As we come to the close of 2020, there is a fresh sense of cheer, with the gradual reopening of the economy and a few green shoots becoming visible around us. On the other hand, the negative impact of the pandemic does not provide us much to cheer on the health and social fronts. So how should you invest in 2021?
One way to invest is to monitor the macro picture of our economy and decide – after studying how the new virus strain would impact growth, inflation, employment, currency and interest rates. Based on such a study, you can then decide on asset classes that may outperform.
If the next wave of the COVID-19 pandemic gathers steam, can it lead to another round of lockdowns? What happens to jobs and would the unemployment levels see another sharp rise? Income levels of households and corporates may get impacted.
To understand what the future holds, let’s see how the year of 2020 evolved after COVID-19 was declared a pandemic in March, earlier this year.
How lockdowns brought economies to a halt
When lockdowns were declared in March, global economies closed down and growth slowed down faster than it had during the global financial crisis of 2008. People lost jobs, sold their investments and moved to cash.
As we accepted the inevitable, we adapted. From April 2020 onwards, central banks and governments announced massive stimulus packages to support various segments of the economy – corporates, households and financial markets. Lockdowns were slowly relaxed and people were allowed to carry on with their businesses. This led to a sharp revival in economic activity, stimulating growth and thereby declining unemployment numbers. While performance across asset classes had bottomed out, some of them had seen a sharp rally.
In hope or despair?
Temporary lockdowns are back in western countries, on the back of a renewed spread of infections. If the situation aggravates during the winter, more people will be confined to their homes. They will spend less money; this is bad news for service and consumption sectors. With reduced demand, companies are bound to operate at lower capacity utilizations, which ultimately curtail private investments, and employment opportunities. Indebted companies would find it difficult to service debt. This means slower economic growth, fewer jobs, and lower levels of income for households, corporates and governments. We would have then moved from a phase of ‘Hope’ to the next phase, that is, the phase of ‘despair.’
How quickly and efficiently governments react will determine the length of this ‘despair’ phase. It is imperative that the government announce massive fiscal stimulus, i.e. borrow more and spend (Keynesian economics). The central bank must support the government’s measures by intervening in the bond market and prevent the long-term yields from rising. Any positive developments on the timelines of the launch of the vaccine, its distribution and no side effects post-vaccination, would act as tailwinds for the global economy to do well.
How should you position your investments for 2021?
Do not invest based on just what you see today. In these times, it should be based on assigning probability to what is likely to happen. Because, we know – and have evidence – that if COVID-19 spreads further, central banks and governments will step in.
One possibility is that equity markets would see selling pressure as they discount the impact of slow growth and insolvency. This would be favorable for asset classes such as treasuries (bond prices rise as yields go down in a weaker economy) and gold (insurance against uncertainty). Some allocation to cash could be done to hedge against rising volatility and for opportunistic reasons. How long the impact would last would depend on a combination of measures adopted by governments and central banks, and the launch of the vaccine. These steps could help to revive the animal spirits back in the economy, which could be inflationary in nature. Hence, allocation to inflation hedgers such as gold and commodities could be useful.
So what should you do with your money? You can make tactical investment decisions and keep changing based on these macro factors. Alternatively, you can create a “Permanent Portfolio”
- allocate 25 percent each across equity funds (within equities choose funds which gives exposure to both domestic and global companies), dynamic fixed income funds (maturity profile of the fund is dynamically managed based on the view on interest rates), dynamic asset allocation funds (combination of equity, debt and arbitrage) and gold funds (combination of physical gold and gold mining companies). Such a balanced portfolio would have the potential to provide reduced volatility, higher liquidity and perform well across different macro phases.