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What can go wrong? Investors’ views on the big risks to markets in 2021

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The outlook for markets in 2021 among investors and analysts is easy to describe: cautious optimism.

Almost universally, fund managers believe the year will bring a rebound in economic activity, supporting assets that have already soared in value since the depths of the pandemic crisis in March, but also lifting sectors that had been left behind. Bond yields are expected to stay low, lending further support to stock valuations.

But the virus mutation found in the UK, which caused a brief wobble in markets late this month, highlights how it is not always smooth sailing.

We asked investors: what can go wrong?

The answers below have been edited for clarity and length.

Howard Marks

co-chairman, Oaktree Capital management

Rising interest rates, unlikely as they are in the intermediate term, are the main threat.

Today’s high asset prices are highly dependent on low interest rates for their appropriateness. If rates were to rise, asset prices would probably fall. However, there’s little reason to believe rates will rise in the short run because there doesn’t seem to be much inflation, and I believe the Federal Reserve isn’t concerned about inflation.

Valentijn van Nieuwenhuijzen

CIO, NNIP

I don’t think central banks will have to look through inflation, because I don’t think there will be any. If I’m wrong and it does accelerate, that’s a meaningful game-changer for markets.

It would mean that a lot of losers in markets that have been left behind could really catch up — think of banks and financials, but also the broader value factor that has suffered secular underperformance over the past decade. Growth stocks would suffer from rising interest rates. They might still rise but less than value. And obviously government bonds would suffer.

Everybody has the same benign outlook. That’s also a risk. We will be monitoring closely to see any concerning concentration in positions.

Sam Finkelstein

Co-CIO of global fixed income, Goldman Sachs Asset Management

Fixed income investors face two key risks entering 2021. 

First, the extraordinary Covid-19 policy response has extended the challenge of low yields. Second, central banks have limited policy ammunition in the event of a negative growth shock. This backdrop sharpens our focus on constructing balanced portfolios that are resilient to bouts of market volatility. 

Vincent Mortier

Deputy CIO, Amundi

The recent market rally is based on blind faith in the vaccine and on the brave assumption that very soon, everything will revert to as it was before, or even better. This is a risk: producing and distributing these vaccines on such a large scale won’t be a walk in the park.

Fiscal and monetary support are keeping economies afloat, but only just. These measures are getting harder to implement. Expect more monetisation of debt and increased pressure on central banks — any withdrawal of measures is unthinkable right now, and the risk of a policy mistake is underestimated by the market. 

The third risk is the consensus itself. The hunt for yield with skyrocketing negative-yielding debt will push the search for yield to the extreme: there is almost $1.5tn tof bonds outstanding in “zombie companies”. The temptation for investors to accept lower quality in their portfolios is high, as is the bet that interest rates will remain low forever. This is dangerous. 

Andrew Law

Chief executive of hedge fund Caxton Associates

The stage may well be set for a great reflation.

Many of the expressions [of this reflation] have been out of favour for the best part of a decade. Most market participants, and consequently their portfolios, are heavily conditioned from decades of disinflation or low inflation.

The change in the inflation regime, and subsequently the investor mindset, will likely have profound implications for asset allocations.

Liz Ann Sonders

Chief Investment Strategist, Charles Schwab

What concerns me most is sentiment. The success of the market itself recently has bred what I think is its greatest risk, which is overly optimistic sentiment. In and of itself, stretched sentiment doesn’t portend an imminent correction, but it does mean the market is likely more vulnerable to the extent there is a negative catalyst, which could come in any number of forms. 

Scott Minerd

Global chief investment officer, Guggenheim Partners

The pandemic has completely reworked our free-market economic system based on competition, risk management and fiscal prudence. It has been replaced by cycles of increasingly radical monetary intervention, the socialisation of credit risk, and a national policy of moral hazard.

This is troubling, as beyond the eyewall lies a poor credit environment judging by credit defaults, rating migration, and corporate fundamentals. In aggregate, the high-yield [debt] market has 4.5 times more debt than last 12 month earnings before taxes and other items, a ratio that already exceeds the 2008—2009 default cycle peak, and is likely to worsen from here.

Gregory Peters

Managing director and senior portfolio manager, PGIM Fixed Income

It’s amazing to me that the market has moved past the “Blue Sweep” idea [of Democrats winning control of both houses of Congress and the White House] . . . I think we could see a “Blue Sneak”, as Georgia’s Senate races are still very much in play to go blue. That could open up the fiscal spigot even more.

I still believe this will be a golden era for credit, but I’m probably more worried about this thesis than I was back in April. Everything is happening at warp speed, so maybe dividends, buybacks and M&A come back quickly as well. 

The biggest market risk continues to be inflation. I think it will only move temporarily higher next year due to base effects and then come back down. But the risk is that it continues to move higher, and that changes everything. We’re putting a lot of faith in the Fed to stand its ground and not respond to accelerating inflation. If the Fed loses its nerve, and gets worried about inflation sooner than what they’ve intimated, then that could be a problem for markets, causing a kind of “Taper Tantrum 2.0” scenario. 

Danny Yong

Founder of hedge fund Dymon Asia

The US dollar has crept lower this year, but could at some point fall precipitously. If that happens, the Fed will lose the flexibility of negative [real] interest rates, and may even be forced to pause asset purchases. That’s the tail risk scenario.

If there’s no Blue Sweep [in January’s Georgia Senate elections], then the Fed is the back-up. But if you lose the back-up, then the world could be in for a rude shock. It’s plausible, it’s not that crazy a scenario. If the dollar goes significantly lower, then the Fed could run out of easing options, which would lead to an equity sell-off. 

Paul McNamara

Emerging-markets debt portfolio manager, GAM

Financial markets have held together because of low policy rates and low bond yields, and lower discount rates have supported asset prices and suppressed government debt costs.

Although emerging-market debt burdens are (mostly much) lower than developed-market ones, yields are not, so debt servicing costs have not been suppressed to the same degree. EM central banks have cut rates as aggressively as DM ones, but bond buyers have been more cautious. Unlike DM, EM central bankers have not had the benefit of the doubt.

Turkey is especially instructive — a government refusal to recognise balance of payments constraints led to the need for a near-unique aggressive rate hike. This is the example of what we see as a broader risk: if EM policymakers do not continue to recognise that they face much tighter constraints due to the balance of payments than their DM counterparts, they risk a debt spiral that seems a very remote possibility in DM.



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Analysis

Musk well-positioned to steer cryptocurrency’s future direction of travel

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When Elon Musk revealed three months ago that Tesla had bought $1.5bn worth of bitcoin, fans of the digital currency claimed the move would hasten its wider adoption as a tool of corporate finance.

On Wednesday, however, Musk withdrew his personal endorsement, swearing off accepting the cryptocurrency as payment for Tesla’s cars and undermining the company’s justification for using it as a destination to park its spare cash.

As usual, Musk’s comments provided immediate fuel for crypto traders as well as ammunition for the warring crypto tribes on Twitter. But it was harder to tell whether his announcement would have any effect on wider perceptions of the currency, or what role Musk’s views will play in the next phase of crypto adoption.

“He’s always saying things every two days and isn’t consistent,” said John Coffee, a professor at Columbia Law School. Tesla’s pretensions to pushing bitcoin into the mainstream of corporate use always sounded secondary to its interest in pure financial speculation, Coffee added. “I think his first investment was much more of a currency investment than anything else.”

Whatever lies behind Musk’s on-again, off-again love affair with bitcoin, his effect on market prices has been hard to ignore. The currency’s price jumped 15 per cent on the day that Tesla’s investment was revealed, and fell 6 per cent in the 24 hours after this week’s announcement.

The latest drop came just days after Musk jokingly denounced dogecoin — another cryptocurrency that he had heavily promoted — as “a hustle” on US television, sending its value down 15 per cent.

“Without question, he’s become the single most important factor in crypto,” said JP Thieriot, chief executive of crypto exchange Uphold. That influence extends beyond Musk’s ability to move prices and helps shape how people think about digital currencies, Thieriot suggested.

Even Musk, however, can’t force cryptocurrencies into mainstream commercial use. He said this week that Tesla had backed away from accepting payment in the currency because of the environmental effects of the energy-intensive “mining” that goes into validating transactions — a well-known issue he has ignored in the past. 

Many crypto experts said that Musk’s change of heart appeared to reflect an acceptance that bitcoin was not suitable for payments. Other companies that had accepted bitcoin as a form of payment in the past, including Dell and Microsoft, also later dropped it.

“I don’t think a lot of people want to spend their bitcoin,” said Wilson Withiam, an analyst at crypto research group Messari. “If there was actual money behind it, would [Tesla] have actually done that?”

Musk’s change of heart extended beyond the issue of payments. He also swore his electric carmaker off becoming an active participant in the bitcoin market, saying that it “will not be selling any bitcoin”.

The commitment came two weeks after Tesla surprised Wall Street with a $101m profit from selling part of its holdings, raising worries that the company’s performance would increasingly be tied to crypto trading.

The pledge not to sell may have reassured some investors, but it also effectively undermined Tesla’s case for using the currency as part of its everyday corporate treasury operations.

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Zach Kirkhorn, Tesla’s chief financial officer, told Wall Street two weeks ago that the liquidity of the bitcoin market justified Tesla holding the cryptocurrency, since it meant the company could buy and sell actively.

That flexibility was particularly important, he said, as Tesla faced greater cash demands to finance plants in Texas and Germany while also dealing with extreme financial stresses in its supply chain caused by the global semiconductor shortage.

“Being able to access our cash very quickly is super important to us right now,” Kirkhorn said. With one tweet that promised to lock in the company’s crypto investment, Musk has torpedoed that rationale.

Some bitcoin backers said that Musk had still helped prepare the way for the wider adoption of bitcoin by corporate treasurers by encouraging other companies to view it as a valid holding — even if there have been almost no examples of others announcing they were buying the currency.

His initial enthusiasm for bitcoin had generated interest — including among treasurers — that was likely to continue well beyond his recent turnround, said Rayne Steinberg, chief executive of digital asset management group Arca. “People were talking about it, it entered the zeitgeist.”

Some corporate treasury experts, however, said that Tesla’s flirtation with cryptocurrency holdings had done nothing to encourage wider adoption.

“It created conversation among treasurers, but I don’t think it changed anyone’s mind,” said Jerry Klein at Treasury Partners in New York. The overriding requirement for treasurers to preserve the value of their companies’ cash had completely ruled out cryptocurrencies, Klein added.

But if Musk’s dabbling in bitcoin failed to change the currency’s standing in the corporate world, his latest intervention has raised another prospect: that he could become a kingmaker for a future cryptocurrency to rival or even supersede bitcoin.

Using his celebrity to draw attention to bitcoin’s large energy consumption — and that many participants in the network are in China, relying on coal-fired power stations — could hasten the search for alternatives, according to supporters. Surveys of millennials and Gen Z, who are big buyers of cryptocurrencies, showed that they were also deeply concerned about climate change, said Thieriot at Uphold. “Eventually, those things have to converge,” he said.

Musk’s comments provoked an immediate scramble for attention among backers of cryptocurrencies that claim to have less adverse effects on the environment. Those included Bitcoin Zero — a carbon neutral version of bitcoin — and Cardano, one of several networks that use a so-called proof of stake mechanism to validate transactions, consuming less energy.

Most newer networks, however, have struggled to win attention and a share of crypto investment. Most of the displaced attention has focused on ether, the digital token used on the ethereum network. With a total value of $440bn, its tokens are worth almost half as much as bitcoin.

Ether is already used by some investors as a form of digital money, and its long-planned move to a proof of stake system could finally be completed within the next year, putting it in a strong position to win wider support, said Withiam, the analyst at Messari.

Musk did not show his hand about which cryptocurrency will win his favour as he turns away from bitcoin, saying only that it would be a token that consumes less than 1 per cent as much energy. His open-ended comment is bound to leave crypto investors guessing — and guarantee that all eyes stay fixed on his tweets for the next clue to his thinking.

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Analysis

UK’s voter ID plan ‘an expensive distraction’

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When the Queen announced in parliament this week that the British government was planning legislation that would require voters to carry photographic identification, her words stirred up worries nine miles to the east, in the London borough of Newham.

Junaid Ali, organiser of the Hope for Humanity Food Bank, which operates from a rundown shopfront in the deprived, multicultural West Ham area of the borough, said families using the service on Tuesday told him they would struggle to find the documents voters are expected to need.

“A lot of the families do not have identification,” Ali said.

Such stories — allied with the near-absence of in-person voter fraud — have raised suspicions that the proposed legislation is an attempt to make it harder for some sections of Britain’s electorate to vote.

A study commissioned by the Cabinet Office and published on March 31 found that 9 per cent of UK adults lacked photographic identification that was still valid and had a recognisable photograph.

Ali said many people reliant on the food bank were citizens of Commonwealth countries such as Pakistan — who have the right to vote in the UK — but that many spent long periods without identity documents while the Home Office processed their visa and immigration applications.

“For asylum-seeker families, the ID is held by the Home Office,” Ali said.

A man hands over ID at a polling station in New Hampshire, US
In the US there have been accusations that new voter ID laws in the likes of Georgia and Florida are part of an attempt to stop black and other minority groups from voting © Suzanne Kreiter/The Boston Globe/Getty Images

The UK government’s move received backing from former US president Donald Trump on Tuesday who said the UK measures were “exactly” what the US should do. There have been widespread accusations that new voter identification laws across a swath of Republican-controlled states — including Georgia and Florida — are part of an attempt to stop black and other minority groups in America from voting.

Jessica Garland, director of policy and research for Britain’s Electoral Reform Society, the election-rights pressure group, queried why a crackdown on in-person voter impersonation was a priority for the government when it was a rarely recorded offence.

“There’s no evidence that there’s a problem that the policy is trying to solve,” Garland said. “We really think this could be quite an expensive distraction.”

Despite vocal opposition to the proposals, the government has so far refused to back down, perhaps raising the prospect of another embarrassing U-turn further down the line.

“Having photographic identification is ensuring a problem doesn’t arise,” Jacob Rees-Mogg told MPs on Thursday. “This country has an electoral system of which people can be proud and of which people can have confidence. We mustn’t allow that confidence to slip.”

The arguments surrounding voter identification have been familiar to Angela Wilkins, leader of the Labour party group on Bromley council, in south-east London, ever since the council hosted one of the pilots for the voter ID scheme at local elections in 2018.

Chart showing that in the 2017 election voters without driving licences or passports were more likely to vote Labour than Conservative

The Electoral Commission, the UK elections watchdog, said after the pilot that the majority of voters had been able to meet the requirements, although some were turned away. It added there was no evidence the requirement significantly deterred people from voting.

Wilkins, however, said she believed the commission had underestimated how many people were put off.

“A lot of people didn’t even attempt to go and vote because they knew they couldn’t because they hadn’t got the right ID,” Wilkins said.

It is unclear, meanwhile, how far the proposed legislation would address issues raised by the UK’s biggest election fraud scandal of recent years, in the 2014 local elections in Tower Hamlets, a London borough that neighbours Newham.

That case — which led to the removal of Lutfur Rahman as the borough’s mayor — related mainly to false registrations of people with no right to vote and a range of other issues, including the exercise of unlawful religious influence over voters’ decisions by Muslim religious leaders.

Former mayor of Tower Hamlets Lutfur Rahman, centre
Former mayor of Tower Hamlets Lutfur Rahman, centre in blue tie, was removed from his post after an election fraud in 2014 © London News Pictures/Shutterstock

The Tower Hamlets case took place while prime minister Boris Johnson was mayor of London. Johnson closely followed the case and after the ruling against Rahman in 2015 said: “I’m very glad that justice has taken its course and the cloud has been lifted from Tower Hamlets.”

But Johnson is also a longtime sceptic of ID cards. Writing in the Telegraph newspaper in 2004 as a Conservative MP, he said: “If I am ever asked, on the streets of London, or in any other venue, public or private, to produce my ID card as evidence that I am who I say . . . I will take that card out of my wallet and physically eat it.”

Garland said the fraud in Tower Hamlets had been caught and there had not been another similar case since.

“To introduce this measure for an entirely different kind of fraud . . . seems like the wrong lesson to be drawn from that,” she said.

It is not clear, either, whether the legislation will follow a key recommendation from the Electoral Commission — that councils should offer a free, official form of photo identification for those lacking other forms. Voters in Northern Ireland — where photographic identification has been needed since 2003, and whose experience the government has cited as evidence the proposals can work — are offered such a card.

The plans are also likely to encounter some political opposition when introduced to parliament. Libertarian-minded Conservative MPs are unhappy with the proposals; one described them as “the very sort of thing we used to tear pieces out of Labour for”. But any rebellion is unlikely to undermine the government’s 80-seat majority.

Ruth Davidson, the former leader of the Scottish Conservative party, described the plans as “total bollocks”, adding they were “a solution to a problem that doesn’t exist”.

She told ITV: “I think that given where we are and the year we’ve had, we’ve got real problems to solve in this country, and the idea that this is some sort of legislative priority I think is for the birds.”

The House of Lords is also likely to seek to amend the legislation. Liberal Democrat and Labour peers are particularly unhappy with the proposals.

Garland said the introduction of a free, official form of ID would be the “absolute minimum” required to make any system fair.

In West Ham, however, Ali said the new plans had simply added to the suspicions of his food bank’s already marginalised users about the government’s intentions towards them.

“They have concerns that it might be another way to check the data of people,” Ali said. “They’re quite scared.”

Additional reporting: John Burn-Murdoch in London and Lauren Fedor in Washington



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Analysis

Future of retail

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FT reporters examine the future of retail after a year disrupted by the pandemic



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