Shares up, cost of money down, how is Findex investing into 2021?

16 December 2020

Although it is still early days and many hurdles need to be overcome, encouraging developments on the vaccine front have allowed the Findex Investment Committee to have greater confidence that the current crisis will prove temporary.

Blackrock - the world's largest asset manager ($7.8 trillion in assets as at September 2020) noted the following on Monday (23/11):

  • “An accelerated restart to the economy in 2021 and structural growth trends already in place will spur a continued rise in US stocks”
  • “Investors should look through any near-term volatility caused by rising daily COVID-19 cases as the distribution of COVID-19 vaccines is just months away”
  • "We upgrade US equities to overweight, with a preference for quality large caps riding structural growth trends, as well as smaller companies geared to a potential cyclical upswing"

Source: BlackRock

The above comments provide an insight into one of the world’s most successful investment managers and are very much aligned to the views of Findex.

US Election

The passing of the US election “event risk” has already prompted a significant rally in equities, while volatility has started to moderate – both typical outcomes after a US election.

Global equity fund flows have improved after US elections historically

Global equity fund flows as a % of assets under management

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Source: Goldman Sachs Global Investment Research

The Democrats underperformed in the voting for the US Senate and we now expect a reduction in the size of potential Government stimulus initiatives. But this also means taxes are unlikely to rise in the near term. In terms of investors, the market environment is dominated by low interest rates, a hunt for income returns and the search for businesses to invest in that can grow their earnings.

2020

2020 saw a rapid decline in financial markets around the world, as investors came to grips with COVID-19 and the associated restrictions. What followed was a sharp recovery, as central banks and governments around the world stepped into support markets and economies. The large levels of support fuelled a sharp recovery, albeit uneven, as some sectors thrive, and others suffer, owing to the nature of the crisis. Dispersion was also evident across countries, as some contained the virus better than others, leading to shorter lockdown periods.

Wealth management NZ 1.1.png

Interest rates around the world have fallen. Below is a chart illustrating the Official Cash Rate (OCR) of New Zealand, showing that we are at historic lows. Low rates tend to support asset prices, reduce the cost of debt and force those who are reliant on income to re-think their investment strategy.

Wealth management NZ 1.2.png

Into 2021…

We see the 2020 bear market as “event-driven” with the collapse and recovery being faster than in “cyclical” bear markets (typically driven by interest rates) or “structural” bear markets (preceded by asset bubbles and imbalances). This dislocation has been unusual with significant economic shock, but extraordinary monetary easing and fiscal support have introduced a central bank and government “put,”1 reducing scarring and tail risks.

From a market perspective, the crucial issue now that the US election is out of the way is what will happen to growth, and this is now increasingly dependent on a vaccine.

COVID-19

The recent approval from the Food and Drug Administration (FDA) sees the United States become the third highly prominent western country (joining Britain and Canada) to issue the green light for vaccine rollout. Although the same vaccine is being used, the three nations all have vastly different healthcare systems, which will present different challenges as they distribute to millions of people.

The below chart illustrates the confirmed cases for the current (14/12/2020) 10 most affected countries, showing variable degrees of success in countries being able to flatten the curve.

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Source: John Hopkins University & Medicine

Revised market forecasts

Based on the current environment and the future economic backdrop, our global asset consultant SSGA (State Street) have undertaken a review of their asset class forecasts. As most readers would expect, the outlook in terms of returns has fallen across most asset classes, with the COVID-19 pandemic forcing central banks/governments to undertake rate cuts and introduce significant stimulus to try to turn global economies around.

Below is a table of revised forecasts at the asset class level, the most striking being the negative expected returns in fixed interest (bonds), as they bake in expectations of rising rates within the next five years.

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Asset allocation views and guidance

Whilst forecasts have been revised down, over the next three to five years our analysis still supports an overweight allocation to “growth assets” (property and shares). Asset price momentum has turned supportive in the current financial quarter and earnings growth has demonstrated some signs of improvement.

Over the long-term we expect an uneven economic recovery to play out, tied to a variable COVID-19 experience globally. Management of the virus remains a crucial milestone in the journey to recovery and announcement of an effective vaccine has certainly been a positive development in this space. Monetary and fiscal policy support from central banks and governments globally has been strong and aims to bridge the recovery gap.

Our outlook remains relatively positive on growth assets, particularly equities. Long-term asset valuations are marginally supportive of equities relative to bonds. While interest rates are close to zero (or in some cases negative), we will likely have this overriding disincentive to invest in bonds.

Summary Asset Allocation Views

Over the long-term we expect an uneven economic recovery to play out, tied to a variable COVID-19 experience globally. Management of the virus remains a crucial milestone in the journey to recovery and announcement of an effective vaccine has certainly been a positive development in this space. Monetary and fiscal policy support from central banks and governments globally has been strong and aims to bridge the recovery gap.

Our outlook remains net positive on growth assets. Long-term valuations are marginally supportive of equities relative to bonds, while interest rates are close to zero (or in some cases negative) which provides a disincentive to invest in bonds. Both fundamental and investor behaviour indicators support an overweight to equities at the current time.

In Conclusion

Concerns leading up to the election centred around markets that were rising on the potential of a vaccine and restrictions lifting while global economies were stalling. We have to look through the noise and focus on probabilities and realistic expectations. While media outlets continue to focus on Trump continuing to resist the inevitable, the harsh reality is global governments will need to remain in sync in terms of significant stimulus and monetary programs, infrastructure spending and job creation while rebuilding consumer confidence and spending.

Whilst it may seem there is a larger disconnect between markets and economies, here are three reasons for the optimism.

  1. Moderate Improvement in Corporate profits (Key driver in share prices). While it is likely to be an uneven economic recovery, huge amounts of stimulus and improvement in consumer activity should see improvement in corporate balance sheets.
  2. Vaccine distribution is underway in some countries. A successful vaccine rollout will be a massive boost to consumer and economic activity.
  3. Government stimulus packages and support have been at higher levels than the GFC (Global Financial Crisis) and delivered in a quicker fashion. Global leaders have been outspoken in terms of their wish to leave rates at close to zero for 2 to 3 years. The show of support by governments also reduces some of the “downside” risk from an investor's perspective. Investors would be less confident without the government’s helping hand.

We will continue to rebalance portfolios, as well as diversify and maintain realistic expectations. There is always the urge to take on more risk when cash rates are at or near zero and whilst assets will be supported in rising higher through low rates and stimulus, one eye must also keep track of valuations and potential bubbles.

Disclaimer:

Findex Advice Services NZ Limited, trading as Findex

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December 2020