Outlook for year appears positive, but expect volatility

Chaos in Washington, another lockdown in London, resurgence of Covid-19 in Europe and elsewhere, a new administration in the United States rolling in and a patchy roll-out of vaccines around the world. Never in recent history have so many geopolitical events weighed so heavily on financial markets at the start of a new year.

No surprises that volatility has been the main discernible state of trading so far, and could remain a feature of financial markets for much of this year. Wall Street indices have reached new record highs, though in stilted fashion.

Still, most analysts and market strategists remain optimistic about the upside for global equities. And they have reason to be.

Despite the chaotic scenes over the past week in Washington, both the House and the Senate have ratified Mr Joe Biden's presidential victory. So while a divided country will still see protests and opposition to the Biden/Harris administration, the country will be swearing in a new president come Jan 20.

What is more critical is that the political party of the administration will control both chambers of the US Congress. The win by the two Democrats in the Georgia run-off essentially provides a "blue wave" for the administration to push through its massive fiscal spending and stimulus agenda during the next two years at least.

As Mr Vasu Menon, executive director for investment strategy at OCBC Bank, points out, the recent weak US employment figures highlight the necessity for fiscal stimulus. "The Republicans had opposed aid for state and local governments, but the Democrats will now be able to pass a package that includes this. The Senate also refused to vote on a House measure to boost stimulus cheques to US$2,000 (S$2,650) from US$600 in December last year," he said. "That could now go ahead as well. More unemployment assistance and healthcare measures could also be on the cards."

Of course, the market is wary of the propensity for the Democrats to reverse the Trump tax cuts. Some market insiders also fear new minimum wage rules and more regulations on the energy, tech and financial service fronts.

But the new administration's priorities, at least in the next year, will likely be to boost the economy, rather than slap on new regulations. In any case, there are enough Republicans and moderate Democrats around - at least for now - to stymie a radical shift in regulations.

Meanwhile, as the new administration readies to unleash a huge stimulus Bill, the Federal Reserve and central banks in Britain, Japan and the European Union have embarked on quantitative easing (QE), unleashing a flood of liquidity into the market. Around the world, other major central banks have followed suit.

This flood of easy money has depressed interest rates and generally weighed down yields. And the search for yield has been pushing equities higher worldwide.

That said, most of the easy money has been made, especially in big tech.

With the vaccine roll-out gathering steam, some of the funds have been rotating to medium-term winners, recovery plays and growth stocks. Hence, sectors like banks, energy, commodities, travel, logistics/supply chain and properties have seen renewed interest. But there are also newer themes emerging, such as in e-commerce, fintech, digital payment systems, artificial intelligence, green mobility, life sciences and renewables.

Meanwhile, a shift from growth stocks to value plays is already evident in the way banks and industrials are recovering.

One overarching investment theme is Asia, which is expected to be the fastest-growing part of the world. But Asia is diverse. Japan, India, China and South-east Asia have their own economic, political and social peculiarities.

But there are some commonalities that the market will play upon. These include the fast-growing middle class, the increasing appetite for travel and luxuries, and urbanisation. Some societies are also facing fast-ageing demographics.

Climate change and issues of environmental, social and governance will also come into sharp focus and into play.

As the Covid-19 situation gradually subsides and normality returns, hopefully during the second half of this year, the accompanying economic recovery could further boost market confidence. The laggards of the Covid era could be revived.

So what are the risks?

Geopolitical events could still be the biggest danger for the market. But there is much hope that a Biden administration will take a more informed and nuanced approach in dealing with friends and foes alike.

DBS strategist and chief investment officer Hou Wey Fook also cites potential inflationary pressures. "The biggest risk is inflation rearing its ugly head, leading to interest rates rising sharply. But our base case is in line with the Fed, that is, low inflation for a while yet. Hence near-zero rates and asset purchases under QE will stay in 2021, lending support to risk assets."

Indeed, given the excess capacity in the economy, it is difficult to see sustained inflationary pressures building up.

Other risks include the possibility that Covid-19 lingers as vaccines do not fully do the job, impacting travel and international commerce as borders remain closed. There is also the risk that the US political turmoil continues and even intensifies.

But given what we know now, the outlook for the year seems sanguine, especially on the global geopolitical front.

A new US administration in place will raise the potential for greater political stability and a return to multilateralism.

As OCBC's Mr Menon summed it up: "In a nutshell, the economic and political benefits from a more stable political environment in the US could augur well for global stock markets, which may continue to enjoy more upside in 2021."

Nevertheless, the road ahead may not be smooth, he added.

The new normal heralded by Covid-19 means that investors must be prepared for continued volatility and intermittent pullbacks, he warned.

Indeed, nimbleness will be the winning strategy.