Welcome to our Winter edition of On the Marc. In this edition, we will review markets for the final quarter of the 2021 financial year and consider the outlook for the new financial year.

Market update 

The June quarter caps off a historically unpredictable and unique financial year for investors. Markets at all-time highs seemed implausible a year ago, but investors appear to have shrugged off pandemic risks and are looking through to a rapid but evolving economic recovery.

Except for utilities, all sectors of the Australian share market had positive returns in FY21. Consumer discretionary and financials both returned more than 40%. Several sectors enjoyed a bounce from the previous year’s drawdown, but retail, health care and information technology delivered year on year positive annual returns.

The performance of growth stocks peaked in the first quarter of FY21 when initial trials from a clutch of COVID-19 vaccines showed impressive results. The subsequent cyclical rally led to a sharp rotation into value stocks, unwinding some of growth’s historic outperformance. Having bottomed in August last year, bond yields rose through March as inflation expectations peaked. However much of this rotation unwound in the fourth quarter, driven by the Federal Reserve’s confidence in transitory inflation and ongoing dovish commentary.

Property prices continued their upward trajectory last quarter. The calendar year to date growth for Sydney residential property is 15.1%. We believe the strong growth will not continue in the new financial year as banks have been increasing many fixed rates in the past three months, which will continue. Early in the new financial year, we have seen prices in many areas come off the exuberant highs experienced in May and June. We are not expecting any meaningful falls but rather no or low single-digit growth into the foreseeable future.

Global shares achieved record highs in most regions with the world’s largest economy, the USA, yet again delivering very strong returns on the back of huge fiscal (government stimulus) and the continuation of record-low interest rates.

Market returns for major indices

Below is a table showing the percentage returns of the major market indices to 30th June 2021.

The outlook for the year ahead 

Significant attention was placed on June’s USA Federal Open Market Committee (FOMC) commentary. Chairman Jerome Powell acknowledged that the committee had begun “talking about talking about” raising interest rates, contrasting last June’s insistence that they were not even “thinking about thinking about” raising rates. Notably, the median expectation for rates to increase moved forward from 2024 to 2023. The market’s response saw a sharp rise in the US dollar and a general flattening of the yield curve. The implied level of future inflation declined which had been steadily rising since the beginning of the year.

The reaction surprised many investors, given the implied negative impact on equity valuations from rising interest rates. Support among investors for the Federal Reserve’s transitory inflation view has grown; however, the pull forward of rate hikes suggests a willingness to contain any breakout. Subsequent economic data has further galvanised the case for a not too hot nor too cold ‘Goldilocks’ economic recovery. While still broadly debated, as the USA begins to cycle soft data from last year, questions around the pace of growth and permanence of inflation will start to be answered.

We can expect further economic recovery in 2021-22 driven by stimulus, vaccines and reopening, albeit with a few bumps along the way.

The spike in headline inflation is likely transitory and reflects base effects, higher commodity prices and goods supply bottlenecks. Underlying inflation to remain more constrained. Global monetary and fiscal stimulus to stay, but gradually start to slow RBA cash rate now 0.1% + full-blown QE. Expect to taper later this year. Here in Australia, the money markets are pricing in the first-rate rise in 2023 (or late 2022) despite the RBA continuing to state this won’t happen until 2024.

Shares are likely to see more constrained gains and volatility but likely to provide reasonable returns on a 6-12 month view helped by rising earnings on the back of economic recovery. Dividends from Australian shares expect to increase in the coming 12 months, as shown in the below chart.

Did you know?

Most high-flying technology companies are not making money and continue to increase their losses year on year. Needless to say, they each expect to follow Amazon’s (red line) achievement and reach an inflection point where revenue exceeds expenses (i.e. become profitable).

Final reMarc

The 2021 financial year had many significant twists and turns. The potential headwinds for the year ahead include:

1. Coronavirus keeps coming back. The rollout of vaccinations domestically and abroad is key to returning to a life close to normal.

2. China tensions remain, and any escalation could have a further impact on Australia & the USA.

3. Economic recovery will be slower going forward.

4. There is a short-term spike in inflation.

The positives include:

1. Vaccines preventing serious illness allowing reopening to continue.

2. Downtrend in coronavirus cases and reopening in developed countries.

3. The safe-haven $US is trending down, which is usually positive.

4. Monetary and fiscal policy remains ultra-easy.

5. Low rates make shares cheap.

6. The US is a lot quieter (& diplomatic) under Biden.

7. Massive US fiscal stimulus continues to support world economic growth.

8. Company earnings expectations continue to be revised upwards.

The key lessons we can take away from the past year are:

- Make the most of the power of compound interest. The below chart clearly illustrates the benefit of compounding returns over time.

- Don’t get thrown off by the cycle.

- Invest for the long term.

- Diversify.

- Turn down the noise.

- Buy low and sell high (selling after a significant fall just locks in a loss).

- Beware the crowd at extremes where shares bottom at the point of maximum bearishness.

- Focus on investments you understand and that provide decent, sustainable cash flows.

“It isn't what you have or who you are or where you are or what you are doing that makes you happy or unhappy. It is what you think about it.”

Dale Carnegie

Key Facts & Figures

1. Australian Cash Rate remains at the record low of 0.10%.

2. The RBA Cash Rate is poised to remain at present levels until 2024.

3. Our annualised inflation rate is 1.1%. This remains well below the RBA’s target band of 2 - 3%.

4. Australia’s unemployment rate sits at 4.9%.

5. The Federal Reserve keeps rates at the record low range between 0% and 0.25% in the US.