Q1 2021 Market Outlook: Recovery, Opportunity, & the K-Recovery

This assessment was written in early February 2021 — delayed deliberately from the usual first-week-of-January publication to allow the dust to settle on two simultaneously significant developments: the fractious transfer of power in the United States following the January 6th Capitol events, and the initial rollout of COVID-19 vaccines that would determine the pace and character of the global economic recovery.  Both developments had clarified sufficiently by February to permit a considered view.

The American Recovery

The American economy entered 2021 with two tailwinds operating simultaneously: the vaccine rollout under the incoming Biden administration, and the prospect of a US$1.9 trillion stimulus package that the Congressional Budget Office’s own projections — which did not even assume the stimulus — already showed returning US GDP to pre-pandemic size by mid-2021.  Real GDP growth was 3.7% in 2021.  GDP averaged 2.6% over the following five years.  Unemployment fell to 5.3% in 2021 and approached 4% by 2024 to 2025.  Inflation is expected to reach 2% after 2023, which means the Federal Reserve was not expected to begin hiking rates until mid-2024 at the earliest.

The Republican Party’s reluctance to sanction the size of the stimulus package was noted but irrelevant.  With the Democrats controlling both Houses following the Georgia Senate runoff elections in January 2021, the legislative arithmetic made obstruction impossible.  The filibuster could not block appointments.  The legislative agenda would proceed.

The GameStop Opportunity

January 2021 produced one of the more entertaining spectacles in modern market history: retail investors on Reddit’s WallStreetBets forum coordinating a short squeeze on GameStop, AMC, and several other heavily shorted stocks, inflicting losses estimated at approximately US$19.75 billion on hedge funds that had built substantial short positions against them.  Melvin Capital — one of the primary targets of the short squeeze — required a US$2.75 billion emergency capital injection from Citadel and Point72 to avoid collapse.  The hedge fund manager, Gabriel Seth Plotkin, became, briefly, the most widely disliked man in American retail investing — which is a competitive category.

The consequence that mattered for most investors was not the GameStop drama itself but its collateral effect.  Hedge funds burned by the short squeeze liquidated positions elsewhere to cover losses and meet redemption requests.  Shares in fundamentally sound companies fell not because anything was wrong with those companies, but because a forced seller was selling regardless of price.  This created buying opportunities in assets whose price had moved for reasons entirely unrelated to their underlying value.  The investor with cash and the discipline to distinguish between a price movement caused by fundamental deterioration and one caused by a forced seller operating under distress found the January 2021 dislocation unusually productive.

East Asia: The Core Conviction

The primary investment thesis for Q1 2021 remained East Asia — specifically Greater China, Southeast Asia, and the associated technology and healthcare sectors.  Client holdings at the time had generated average annual growth of approximately 40% to 60% over the preceding year, despite market conditions that had tested every other portfolio construction approach.  This was not luck.  It was a structural position taken on the basis of identifiable tailwinds.

The World Bank’s data confirmed the thesis.  After a sharp slowdown to 0.9% in 2020 — the region’s worst performance in decades but still positive when every other major region contracted — East Asia and Pacific output was projected to expand 7.4% in 2021.  China was expected to lead, with GDP growth between 2% and 4% — below its historical potential but with significant upside from a manufacturing base that had weathered the trade war and resumed production ahead of any other major economy.

The K-recovery was the most important analytical framework for understanding where, within the region, capital should be directed.  A K-recovery describes an economy in which some sectors and some participants recover strongly while others continue to decline — the letter K capturing the divergence between the two trajectories after the initial shared shock.

Vietnam, Indonesia, and Singapore were positioned on the upward arm of the K.  Malaysia, Myanmar, and Thailand carried domestic political risk that placed them on the more uncertain arm.  South Korea and Japan would recover but more slowly, their export-dependent models requiring global demand normalisation that would take longer to materialise than the domestic consumption recovery in China and Southeast Asia.

China’s specific position deserved particular attention.  It had kept new infection rates down through 2020, resumed production earlier than any other major economy, and maintained its manufacturing competitiveness through the trade war — the US trade deficit with China having widened rather than narrowed despite the tariff escalation, as the American economy discovered that Chinese manufacturing capacity was not easily substitutable in the short term.

The Sectors

Technology funds represented the primary growth driver.  The pandemic had compressed years of digital adoption into months — e-commerce, cloud computing, remote working infrastructure, digital payments, and online entertainment had all experienced demand acceleration that would not fully reverse when physical restrictions lifted.  The consumer habits formed during the pandemic had demonstrated the kind of stickiness that makes structural thesis investments compelling.

Healthcare represented the secondary driver.  Demand for PPE and vaccines was immediate and quantifiable.  Longer-term, the pandemic had exposed chronic underinvestment in healthcare infrastructure across the region — creating both public and private investment demand that would sustain the sector well beyond the acute phase of the pandemic.

The Risks

The downside risks were identifiable and worth naming clearly rather than treating as remote possibilities.  Renewed COVID-19 outbreaks and delayed vaccine rollout represented the primary risk — particularly relevant for maritime Southeast Asia and Thailand, where elevated infection rates persisted into early 2021.  The young demographic profile of most Southeast Asian economies would ultimately work in favour of the recovery, reducing the mortality burden and allowing economic activity to resume more quickly than in older-population economies.

Financial stress amplified by elevated debt levels was the secondary risk — particularly in economies with petrobond maturities approaching, where the combination of low oil prices and high debt service requirements created cascading default risks.  Malaysia’s domestic political instability added a specific country risk layer that warranted caution on Malaysian-specific positions.  Neither risk category was sufficient to overturn the core thesis.  Both were near-term in character.  For investors with an extended horizon — the investment approach that the positions were structured around — the near-term risks represented noise rather than signal.

The Summary

The Q1 2021 outlook was constructive.  The American recovery was underway, the stimulus was coming, and the GameStop dislocation had created buying opportunities in fundamentally sound assets that had been sold for reasons unrelated to their quality.  East Asia was positioned to outperform, with China leading and Vietnam, Indonesia, and Singapore following on the K-recovery’s upper arm.  Technology and healthcare remained the sector convictions.

The investor who stayed the course through the January volatility, maintained their East Asian positioning, and recognised the GameStop-induced dislocation as an opportunity rather than a signal was well positioned for what the rest of 2021 delivered.  The S&P 500 returned approximately 28.7% in 2021.  The MSCI Asia ex-Japan Index returned approximately 2.3% — underperforming due to China’s regulatory crackdown in the second half of the year, which could not have been predicted from Q1 data.  The specific country and sector selections within the Asian positioning, therefore, mattered more than the regional thesis alone.

The lesson from that divergence — that a correct regional thesis requires correct country and sector selection to deliver the full return — is one that every market outlook should state explicitly rather than leaving the client to discover retrospectively.

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Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code