2020 was a rollercoaster year
Global equity markets rose strongly following promising COVID-19 vaccine news; The Pfizer and Moderna vaccines were approved in several jurisdictions and reported higher than expected efficacy levels.
The resolution of the US election, ongoing monetary and government support as well as improving economic data further supported the rally. However, an increase in COVID-19 cases, particularly in the northern hemisphere, along with increasing restrictions impacted mobility levels and economic activity toward the end of the quarter.
In Australia, a market-friendly Federal Government budget, supportive measures from the Reserve Bank of Australia (RBA), and the re-opening of Victoria, produced a bounce in business and consumer sentiment and job growth.
While economic indicators are trending more positively, Australia-China relations have soured and need to be closely monitored.
Other notable points included:
• The S&P/ASX 200 Accumulation Index surged 13.7% over the December quarter.
• The global equity market recovery was broad-based. Markets such as Australia that had lagged due to their higher composition to cyclical sectors, such as Banks and Energy, rebounded strongly.
• As investors factored in an economic recovery, Australian 10-year bonds sold off with yields rising 18 basis points (bps) to 1.02% over the quarter. US 10-year yields also rose +23bps to 0.92%. As clarity emerges with respect to vaccine distribution, the yield curve should moderately steepen as short-term rates are kept low but longer-term rates move higher.
• Credit spreads have continued to tighten indicating a more promising economic and business environment.
• The Australian dollar rose strongly +7.4% to close at 76.94 US cents highlighting increased risk appetite in global markets.
• Commodities generally rose as investors forecast rising demand for base and bulk metals. The London Metals Exchange (LME) Index rose 15%, while oil rallied another 20%. Iron ore rose more than 30% to US$160/t as Chinese demand remains stubbornly robust and Brazilian supply issues re-emerged. Gold marked time during the quarter, closing broadly flat.
• In November, the RBA unveiled further easing measures including cutting the cash rate to 0.1% and expanding their quantitative easing program to buy longer dated bonds. The RBA does not expect to increase the cash rate for the next three years. The housing market has responded positively to this accommodative policy setting.
• 2020 was a rollercoaster year, but despite the impact of COVID-19, the ASX200 Accumulation index ended 2020 +1.4%.
OUTLOOK AND STRATEGY
As 2021 begins the economic outlook remains dominated by the need to balance COVID-19 impacts with the overtly accommodative monetary and fiscal support provided by central banks and governments around the world.
At least in the short term, we are cautiously optimistic that the globally co-ordinated stimulus coupled with vaccine rollouts will enable the current economic recovery to strengthen further in 2021. The US election result, with Democrats now controlling both houses, will only elevate and reinforce the quantum of near-term financial support.
There is no doubt that future policy flexibility will be adversely impacted by current decisions to expand central bank balance sheets and by the size of fiscal deficits. While we do not believe that this will be the focus of markets in the near-term, it may quickly become so if there is any faltering of the current recovery.
We believe that this environment will lead to rising bond yields and a steepening yield curve as rates at the longer end rise while the shorter end (zero to three years) is anchored by central bank bond purchases. Our expectations are that Australian and US10 year bonds could see out 2021 at between 1.5% to 2% and as such there is the real potential for fixed income returns to be negative over the coming year.
A rising and steepening yield curve, alongside low coupon rates, increases the relative appeal of equities as an asset class. Of course, this environment will also have implications for stock selection with “bond proxy” stocks - such as infrastructure and REITs - likely to come under pricing pressure as well as “long duration” growth stocks.
In this environment portfolio returns are more likely to be driven increasingly by stock selection rather than macro factors. This should be a positive investment climate for our Quality at a Reasonable Price (QuARP) investment philosophy which is largely a research driven, bottom up process that emphasises stock selection over thematic investing.
Throughout this period, our focus will remain on identifying attractively priced companies with strong balance sheets and relatively safe dividends to produce a diversified and well-managed portfolio.