The financial markets have for some time now been riding a wave of exuberance over the prospect of economies again being able to run at full steam in the foreseeable future. This has lessened the impact of another slowdown in Europe and the US on the back of this winter’s new lockdowns.
Instead, the financial markets have looked ahead – beyond the crisis – and focused on the vaccine rollout.
“An unequivocal farewell to restrictions and lockdowns is probably still some way off, but recent developments give grounds for optimism and we continue to recommend that investors have a modest overweight of equities in their portfolios – in other words, a slightly higher share of equities than they expect to have in the long term,” says investment strategist Lars Skovgaard Andersen in Danske Bank’s new Quarterly House View report.
A good deal of positivity already priced in
While rising yields in recent weeks have triggered some turbulence in equity markets, Lars Skovgaard Andersen does not consider higher market rates and yields a major problem, as long as they increase for the right reason – namely stronger economic growth.
However, as the investment strategist points out, the speed and strength of the global economic recovery is still tinged with considerable uncertainty.
“Equities typically perform well overall during periods of increasing economic growth, so the trend still appears to be up for equities. We must remember, though, that the financial markets are naturally forward-looking and focus on what the world is expected to be like in 6-9 months. We should therefore assume that a significant share of the expected economic upswing in 2021 is already priced in by financial markets. Hence, the biggest equity price rises may well be behind us, even though we still expect equities have more to give over the next 12 months. Investors should also be prepared for periods of market turmoil and volatility along the way if, for example, the global economic recovery does not unfold as quickly as expected,” says Lars Skovgaard Andersen.
More specifically, we expect a return of 3-7% from equities over the coming 12 months (calculated in euro).
No celebration for bonds
In the world of bonds, an economic upswing can be expected to push inflation and long yields up – a trend we have already seen recently. This in turn means falling bond prices and thus an eroded return from bonds, which already provide only limited interest payments.
“While the accommodative monetary policies of the central banks, with low interest rates and massive bond purchases, may put a lid on how far yields can rise in the near future, the return potential from bonds is extremely limited, so we are maintaining our modest underweight here,”says Lars Skovgaard Andersen.
He currently sees the greatest return potential in more risky bond types, which would tend to benefit most from an economic upswing in 2021. More specifically, he points to emerging market bonds and high yield bonds, which are corporate bonds of low credit quality.
“That being said, during periods of market turbulence these bond types would also be the hardest hit, which is why investors should include other, more secure bonds in their portfolios, even though interest rates are lower here,” says the investment strategist.