Julius Baer: Eight surprises for 2021
Christian Gattiker, Head of Research and Mathieu Racheter, Strategy Research Analyst Emerging Markets, at Julius Baer take us through eight events that would qualify as “low probability-high impact” in 2021.
Thinking the unthinkable
Expecting the unexpected does not only defy linguistical logic but also, is a very hard thing to do. After issuing our yearly outlook expectations, we are regularly asked about what could go wrong and what would be the most devastating things that could happen. That usually leads straight into black swan discussions. This is when we throw in that even Nassim Nicholas Taleb, who hammered the term ‘black swan’ into the consciousness of the financial community, has declared that neither the Great Financial Crisis nor the Covid-19 pandemic qualify as black swan events as these types of risks have been known for generations. We therefore settle on the term ‘low-probability, high-impact events’ hereafter to discuss the uncertainties in the months ahead.
1: An utterly dull 2021 disappoints high-flying hopes
After coming out of a crisis, investors expect things to continue as least as spectacularly – for good or bad – as during the crisis. History tells a different story. After the heavy interventions of policymakers, markets tend to calm down. This can be seen in chart 1, where we show the US Federal Reserve’s policy rate as a leading indicator for market volatility. By this measure, the level of price fluctuations should break down by summer 2021.
Hedging strategy #1: ‘Stay put or trade like hell’ – i.e. either accept the low volatility environment and respond by minimising transaction costs, or use the minimal shifts by being more active to capture any divergences in the short run.
2: Wave three of the virus ahead and vaccine does not work
This one sounds as familiar as disconcerting. In this scenario, a third coronavirus wave would emerge and cause renewed restrictions before vaccinations are rolled out. According to investor surveys in 2020, a malign mutation of the virus was the biggest fear of investors.
Hedging strategy #2: Build up safe-haven assets (US Treasuries, German bunds, gold, etc.) based on epidemiological evidence.
3: US dollar bear
The US dollar enters a bear market and weakens beyond any forecast, most likely due to a policy mistake such as the Federal Reserve applying negative rates to their banking system or something going terribly wrong in Washington.
Hedging strategy #3: Buy gold and/or assets denominated in other currencies with limited US dollar exposure such as European or domestic Asian assets.
4: Globalisation redux
Globalisation 2.0: a 2009-style rebound of global trade volumes with more exchange of information technology in the wake of Covid-19 leads to the better growth of emerging economies and validates the current capital flows into emerging market bonds. Funnily enough, the long-awaited breakdown of globalisation can be found anywhere but in the trade numbers.
Hedging strategy #4: Buy reflation assets such as emerging market stocks and bonds as well as commodity grades; buy mature market cyclicals.
5: Bond markets crash, yields spike
Against all odds, the economy comes back faster and stronger. Even central banks start to doubt their statements earlier in the crisis of keeping rates low forever. Hence, bond markets price in the new reality and crash on better growth and inflation prospects; yields surge accordingly.
Hedging strategy #5: Buy developed market cyclicals/commodities as long as the US 10-year yield stays below 5%.
6: Emerging market crises resume
A pre-emptive reversal of loose fiscal and monetary support in mature markets leads to renewed capital outflows out of emerging economies. The market would then start to price in rate hikes and this would trigger a prompt reversal of capital flows out of emerging markets into developed markets. As emerging market asset prices fall and the US dollar appreciates against emerging market currencies, investors would focus on the external vulnerabilities of individual emerging markets.
Hedging strategy #6: Buy safe-haven assets in hard currencies and gold.
7: Stock market ‘melt-up’ à la 1987
After some scepticism, the TINA (‘There Is No Alternative’) narrative becomes the encompassing mantra of financial markets and stocks rise further. This triggers momentum players to jump on the bandwagon, leading to investors piling into stocks.
Hedging strategy #7: Put all your eggs into one basket and watch the basket (to paraphrase Warren Buffett).
8: Information technology stocks meet their baby-Bell moment
After reaching consensus about the market abuse of monopolies, the new US administration breaks up large IT companies in an unprecedented move similar to the anti-trust actions in the telecommunications or oil industries during the last century.
Hedging strategy #8: Buy brick-and-mortar businesses in the run-up to the event, thereafter buy the runners-up across the world, then buy the broken-up parts.
