In the middle of the pack
For example, UK equities underperformed global stock markets in 2020, with the uncertainty surrounding Brexit weighing on investor sentiment, in addition to the coronavirus pandemic. UK small-cap stocks lagged the rally substantially and we expect them to catch up over the coming months. They are trading at a significant discount to global markets, leaving plenty of room for share prices to rise.

The UK small-cap segment is more heavily weighted to sectors that stand to benefit most from the recovery – including industrials, consumer discretionary and real estate – than its global counterparts. Notably, most of these sectors are cheaper among UK small caps than abroad. The country’s recovery from the pandemic is likely to be in line with most other large economies, enabling cyclical small caps to catch up with global stocks. Fading Brexit uncertainty following the deal with the EU should help too.

At the end of 2020 we dialled up risk in portfolios slightly to reflect our more positive outlook. The start of Covid-19 vaccination programmes and the fading of political uncertainty surrounding the US elections and Brexit have confirmed our confidence about the recovery. Although the winter lockdowns have put temporary brakes on growth, we’re maintaining our tactical risk-on stance.

Following the broad-based rally of risk assets from their 2020 lows, our focus will increasingly shift to asset classes that still offer the potential to catch up. They include UK small-cap stocks. We are also overweight US equities, which have compelling characteristics in terms of innovation, sector composition and higher profitability.

Although many countries have started 2021 with strict lockdown measures in place, the main difference from last year is that effective vaccines mean the economy is likely to begin reopening from this spring. Meanwhile, central banks are continuing to hold interest rates at record low levels to help governments fund their stimulus spending programmes. These debts will inevitably continue to rise, but the costs of servicing them should remain very low.

We’re expecting a strong deficit-financed fiscal boost to growth. As a result, those areas of the economy that have been particularly hard hit by the pandemic should bounce back more strongly during the recovery phase. They include more economically sensitive cyclical sectors, smaller businesses and some individual countries. As assets exposed to these areas close the relative valuation gap, they should outperform.

Several countries started vaccinating their most vulnerable groups at the end of 2020. Although the programmes have been slow to get going, the number of people receiving the vaccine is growing steadily and the pace is even accelerating in the UK and America. This trend should allow governments to relax lockdown measures in the spring, which in turn should reignite economic growth.

Effective Covid-19 vaccines mean we can at last look forward to our lives returning to the way they used to be before the health crisis. Encouragingly, Norway has already become the first European country to begin relaxing the latest round of coronavirus restrictions. We’re confident the vaccination programmes will allow our economies to reopen as 2021 progresses and that there will be a strong bounce back.

The brighter outlook has already rippled across financial markets. We follow a rigorous research-based approach to uncover the regions, sectors and investment styles that have the most to gain during the recovery – which are the ones that have been hit the hardest by the pandemic. We continue to have an overweight allocation to selected risk assets in portfolios, which we think will perform well this year.

For an overview of all these themes have a look at our Counterpoint 2021.

Countries, sectors and businesses that have suffered the most throughout the pandemic should bounce back the strongest during the recovery

Mind the gap

COUNTERPOINT FEBRUARY 2021

We also have an overweight allocation to emerging market equities. The composition of stock markets in these regions is attractive, with a relatively high exposure to technology and low exposure to ‘old economy’ sectors. Long-term growth expectations remain higher than for other markets, while earnings growth has bottomed. EM stocks currently show particularly strong positive momentum.

We have recently reduced our allocation to gold from overweight back to neutral. Following a strong run last year, we believe the price is unlikely to rise much higher from here. Lastly, we include US government bonds and Treasury inflation-protected securities as diversifying assets in our tactical allocation.