Colonial First State’s top three for 2020 and 2021
What does the Investments team make of where markets were in 2020 and where they could be in 2021? In case you missed the video, we’ve shared the highlights of their panel discussion below.
|Written by George Lin
Senior Investment Manager | Colonial First State
Last quarter, the announcement of vaccine approvals and vaccination programs kick-started a reflation trend (that is, price growth supported by fiscal and monetary policy) – one that continued into the new year. Key share indices reported strong gains during this time, but the strong performance of higher-risk assets has contrasted with the deteriorating pandemic situation in the US and Europe. Economic data has also been somewhat disappointing for several economies – driven, in part, by some governments’ social-distancing measures in response to Coronavirus. Nonetheless, financial markets seemed to ignore the negatives. And by quarter’s end, Australian shares rose 13.8% while the Australian Dollar (AUD) traded at 77.2 US cents – for the most part, continuing this positive momentum into the month of January.
New waves of Coronavirus accelerated during the December quarter, particularly across Western Europe and the US. As the number of new cases surged, the UK and several European countries introduced more severe social-distancing measures that were similar to those imposed in early 2020. Since then, the tide seems to have turned – at least for parts of the world. In both Western Europe and the US, daily new cases reached a peak in early January and have since declined.
Another negative development was the discovery – and subsequent spread – of new, mutated strains of the virus from the UK and South Africa. The UK strain is believed to be significantly more infectious and more deadly than the original variant. The South African strain is also more infectious and more resistant to vaccines, and also seems to have a stronger effect on younger people.
Global economic data began losing steam in December, as industry sectors more reliant on face-to-face contact were impacted by social restrictions. This is reflected in the divergence between the global manufacturing and services sectors. For example, while the Manufacturing Purchasing Managers’ Index (PMI) continued pointing to a healthy expansion, the Services PMI fell – particularly in Europe, where the level (firmly anchored below 50) points to a contraction in the sector.
As many European countries introduced more restrictions in December, economists have revised down their forecasts for the region’s economic growth. Consensus expectations are that several European economies will have suffered a “double-dip” recession for the December quarter – with Gross Domestic Product (GDP) growth ranging from a mild -0.9% in Germany to a more severe -4.8% in France. However, forecasters also expect European economies to recover about half their GDP losses for the March quarter as cases peak and as social-distancing measures are relaxed.
|December quarter 2020||March quarter 2021|
While the US economy seems to have weathered the recent escalation in Coronavirus cases better than Europe, that doesn’t make it immune to economic setbacks. For instance, the level of non-farm employment fell by 140,000 in December – ending the country’s run of seven consecutive monthly rises. Retail trade also fell by an unexpected 0.6%, the first monthly fall since April 2020. Higher frequency economic data suggests that while the US economy still grew over the December quarter, the pace of the economic recovery has slowed significantly compared to the September quarter.
In comparison to our developed peers, Australia has benefitted from the government’s containment of the pandemic over the past few months. While there have been small-scale clusters of active cases in a number of capital cities (Sydney, for instance), lockdowns in Australia have been localised and limited. Australian retail trade rose by an impressive 7.1% in November, the second consecutive monthly rise. The level of employment also increased by 90,000 in November with a 70,000 rise in full-time roles, while the unemployment rate fell to 6.83% after reaching a peak of 7.44% in June.
Markets largely treated Coronavirus developments as short-term noise, focusing instead on vaccination programs. Indeed, a number of vaccines were approved over the December quarter, with several developed economies quickly commencing ambitious programs to vaccinate their populations – including the US, the UK, Europe, Canada, Israel, and Singapore. The number of doses manufactured, delivered and administered is impressive. In the US alone, 44.4 million doses were manufactured and distributed, while 23.5 million doses were administered as at 26 January this year – a little more than a month since the program started. However, it must be emphasised that with the exception of Israel, the proportion of the population which has been vaccinated is still comparatively small and is far lower than the threshold of 60%–70%, which experts believe is required to achieve herd immunity.
|Country||Doses (per 100 of population)|
The start of immunisation programs kick-started a significant reflationary trend in markets. While this trend has faced some challenges from rising Coronavirus cases, concerns about new virus variants, and political volatility seen in the US in January, it has remained largely on track. In particular, the US Senate elections in Georgia (where the Democrats won a narrow two-seat majority) as well as President Biden’s US$1.9 trillion fiscal stimulus proposal furthered the momentum in markets. While the proposal has yet to be passed and the eventual package will likely be smaller than the initial number, markets are still boosted by the belief that US fiscal policy will remain supportive in 2021 and, if the need should arise, that further stimuli will be provided.
Higher-risk assets including shares, credit, commodities and the AUD all performed strongly over the December quarter and into January. Among the main share markets, the US market stood out once again. Hong Kong’s Hang Seng Index, which is dominated by Chinese stocks, also recorded a strong rise during this time. This has been driven by a combination of the strong economic recovery in China and an inflow of Chinese capital into the Hong Kong share markets as more Chinese stocks relocate their listings from New York to Hong Kong. Australia’s All Ordinaries Index has been another beneficiary of this reflation, driven by the recovery in global manufacturing activity and strong commodity prices. The Iron Ore spot price rose to an all-time high and the AUD, which traded at a low of USD 0.575 in March 2020, surged to a high of 77.7 US cents at the end of the December quarter. By the end of January, this declined somewhat to 76.7 US cents.
|All Ords||Hang Seng||S&P 500||NASDAQ||Euro STOXX|
At this stage, we believe reflation will still be the dominant theme in 2021. However, there are two key risks that could potentially lead to a correction in asset prices:
The first risk is that markets’ total confidence that key developed economies will achieve herd immunity by the end of 2021 may turn out to be too optimistic. Such confidence has allowed markets to “look through” the sharp surge in new cases over the past three months and focus on a normalisation of the level of economy activities, which will allow corporate earnings to recover sufficiently to justify expensive valuation. A weakening of conviction on the expected timing of herd immunity has the potential to produce a significant market correction. While it is difficult to forecast the path of the pandemic, there are several material risks in the path to herd immunity:
The second risk is the surge in share prices over the past few months, which has pushed valuations in several major share markets (as measured by the trailing and forward price-to-earnings ratio) firmly into ‘expensive’ territory. In particular, both the S&P 500 and the NASDAQ are trading at or close to their most expensive valuations. To some extent, more expensive valuations can be justified by the extremely low level of bond yields and the expectation that earnings will recover in 2021. Further, the US share market benefits from having greater exposure to technology stocks, which have better growth prospects. However, the difference between the earning yield of shares versus bond yields, a proxy of investor-expected returns from owning risky assets (shares) over the returns of lower-risk assets (bonds), has declined sharply. While this doesn’t necessarily signal an imminent share market correction, it does suggest markets may not be pricing in some downside risks.
In the meantime, our team will continue closely monitoring market developments and keep our investors up to date on the latest. Visit our market updates page for news, insights and more.
*Since all the approved vaccines, with the exception of Oxford University/AstraZeneca, require two doses, the figures overstate the number of effective vaccinations.
1The magnitude of the reduction in production volume is not known but press reports suggest that it may be as high as 30 million does out of the roughly 80 million doses which the EU ordered.
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Unless otherwise specified, this document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at the date of publication. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State or any member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. Colonial First State is the issuer of interests in FirstChoice Personal Super, FirstChoice Wholesale Personal Super, FirstChoice Pension, FirstChoice Wholesale Pension, FirstChoice Employer Super offered from the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557. It also issues interests in the Rollover & Superannuation Fund (ROSCO) and Personal Pension Plan (PPP) offered from the Colonial First State Rollover & Superannuation Fund ABN 88 854 638 840. Colonial First State also issues other investment products made available under FirstChoice Investments and FirstChoice Wholesale Investments, other than FirstRate Saver, FirstRate Term Deposits and FirstRate Investment Deposits which are products of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is a wholly owned subsidiary of the Bank. The Bank and its subsidiaries do not guarantee the performance of FirstChoice products or the repayment of capital from any investments. This document provides information for the adviser only and is not to be handed on to any investor. It does not take into account any person’s individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) before making any recommendations to a client. Clients should read the PDS before making an investment decision and consider talking to a financial adviser. PDSs can be obtained from colonialfirststate.com.au or by calling us on 13 18 36.
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