Almost twelve months on from March 2020, and it’s been a tumultuous year.
As we have reported throughout the months – March, April, June and September – we have experienced a great deal of volatility across global markets… but as we look ahead, while there are still some hurdles to overcome, positivity is returning.
Where are we now?
The investment committee continually analyses the current market environment, looks at themes that are presenting themselves and seeks to understand how it will impact our clients. Graeme believes that we have most likely experienced the sharp V shaped event we highlighted back in June. He explains,
“When we consider where we are now, it’s incredibly likely that the coronavirus market impact will result in a V shaped event. There were many people postulating that we would have a depression, but it appears more likely that we’ve had a short sharp shock.
Looking back to March 2020… it was about the worst month we’ve ever seen in markets, but it was just a month. And then in the second half of the year we’ve witnessed a relatively solid recovery.
Fortunately, here at First Financial, we were able to look at the long-term fundamentals through that period and they indicated most asset classes still looked attractively priced, even when we factored in the damage that might have been done.
That meant we definitely weren’t advising to sell during that time and in hindsight it turned out to be a sound decision… the tools we used have served us well when there was a lot of fear and anxiety gripping markets.”
We are at an interesting point now where asset prices have risen, and when prices rise, future returns drop. This is just the way the market works, unless there is a corresponding improvement in the earnings outlook. Graeme continues,
“While prices have increased, we’ve suggested that the damage from COVID probably isn’t going to be as bad as what we factored in six months ago. So even when you do factor in a small earnings uplift, the price increases have dwarfed that in terms of the forecast.
At this point, the future returning markets are not as attractive as they were… but we are also experiencing a phenomenon where cash and term rates are the lowest they have ever been – effectively at zero.
So, if we are looking at a return of 5% or 6% for the next few years out of equity markets, which would ordinarily be horrible, in the context of not even a 1% return on term deposits, it’s actually not too bad.
We still have the view that most markets, with the exclusion of the US market, are still fairly priced… they are neither terribly cheap nor terribly expensive, so we are staying invested.”
As vaccine programs roll out across the globe, we’ve seen renewed optimism and this has been reflected in the markets over the last three months.
“We expect for this optimism to continue and as vaccines are delivered, improving sentiments in the market will drive prices further… but this means it will get to a point where if we don’t see a dramatic increase in the earnings outlook then the shares and property will no longer look cheap.
That is a key issue – there’s really nowhere else to go… other assets such as bonds and cash aren’t looking attractive, so it’s a challenging investment environment.
More than ever, we will be relying on good research… as the broad asset classes are fairly priced, to find value you have to look within each asset class and ask, ‘What sector or individual investment looks attractive compared to others?’”
The Government implemented a range of stimulus packages to support Australians and the economy during the pandemic, and we believe that has had a positive impact.
“We still think that monetary and fiscal policy will remain pretty accommodating. We believe Government will still support jobs growth, and we can’t see interest rates rising any time soon either. On that basis, the fiscal environment will remain expansionary and that will support asset prices as well.
But we need to acknowledge that you can’t continue forever without the fundamentals catching up with earnings.
There are certainly risks around and it would not be surprising to get a correction at any stage, if there are major disappointments. The most obvious would be failure in the vaccine rollouts; this could create a significant re-rating of markets.”
US market risk
There is also a recognised risk in the US market. Graeme explains,
“We are cautious of the US market at the moment… it is really highly valued – currently valued price vs earnings (PE) of 33 times, which is very high. We would expect something normal to be around 20 PE and long-term average is about 15, but when you are at 33 you know the market has some exuberance behind it.
There could be regulatory and tax risks as Biden and Yellen have already made suggestions that they will be addressing wealth inequality. This could lead to higher taxes, and there is room for the US equity market to drop more than others.”
To summarise, there’s no denying we will have more debt than we would have without the virus, but the policies of Government and the overall approach have been successful. Graeme concludes,
“We haven’t seen wide scale damage to the economy, and we’ve allowed the health people to deal with the crisis. JobKeeper and other stimulus seem to have avoided large scale unemployment scenarios… so far, the measures that have been put in place have been effective. But it’s not like there won’t be a hangover… we have more debt than we’ve had in the past, and we aren’t out of the woods yet. There are still things that can go wrong.
The next six months will still be interesting, but I feel that it’s overwhelmingly likely that things will get back to something that is more normal… it will take all of 2021 and some sectors will hurt more than others, such as tourism and hospitality, but when you start looking into 2022 and beyond, we can be optimistic that we should almost be back to where we were in 2019.”
If you have any questions please contact our team today.