2021 Market Outlook – Asset Allocation

Eastspring’s Singapore-based Eastspring Portfolio Advisers team believes global growth will come in above trend from the second half of 2021 but that any acceleration in core prices is unlikely to be sufficient to prompt a rate hike. That said, they remain bearish on a large portion of developed market government bonds and favour an allocation to equity on a selective basis.

Q. What are some macro themes one needs to be aware of in 2021 and beyond?

Craig Bell, Investment Director, Eastspring Portfolio Advisers: Two macro themes stand out; the first being the US fiscal policy outlook and second, the COVID-19 progression. At the time of writing, the direction of fiscal policy remains unclear, but we believe the bias is for further expansion. The COVID-19 crisis quickly exposed the limits of accommodative monetary policy and led policymakers to jointly implement an expansionary fiscal policy to mitigate the exogenous demand shock.

As we emerge from the crisis, it will be very tempting for governments to continue expanding fiscal policy especially if inflation remains benign. But there are challenges. In the US for example, a fiscal gridlock may last until next year depending on the final Senate make up. Notwithstanding this, President-elect Joe Biden may want to achieve some level of bipartisan agreement between now and Jan 2021 or indeed through 2021 as he seeks to bridge the gap after four years of a divisive Trump presidency. The direction of US fiscal policy will be key to the path of future bond yields; an expansionary policy will likely see bond yields in the long end rise.

COVID-19 cases continue to rise in the US and Europe. Nevertheless, full-scale national lockdowns are unlikely as governments would not want to repeat the drastic approach taken in early 2020. Even if it comes to pass, markets are likely to look through any additional lockdowns and expect further monetary easing which will keep risk assets supported. In addition, the roll-out of a COVID-19 vaccine suggests that life can return to normal from spring 2021 and underpin risk sentiment.

Therefore, we believe the path for risk assets remains constructive. Fiscal policy will be supportive while  a COVID-19 relapse would not disrupt the market for long. Bond yields, although off the lows in March still do not offer great value. Hence, we believe investors will gravitate to equities.

Q. What are the challenges facing asset allocators and how are you positioning your portfolios going into 2021?

Joanna Ong, Investment Director, Eastspring Portfolio Advisers: Constructing resilient portfolios in a low yield environment where asset prices appear disconnected from the real economy will continue to be the key challenge. This situation calls for more diversification, not less. We acknowledge that asset class correlations tend to rise during periods of heightened market volatility, but over the medium and long-term the traditional relationships between different asset classes should re-exert themselves and reflect the benefits of diversification. Therefore, one needs to have a medium-term investment horizon in order to enjoy the “free lunch” that diversification brings.

The current low bond yields and at-best neutral equity valuations in the medium-term context means that asset allocators should consider expanding their investment universe beyond the traditional bond and equity asset classes, into alternative assets or physical assets such as property or gold. In doing so, they can enhance their long-term expected portfolio returns and reap further diversification benefits.

We have approached the final quarter of 2020 with caution, in light of the growing number of economic lockdowns imposed again by COVID-19 and the risk of further US election outcome issues that may trigger market volatility.

We remain bearish on a large portion of developed market government bonds which seemingly offer return-free risk. Our central scenario projects positive economic growth into 2021 as a vaccine accompanied by expansionary monetary and fiscal policies combine to drive household and corporate demand. As this scenario plays out, we will increasingly express our pro-growth view in favour of an allocation to selective equity at the expense of cash and other low yielding fixed income assets.

Q. Should long-term investors start thinking about inflation protection given the unprecedented monetary and fiscal response, and the US Federal Reserve’s (Fed) shift to average inflation targeting?

Joanna: Prior to COVID-19, the US economy experienced one of its longest ever growth periods aided by accommodative monetary policies. But, despite this expansion and low unemployment, inflation remained benign. The Fed’s new average inflation targeting policy is aimed at pushing up inflationary expectations over time. Unsurprisingly, the initial market response was a bear steepening in the US yield curve in which longer term bond yields rose more than the short-dated ones.

But we think the market is less convinced on the Fed’s ability to achieve its 2% average inflation target simply through forward guidance rhetoric. Long-term inflation expectations are being questioned; Japan’s “lost decade” of deflation is cited as a risk. With concerns over an undesirable cycle of ever-lower inflation and inflation expectations coming to the fore, a more proactive response from the Fed may be needed to see higher longer-dated bond yields in 2021.

Craig: To add on, the Fed will likely continue its current policy until they see inflation shoot above its 2% target for an extended period. Historically, the Bank of Japan cut its interest rate to 0% in 1999, and it only managed to keep policy rate above 0% for a brief period of time in 2000-2001 and 2006-2008. It is a challenge to see a sustained rise in inflation given that on the demand side, we are still in an early cycle and far from experiencing labour and resource shortages.

Meanwhile, the secular disinflation trend spurred by an acceleration of technology adoption in the wake of COVID-19 and aging global demographics may persist for longer. But on the flip side, COVID-19 has further called into question globalisation which was already under political pressure. Increased onshoring and the costs associated could put upward pressure on prices.

Our base case is for above trend growth in the second half of 2021 at which point core inflation will rise, but this could prove temporary and insufficient to prompt a monetary policy response. If inflation, elusive for so many years, does return, investors will need to be mindful of the impact this will have on their investment returns. Cash deposits become even more unattractive as real yields fall and purchasing power is further eroded. This may well act as a catalyst for asset allocation away from cash and towards investments better suited to an inflationary environment. Traditional government bonds and credit, all else being equal, will suffer in an inflationary environment due to their fixed / nominal return. Inflation linked bonds could be an interesting alternative although selectivity here is key as valuations are currently unattractive. But with interest rates at zero and the yield curve relatively flat, the long-term benefit of holding developed government bonds is questionable.

Equities are traditionally seen as a good hedge against inflation as corporate revenues in certain sectors will track rising prices. However, it is not a linear relationship and changes to the input costs of production and a dampening effect on consumer demand need to be considered - so once again selectivity is key.

Fig. 1. Central banks are likely to remain accommodative

Fig for Asset Allocation

For Use with Professional Clients / Qualified Investors Only. Not Approved for Further Distribution or Use with the General Public.

The information and views expressed herein do not constitute an offer or solicitation to deal in shares of any securities or financial instruments and it is not intended for distribution or use by anyone or entity located in any jurisdiction where such distribution would be unlawful or prohibited. The information does not constitute investment advice or an offer to provide investment advisory or investment management service or the solicitation of an offer to provide investment advisory or investment management services in any jurisdiction in which an offer or solicitation would be unlawful under the securities laws of that jurisdiction.

Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the strategies managed by Eastspring Investments. An investment is subject to investment risks, including the possible loss of the principal amount invested. Where an investment is denominated in another currency, exchange rates may have an adverse effect on the value price or income of that investment. Furthermore, exposure to a single country market, specific portfolio composition or management techniques may potentially increase volatility.

Any securities mentioned are included for illustration purposes only. It should not be considered a recommendation to purchase or sell such securities. There is no assurance that any security discussed herein will remain in the portfolio at the time you receive this document or that security sold has not been repurchased.

The information provided herein is believed to be reliable at time of publication and based on matters as they exist as of the date of preparation of this report and not as of any future date. Eastspring Investments undertakes no (and disclaims any) obligation to update, modify or amend this document or to otherwise notify you in the event that any matter stated in the materials, or any opinion, projection, forecast or estimate set forth in the document, changes or subsequently becomes inaccurate. Eastspring Investments personnel may develop views and opinions that are not stated in the materials or that are contrary to the views and opinions stated in the materials at any time and from time to time as the result of a negative factor that comes to its attention in respect to an investment or for any other reason or for no reason. Eastspring Investments shall not and shall have no duty to notify you of any such views and opinions. This document is solely for information and does not have any regard to the specific investment objectives, financial or tax situation and the particular needs of any specific person who may receive this document.

Eastspring Investments Inc. (Eastspring US) primary activity is to provide certain marketing, sales servicing, and client support in the US on behalf of Eastspring Investment (Singapore) Limited (“Eastspring Singapore”). Eastspring Singapore is an affiliated investment management entity that is domiciled and registered under, among other regulatory bodies, the Monetary Authority of Singapore (MAS). Eastspring Singapore and Eastspring US are both registered with the US Securities and Exchange Commission as a registered investment adviser. Registration as an adviser does not imply a level of skill or training. Eastspring US seeks to identify and introduce to Eastspring Singapore potential institutional client prospects. Such prospects, once introduced, would contract directly with Eastspring Singapore for any investment management or advisory services. Additional information about Eastspring Singapore and Eastspring US is also is available on the SEC’s website at www.adviserinfo.sec. gov.

Certain information contained herein constitutes "forward-looking statements", which can be identified by the use of forward-looking terminology such as "may", "will", "should", "expect", "anticipate", "project", "estimate", "intend", "continue" or "believe" or the negatives thereof, other variations thereof or comparable terminology. Such information is based on expectations, estimates and projections (and assumptions underlying such information) and cannot be relied upon as a guarantee of future performance. Due to various risks and uncertainties, actual events or results, or the actual performance of any fund may differ materially from those reflected or contemplated in such forward-looking statements.

Eastspring Investments companies (excluding JV companies) are ultimately wholly-owned / indirect subsidiaries / associate of Prudential plc of the United Kingdom. Eastspring Investments companies (including JV’s) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America.