Covid-19 has pushed the world into an age of uncertainty. The certainty and predictability of normal times have been replaced by the uncertainty, confusion, and unpredictability in these abnormal times. How should investors manage this uncertainty, which makes investment decision-making challenging?
Will the global economy sharply rebound in 2021?
Will the near-zero interest rates and ample liquidity continue?
Will the capital flows to emerging markets sustain?
How are central banks going to exit from the cheap money policy?
Answers to these questions will determine the behaviour of stock markets this year. Unfortunately, there are no clear and certain answers to these questions. There are different views with different implications for investors. One thing is certain: twists and turns in events and deviations from expectations will cause huge volatility in markets. Investors should be prepared to manage this volatility.
The consensus is that the global economy would sharply rebound in 2021 with a growth rate of 5 percent after the contraction of 4 percent last year. Regarding interest rates and liquidity, the consensus is that the low-interest rate regime and ample liquidity will continue, not just in 2021 but through 2023. Since capital will be available in abundance, the near-consensus is that capital flows to emerging markets will continue. Even though exiting from the ultra-loose monetary policy would be a challenge, the near-consensus is that the leading central banks will not be in a hurry to exit from this policy. The near-consensus on these crucial issues is favorable for the markets in 2021.
The risk is the consensus going wrong.
If the actuals deviate from the expectations, there will be huge gyrations in the market. In the present context of high valuations, volatility means sharp corrections, even major crashes in the market. So, what are the chances of the consensus going wrong?
The expectation that the global economy will sharply rebound in 2021 is based on the assumption that the massive vaccination drive will end the unlocking and bring economic activity back to normal. But a mutated virus and a new strain, which is immune to the present vaccine, may pose a serious threat. The second wave of the pandemic in the West is turning out to be severe. Regarding monetary policy, the near-zero interest rates and ample liquidity assume inflation to remain under control. So, a possible return of inflation can prove the consensus wrong. This, in turn, may force the central banks to initiate an early exit from the cheap money policy leading to capital outflows from emerging markets. In this scenario, markets will correct sharply.
Now, we don’t know how things will shape up. A high probability is the consensus getting it right. This is the logic behind the advice to investors to stay invested. But investors should be aware of the possibility of the consensus breaking down.
Investors can remain invested so long as the monetary policy of the leading central banks continue to be loose and accommodative. If inflation stages a comeback, central banks will be forced to change the policy. That would warrant a change in investment strategy. Let’s keep our fingers crossed.