(Bloomberg Opinion) -- With the pandemic threatening to trash the global economy, governments have opened the fiscal spigots and central banks have pumped even more money into the monetary system. Financial assets, from stocks to bonds to Bitcoin, have responded by rallying to record highs. Hopes that vaccinations can replace lockdowns as the best defense against the coronavirus are feeding expectations that the trend — mostly — is likely to continue in 2021.
A Shock to the System
A second wave of lockdowns is shutting down half the developed world over the holiday season. Since the beginning of the pandemic, different parts of the world economy have had divergent experiences.
China has regained all of its lost momentum and activity is actually growing again. The same cannot be said for the big economies of Europe or the U.S. Economic growth is expected to pick up strongly next year, but it’s evident the effects of the wrecking ball of 2020 will linger awhile, with a full return to pre-Covid levels not expected until 2022 at the earliest.
Bring in the Sledgehammer
No one can complain that the world’s central banks haven't learned the lessons of the global financial crisis. All of the existing unconventional tools — with several new interpretations — were swiftly utilized.
Central banks have not lacked for imagination in their coordinated monetary policy response. Since March, the Federal Reserve alone has purchased $3.3 trillion of Treasuries and mortgage-backed securities, as well as adding corporate bonds, junk-rated debt and exchange-traded funds to its shopping list. The rising tide has lifted all asset prices.
Don’t Fight the Fed (or the Robinhood Crowd)
The pandemic roiled stock markets in March, driving the total value of global equities down to its lowest level in almost four years. The rally since then has been pretty relentless, with the combined world indexes posting a gain of more than 60% since that low.
The world's stock markets are now worth a combined $100 trillion for the first time. With Wall Street analysts racing to compete with the highest forecasts for benchmark equity indexes next year, the imperative to "buy stonks," as Twitter puts it, looks irresistible.
How Low Can You Go?
Bond markets have also set records, albeit in a way that threatens to make life even harder for savers trying to find a safe place to store their retirement funds. The world’s stock of debt that yields less than zero has soared past $18 trillion, more than double the amount at the start of 2019.
It’s been less than four years since investors were charging Portugal more than 4% for 10-year money. Earlier this month, they started paying for the privilege of owning the country’s securities. Who’d bet against Italy and Greece, whose 10-year bonds yield about 0.5%, joining the sub-zero benchmark borrowing club next year?
Banks Bear the Brunt of Negative Rates
Much has been written on the merits or drawbacks of extending the lower bound of official interest rates below zero, as the European Central Bank has done. So far, the Federal Reserve and the Bank of England have resisted. But simply looking at the valuations of the relative banking sectors, it is clear that compressing net interest margins has a long-term deleterious effect on the finance industry.
Even the best European banks have tangible book values that are a fraction of those of their U.S. peers. Their lower profitability shows up with an average return on equity that’s less than half what the U.S. financial sector delivers. Competition is fierce in overbanked Europe, where companies rely on bank loans for corporate finance rather than the fragmented capital markets but lenders are unable to charge much interest for money. There are concerns too that the ghost of the euro zone debt crisis — a mountain of non-performing loans — might reappear with the pandemic.
Can the Euro Zone Avoid Deflation?
The scourge of inflation used to keep central bankers awake at night — now it’s the reverse. Looking at the longer-term chart of European inflation and official rates brings a sense of nostalgia for not only when rates were positive but when they moved by 25 basis points at a time.
While driving rates deeper into negative territory had some initial impact for the ECB, that effect has faded, with headline consumer prices now signaling deflation. It’s hard to see how the central bank can reach its target of inflation running below, but close to, 2%. The 2023 official forecast is only for 1.4%.
The Green Revolution
This year has brought a significant acceleration in green bond issuance, from banks and corporates to governments. Next year will see bigger diversification toward social- and sustainability-linked supply. The European Union alone plans to issue 70 billion euros of social bonds under its SURE job support scheme, with another 240 billion euros of green bond sales for its Recovery Fund. Bloomberg Intelligence estimates the stock of environmental, social and governance debt could reach $53 trillion by 2025 — a third of all assets under management.
The U.K. will belatedly join the party with its first green gilts next year, but the big surprise could be from the U.S. The Federal Reserve has joined the Network for Greening the Financial System, a global central bank initiative with 75 members. Under the incoming administration of President-elect Joe Biden, could green Treasury bonds be next?
ETFs in Vogue
The market for low-cost exchange-traded funds continues to explode, with the global value of these instruments reaching $6.6 trillion this year as their low fees continue to attract cost-conscious investors.
Eric Balchunas at Bloomberg Intelligence reckons U.S. inflows into the sector could reach a record $600 billion next year. And it’s not just the traditional stock index trackers that are in vogue; actively managed ETFs, as well as more fixed-income flavors of the product, are set to swell the market.
Hunting for Yield
Yield-starved fixed-income managers in Europe have snapped up about 86 billion euros of new high-yield debt this year, according to our Bloomberg News colleague Irene García Pérez. That’s the most since 2017 even though the pandemic effectively closed the new issues market for two months earlier in the year. The U.S. junk-rated market is enjoying its busiest December since at least 2006 with $4 billion of sales, Davide Scigliuzzo reported.
Taking on more risk has proved profitable this year, with yields across the rating spectrum either at or near record lows. Fortune may continue to favor the brave next year. Moody’s Investors Service is predicting that the default rate among junk European borrowers will peak at 5.7% next year, less than half the level reached during the nadir of the global financial crisis a decade ago. And central banks are continuing to pump global liquidity.
Something Glitters But It’s Not Gold
After gaining more than 270% this year, the digital currency has left gold in the dust. Bitcoin “is taking much of the interest and attention from what used to be a store-of-value space mostly reserved for precious metals,” according to Bloomberg Intelligence’s Mike McGlone.
Bitcoin’s ascent has seen it rise to a record $20,000, even though its real-world uses remain almost non-existent. In Bank of America Corp.’s most recent survey, the currency was deemed the third most-crowded trade by 15% of fund managers overseeing $534 billion, only beaten by owning technology shares and betting against the dollar. So caveat emptor: When Bitcoin last peaked near these levels, in December 2017, the following year saw it lose 80% of its value.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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