The new ISA year is upon us. Most investors rejoice at the prospect of putting another lump sum to work, tax-free of course. But what should you buy to maximize the return of your stocks and shares ISA in 2021?
Post-Covid New Economic Landscape
This time last year was an extraordinary period in human history. For the first time in a century, the world was hit by a virulent pandemic. In the UK, prime minister Johnson was struggling in the ICU with the virus, while deaths and infection rates were rocketing across nations. Fear was palpable, both in the streets and in the market.
That was then. Now, the public mood has changed. Multiple vaccines are helping to turn the tide. Infection rates are suppressed as vaccination rates increase. Soon, the world will get back on its feet.
It is this new, post-pandemic, world that investors will be investing in. So where should we put our money as to maximum returns?
The first question at the back of every investor’s mind is this:
Will the global economy boom or slump post-pandemic?
Certainly, titans of industry are vouching for the former. ‘I have little doubt,’ predicts James Dimon of JP Morgan recently, ‘that with excess savings, new stimulus savings, huge deficit spending, more QE, a new potential infrastructure bill, a successful vaccine and euphoria around the end of the pandemic, the U.S. economy will likely boom.‘
The latest Fed minutes commented on the ‘improved economic outlook’ in the US due to the fiscal stimulus and accommodative monetary policies. Meanwhile, international trade is humming, so much so that shipping companies are ordering a record number of container ships. Even cruise ships are reporting a sharp rise in forward bookings.
Pent-up demand, coupled with pent-up savings and a desire to splash out as the economy re-opens, could do wonders for the economy. If you believe, as I do, that this year will be better off than the last, then investing in cyclical industries (airlines, cruise) is one way to benefit from the covid recovery.
Will rates rise further in 2021?
The next issue investors should worry about is interest rates. Investors were recently unnerved by the sharp rise in the long-maturity government yields, such as the 10-year US Treasury yield. Last August, this yield traded at a mere 0.52 percent. Now it fetches 1.65 percent.
Higher rates bring about all sorts of economic complications. First, it makes borrowing more expensive, albeit from a low level. Secondly, it raises the prospect of higher inflation. Some argued that it is the other way round, higher inflation expectations are dragging bond prices lower. What spooked investors is this – long-maturity yields are rising despite the ongoing Fed quantitative easing ($120 billion per month). Investors are afraid that the Fed may lose control of inflation expectations.
Given the sustained rise in commodity prices from copper to iron ore to food, this inflation theme is likely to continue to play out in 2021. Unsurprisingly even Warren Buffett wrote in his annual letter that “fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future.” Hence long-term government bonds should be underweighted.
Another point worth mentioning concerns the shape of the yield curve. Only the long-maturity yields are rising. Short-term yields are still pinned to the floor due to the ongoing QE. This creates a very steep yield curve. A steep curve provides a source of large profits for banks simply because financial institutions borrow short and lend long.
Look at iShares Financials (XLF). Prices are rising into new cyclical highs at the same time when yields started to climb. I expect financials to outperform this year.
What will be the hot sectors for 2021?
Investing is often about catching ‘hot stocks’ that produce stellar performances. Dot-com stocks in the nineties to new tech stocks (e.g. Zoom) last year.
In 2021, we already saw some very impressive performances from alternative energy sectors, crypto-related, biotech, and other niche subsectors such as 3D and space. These new sectors are growing rapidly and are likely to appeal to forward-looking investors. Sectors like:
- Alternative vehicles (e.g. electric vehicles, autonomous driving, battery-related)
- Fintech (e.g. insurtech, payments)
- Robotics & 3D printing
- Space exploration
- Blockchain (e.g., crypto-related)
- Biotech (e.g., genome, molecular, targeted therapeutics), etc
Moreover, many of these thematic-related stocks are small to mid-cap. They usually are higher beta. Higher price volatility is the price investors pay for performance. In the US, the Russell 2000 Index is breaking out to new cyclical highs, suggesting a rotation into smaller-cap stocks.
As such, some capital allocation into these sectors is favoured. Look for funds that invest in these topics including Scottish Mortgage (SMT) here in the UK or ARK funds in the US, such as Ark Fintech Innovation ETF (ARKF)
Should investors buy value stocks in 2021?
Another question investors often wonder is whether value investing works anymore. Last year saw value stocks underperform growth by the widest margin on record. Will 2021 be any different?
In the past few weeks, a few of these value stocks are reverting to their long-run means while growth stocks consolidate. This narrows the gap between value and growth (see below). The issue is whether this outperformance is sustainable. Perhaps yes. As the world economy normalises in the next 12-18 months, value stocks will slowly climb upwards, perhaps aided by a resumption of dividends, share buybacks and better profit expectations.
Of course, a lot of value is found outside the US. Some parts of Europe (particularly UK) and Asia are still lower-priced than the averaged US stocks. So I would look to these areas for long-term reversionary moves. Look for ETFs that have a value tilt.
Source: Financial Times (Paywall)
Should investors be in the stock market at all?
The last question is about capital allocation. Should we in the stock market at all? GameStop-type speculation, above-average valuation in the US, massive retail participation and an uncertain economy makes investing in stocks these days a risky business. All true. But keeping all our financial resources in cash is also risky too.
Remember, inflation will certainly encroach the value of cash over time. Interest on savings are low and significantly below official inflation rates. As such, it is imperative that some capital must be to work in the financial markets to generate returns just to protect the buying power of our capital. Tax-efficient wrappers like ISA stock must be utilised.