My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Recap of 2020 in the Global Financial Markets

2020 was an amazing year in the financial markets, in that the trajectory and volatility of asset prices could have never been imagined at the end of 2019. Back in December 2019, there was some chatter about a strange virus in China, but these rumours were routinely dismissed as a local issue with not even an inkling that it would – within a matter of months – turn into a profound global pandemic that would shake every corner of the world. COVID-19 arrived with a vengeance and reality sat in by late February, as financial markets sold off and governments scrambled to respond. In case you want to review the chronology as the reality of the pandemic settled in, I have attached a brief chronological summary at the end of this article.


This unusual journey in 2020, driven by what is hopefully the only pandemic we will witness in our lifetimes, led to profound changes in consumer behaviour and accelerated some trends that were already occurring, including:

  • WFH, or “work from home”, which will have long-term effects in the future on where people choose to live and work, how often people will need to travel for business, etc.,

  • A thriving delivery / logistics business for food, groceries, and nearly anything retail,

  • Concurrently, the demolition of large swaths of traditional retail storefronts and restaurants that were unable to rapidly adapt to the reality of on-line ordering and delivery to ensure their survival,

  • Threats around travel and entertainment, as airlines, hotels, cruise ship companies, casinos, cinemas and theatres were decimated; the availability of more “down time” focused consumers’ attention on streaming, at-home exercise, on-line shopping, etc, all of which will reorder consumer preferences and priorities when the pandemic ends,

  • Initial concerns about the solvency of banks gave way to the reality that banks were (so far) fine, as growing deposits strengthened their liquidity positions and fiscal stimulus helped to support borrowers and perhaps entire industries that would have otherwise defaulted on their loans,

  • Rising savings that flowed – and is continuing to flow – into risk assets like equities and cryptocurrencies, as the global financial system became flooded with liquidity,

  • Related to the prior point, assurances from central banks that interest rates would remain at or near record lows for an extended period of time through unconventional monetary policy in the form of quantitative easing,

  • The most robust borrowing by companies and governments that has ever been seen, with governments especially being forced to address the severe crisis at hand without consideration to the burden that will be borne by future generations in terms of dramatic increases in government spending to prop up their economies, and

  • The acceleration of wealth inequality.

Now that 2020 has ended, I have prepared a series of tables, charts and graphs in this article that capture performance across an array of asset classes for this tumultuous year. It seems remarkable that the global economy and select sectors experienced such poor performance, yet risk assets nonetheless continued to march steadily higher throughout the year. In fact, some asset classes – including US equities and cryptocurrencies – reached record highs by year end. The performance of financial assets in 2020 was undoubtedly stoked by governments unleashing unprecedented amounts of debt-financed stimulus, and central banks printing money hand over fist. The reality is that the cost of these policies to address the pandemic are not really considered by investors at the moment. Also, as the year progressed, more rationality slipped into some asset classes, as the relationship between prices and expected performance became more of a focus at the expense of pure momentum investing / FOMO (i.e., “fear of missing out”). Investors have become slightly more discriminating since late August, leading to trends like the emergence of value over momentum in the equity markets, and WFH stocks falling in and out of favour depending on sentiment with respect to the direction of the pandemic.


Even so, the reality is that valuations in equities in the US are at “nosebleed” levels and corporate credit (bond) yields are at record lows. The price of WTI crude oil recovered much of its losses, and gold found a trading range at levels much higher than pre-pandemic levels. US Treasury yields remain at historically low levels. The yield on the 10-year German bund (Eurozone proxy) is negative, whilst the yield on the 10-year JGB is managed (by the BoJ) to around 0%. Bitcoin has surged, especially in the second half of 2020. The only real loser this year has been the US Dollar, but even that journey had two parts, with investors flocking to the world’s safe haven currency in the darkest days of the onset of the pandemic (through 1Q20), and then shedding the currency with impunity as risk appetite geared up (2Q-4Q2020).


I hope you find the charts below useful as a reference point as 2021 unfolds. I have provided limited commentary as the charts largely speak for themselves.


Equities


The S&P 500, the Nikkei 225 (Japan) and the MSCI EM indices all generated strong returns in 2020, trailed slightly by the Shanghai index (China). The European indices had negative returns, with the FTSE 100 (UK) having a negative double-digit return, by far the worst of the indices that I track. I suppose there is some good news though, in that the fourth quarter returns for the FTSE 100 (+10.1%) and the STOXX 600 (+10.5%) were only slightly below the return of the S&P 500 (+11.7%), as investors shifted from more expensive US equities into other equity markets that offered more value. Whilst the P/E ratios for both the S&P 500 and Nikkei 225 are in the mid 30x’s, the P/E ratio for the FTSE 100 is only at around 20x

The graph below is the PE ratio of the S&P 500 index since the 1870s (source: www.multpl.com)

Focusing on the US equity markets a moment, the NASDAQ Composite outperformed all other US indices as the tech and healthcare heavy index soared during the pandemic. Surprisingly, the Russell 2000 was the second best performer as value stocks and mid-cap names rallied in the autumn as investors sought less expensive stocks that offered more value.

Government Bond Yields


Government bond yields fell across the board in most countries as central banks engaged in unconventional monetary stimulus, anchoring the overnight borrowing rate at or below zero, and using quantitative easing to lower intermediate and longer term rates to stimulate borrowing. The slope of the yield curve – expressed by the difference between 2- and 10-year USTs, has steepened modestly throughout the post-recovery period as the economic outlook post-pandemic brightened.


As you can see in the table below that compares yields on government securities in other large developed markets over time, the 10-year US Treasury is currently the only government bond (of these) that remains comfortably positive. The historical sequence shows that yield have fallen across the board, starting with the Great Recession and largely continuing from then.

Corporate Credit (i.e., corporate bonds)


Had you not witnessed the significant widening of credit spreads in the 2Q2020, this might have looked like an ordinary year in credit with spreads in investment grade (BBB) ending at about the same level as the end of the prior year, and US and European high yield spreads ending only slightly wider. As corporate bond investors know though, it was far from a smooth journey. The Federal Reserve’s inclusion of investment grade corporate bonds, “fallen angels” and high yield ETFs in their massive quantitative easing programme bolstered the corporate credit markets, driving down spreads and ensuring that companies had access to the capital markets for funding. Yields on corporate bonds were an even more positive story, as the decline in underlying benchmark rates (i.e., US Treasuries) pushed yields on investment grade and high yield credits to record lows.


Gold, Yen and the US Dollar (all safe havens), WTI Crude Oil and Bitcoin


This is an interesting mix of assets. Gold rallied in 1H2020, benefitting first from its safe haven status and then as a potential inflation hedge, before finding a range mid-year in the $1,850-$1,950 area. The Yen weakened for similar reasons to the US Dollar, as investors moved into riskier assets and riskier currencies as the recovery strengthened. This migration largely benefitted emerging markets stocks and bonds, as investors sold the US Dollar to take on more risk. WTI crude has a journey one could have never imagined, even going negative for one day in April as global demand waned and OPEC+ struggled to develop a consensus on supply cuts to support prices. As the economic outlook brightened slowly but surely in the second half of 2020, oil found its footing and OPEC+ held to its production cuts, pushing oil gradually higher. Bitcoin and other cryptocurrencies rallied strongly from the 2Q20, gaining momentum in the 4Q and especially in December. Bitcoin reached a record high by year end and has continued to trade higher during the holiday weekend, reaching $34,000/BTC. The surge is perhaps attributable to FOMO, a (reported) growing number of hedge fund investors embracing the crypto asset class, a weaker US Dollar, use of BTC as an inflation hedge, or some combination of all of these factors.


 

Appendix: Chronology of COVID-19 in 2020 – Effect on Governments and Markets


COVID-19 went from a concept early in 2020 to a harsh reality, and the reaction of governments and financial markets evolved in an unimaginable path during the course of the year.


  • Early 2020 – Initially, most officials, including public health officials, dismissed the virus because it was local / “a China issue”,

  • Feb 2020 ­– Eventually, as COVID-19 spread outside of China, the risks were acknowledged albeit diminished, since the virus was expected to be containable and – in any event – “no worse than the flu”,

  • Late Feb / Mar 2020 – When the gravity of the virus was finally recognised, sentiment changed very quickly and adversely in the financial markets as investors ran for the cover of cash and safe haven assets, dumping risk assets en masse,

  • Mid Mar / Apr 2020 – Governments around the world tried to slow the spread of the virus by mandating comprehensive and severe economic lockdowns that led to “manufactured recessions” in many parts of the world,

  • Late Mar / Apr 2020 – Concurrently with self-imposed lockdowns, governments and central banks unleashed an unprecedented amount of fiscal and monetary stimulus to soften the blow of the “manufactured” global recession,

  • Apr / May 2020 – Savings skyrocketed (because folks couldn’t travel, eat out, etc) and financial assets began to recover, as liquidity awash in the financial system pushed assets of all shapes, forms and sizes in one direction – up – in spite of the uncertainty that lay ahead and the poor earnings outlook for many companies,

  • Jun-Aug 2020 – Feelings of optimism in the summer increased as warmer weather (in the northern hemisphere) and adherence to rules like social distancing and mask wearing seemed to bring the spread of COVID-19 under control, which gave way in the late summer / early autumn to the reality that the virus was again spreading as people and (many local) governments became too relaxed,

  • Sept / Oct 2020 – As might have been anticipated in retrospect after governments relaxed constraints and people let down their guard in the late summer, cases of COVID-19 began to increase again in Sept; further lockdowns to varying degrees occurred in October starting in France and then spread to most of the rest Europe by early November; stricter provisions were also adopted by some US states (as federal leadership in the US on this matter remained non-existent),

  • Nov 2020 – Optimism returned in Nov as several pharma and biotech companies announced the development of highly effective vaccines in November (Pfizer-BioNTech, Moderna, AstraZeneca-Oxford University), concurrently with some re-relaxation of partial lock-down provisions,

  • Dec 2020 – The reimposition of lock-downs of varying degrees occurred throughout the latter half of December as the spread of the virus increased again, and the reality as far as the eradication of the virus through the implementation of vaccines began to be better understood (meaning that the virus would continue to thrive in 2021 until vaccines could be sufficiently administered in most countries around the world). Financial markets didn’t seem to care.


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