Market Outlook December: Brighter prospects ahead

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Monday 21 December will be the shortest day of the year in the northern hemisphere. From then on, the days will be longer, and we’ll have more daylight. Back in the olden days, the date of the winter solstice was 25 December. The days leading up to that date became steadily shorter, and for our ancient ancestors, the sun appeared to be at a standstill on 22, 23 and 24 December. Three days of complete standstill followed by a turning point, which was heralded by a star in the east (Sirius) aligning with the sun and with the constellation the Three Kings (Orion’s Belt). This is why many of us celebrate Christmas soon after the winter solstice.

In the stock market, the celebrations have already started. Oslo Børs saw a rise of 15 per cent in November, greatly helped by an increase in the oil price and equities in the energy sector. Global equities rose almost as much, but the returns measured in NOK were a meagre 4 per cent, due to the Norwegian krone gaining strength. Nevertheless, this corresponds to almost a full year’s return based on the current, moderate return expectations.

Interest rates remained largely at the same level but yields on global bonds were above 2 per cent as a result of shrinking credit risk premiums. The effective interest rate is below 2 per cent, so this corresponds to more than a year’s expected yield in just a month.

This upturn coincides with what is often a strong period on the stock exchange. Several catalysts contributed to the impact being so great this time:

· It looks like President Trump is finally acknowledging defeat, and Biden seems to be assembling a strong team. This means that the relationship between the US and Europe will improve, while relations with China are unlikely to change much.

· In the Senate, a cross-party group has proposed a new stimulus package worth nearly a thousand billion US dollars. Hopefully, a package will be adopted before the final adjournment of the current Congress.

· We’ve had a lot of good news as far as the pandemic is concerned. The R number is once again falling in Europe. The UK has approved the vaccine developed by BioNTech/Pfizer and is already due to start vaccination next week. Over the next few months, more vaccine candidates will be approved.

· It looks as if the EU and the UK will agree on the outline of a post-Brexit trade agreement by the 31 December deadline. Negotiations on fishing quotas and competition rules will take longer.

November is a good example of how the markets are forward-looking, and how new information is quickly discounted.  It’s also a good illustration of the stock market rule that short-term timing is tricky, and that it rarely pays off to pull out of the market completely. Not having the line out when the fish are biting may prove costly.

The world after the coronavirus
So, despite the fact that the pandemic is not over and that we’re heading into the flu season, risk appetite has increased. Investors are catching a glimpse of a more normal world on the horizon. Preliminary estimates for next year indicate a total production of 9 billion vaccine doses, and when asked, around three in four people say they will have the vaccine once it’s available. Economic growth in the second half of 2021 may thus turn out to be extremely strong.

If this proves right, the big question is: what will happen to inflation and interest rates? The yield on 10-year US government bonds has collapsed, from around 3 per cent in 2018 to less than 1 per cent today. This is one of the most important factors underlying the stock market’s rapid recovery.  Low interest rates result in a flow of money from bonds and bank deposits to equities.

In addition, they have a positive effect on the valuation of equities. Equities are risky investments because you pay for an unknown cash flow at some point far into the future. The value of this cash flow is discounted down to the current value of the company, based on expectations of both growth and interest rates.

Everything else being equal, lower interest rates give a higher present value, a higher price multiple and better valuation. For companies whose earnings are largely expected to be far into the future, such as technology companies, this effect is especially strong. For cyclical equities and banks in particular, the effect is less positive, as low interest rates signal lower profitability.

However, cyclical equities have begun to make something of a comeback in recent months, doing a lot better than defensive equities since the market reached the bottom in March. We believe this trend will continue, driven by a moderate rise in long-term interest rates.

 

Market outlook for December 2020
We’re not making any asset allocation changes as we enter the month of December. Our equity position is kept at a neutral position. Within our fixed-income part of the portfolio, we’re maintaining Nordic high-yield bonds in an overweight position. Yields so far this year have been weaker than for global high-yield bonds, but we believe this will be the best fixed income position in 2021. The effective interest rate is at around 7 per cent as the credit margin has not contracted as much in this market. In addition, the interest rate duration is far shorter, making the position less vulnerable to a rise in the long-term interest rates.