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Monthly Wrap: November 2020

November saw plenty of developments competing for headlines – from three Coronavirus vaccines reporting positive stage-three trial results, to the election of a new US president and a geopolitical clash between Australia and China. George Lin talks market developments in November.

       Written by George Lin
Senior Investment Manager | Colonial First State
 

 

 

World financial markets closed November on a strong note, driven by positive sentiment surrounding vaccine trial results, investor support for US president-elect Joe Biden and an uptick in risky asset prices as investors contemplated a recovery from Coronavirus. While tensions escalated between Australia and China, the Australian market was also higher for the month – with Australian shares rising about 10% and the Australian Dollar (AUD) trading at a high of 74 US cents.

Key developments in Australia

In November, the Australian share market rose about 10% off the back of the positive vaccine news, easing lockdown restrictions in Victoria and the Reserve Bank of Australia’s (RBA) decision to expand its quantitative easing program. Cyclical stocks such as airlines, hotels and retail REITs have been the worst affected by the pandemic, but last month enjoyed strong price rises. The AUD was also a beneficiary of a jump in oil prices, and is now at its highest level versus the US Dollar since the start of the pandemic. The AUD traded at a high of 74 US cents before finishing the month 4.9% above its October level of 73.7 US cents.

 

Tensions escalated between Australia and its largest trading partner, China. After previously banning the involvement of Huawei, China’s largest telecom equipment manufacturer, in the construction of a 5G network in Australia, the Morrison Government’s support for an enquiry into the origins of Coronavirus upset Beijing further – resulting in a series of aggressive duties on Australian goods, in what has been dubbed ‘economic coercion’. The latest included ‘anti-dumping duties’ of up to 212% on wine. Treasury Wine Estates, whose Chinese exposure accounts for two-thirds of sales, finished the last day of November trading about 7% lower.

Source: Factset

Australian economic data released in November had a positive tone, reflecting the gradual easing of restrictions in Victoria. While the unemployment rate increased to 7% in October due to a rise in the participation rate, employment also grew by a surprising 178,000 positions in October after falling in September. After two consecutive monthly falls, retail trade also increased 2% in October. And another sign of improving sentiment was the sharp increase in the Westpac-Melbourne Institute Consumer Confidence Index to 105.02 – its highest level since July 2018.

Source: Factset
Source: Factset

In November, the RBA announced it would expand its quantitative easing program and introduce new forward rate guidance which promises lower policy rates for longer. The RBA announced reductions in its cash rate target and its target for the yield on the 3-year Australian Government bond to 0.1%. Further, the RBA also announced the purchase of $100 billion worth of government bonds of maturities of around five to ten years over the next six months. Under the program, the RBA will buy bonds issued by the Australian Government and by the states and territories in the secondary market with an expected 80/20 split. To dispel any lingering concerns of an interest rate rise, the RBA also changed its forward policy guidance, stating it “will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range” which “will require significant gains in employment and a return to a tight labour market”. Given the outlook, the Board noted it was not expecting to increase the cash rate for three years.

Key developments globally

The US presidential election was closer than most pre-election polls suggested. While this led to some uncertainty in the days following the election, Joe Biden secured enough electoral votes to capture the presidency. Financial markets were largely satisfied with the result of a divided government, with the Republican-controlled Senate acting as a ‘check and balance’ against the more interventionist, income redistributionist tendencies of a Democrat president1. Markets were further assured by news that former Federal Reserve chairman Janet Yellen, a respected and moderate policymaker, had been nominated to the post of Secretary of Treasury under Biden’s administration.


A surge in new Coronavirus cases across Europe and the US accelerated in November, leading to ‘mini lockdowns’. Many European governments imposed various social-distancing measures, resulting in new case numbers declining. In the US, many state governments have been reluctant to impose sweeping controls, and by month’s end, the number of cases reached new highs.

 

However, this was largely overshadowed by positive vaccine developments. Pfizer/BioNTech announced their vaccine was more than 90% effective in phase-three trials. Moderna, which uses the same mRNA technology as Pfizer, later announced its vaccine was 94.5% effective based on an interim analysis of phase-three data. And AstraZeneca and Oxford University announced their vaccine was 90% effective when administered as a half dose followed by a full dose at least a month apart. Pfizer/BioNTech applied to the US FDA for emergency approval of its vaccine in November, but was approved for use in the UK (which purchased 40 million doses) in early December.

 

Positive vaccine developments and the results of the election drove risky asset prices higher in November. Markets adopted a ‘look-through’ perspective on the surge in new Coronavirus cases, largely ignoring the short-term negative economic impacts of more social restrictions and focusing on the vaccine-induced longer-term prospect of a return to economic normality. The major share indices surged – the S&P 500 rose 10.8%, the NASDAQ rose 11.8% and the Euro STOXX rose 16.9%. The outperformance of cyclical stocks helped value stocks to outperform growth stocks. The Russell 3000 Value Index returned 13.5%, outperforming the Russell 3000 by 2.9% in October. However, on a rolling 12-month basis, growth has outperformed value by 34.5%. Oil prices also benefitted from vaccine optimism and hopes that demand will recover faster than expected. The WTI spot price jumped 32.6% in November to US $48.2 per barrel – its highest level since the start of the pandemic.

Source: Factset

The global economy continued to recover in November. In particular, the recovery in the manufacturing sector consolidated, as evidenced by the strong Purchasing Managers’ Index (PMI) rises in the US and China. Elsewhere, weakness in Europe’s services sector persisted, with the PMI falling for the second month and remaining below the level of 50 – suggesting a contraction. Given the full impact of social restrictions in Europe is yet to be fully reflected in data, we expect further weakness in European economic data.

Source: Factset
Source: Factset

Looking ahead

As we round out an eventful year, we anticipate positive vaccine developments will be a ‘game changer’ for financial markets over the coming months. With at least one candidate vaccine now approved for emergency use in one part of the world, a key question now is: when will the world achieve herd immunity, thereby allowing the global economy to re-open? There are two main challenges from regulatory approval to the achievement of herd immunity:
 

  • The first is the manufacturing and distribution of a vaccine. While developers have geared up for large-scale manufacturing, 85% of the initial production volume has been reserved by major developed economies. From here, a vaccine would likely be distributed to priority groups before broadening out. In the UK, that’s healthcare workers, the elderly, those most at risk and their carers. This suggests herd immunity may be achieved in developed economies by the end of next year. Less developed economies are unlikely to gain access to a vaccine as quickly, with the exception of China and Russia. Herd immunity for these economies will likely come later, possibly around mid-2022.
  • The second challenge is the willingness of the population to be vaccinated. Surveys have suggested that only 73% of the world population is willing to be vaccinated. The proportion varies considerably across countries and is lowest in France (54%) and highest in India (87%). Governments will likely launch information campaigns to convince people to be vaccinated. Dependent on the success of such campaigns, herd immunity may be delayed in some regions.

 

Nonetheless, financial markets are forward-looking and discount long-term cash flows in the pricing of bonds and stocks quickly in response to news. As long as the candidate vaccines live up to their trial results, markets will focus on economic re-opening efforts, stronger profits and cash flows for stocks.

 

We expect reflation will be the dominant theme over the next year. The general environment will likely be bullish for risky assets like shares and slightly bearish for bonds. As the pandemic eases, inflation should rise but the magnitude of the rise may be modest given the low level of capacity utilisation in the global economy. Central banks’ continuing dovish policies will support asset prices and lead to a further chase for yield. Corporate bonds will likely outperform sovereign bonds in this environment. Within shares, value should outperform growth – driven by the recovery in the cyclical sectors. However, we caution against the expectation that value stocks will recover all their relative underperformance versus growth stocks, given some of the structural advantages of growth investments. Finally, we expect active managers to outperform as different sectors and regions will recover at different speeds and as markets will be less dominated by Coronavirus headlines.

 

Looking ahead, it’s helpful to remember that markets rarely move linearly and that there will likely be market fluctuations in this reflationary phase. The most significant short-term risk is escalating Coronavirus cases in the Northern Hemisphere, which may lead to more lockdowns and, in a worst case scenario, technical ‘double-dip’ recessions for some countries in the December quarter. However, positive vaccine developments may mean financial markets will pay less attention to such developments. Investors should also be wary of being overly optimistic over share market returns. While they’ve significantly recovered most if not all their losses, the upside potential may be more limited.

 

In the meantime, Colonial First State will continue closely monitoring market developments and communicating closely with our skilled investment managers about the risks and opportunities in markets. Learn more about investments and get the latest updates on our website.

 

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