2020 has been one of the worst years in living memory. Worse than 2008, which has earned the moniker “Great Finance Crisis” to follow on from the Great Depression of the 1930s. The year started with a growing panic caused by a looming global climate crisis that was quickly followed in short order by multiple shocks from collapsing oil prices to a global pandemic with a liberal sprinkling of increasingly illiberal democracies, several wars and persistent terrorist attacks. That’s not to mention US President Donald Trump – arguably the worst president in US history.
"This is the worst crisis since the Great Depression, and it will take significant innovation on the policy front, at both the national and international levels, to recover from this calamity," the IMF said in a recent blog post.
But take heart. As 2020 draws to a close 2021 is already looking like it will be a lot better. There are now four competing vaccines to deal with the coronavirus (COVID-19) pandemic that will start to be available in December. Oil prices are returning to reasonable levels. Economies around the world are already starting to recover and the International Monetary Fund (IMF) predicts global growth for next year. The climate crisis remains a problem, but the reduction in travel has already helped reduce emissions and bought a little extra time. Terror, illiberalism and the wars will also not go away, but some economic prosperity will help to ameliorate those problems too.
“Our base case assumes the launch of mass vaccination against COVID-19 sometime in 2Q21-3Q21 and a ‘victory’ over the pandemic in late 2021 or early 2022. In the short term, the epidemiological situation will likely remain rather complicated, but infection rates should slow significantly in Russia, Europe and the US with the approach of spring and summer,” BSC Global Markets chief economist Vladimir Tikhomirov said in a note at the end of November.
“The turning point should come around March-April 2021, when a reversal in the base factor and the approach of spring should bring Russia’s – and the world’s – GDP growth rate back to black. These positive changes should be supported by the mass vaccination of the global population from mid-2021. Russia’s economy should get a double boost from rising levels of domestic activity in the services, trade and investment areas, as well as from positive shifts in external factors (higher global demand will support commodity prices and should trigger more activity from Russian exporters),” Tikhomirov added.
Indeed, some analysts are arguing that 2021 might be the start of a huge multi-year long boom as a new super cycle starts. Equity markets are likely to see a big relief rally – especially in Emerging Markets (EMs). As populations emerge from their artificial hibernation – both official and self-imposed – a year’s worth of pent up demand for shopping, eating out and holidays will be unleashed that will give everybody’s economies a large impetus. The same is true at corporate level, where delayed fixed investment plans will be reactivated, hopefully starting a virtuous circle turning of investment-growth-profits-wage hikes-spending.
On top of that there will be the government-led fiscal stimulus initiatives that will lift growth. The EU has borrowed an unprecedented $150bn that it is using to support member states, and those in the Balkans will receive aid equivalent to a third of GDP in some cases. In general, borrowing has soared to new all-time highs as governments and companies around the world top up on debt to get themselves through the COVID slowdown.
Indeed, there are many signs that the coming recovery is already underway as some investors begin to position themselves for a dramatic change in the mood music.
“The trio that has injected optimism into the risk trade remains alive and well. Indeed, still operative are the prospects for a COVID vaccine much sooner than expected, expectation of central bank stimulus (US Fed stands ready, as per FOMC minutes) and an improving global economic growth outlook in the medium term (as vaccines are administered, lockdowns ease and Biden’s economic policy of engagement vs Trump’s bent toward protectionism reduces trade tensions),” BCS GM said in a note at the end of November.
But be warned: in the short term things could get worse before they get better as the second wave gathers momentum and infection rates soar around the world ahead of the holiday season.
The mood brightened dramatically in November after several pharmaceutical companies released the preliminary results of their corona-candidate vaccines. Pfizer, Moderna and Russia’s Sputnik V all released preliminary Phase III trial results that showed all three vaccines have at least a 90% efficacy – very high for a vaccine.
Economists immediately upgraded their 2021 economic outlooks or added a back-to-work scenario where the pandemic fades away.
“The preliminary trial results for the vaccines of Pfizer and Moderna have shown markets a light at the end of the tunnel of the pandemic... With the preliminary trial results showing effectiveness above 90% for two vaccines having sparked enthusiasm, the S&P 500 has hit record highs and Brent has advanced to $44/bbl,” analysts Sberbank CIB said in a note in the middle of November. “Within stock markets, pandemic underperformers have massively outperformed the so-called stay-at-home stocks.”
It's still early days, as not all investors are convinced the nadir has been passed and Sberbank CIB was predicting more swings as fund managers see-saw between “enthusiasm” and “despair,” the bank said.
The release of trial results by the rivals has been marked by rallies, one-upmanship and Schadenfreude, but the bottom line remains: none of the leading drugs has shown any major problems to date, and actually all seem to work much better than could have been expected.
Russia was the first to register a vaccine and has already started inoculating health workers (and journalists). The mass global deployment of the first vaccines is due to start in December-January. Russian officials say that all of the country’s population over the age of 60 years could be inoculated in the first two months, which will rapidly reduce mortality rates there. Globally nursing homes and health workers will be vaccinated in April and March, with the general population in April and May. Analysts say that the effect of the vaccine roll-out will become fully apparent in the second half of next year, when the world could return to normal.
Analysts were also buoyed by the latest IMF World Economic Outlook released in October that predicted 27 of the 78 countries it covers will return to growth in 2021, albeit at reduced rates.
“In 2021 global growth is projected at 5.4%. Overall, this would leave 2021 GDP some 6.5 percentage points lower than in the pre-COVID-19 projections from January 2020,” the fund said in its outlook. It went on to say that the pandemic has caused the global economy to contract by 3% – much worse than in the 2008-09 financial crisis.
And growth will be uneven, disproportionately favouring EMs. The most important was the 2% growth expected in China, pushing its GDP up to $14.9 trillion, or 18% of global GDP. And China, Taiwan and Egypt are the only EMs predicted to grow in 2020. From the New Europe region only the frontier markets of Uzbekistan and Tajikistan are expected to put in positive growth this year, according to the World Bank. But almost the entire region is anticipated to be back in the black next year.
Stepping back a little and the Developed Markets (DMs) have suffered more in 2020 than the EMs. The IMF calculates that DMs will see a -5.8% contraction in 2020 and 3.8% growth in 2021. That compares with a -3.0% contraction in EMs in 2020 and a 6.2% bounce back in 2021.
Among the EMs Asia does best with a very mild 0.7% contraction this year and a whopping 8% bounce back next year. For Emerging Europe the numbers are -4.5% and 3.8% on aggregate respectively.
End of trade wars, resumption of FDI
Back-to-work scenarios will lift growth, but the general investment climate has also improved and will act as a tailwind, says Charlie Robertson, the chief economist at Renaissance Capital, thanks to the change of administration in the White House.
One of the remarkable features of the Trump presidency is that FDI reversed and the net flow was into the US, whereas previously Americans were net investors into foreign markets.
Speaking at the bank’s 25th anniversary conference, Robertson explains it simply that as companies couldn't predict which market Trump would pick a trade fight with next, and so bring down punitive retaliation, so they chose to build new factories at home, despite the higher wage bill. At the same time, Trump introduced tax breaks for US companies investing at home. Combined, this reduced outbound FDI by $200bn in 2018 and kept outbound FDI to under $100bn in 2019 and 2020.
The last time EMs were booming, US FDI to other countries (not just EMs) rose to a 2007 peak of $400bn annually, well in excess of the peak value in the period of a little over $200bn. The difference was an FX outflow worth nearly $1bn per working day and dollar weakness is usually good for EM markets. Under Trump the US attracted a net $1bn of inflowing FDI a day, which led to strengthening of the dollar.
As the trade wars are due to end, those FDI flows are anticipated to reverse again, with EMs being one of the biggest beneficiaries. Robertson is predicting a medium-term consistent weakening of the dollar as a result of the FDI outflows that will lift EM markets.
“Unsurprisingly, when MSCI EM is about 40% China, the trade wars have not been helpful to the EM investment case. With President Joe Biden, we expect the US to build stronger links with America’s allies, rather than to escalate attacks on them,” says Robertson.
Robertson thinks it will take a little time for this FDI reversal to kick in, but by 2022 the flows will return to their 2007 levels that will bolster inflows into EM markets and at the same time lead to a sustained weakening of the dollar. A $1bn a day flowing out of the US into EM markets is a lot of money.
Another expected dynamic is the falling inflation rates that will lead to a fall in bond yields as central banks across the EM world continue to cut rates. Ukraine’s inflation performance has been outstanding in the last two years, with the NBU aggressively bringing inflation down from double digits to only 2.6 as of October – its lowest level in modern history. The story in Russia is the same, with inflation down to 4% as of October and overnight rates repeatedly slashed to the current 4.25%.
There was a boom in local bond investment in 2019 after several markets in Central and Eastern Europe (CEE) got hooked up to the Clearstream international settlements and payment system, but as the yields fall investors have already begun switching into equities – a trend that is forecast to continue and gather momentum in the coming two years.
“So for the first time in years, probably since the taper tantrum in 2013 and the commodity crash of 2014, we think there are good reasons for a sustained bull run in EM,” concludes Robertson.