At the 2021 annual SFNet Asset Based Capital Conference (ABCC), financial experts from four top companies gathered to discuss the economic and political outlook for the year ahead. The panel consisted of:

• Jeffery Wacker – head of U.S. ABL Originations, TD Bank Group
• David Mericle – chief U.S. economist, Goldman Sachs
• Lyuba Petrova – head of U.S. Leveraged Finance, Fitch Rating
• David Chmiel – managing director, Global Torchlight

Some key themes emerged throughout the panel discussion: 

• While US GDP fell approximately 3.5% in 2020 due to COVID, The EU posted a drop of over 6% and UK GDP fell by nearly 10%.  Pent-up consumer demand is expected to support a robust US growth picture in the second half of 2021.  Low interest rates could continue until 2023, helping keep housing and other rate-sensitive costs from escalating.  Inflation is expected to remain relatively in check, despite short-term pricing spikes in certain sectors and commodities. 
• Rapid and innovative injections of liquidity in the US economy in a variety of forms has helped business of all sizes continue operating during the COVID period. After initial constraints, capital markets recovered very quickly in 2020.One of the benefits of this is a relatively low corporate default rate supported by access to capital compared to what was seen in 2008-2010 when widespread defaults across numerous sectors occurred and capital markets were slower to reopen. While the overall default risk is muted, several sectors including hospitality and travel will be more sensitive to default risk.
• Politically, one factor to watch globally is upcoming elections. While the US election occurred in 2020, most major global economies will not hold elections until 2021-2022.Progress addressing COVID and economic growth are expected to be key drivers of voter choices. National agendas could take new directions depending on how strongly local economies emerge from the COVID downturn.

Look Forward to a Quick Recovery and a Dovish Fed

David Mericle, chief U.S. economist at Goldman Sachs, shared why he expects the economy to make a quick recovery in 2021. He projected about 7% GDP growth on a full-year basis (or 8% Q4/Q4) through the end of the year, driven by three key factors: fiscal stimulus, vaccinations and pent-up savings.

Fiscal stimulus in 2021 is projected to exceed the stimulus we saw in 2020. Additionally, as vaccination levels increase, Mericle said we can expect to see the economy reopening. "Solve the virus problem, and you largely solve the economic problem," Mericle said. This is especially true for high-contact consumer services like travel, dining and transportation that have not yet seen the recovery that some other industries have.

The saving rate for American households remains high and will likely fall as normal spending opportunities open up. Mericle anticipates this saving rate to drop back to around average at somewhere near 7%. On top of spending a larger share of their future income, households will also likely spend at least a moderate share of the pent-up savings they have accumulated over the course of the pandemic. All this sums to a likely growth peak in the second quarter of 2021.

Aiding this quick recovery is the anticipation of a fairly dovish Fed for the rest of the year. Mericle expects we can see the Fed begin tapering in early 2022, with liftoff sometime around 2024 under current guidelines.

Mericle noted that the liftoff criteria set to a much higher bar for the first hike than last cycle.  Mericle also noted the Fed's new framework includes some features that could imply a slower pace of tightening than the peak seen last cycle, including the idea that the Fed won’t hike solely because unemployment is low and the Fed's intention to roughly compensate for the inflation shortfall, though the speed of tightening will depend on the future path of inflation.

Expect Rating Outlooks to Vary by Sector

Lyuba Petrova, head of U.S. Leveraged Finance at Fitch Ratings, spoke about the rating and sector outlooks for 2021. Nearly half of U.S. speculative-grade businesses have experienced a negative ratings action of some kind, and the number of corporations with a negative outlook/watch more than doubled from 14% at the on-set of the pandemic to 35% at the end of 2020. Historically these convert to a downgrade at a rate of 50-60%. However, Petrova pointed out that the conversion rate this time might be lower, and in favor of stabilizations rather than downgrades. Factors contributing to this lower conversion rate range from improvement in oil prices, the roll-out of the vaccine, as well as the fact that many of the negative outlooks are in highly exposed sectors and have a precautionary element.

"Our sector outlooks indicate improvement or stabilization relative to 2020," Petrova said. Don't expect normalized volumes for airlines until 2024, as international and business travel are expected to lag recovery. Department stores and specialty apparel retailers still face a long and uncertain recovery, and an energy sector recovery will depend on a broader rebound in economic activity and global mobility. Petrova says to expect issuers to focus on deleveraging and capital expenditure reductions.

First-lien term loan recovery ratings were mostly steady throughout the pandemic, with 80 of first liens maintaining their recovery rating. Fitch’s current default forecast for 2021 stands at 2.5% for loans and 2.0% for bonds, underpinned by meaningful refinancing activity, better liquidity and improving operating environment.

Trade and Trust are Changing Globally

David Chmiel, managing director at Global Torchlight, noted that even before the pandemic, we were seeing profound shifts in the global environment. The percentage of Americans who saw free trade as an opportunity, rather than a threat, to the U.S. economy was at an all-time high before the pandemic at 80%, though Chmiel warns that we may need to rethink the way we look at trade.

"We need to bear in mind that history never stands still," Chmiel said, noting that we cannot look at trading relationships, particularly with China and the U.S., without taking into account geo-strategic context. Both nations are increasingly viewing one another as competitors, and the U.S. has seen a rise in isolationist rhetoric.

The pandemic made many countries wary of over-dependency on other nations – and their definitions of what constitute “critical” sectors of their economy have expanded accordingly. For example, the French government now considers self-reliance in food security a matter of national security. Japan and America have echoed this concern of over-reliance on foreign supply, with both nations trying to incentivize domestic production rather than increasing their dependency on China. Favorable views of China in a number of countries have showed steady declines since 2005, and Sweden recently broke from its usual neutrality to declare Chinese investment in telecommunications infrastructure to be a national security threat.

Adding to the complexity of the political landscape is declining trust of American citizens in institutions. Chmiel pointed to research from Gallup that showed declining trust in Congress, the presidency and institutions like big tech.  This, paired with pockets of populism in a number of countries, could shape the tone for years ahead. Additionally, though the United States has already been through an election cycle in the wake of the pandemic, many countries are still waiting to see what impact the pandemic will have on their elections.

Peering into the Crystal Ball

At the close of the conference, moderator Jeffery Wacker from TD Bank asked each panelist what their big-picture predictions and indicators were for the year ahead:

• David Mericle: I predict a big mid-year boom this year.
• Lyuba Petrova: I am focused on watching liquidity trends and seeing if there is continued access to capital markets. Another important factor is the successful rollout of the vaccine.
• David Chmiel: I'm watching two things. First, we've seen the pandemic heighten inequality. To what extent do we see that heal? Second, globally, I'm curious what China does next. They've become more assertive, with flashpoints in places like Taiwan and Hong Kong. How does China balance expanding economic interests with their growing military and foreign policy assertiveness?