Asset allocation strategy for the New Year

Quality and careful selection imperative with an equity bias

Equity markets are expected to climb higher in 2021 as anticipation of a cyclical upturn in the global economy continues to grow. But the path ahead may be rocky until the pandemic is more firmly under control.

The only way to begin prognosticating about 2021 is to first look back on one of most tumultuous years in modern history. The Covid-19 pandemic has left an indelible mark on all who lived through it and those who lost loved ones will never be the same. It has tested our resolve and demanded our compassion, but it has also exposed our fault lines and laid bare the inequalities that are keeping society from reaching its full potential.

This is true across all facets of life, but the economic lockdowns induced by the pandemic in 2020 have had their own unique impact on investors. In fact, never have stock markets collapsed as quickly as they did last March, and never has an economy fallen into a recession as abruptly or as deeply before. And yet here we are, more than 10 months since the crisis began, riding one of the most remarkable market rebounds of all time, all the while anticipating a potent economic recovery that could push stocks and other risk assets even higher over the next 12 months.

Still, investors may not want to get too far ahead of themselves. While the beginning of a new economic cycle seems inevitable, the timing of it remains tenuous, and in the first few months of 2021, markets may become even more volatile before giving way to a less tumultuous, more favourable trajectory in the second half of the year.

The key in all of this, of course, is the ongoing fight to end the pandemic as it continues to rage and force new temporary lockdowns in several countries around the world including the United States and Canada. Left unchecked, this could result in a double-dip recession in at least some regions of the global economy even as optimism about a Covid-19 vaccine continues to grow.

In fact, while there are at least two vaccines (and potentially several others) either approved or in process for approval from regulators in Europe and North America, it will be several months before enough doses are manufactured and made available to quell the global spread of the virus. At the same time, regional differences in vaccine availability will also have an impact on the breadth of the economic recovery going forward.

In turn, this only puts more pressure on governments and central bankers to step up their support over the next few months. Fiscal and monetary policy has never been so globally coordinated or so accommodative as it is today, but the need for more stimulus remains critical to bridge the gap between now and when the pandemic is more firmly under control. Thankfully, the political will to do so remains relatively strong, but time is of the essence and the rollout of new spending in the U.S., in particular, could end up taking longer than would otherwise be desired given the current dynamics of the presidential transition now in progress. A stimulus bill would be received well by an equity market hoping for the recovery to truly begin.

Clearly then, the pandemic – and response to it – will remain one of the big uncertainties facing investors in the early part of the new year. There are, however, several other factors that may come into greater focus as 2021 progresses. For instance, the potential market implications of the new political landscape in Washington, D.C. go beyond the timing and magnitude of the next stimulus package and may still encompass the prospects of higher corporate taxes and stricter industry regulation now that the runoff for two seats in the U.S. Senate has ended up in favour of the Democrats.

Asset allocation strategy going into the New Year

Given this backdrop, it remains crucial to position investment portfolios in a way that protects against downside risks but also takes advantage of the opportunities that will become increasingly evident as the economic recovery picks up more steam.

We believe a bias towards equities over fixed income within the context of a 60/40 portfolio will serve investors well when considering the next year in its entirety.

Within equities, a barbell approach that focuses on quality growth companies, but which also tilts towards cyclical stocks, will help navigate the near-term uncertainty around the economy as well as the path to recovery. But then as a vaccine takes hold and economic progress becomes even more certain, a rotation towards those areas of the market that have done well in prior upturns should become more emphasized. Emerging Markets, for example, tend to do particularly well in new economic cycles, as do commodities and those sectors that are most tied to the early stages of an expansion such as financials, consumer discretionary, and industrials.

That’s not to say investors should completely abandon what benefited them most in 2020. Fixed income will continue to provide important capital preservation despite the threat of rising yields, and while the so-called “work-from-home” equity portfolio may be due for a correction, we believe many of the technology stocks associated with it should continue to resonate long after the pandemic has ended.

Moreover, alternative investments, including long/short hedging strategies and asset classes such as private credit, will continue to offer important diversification to stocks and bonds, and sustainable investment themes may only become more top-of-mind with investors as the need to direct capital more effectively towards environmental and social issues continues to ramp up in the coming years.

Ultimately, investors can take comfort in knowing the worst of the pandemic will soon be over, but what could end up being a very good year for the global economy and financial markets may not necessarily start out that way.

Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.

Notes and Disclaimer

The commentaries contained herein are provided as a general source of information based on information available as of Dec. 8, 2020, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries, or any of its affiliated companies, funds, or investment strategies.

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