Around the world, stock markets partied as the deadly virus spread in 2020, but there are at least three reasons to expect the revelry to end in 2021.
After the flash crash last March, many investors came to see the pandemic as a natural disaster, not the kind of long-term shock generated by financial crises. Then record fiscal and monetary stimulus persuaded investors that policymakers will do whatever it takes to prevent any more market shocks. Shut at home, many saved their stimulus bonuses and poured a big chunk of that savings into stocks.
Now, most people expect markets to keep rallying, as the global economy reopens. But the end of the pandemic is already priced into record high stock valuations. As people emerge from lockdown, they will save less, invest less in the markets, and shop more. Stimulus will flow less into stocks, more into goods and services. And by raising the prospect of higher consumer price inflation, leading to higher long-term interest rates, an overheating economy could easily suck money out of the stock markets.
That’s why this year could unfold as a mirror image of last, with the stock market going flat amid a global recovery, after booming during a devastating global recession.
To understand why, follow the money. The rally began in late March, the day after the US Federal Reserve announced its first pandemic-relief measures. The relief kept coming. Nearly 20% of the dollars in circulation were printed in 2020. All the major central banks followed the Fed; India’s central bank stimulus equalled 6% of GDP, four times the emerging world average.
Governments topped up the central bank efforts with massive new spending. Stimulus checks helped boost disposable incomes in the United States at the fastest rate in 70 years, but much of that went unspent. Savings spiked all over the developed world. Americans alone saved at the highest rate since World War II, putting away an additional $1.7 trillion, or more than 16% of their 2020 income.
With more money in the bank, and more time on their hands, many workers turned to punting in the markets. From the US and UK to South Korea and India, individuals bought stocks at a furious pace. The number of online trading accounts opened in India rose 45% from 2019 to 2020. All of this pushed markets higher. The big winners however were large growth stocks, particularly in the United States and China, which together accounted for most of the 2020 market gains worldwide.
The big question now: where will all the money go when the virus fades? Epidemiologists are saying the pandemic could be contained by summer, perhaps even by spring in countries like the United States and United Kingdom where vaccines are rolling out most rapidly.
As consumers emerge from lockdown, excess savings are likely to drop sharply. Even by conservative estimates the release of pent-up demand could add two to three percentage points to GDP growth in the United States alone.
The consensus forecasts put 2021 GDP growth at just over 5% worldwide, and near 6% in the United States. I think growth could top 6% worldwide and approach 8% in the United States, an astonishing pace for a developed country. Forecasters may be underestimating the pace of recovery given the massive pent-up demand, the savings glut and the eagerness of policymakers to err on the side of overstimulating.
Ironically, a booming economy may not be good for markets. Savers will become spenders again. Resurgent demand for leisure travel and other services will strain the capacity of industries gutted by the pandemic. The deflationary impact of business closures could give way to the potentially inflationary impact of supply shortages, which are already visible in sectors such as shipping and semiconductors. The prices of commodities from oil to soy beans have been surging of late.
The bond market is beginning to price in higher inflation and the prospect of higher yields could pull investors away from stocks, which are now particularly vulnerable to interest rate swings. Last year stock valuations got an unusually large boost as interest rates plunged to extremely low levels: a sharp rise is likely to deliver a proportionately large shock. Further, the rally was driven mainly by growth stocks – the kind most sensitive to interest rate shifts – and they now dominate many stock market indices.
Higher long-term interest rates could bring an end to the extraordinary bull run for giant tech stocks in the US and China, and a shift in flows toward a new set of countries and industries. The buzzwords of last year – the virus, virtual, work from home, recession – are likely to make way for vaccines, the real world, back to the office and reflation. This transition could rattle the financial markets, which are hooked on low long-term interest rates.
Markets often underestimate big shifts in the global economy. In the early 1980s, disinflation led to a sharp fall in interest rates, with much greater fallout for the markets than investors expected. Now the risk is that inflation resurfaces, and bond yields rise more sharply than anticipated, overwhelming the rise in earnings during a recovery. The impact could easily end the rally of 2020, leaving markets suffering withdrawal symptoms in a global economic boom.
Views expressed above are the author’s own.
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