Economic trends in 2021

The economic outlook for 2021 was largely dependent on recovery from the pandemic. Thanks to vaccines we saw economies reopen and start to recover. However, supply issues and surging energy costs fuelled increased inflation. 

After the shock of 2020, 2021 was a year of renewal. The rollout of vaccines across the world allowed economies to reopen after the pandemic and activity to resume. But the restart brought some unwelcome side-effects, such as rising energy prices and supply chain difficulties. Policymakers have been left wrestling with how to rebuild shattered government finances without derailing the recovery.

As many economists had predicted, once released from lockdown, economies in 2021 bounced back sharply. US GDP grew at over 6% in the first and second quarters of the year. However, a resurgence in Covid-19 cases led to new restrictions but with decreased financial support in Q3 and US GDP growth fell to 2.3%. According to the IMF economic outlook for 2021 – which was published prior to the spread of the Omicron covid variant – the Euro area is expected to grow at 5% overall, with France, Italy and Spain seeing the strongest expansion. The UK remains on track for growth between 6% and 7%. 

The emergence of the Delta covid variant in mid-2021 forced many countries into renewed lockdowns, particularly across Asia. Equally, many emerging market countries have struggled to get hold of sufficient vaccine supplies, delaying their reopening and creating a two-speed global economy in 2021. The Omicron covid variant spread rapidly at the end of 2021 but fewer restrictions have been required, with more emphasis placed on encouraging take-up of vaccines and boosters where these are readily available.

The restart brought an uncomfortable collision of rising demand and limited supply for many goods and services. Production of cars, laptops and other goods have been disrupted by shortages of elements such as semiconductors, plastics and glass. Labour shortages have affected all sectors, raising input costs for companies. In the final few months of the year, rising energy prices started to become a significant problem.

Central banks continued to insist that these inflationary pressures were short-term and that they wouldn’t be panicked into a premature interest rate rise. However, US inflation has run at over 5% since early May and markets have started to factor in rate rises. The consensus now appears to be that inflation will peak in the first half of 2022, but structurally higher prices may be here to stay.

In 2021, governments progressively stepped away from handouts and furlough schemes to support their economies. The main fiscal stimulus now is in the form of infrastructure spending, often with a green focus. Examples include the US$1.2trn infrastructure package in the US and the NextGenerationEU fiscal plan in Europe, which will filter into the global economy over the next few years. The drive for net zero continues to exert a profound influence on markets and 2021 saw environmental, social and governance investing firmly enter the mainstream.

In the first half of the year, markets were in recovery mode. They were led higher by economically sensitive sectors such as energy, mining and financials, rather than the high growth technology stocks that had dominated in 2020. These high growth stocks proved more sensitive to the potential for rate rises.

However, as momentum on the initial recovery faded, market direction became less clear. The mining sector slowed with China’s economy, reducing demand for industrial metals such as iron ore. Share price movements were more likely to be driven by stock-specific factors such as earnings growth and reviving dividends. In general, earnings growth was stronger than expected as the corporate sector showed its adaptability.

Investors have started to grow more concerned about rising input costs. Pricing power has become increasingly important for companies and characterised many of the winning stocks and sectors in 2021. They have also been alert to the prospect of the Federal Reserve cutting back on its purchases of government bonds, which was confirmed towards the end of the year. Previous episodes of such tapering have brought volatility, so investors were looking for companies that could continue to thrive whatever the direction of monetary policy. Against this backdrop, the top and bottom performing sectors were a mixed bag. Financials and property have done well, along with more defensive areas such as healthcare. The US, Europe and UK have all performed well. Among the emerging markets, India stands out. The weakest spot has been China. 

Its markets were hit by a broad-based government clampdown on key sectors, including the giant internet stocks, education and entertainment companies. It became clear that Chinese policymakers would only tolerate capitalism to the extent it didn’t clash with its social goals. Long-term bond yields started to spike higher towards the end of the year as investors became increasingly nervous about the prospect of higher rates. The US 10-year treasury yield moved from around 1.2% in August to 1.5% at the end of December. 

Central bank and institutional investor buying had kept yields low, but as this is removed, it could be a difficult time for fixed income.

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