Markets were subdued in January as COVID cases increased in Europe and the US and the world tried to come to grips with the challenges of mass vaccinations. Perhaps most importantly, returns were strong in the preceding quarter and it seems likely there was some profit taking in January and a consequent loss of momentum after significant price rises. One "headline" was the share price performance of US computer game retailer GameStop - which has been impacted via online discussion boards to create a price rise of 2879% in the three months to the end of January. This created a lot of media attention but has not had a significant effect on markets overall.
Australian Equities was the only broad asset class to post positive results, with global equities slightly negative. Australian listed property and infrastructure extended their recent pattern of underperformance, whilst rising bond yields generated small negative returns across fixed interest benchmarks.
International Equities
China remained the best performing market in January with both Hong Kong and Shanghai managing better than +3%. Economic indicators here continue to show increased activity due to government stimulus and rising international demand for Chinese exports. The other major markets were muted - focused on more fraught outlook in Europe and the Us due to the economic impact of COVID and changes in government support and restrictions.
In the US, the new economic stimulus package is being prepared and is expected to be approved in March, paving the way for increased consumer spending via an additional $US1,400 payments to individuals. The US company reporting season has been slightly better than expected, despite a 1% reported decline in second quarter earnings. The UK has been assessing the impact of finally executing the BREXIT deal and there have been significant impediments to trade in food, goods and services - as well as COVID related impacts on trade and activities. Despite these impacts, share market losses have been minimal.
Australian Equities
The Australian market rose 0.3% in January. Consumer Discretionary stocks - particularly retailers - delivered a 4.7% return in the month. Retailers benefited from strong consumer spending in the December quarter, following government support payments and expenditure being redirected from travel. A large build-up of savings in the household sector implies further buoyant consumer spending may be possible. Banks performed well, as the proportion of poorly performing loans continue to drop, which should enable banks to restore some of the dividends that were cut last year. Property Trusts however were weak, possible in response to rising bond yields, which acted to reduce the relative attractiveness of rental yields.
Fixed Interest & Currencies
Longer term bond yields increased in both the US and Australia, with 10 year government bond yields now approximately 1.1% in both countries. Expectations of improved economic growth and inflation appear to be driving long term bond yields higher. However we do not yet see the evidence of consumer price inflation needed to justify a significant rise in interest rates. Non the less, inflationary expectations have increased over recent months as strong consumer spending and some areas of supply disruption provide two preconditions for inflation. Another potential source of inflationary pressure is higher energy and commodity prices. Prices for Iron Ore, in particular, have continued to push higher, as Chinese import demand remains buoyant and Brazilian supply weak. Offsetting these factors is spare capacity in labour markets, where elevated unemployment continues to be a deflationary force.
The Australian dollar is showing signs of plateauing, following a period of strong growth. In January, the $A fell US 0.6 cents to close at US 76.5 cents. Australia's currency remains underpinned by strong trade fundamentals. Higher commodity prices have supported the trade balance and neutralised the impact of some lower export volumes and stronger spending on imports by Australian consumers. As a result, the trade balance has remained in a strong surplus position over recent months.
Outlook and Portfolio Positioning
Notwithstanding the headlines surrounding the GameStop share price episode, share markets have been relatively steady over the past 2 months, following the significant increases recorded in November. It could be argued that this period of consolidation was overdue, as greater insight was required into the likely success of the vaccine program in allowing normalisation of economic activity before any further price rises could be justified.
Although the vaccine rollout is demonstrating inevitable challenges, the path to normalisation remains visible and this forms the basis of the market consensus assumption that 2021 will display a strong cyclical economic recovery. Hence, there remains a material risk that any evidence emerging to the contrary of this consensus assumption will produce negative impacts on share markets as forecasts for improvements in company earnings will need to be reassessed.
A second risk that has emerged as being slightly more significant over recent months is that of higher inflation and higher longer term interest rates. The rise in bond yields that has occurred to date has not had any noticeable impact on equity market sentiment. However, with valuations at such elevated levels when compared with historic norms, a change in the longer term market assumption around interest rates could start to challenge some of the basis for current valuations.
Given the risks described above, portfolios should continue to be biased towards the more defensive end of the equity market spectrum, particularly to selected areas of the property and infrastructure asset classes. Sectors that are less reliant on an imminent economic recovery provide less dependency on assumptions around a speedy vaccine rollout. These sectors are also appearing to be more attractively priced, as indicated by the fact that the broader global property and infrastructure asset classes are still priced 15% below the levels recorded one year ago. It is also these sectors that may prove to be more robust should inflation rise above expectations, with earnings from infrastructure and property assets often linked to inflation.
Over time, more defensively positioned equities are likely to gain increasing support from investors that previously held the majority of their assets in cash and fixed interest. With many investment grade assets now offering prospective returns below that of forecast inflation, a broad based shift in investment strategy around defensive assets can be expected. This may also involve an increased take up of Alternative investments, where the return profile is dependent on neither positive real interest rates nor positive equity markets.