When will the music stop? An Outlook on Financial Markets for 2021 and Beyond

by Raihan Woodhouse

Image Credit: UN Women Galley / Creative Commons

Contrary to one’s credence, all the unfortunate events that transpired in 2020 did not deter the faith of investors in global financial markets. It was, in fact, a very strong year for equities across the board, especially in the United States—the largest economy in the world. This is evident in the returns displayed on US equity indexes such as the S&P 500 and Dow Jones Industrial Average, which climbed 16.3% and 7.3%, respectively. As for the Nasdaq Composite, it experienced a 43.6% gain, having its best year since 2009. 

The market’s bullish trend has continued into the new year. Despite the unsettling political atmosphere following the American presidential election, Wall Street stock market indices hit new highs. The gains registered in New York were infectious. Markets across the globe rallied to welcome the newly-elected US President Joe Biden into office, who, as investors believed, would spend budgets well, implement low borrowing costs, and further ignite hopes for the vaccine roll-out program to end the coronavirus lockdowns. Through an evaluation of the current global economic, political, and social atmospheres, this article aims to explore the two opposed perspectives in the investment world and answer one of the most pressing questions regarding the outlook for financial markets in 2021: are we approaching yet another potentially cataclysmic crash?

Stock prices were in free-fall in March 2020 as the market reacted to the effects of the COVID-19 pandemic. Thenceforth, changes in interest rates instituted by the Federal Reserve (the Fed)—the US central bank—allowed for markets to rebound in a V-shape recovery, leaving investors optimistic. Given the state of the current US economic and political environment, it has been difficult to falter some of the optimistic sentiment on Wall Street; one that has been brewing for some time. According to Kiran Ganesh, a multi-asset strategist at UBS Global Wealth Management, “this is an environment to be pro-risk”, and there are a multitude of reasons for this.

So far, the US government has offered two stimulus packages in an attempt to sustain the economic progression. Each stimulus provided eligible individuals with a total of $2000 in relief money. Consequently, middle-class individuals who did not need to worry about affording basic necessities looked to place that money elsewhere: in the stock market. The additional support from the government meant that the market still had room for gains as people  continued to consume products and invest in stocks despite the restrictions of the pandemic. Furthermore, with the majority of the workforce working from home, there was a greater volume of retail traders trading stock who now account for 25% of market activity. Furthermore, the Fed had cut interest rates to 0.25 from 1.75, making it easier for individuals and businesses to borrow or loan out money to operate, thus promoting a general productivity in the economy. Ganesh added that central banks across the world have no desire to raise interest rates and bond yields, which move inversely to prices, providing the conditions for continued stock market gains. As a result of the actions undertaken by the Fed, treasury bonds [T-bonds] issued by the US government now have lower rates of return. Safe and long-term T-bond investments have become less enticing for all kinds of investors who have begun looking towards purchasing more profitable but slightly more risky alternatives, such as equities.

The aforementioned reasons, however, incited a divide in opinion in the investment world. With each record-setting trading day, there is a skeptical belief among some investors that the optimism would soon turn into delusion. According to the billionaire hedge fund manager Paul Tudor Jones, “more companies were priced at more than 100 times their earnings than at any other point in history – and about 50% more than during the dotcom bubble of the early 2000s.” As seen countless times before, history is screaming directly at our faces to warn us about oncoming consequences of an asset bubble featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour.

British veteran investor Jeremy Grantham, the co-founder of the US investment firm GMO, cited the aforementioned reasons on a call to his investors. He described this current bull market as “a fully fledged epic bubble” that has grown out of the ‘recovery’ of the 2007-09 financial crisis. To support his claims, analysts at the Bank of America warned investors of “frothy prices, greedy positioning”, telling their clients to sell equities.

Moreover, while the intention of the stimulus packages is to benefit all, they are in fact economic burdens as they push individuals, businesses, and governments deeper into the depths of debt. The stimuli checks have created a vicious debt cycle: individuals now have the opportunity to invest in the stock market from a leveraged position with the borrowed money, a term known as ‘buying on the margin.’ Combined with the tremendous amount of “fomo,” a number of retail investors have taken on risky and speculative decisions by targeting specific stocks thus drawing more investors towards companies that had already seen their values rocket. Additionally, after central banks across the world injected trillions of dollars into their respective economies by buying government bonds through the process of quantitative easing [QE], there has been a number of vociferous critics crying out about their actions.

Though the pandemic left the central banks with very limited choice, it is undeniable that the efforts to stave off financial collapse have stored up problems for the future. Central banks have a massive influence in the market. Jumps in borrowing costs caused by rising interest rates instituted by central banks was enough to persuade central bankers that taking away support would cause painful stock market drops. Thus, central banks have maintained low interest rates for the purpose of maintaining stock market gains; this, however, would mean little room for manoeuvre when facing rising inflation given falling unemployment, a booming market, and a weaker US dollar. The aforementioned debt cycle would continue because investors with money in equity markets would adopt the misleading assumption that the Fed is, and will always be, a safety net in the case of a financial crisis. This is yet another warning sign as this assumption can stray investors away from reality. Guy Monson, the chief investment officer at Sarasin & Partners, commented that the strong year for equities was marked by “near universal asset-price inflation.” The overall concern is that globally, the central banks have created and prolonged a massive asset bubble with price distortion, creating “this monster that they need to keep feeding.”

Unlike the use of subprime mortgage bonds in the global financial crisis of 2007-2009 or the overpriced tech stocks of 2001, this bubble is unique in the fact that it is difficult to lay its cause upon a single factor or financial instrument. Prices in the market appear to be inflated across the board, thus it is becoming ever more important to consider the pessimistic investment outlook if not for now, then for  the future. This is because there is another potentially cataclysmic market crash on the horizon as we approach the end of a long term debt cycle. There may be less support from governments in debt, increasing taxes, rising interest rates, less disposable income (if any), and massive personal debt levels. Those who have lived beyond their means are going to struggle adjusting to ‘real life’. When the chickens come home to roost, the future looks likely to end in tears.

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