As we start 2021 and explore what could happen in financial markets over the coming months, it seems sensible to quickly look back and review what happened in 2020, a year of contradictions.
It started off with markets reaching record highs, an initial optimism that was dashed by the COVID-19 global pandemic, a unique challenge that has forced governments across the globe to undertake “lockdown policies” to combat the threat to their healthcare systems.
It is worth lingering on that point, when faced with the arguably the largest challenge since the Second World War, we have seen self-described liberal democracies take their policy lead from the Chinese Communist Party.
I make this point not to necessarily criticise these governments, but it does put into question the complete faith the US and her allies have shown in combatively promoting Democracy, often through force, as the ultimate political solution across the globe. Food for thought and just one example of how this unprecedented event has made societies across the globe reflect on their own governance and question their social contracts.
Along with the enormous social impact of pursuing lockdown policies, governments had to also contend with the economic damage that hibernating their economies would cause. Unsurprisingly, given the policies undertaken after the 2008-09 Great Financial Crisis (GFC), the solution was to undertake a further reduction of interest rates and yet more quantitative easing.
While there has always been a debate as to whether governments should have bailed out failing banks, there was a universal acceptance that if a government were to force companies to mothball themselves for an extended period, that they should provide appropriate financial assistance.
Meanwhile, while governments were getting to grips with the arrival of a global pandemic the financial markets followed a similar, yet swifter, trajectory as witnessed during the GFC.
Initially equities dropped dramatically across the board. Central Banks, led by the Federal Reserve, then implemented support measures that saw a gradual reversal of the initial freefall.
This support coupled with the realisation that, outside of specific sectors, many multinational companies were able to embrace the horrifically termed “new normal” and either remain profitable or, in some cases, benefit significantly from the lockdown policies saw equity markets recover significantly.
Incredibly, by the end of the year, financial markets had produced stronger returns than in 2018, a year in which little happened of note aside from England not being terrible at the football World Cup.
It seems that we now exist in a reality in which “black swan” events are no longer cause for concern. Instead, it could be argued that they represent an opportunity to buy cheaply in the knowledge that governments will implement extraordinary measures to protect the value of their financial markets.
And so, as we start 2021, despite the virus continuing to prevent global travel and causing societal havoc across the board, there is a general sense of optimism within financial markets.
You could be forgiven for finding this situation puzzling, unemployment rates are rising, GDP figures have been terrifying, and government debt has risen to levels last seen at the end of the Second World War. However, it is important to recognise that an environment in which interest rates are likely to remain at record lows will ensure that the potential growth and dividends provided by equities will continue to attract investment.
Along with this interest rate backdrop, and the clear commitment of governments to support financial markets, there has also been significant political movement alongside the success of the vaccine which has further increased the sense of optimism.
With Biden winning the US presidency, there is broad acceptance that a Democratic president will not put a halt to the continued government support to the economy. On the international stage, there is also optimism that there will be a cooling in relations with China and a reversal of the ‘trade war’ policies that Trump initiated.
It is not only in the US where political outcomes have helped to settle market nerves, but the resolution of Brexit has also provided some cautious optimism in the UK and Europe. While in Asia and within emerging markets, there is also a belief that growth could follow the difficulties of 2020.
At the heart of this optimism is the roll out of the vaccine, one of the great achievements of last year. If there can be a successful international vaccination programme that enables governments to move away from lockdown policies, there is the potential for a large rebound in consumer spending and confidence from a global population that has been forced to hibernate for a large portion of the past 12 months.
Much of this optimism, however, is based on the continued ability of governments to keep inflation low and not be forced into raising interest rates. It is also based on the vaccine roll-out being successful and a movement away from lockdown policies.
The success of the year ahead within financial markets will likely continue to rely on governments controlling interest rates and inflation, a historically difficult tightrope to traverse.