Market performance

After severe disruption in global markets in early 2020 due to the pandemic, equity markets rallied in Q2 and Q3 2020 as a slowdown in new cases and the relaxation of lockdown measures resulted in a sharp economic rebound.

After severe disruption in global markets in early 2020 due to the pandemic, equity markets rallied in Q2 and Q3 2020 as a slowdown in new cases and the relaxation of lockdown measures resulted in a sharp economic rebound. Economic optimism was dampened at the start of Q4 2020 with further COVID-19 outbreaks. However, equity markets continued to rally as huge fiscal and monetary stimulus, together with optimism over vaccine rollouts led to investor willingness to overlook the sharpest economic recession in generations. Heightened political uncertainty around November’s US presidential election provided some drag on risk sentiment, but increased expectations of expanded fiscal spending, following Democrat Joe Biden’s victory, boosted markets.

Global COVID-19 cases continued to surge in Q1 2021, with many countries going back into lockdown as new variants became more virulent. Health concerns also halted the vaccine rollout in some countries, whilst supply constraints led to a slower than expected rollout in Europe. However, improving economic data over the quarter in most countries and global vaccination rollouts boosted economic recovery optimism. The MSCI AC World Index rose by 51.1% in local currency terms over the past twelve months and by 38.9% in Sterling terms.

Central banks loosened monetary policy with quantitative easing (QE) programs. The US Federal Reserve (the Fed) even began buying individual corporate bonds directly from the secondary market for the first time in Q2 2020. In Q3 2020, the Fed then announced a major policy shift by adopting an “average inflation targeting” approach, implying a higher tolerance towards inflation. In Q4 2020 and Q1 2021, the Fed maintained its guidance surrounding keeping interest rates near zero until at least 2024 and continuing to buy $120bn of debt per month, until “substantial further progress has been made” towards its employment and inflation targets.

In Q3 2020, the Bank of England (BoE) reported in its meeting minutes that it was examining how negative interest rates could be implemented effectively should this be required. However, deputy governor Dave Ramsden later suggested that the current base rate represented the “effective lower bound” for interest rates. The European Central Bank (ECB) launched a €1.9tn Pandemic Emergency Purchase Program (PEPP) which will continue until March 2022.

After years of negotiations, the UK and the European Union (EU) reached a historic Brexit trade deal. The deal was reached after issues including EU fishing rights in UK waters and fair competition rules were agreed. The agreement allows most goods to be traded between the UK and the EU without tariffs or quotas. Meanwhile, EU fishing rights in UK waters will be reduced by one-quarter over a five and a half-year transition period, after which access will depend on annual negotiations. Spain and the UK also agreed to keep the land border between the British overseas territory of Gibraltar and Spain open.

Brent crude oil prices rose by 179.4% over the last twelve months to $63 a barrel. After Q1’s sharp fall, oil prices recovered in Q2 2020 rising by 81%, supported by record-setting production cuts by the Organisation of the Petroleum Exporting Countries and allies (OPEC+) and the easing of lockdown measures in major economies, leading to expectations of higher oil demand. Optimism over vaccine approval and the commencement of vaccination programmes supported oil prices later in the year, even though OPEC and Russia agreed to increase oil production by 500,000 barrels per day from January 2021. OPEC also cut its forecast for 2021 growth in oil demand, citing continued virus uncertainty and weak labour markets. In Q1 2021, crude oil prices were again boosted by positive vaccine developments and easing lockdowns. OPEC+ decided to maintain a production rate at 7m barrels per day, slightly down from the previous quarter’s 7.2m barrels per day.

Sterling ended the period 5.7% higher on a trade-weighted basis. Sterling depreciated in Q2 2020 due to: the deteriorating COVID-19 situation in the UK, Brexit uncertainty, and a poor economic outlook. However, in Q3 2020, the weak US Dollar led to Sterling gains against it. Sterling continued to more broadly appreciate in Q4 2020 in anticipation that a Brexit deal would be reached. The relief rally in Sterling in Q1 2021, in the wake of the Brexit deal, was boosted by the launch of a successful UK vaccination program.

UK gilt yields fell to extreme lows in the summer of 2020 on the back of the pandemic, Brexit uncertainty, and increased expectations of a BoE rate cut to negative levels. However, yields started to edge up across maturities in Q3 as global risk sentiment improved. In Q1 2021, gilt yields rose sharply on the back of economic optimism in the light of several vaccine discoveries, further fuelled by the new US stimulus package. Credit markets benefited from risk-on investor sentiment over the year, with credit spreads (the difference between corporate and government bond yields) continuing to contract to ever tighter levels.

UK commercial property returned 2.6% over the period, as the income return of 5.5% offset the 2.9% fall in capital values. Virus pressure impacted the already struggling retail sector, whilst the industrial sector performed strongly.

The following graph summarises the index returns on the main asset classes and regions for the year to 31 March 2021. Returns are shown in Sterling terms and local currency terms.

Chart:Index returns from 31/03/2020 to 31/03/2021 Source: FactSet, MSCI. U.K. Equities, Sterling Terms 20.1 Percent. U.S. Equities, Sterling Terms 43.2 Percent, Local Currency Terms 59.3 percent. Europe ex U.K. Equities, Sterling Terms 34.4 Percent, Local Currency Terms 40 percent. Japanese equities, Sterling Terms 26 percent, Local Currency Terms 43.5 percent. Emerging market equities, Sterling Terms, 42.8 percent, Local Currency Terms 53.5 percent. U.K. fixed interest Gilts, Sterling Terms, minus 5.5 percent U.K. Index linked Gilts, Sterling Terms, 2.3 percent U.K. Corporate bonds, Sterling Terms, 7 percent. Global bonds, Sterling Terms, 0.9 percent. MSCI U.K. Property, Sterling Terms, 2.6 percent.
Index returns from 31/03/2020 to 31/03/2021 Source: FactSet, MSCI. U.K. Equities, Sterling Terms 20.1 Percent. U.S. Equities, Sterling Terms 43.2 Percent, Local Currency Terms 59.3 percent. Europe ex U.K. Equities, Sterling Terms 34.4 Percent, Local Currency Terms 40 percent. Japanese equities, Sterling Terms 26 percent, Local Currency Terms 43.5 percent. Emerging market equities, Sterling Terms, 42.8 percent, Local Currency Terms 53.5 percent. U.K. fixed interest Gilts, Sterling Terms, minus 5.5 percent U.K. Index linked Gilts, Sterling Terms, 2.3 percent U.K. Corporate bonds, Sterling Terms, 7 percent. Global bonds, Sterling Terms, 0.9 percent. MSCI U.K. Property, Sterling Terms, 2.6 percent.rce: FactSet, MSCI

Further details on the performance of specific asset classes over the period are provided below.

Equities

Over the year, UK equities regained most of the value that had been lost as a result of the pandemic, returning 20.1%. Broadly speaking, UK equities underperformed much of the developed world in Q2 and Q3 because of their large exposure towards financials and energy, as fears over negative rates and lower long-term oil prices set in. Heightened Brexit uncertainty and a larger economic contraction relative to the UK’s peers weighed on prospects of a rapid economic rebound. However, there was a reversal in trend from the end of 2020 with UK equities outperforming peers, as a Brexit deal was finalised and the UK came out ahead of the curve on the vaccination front. The rise in oil prices, attributed to the vaccine breakthrough and the record-breaking oil production cuts made by Saudi Arabia, supported the energy sector, to which UK equities have a large exposure. UK large-cap stocks outperformed their smaller counterparts as a result of Sterling appreciation and rising investor risk sentiment.

US equities outperformed other markets over the year, boasting an impressive 59.3% return in local currency terms. The strong rebound in equities is a reflection of the implementation of vast and highly coordinated monetary and fiscal policy regimes which aim to stimulate the economy. In particular, US monetary policy has induced a higher demand for equities by lowering the rates of interest on safer assets, such as government bonds, as investors search for yield. The growth-oriented technology sector has been amongst the highest performing stocks, supported by lower interest rates and the transition to virtual life. Consumer discretionary and cyclical companies have also fared well as the economy has started to rebound.

European equities (excluding the UK) returned 40.0% over the year in local currency terms. Although the region became the epicentre of the COVID-19 outbreak during its early stages, support from the ECB’s asset purchase programmes provided a boost to the markets. The EU also approved the bloc’s €1.8tn budget and recovery package, further improving the outlook for the region. Much needed relief over Brexit uncertainty reduced a major source of risk for equities.

Japanese equities returned 43.5% in local currency terms over the year. Because of low virus cases and less severe lockdowns, the market suffered a better downturn than many others at the onset of the pandemic. Concerns over whether Japan’s ultra-loose monetary policy and fiscal spending would continue following Prime Minister Shinzo Abe’s departure were brushed aside as Abe loyalist Yoshihide Suga won the election. Japanese stocks posted the strongest local currency gains in Q1 2021 because of their cyclical market exposure and the growing demand for Japan’s exports. However, most of these returns were eradicated in Sterling terms due to the depreciation of the Yen against it.

Emerging market equities returned 53.5% over the year in local currency terms, boosted by the successful containment of COVID-19 across East Asian economies, which make up the bulk of the index. Latin American equities also performed well over the year due to rising commodity prices. Emerging market stocks have been underperforming recently because of the headwinds of a stronger Dollar and rising US yields. Corporations in the region have a significant amount of Dollar-denominated debt and are likely to rely on US financing for their operations.

Bonds

UK fixed gilts returned -5.5%, whilst UK index-linked gilts returned 2.3%, as yields rose across both curves. Following a fall in gilt yields in Q2 2020, the gilt market recently experienced a sell-off on the back of accelerated economic recovery, rising risk sentiment, and more recently, a rise in inflation expectations because of the increased level of money supply and economic activity.

With the exception of Q3 2020, index-linked gilts outperformed fixed interest gilts over the period, driven by a strong increase in breakeven inflation (a market-based measure for expected inflation, calculated as the yield of a fixed interest bond minus the yield of an inflation-linked bond of the same maturity) which meant real yield movements were generally less pronounced.

Global sovereign bond yields remained range-bound in the early part of the year. Over Q3 2020, the US yield curve steepened when longer duration yields rose while short term yields fell, as broader policy support helped anchor short-term yields at low levels. Later in 2020 and into 2021, yields increased supported by the positive risk sentiment and improved economic recovery prospects. US rates led the way, driven by stronger growth, higher inflation expectations, and a repricing of when central banks may start to raise rates.

UK corporate bond spreads (the difference between the yields on non-government bonds and equivalent maturity government bonds) narrowed across all credit grades, although the change in spread stabilised in Q1 2021. The move was caused by a persistent risk-on sentiment with the largest spread tightening occurring in lower-quality corporate bonds. Since the second quarter of 2020, the rate of change in spreads has been falling consistently. UK and US investment grade corporate bonds across all maturities returned 7.0% and 9.9%, respectively.

Global credit spreads fell steadily over the year, initially triggered by the unprecedented speed and size of the fiscal and monetary response as central banks rolled out large-scale asset purchase programmes and governments announced stimulus packages. By Q3 2020, credit spreads across investment grade, high-yield and emerging markets had reached levels in line with their 20-year averages. Market optimism and strong macroeconomic data continued to support spread tightening later in the year, with credit spreads near their pre pandemic levels by the end of 2020.

Property

The MSCI UK Monthly Property Index reached an all-time high in the first quarter of 2021, returning 2.6% over the past 12 months. Following a fall in property values in much of 2020 due to the economic downturn, the real estate market entered a recovery phase in the third quarter. However, the rental property sector struggled to achieve the same level of success with rental growth only entering positive territory at the beginning of 2021 and vacancy rates continued to rise modestly. The industrial sector significantly outperformed the retail and office sectors posting an impressive return of 13.9%, boosted by the heightened demand for logistics during the pandemic.

The COVID-19 pandemic weighed heavily on global commercial real estate investment, with 2020 volumes down significantly on the previous year; however, investment activity surged in Q4 2020, demonstrating a strong recovery in investor sentiment. Western countries with sectoral diversity, scale and transparency led the recovery, notably France, Germany, and the United States. Some loss of office-utilising employment lowered overall office demand in all regions in 2020, with vacancy rates rising by at least 1.0-1.5% globally. The retail sector continued to struggle in the wake of the pandemic, with weaker sales in physical stores, less tourism in some markets and rising online sales. This pushed rents lower in Q4, falling the most in the Americas. The growth of online retail accelerated demand for industrial assets globally, and as such, industrial rents remained resilient, driven primarily by America’s demand.

Infrastructure

Although the pandemic will have undoubtedly temporarily disrupted some infrastructure projects, investment continues to grow, and there was an increase in the number of announced projects over 2020 compared with previous years. Governments worldwide, most notably the US, have plans to take on large infrastructure projects to stimulate economic and employment growth. Further, the green infrastructure trend continues, and renewables power generation is expected to be a substantial driving force as governments aim to hit their carbon emission targets. As with all illiquid asset classes, valuations need to be treated with an element of caution, and the true performance of these assets is known only once assets are realised.