Happy New Year and welcome to our Summer edition of On the Marc. In this edition, we will review markets in 2020 and consider the outlook into the foreseeable future.

Market update

Despite the pandemic, recession and a 35% plunge in shares into March the 2020 calendar year ended much better than feared as:

Massive fiscal support shielded businesses, jobs and incomes.
Schemes put in place to prevent debt holders from defaulting.
Massive monetary stimulus resulted in plunging interest rates helping borrowers service loans.
Economies reopened after social distancing helped contain the virus – albeit much better in some countries (e.g., Asia, Australia and NZ) than others (e.g., the US and Europe).
The election of Joe Biden as President in the US offered the prospect of less global policy uncertainty and tensions ahead.
Good news on vaccines' effectiveness later in the year offered the hope of a return to something more normal in 2021.

The first four points contributed to economies bouncing back faster than expected through the second half of 2020 – even though we are still far from a full recovery and coronavirus continues to wreak havoc.

Australian economic data releases in December were solid with another surge in November retail sales (up 7% month on month as Victoria reopened - see below chart), further gains in building approvals, another strong rise in job ads (which are now actually up 5% year on year) and a strong rise in imports. Home prices continued to surge in December, resulting in a 2% increase through 2020.

Chart: Total Australian Retail Turnover

Credit growth (bank lending) remained soft but looks like it might be bottoming and APRA data showed that the share by value of housing loans in deferral had fallen to just 2.8% from 11% in May, suggesting that the wind-down of bank payment holidays won't pose a significant problem for the property market. The much-forecasted financial cliff looks to be a non-event.

The data released above was before the latest coronavirus scare in NSW. While new cases appear to be under control again the scare compounded by partial lockdowns and a return to border closures will weigh a bit on confidence which may not be enough to stop the recovery but will slow it. This, along with the reality that we still have a long way to go to full employment and the continuing surge in the value of the Australian dollar acting as a dampener on the recovery, will likely see the RBA remain under pressure to maintain easy money.

A rate hike remains several years away. The RBA is still likely to extend its Quantitative Easing (QE) program beyond April to match other central banks QE programs to help slow the rise in the Australian dollar.

In the US it's been a big start to the year with Kim and Kanye splitting followed by Trump and Pence! More importantly, Congress has confirmed that Biden won with Trump committing to ‘an orderly transition’ (even though he ‘disagrees with the outcome’). As unbelievable as Trump's quixotic efforts to overturn the election have been - through numerous failed court challenges culminating in his egging on of his supporters who stormed the Capitol resulting in several deaths - they have now failed. Senate Majority Leader McConnell denounced efforts to reverse the result, challenges to state results received little Senate support and Vice President Pence refused to block Congress' confirmation of the election outcome because he has no power to do so.

Trump has less than one week left before Joe Biden is inaugurated on 20th January. Trump has left behind much damage and division, and the deeper problems in US society that Trump tapped into have not gone away, posing challenges for Biden. Trump ends his presidential term far from his promise of 'making America great again'.

In Europe the UK managed to reach a Brexit trade deal at the eleventh hour. This headed off a hard exit for the UK from the EU which could have knocked 2 to 3% of the UK economy next year. So, given that this has been averted it's good to the extent that it's favourable for global growth. That said the deal leaves significant uncertainty over services trade and still sees the return of customs checks at borders and will still leave the UK economy 0.5% or so per annum worse off over ten years relative to what would have happened if it had remained in the EU. It clears the way for free trade deal negotiations between Australia and the UK, but this may take years and while it may help a few agricultural producers its overall impact on the Australian economy is likely marginal.

On the share market, the Australian market ended up for the year with a 1.73% gain while the world share market closed up 5.58% (in AUD terms). The below chart illustrates it was the second most volatile year in the past two decades.

Market returns for major indices

Below is a table showing the percentage returns of the major market indices to 31st December 2020.

The outlook for the year ahead

After having run up so hard since early November, shares are vulnerable to a decent short term pullback and 2021 is likely to see a few rough patches along the way (much like we saw in 2010 after the recovery from the GFC). Looking through the inevitable short-term noise, the combination of improving global growth and low-interest rates augurs well for growth assets generally in 2021.

Likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns - like US shares, technology and health care stocks & bonds - to investments that benefit from recovery - resources, industrials, tourism stocks and financials. The following chart shows the number of cars sold and market capitalisation of the major car manufactures compared with Tesla (US growth stock). It is truly amazing that Tesla has the same market capitalisation!

Global shares are expected to return high single digits but expect a rotation away from tech-heavy US shares to more cyclical markets in Europe, Japan and emerging countries.

Australian shares are also likely to be relative outperformers returning low double digits helped by better virus control, enabling a stronger recovery in the near term, stronger stimulus, sectors like resources, industrials and financials benefitting from the rebound in growth and as investors continue to drive a search for yield benefitting the share market as dividends are increased.
Ultra-low yields & a capital loss from a 0.5-0.75% or so rise in yields are likely to result in negative returns from bonds.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield, but the hit to space demand and hence rents from the virus will continue to weigh on near term returns.
Australian home prices are likely to rise in the mid to high single digits this year, boosted by record-low mortgage rates, government home buyer incentives, income support measures and bank payment holidays. Still, the stop to immigration and weak rental markets will likely weigh on inner-city areas and Melbourne and Sydney units. Outer suburbs, houses, smaller cities and regional areas will see stronger gains in 2021 (as was the case in 2020).
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
The Australian dollar is vulnerable to uncertainty around coronavirus, China tensions and RBA bond-buying will keep it lower than otherwise, but expect it to rise above $US0.80 helped by rising commodity prices and a cyclical decline in the US dollar. The declining US dollar is also positive for bitcoin, which has more than doubled over the last month as more have jumped on to its bandwagon. Still, it remains hard to value and hard to take seriously as a currency given its extreme volatility.

Once Joe Biden takes office it likely means another $1.5-$2 trillion in fiscal stimulus (including $2000 stimulus payments and other pandemic measures in the next month or so, followed by more on climate and infrastructure later in the year) and likely corporate and top income tax rate increases (which will be necessary to pay for the extra stimulus over 10 years under the budget reconciliation process).

Moving forward stoushes over government funding in the USA should be avoided along with debt ceiling increases. However, Biden will likely still be a centrist and moderate Democrat senators will limit tax hikes and any leftward lurch, particularly in the 2022 mid-term elections. A corporate tax rate hike (say from 21% to 25%) is still negative for shares, but it's likely to be offset by more near-term fiscal stimulus. Historically US shares have done best with a Democrat President and Republican control of at least one house in Congress. Still, a Democrat President with a Democrat Congress has been a good second best. Combining a higher US corporate tax rate and more fiscal stimulus is on balance more positive for global, including Australian, shares as it benefits global growth.

Did you know?

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Final reMarc

There is so much doom and gloom in the media accompanied with extreme views. The longer-term negatives from the pandemic include higher unemployment; a further blow to globalisation; tensions with China; increased social tensions; more public debt; the risk of higher inflation long term; disruption for various industries like airlines, retail and office. However, there are here are four key longer-term positives:

Increased productivity – the disruption caused by the pandemic massively accelerated the adoption and efficient use of new technology in relation to virtual meetings, e-commerce and the use of the cloud that can cut costs and boost output.

A more balanced lifestyle and more affordable housing – with the pandemic showing that many can work from home more, can lead to a more balanced and less stressful lifestyle and allow more disperse living, taking pressure off expensive city property prices (but pushing up suburban and regional prices).
The benefits of science and relying on expert advice – the rapid development of vaccines highlighted what science can achieve, and the better management of the virus in some countries like Australia with minimal loss of life highlights the benefits of relying on expert advice. Both serve as a rebuke to ignorant populist politicians and offer hope for better management of other issues – like climate change.
The US is moving to more stable, less divisive leadership more reliant on expert advice under Biden, with democratic institutions withstanding an onslaught from Trump.

The above will support a solid rebound in global growth and profits (beyond near term COVID-19 lockdowns). At a time of significant spare capacity, it should be accompanied by still-low inflation and interest rates, meaning that we are still in the "sweet spot" of the investment cycle.

“Don’t underestimate the power of vision and direction. These are irresistible forces, able to transform what might appear to be unconquerable obstacles into traversable pathways and expanding opportunities. Strengthen the individual. Start with yourself. Take care with yourself. Define who you are. Refine your personality. Choose your destination and articulate your Being. As the great nineteenth-century German philosopher Friedrich Nietzsche so brilliantly noted, “He whose life has a why can bear almost any how”.”

Jordan B. Peterson

Key Facts & Figures

Australian Cash Rate remains at the record low of 0.10% with a reduction of 0.15% in November.
Interest rates are poised to remain at present levels for the next three years.
Our annualised inflation rate is 0.7%. This remains well below the RBA’s target band of 2 - 3%.
Australia’s unemployment rate sits at 6.8%.
In the US, the Federal Reserve keeps rates at the record low range between 0% and 0.25%.