29 January 2021
Themes For January
Following the turbulence of 2020, markets got off to a fairly subdued start to the new year with most major exchanges either flat or slightly higher. Both Australia and the US were just 0.3% higher while Europe finished marginally lower for the month. Indeed, most of the market’s attention was focussed on the trading fiasco surrounding the US electronics retailer GameStop, where coordinated buying from a bunch of day traders, inflicted major losses on hedge funds that were heavily short the stock. Yield curves began to steepen as long dated bond yields crept higher, factoring in the potential for inflation to emerge as a consequence of the monetary and fiscal stimulus measures used to blunt the economic impact of the pandemic. US 10-year treasury yields were 20bp higher to edge above 1% for the first time in almost a year. Following its strong appreciation from the lows of March last year, the AUD fell slightly against the USD to finish at 76.4c while gold was also a touch weaker to finish at US$1850/oz.  

Vaccine rollout still the key

While much of the world is still in the grip of various forms of lockdown to contain the spread of the virus, our central case remains that by the end of 2021 sufficient herd immunity from vaccinations will allow the global economy to return to its pre-COVID level of activity. While the vaccination task was never going to be a smooth process given manufacturing, storage and distribution challenges, the US are currently vaccinating a rate of 1.3 million people per day and smaller countries such as Israel have already vaccinated one third of their population. The three approved vaccines Pfizer, Moderna and AstraZenca all require two doses at three-week intervals before they take full effect. A single dose vaccine developed by Johnson & Johnson is currently before the FDA in the US for approval. While new variants of the virus are beginning to emerge, the advantage of the mRNA technology used to produce these new vaccines is that they can be tweaked to combat the new strains fairly easily. While COVID-19 mitigation measures will continue to be a factor restraining growth in 2021, there is no doubt the vaccine rollout will be a major step forward to the reopening of the global economy.

Monetary and fiscal stimulus driving asset markets

Governments and central banks continue to provide substantial liquidity support and fiscal stimulus to the global economy. In Australia, the RBA announced they are unlikely to adjust their 0.1% cash rate until at least 2024 and will increase their bond buy-back program by a further $100 billion in April. This is designed to both suppress bond rates but also dampen the strength of the AUD which has appreciated by an uncomfortable 38% from its low in March 2020. The local unit has been boosted by improving terms of trade as a result of strong iron ore prices driven by Chinese demand. While the JobKeeper run-off in March will provide some challenges to the employment market, the local economy is holding up much better than expected as evidenced by renewed strength in the residential property market which is benefitting from the ready availability of cheap credit. Australia’s geographic isolation, low population density and restrictions on international arrivals has helped us contain the virus to manageable levels and maintain a relatively open economy albeit hampered somewhat by intermittent internal border closures from alarmist State premiers.

In the US, the newly installed Biden administration have announced a massive $1.9 trillion stimulus bill which includes cash payments of $1,400 to people earning less than $75,000 per annum. While the bill is unlikely to gain bipartisan support, it only requires a simple majority and so can pass purely on Democrat votes given they now control both houses of congress. This kind of massive deficit spending and the burgeoning growth in money supply is likely to present economic challenges down the road. In the US, M2 money supply has increased by a massive 23% over the course of 2020, raising concerns of potential long term inflationary consequences once demand levels recover and spare capacity is used.

Investment Outlook

In an environment of virtually zero interest rates and a global financial system awash with liquidity, investors have a strong incentive to take on equity risk. While valuation measures are not exactly cheap, the prospect of improving profits and dividends facilitated by steadily reducing COVID economic drag will likely propel equity prices higher. In normal economic times you would expect higher interest rates and tighter credit conditions to dampen the markets advance, but these are anything but normal times. Given the severe economic dislocation caused by the pandemic, interest rate and monetary settings will remain easy for several years meaning that improving profits will leverage share prices higher. At some point the impact of the explosion in money supply will create challenges for both currency depreciation and inflation, but this is not an immediate concern given the excess capacity that still exists in the global economy.