Covid-19 will leave a lasting legacy of disruption

This creates major challenges for investors.  How those investors fare over the next five years will in part be determined by the massive waves of stimulus launched by governments and central banks 

Having pumped liquidity equivalent to 14 per cent of global GDP during 2020, central banks will aim to put a ceiling on bond yields, to reverse deflationary pressures by closing output gaps that opened up during the crisis, and then to keep growth on trend. They have plenty of firepower to keep monetary policy loose for a long time yet.

Bond markets have already discounted this to a great extent , leaving fixed income investors with little upside but plenty of downside risk if policies work and spark growth and inflation. That’s particularly true for government bonds. Negative real interest rates mean that inflation-protected bonds should outperform, however.

Fixed income investors should look to local currency emerging market debt for attractively priced income-generating assets, especially at a time when EM currencies are undervalued.

Equities are also likely to deliver lower returns in the next five years compared to   the past decade. Valuations are expensive at  this stage of the cycle; economic growth will be lukewarm; and corporate margins remain under pressure as governments look to less business-friendly policies. 

While we expect less divergence in the returns of stocks across regions and countries than in the last decade, the US is likely to underperform. 

US equities trade at record premiums in an expensive currency –the US dollar should weaken over the coming years – at a time when the economy’s pace of growth is likely to slow towards that of other developed economies. 

European and emerging Asian equities will do better in our view, with Chinese stocks  set to be the star performer.

Asia’s relative strength is likely to be played out in tech stocks where the region looks ready to take over leadership from the US. Overall, technology, staples and health care, relatively well capitalised and good at generating cash, are likely to be the best performing equity market sectors.

Investors will need to move away from a traditional balanced portfolio to secure attractive single digit real returns over the next five years. Investors will need to boost allocations to emerging markets, alternatives, TIPS and absolute return strategies. 

Only then can they hope to secure a real return of 5 per cent per year.  Given the great uncertainty of these times and the base from which we start, that would be a creditable performance.”