the hunt for yield to drive demand for emerging market high-yield bonds, selected Singapore REITs, and steady dividend payers in equities. Overall, we emphasise maintaining a well-diversified portfolio with adequate cash buffers, focused on strong equity fundamentals and sound credit quality in bonds.

Finally, the rising severity of the climate crisis and ESG considerations by investors will prompt interest in sustainable investing.

Intensifying efforts by governments worldwide to enforce sustainable economic reforms and enhance incentives for decarbonisation will benefit industries and companies that support decarbonisation efforts and focus on generating profits with an eye on its purpose.

-- Contact us at [email protected]

Jean Chia

Chief Investment Officer and Head of Portfolio Management and Research Office at Bank of Singapore