Macro Matters – January 2021

(Source: Merlea Macro Matters)

Summary

Throughout this pandemic year, we have experienced a further sharp widening of an already remarkable gap between financial markets and the economy. A rapid recovery in asset prices from the March 23 lows took major US indices to record levels, even before the recent good news on Covid-19 vaccines. Combined with even more accommodative central bank policies, this enabled record debt issuance at historically low levels of compensation for creditors.  The result is not just seemingly endless liquidity-driven rallies regardless of fundamentals. It also alters market conditioning and inverts traditional cause and effect.  Based on what we know today, the challenges facing investors in 2021 are probably less about the first few weeks and more about later in the year.

Central banks’ deepening distortion of markets will be harder to defend in a recovering economy amid rising inflationary expectations. As welcomed as this recovery will be, it is unlikely to be sufficient to fully offset the impact of corporate bankruptcies or the detrimental effects of higher inequality. Investors might rue the day they ventured into asset classes far from their natural habitat that lack sufficient liquidity in a correction.

Of course, a reflationary outcome is precisely what every establishment entity wants, from central banks to politicians across the globe.

Repeat after me, the markets are not the economy.  Already, the great disconnect has continued much longer than most expected. This illustrates, yet again, the unintended consequences of a policy approach that places an excessive burden on central banks. The hope for 2021 is that, with a vaccine-enabled economic recovery, better corporate fundamentals will start validating elevated asset prices and allow for an orderly rebalancing of the monetary-fiscal-structural policy mix. There are two risks, and not just for markets. First, what is desirable may not be politically feasible, and second, what has proven feasible is no longer sustainable.

Bonds

In response to the Covid-19 pandemic, central banks and governments have rolled out monetary and fiscal support unprecedented in size, timing, and coordination – driving rates lower for longer. In March 2020, the Reserve Bank of Australia (RBA) cut its cash rate two times to 0.25% and again in November to a record low of 0.10%.

Looking forward, rates are likely to stay lower for longer as the US Federal Reserve (the Fed) announced in September 2020 a shift in focus to target an average inflation level of 2% over time. After years of failing to reach its inflation mandate, the Fed is prepared to tolerate higher rates of inflation before raising interest rates to ensure an average inflation of 2%.

This pushes any expectation of a rate hike by the Fed well beyond 2023, as priced by the market. It also means that other central banks, including the RBA, are unlikely to be able to raise their rates if the Fed doesn’t, given it could cause currencies to further appreciate against the US dollar. As real rates and real yields are expected to remain negative for some time, this would further limit the appeal of core government bonds.

Global Bonds – The overriding objective for monetary policy this year has been to support fiscal policy by keeping global bond yields low. This policy is likely to come under pressure as growth recovers, but central banks are unlikely to tolerate anything other than a modest increase in bond yields.

US Bonds – The Fed’s shift to average inflation targeting is designed in large part to push inflation expectations higher. While this would normally be expected to push interest rates higher as well, we expect the central bank to support the economic recovery by continuing to purchase US Treasuries and preventing rates from moving materially higher.

Euro Bonds – With headline inflation negative and core inflation at a record low, the European Central Bank (ECB) is likely to expand and extend its Asset Purchase programme in December, placing a cap on core and peripheral bond yields.

Japanese Bonds – Tweaks from the Bank of Japan (BOJ)—dropping the Y80 trillion per annum purchase target—largely validate the status quo. Yield-curve control (YCC) should anchor 10-year bond yields close to zero for the foreseeable future.

25% of the global bond market is negative yielding

Global bonds on issue with negative yields.

Inflation

On the surface, the rationale for low consumer price inflation to continue in 2021 appears straight forward. The economy will be operating with an output gap and that will mean weak wages growth (the unemployment rate will fall, but it will remain above the non-accelerating inflation rate of unemployment–the ‘NAIRU’). In addition, we expect the Australian dollar to appreciate a little over 2021 which will put downward pressure on import costs.  So there will be little in the way of ‘cost-push’ inflation. However, we think the inflation outlook is a little more complicated. The unique nature of the Covid-19 economic shock and the policy response means that we are likely to see some ‘demand-pull’ inflation in 2021. It may not be broad-based, but it could be enough to see inflation step up a little and that could make financial markets edgy. There were some components of the Q3 20 CPI that gave us a taste of what could be more widespread in 2021. The prices of several goods rose quite sharply due to a spike in aggregate demand. As a result, market goods inflation stepped up (chart 2). To be clear, overall inflation has so far been low (chart 3). But there have been some upward movements in the prices of some goods over the Covid-19 period that means it is prudent to take a deeper dive into the inflation outlook.

The case for higher inflation – Cost-push inflation is not the only type of inflation to consider. Demand-pull inflation, which is the increase in aggregate demand, categorised by the four sections of the economy: households, business, government, and foreign buyers, is the other key type of inflation.  It is harder to model demand-pull inflation, but we think a good starting point is to have a look at the relationship between household disposable income and inflation. We do this because changes in household disposable income capture changes in the spending power of the household sector.

The analysis shows that there has been a close relationship historically between growth in household disposable income and consumer price inflation. That is largely because household disposable income and wages have tended to be closely positively correlated. Indeed, as it currently stands that purchasing power has not been fully realised. That is because a lot of the income that has been channelled into the household sector has been saved due to Covid-19 restrictions. Australian household sector has built up more than $A100bn (5% of GDP) in additional savings that have been accrued since Covid-19 arrived in Australia – this excludes the early withdrawal of superannuation of ~$A36bn. An expected drawdown of some of these savings due to the elevated level of consumer sentiment and a willingness to spend will see the demand for certain goods and services lift. It is reasonable to assume that as this happens some businesses will lift the prices of the goods and services they are selling where there is higher demand.

There is evidence that this has been happening already over the Covid-19 period. Prices for furniture, textiles, major household appliances and small electrical appliances have all risen very sharply since Q1 20 (chart 8). And this is where there has been a strong lift in consumer demand (chart 9). Overall, the inflation story is very much one to watch in 2021.

Listed Property

After a rollercoaster year, analysts are tipping Australian real estate investment trusts (A-REITS) to perform strongly in 2021 – especially those that are trading at attractive discounts, but which own quality income-earning assets.  The benchmark S&P/ASX 200 A-REIT index ended 2020 down 8 per cent (or 4.6 per on a total returns basis), underperforming the broader equities market but mostly recovering from a 39 per cent plunge in March when Australia entered a nationwide lockdown and tenants stopped paying rent.

Heading into an uncertain 2021, momentum is with listed property trusts, with the index recording a 13.3 per cent per cent gain in the December quarter as the virus threat abated nationally and news of a coronavirus vaccine lifted retail property stocks like Vicinity Centres and Scentre Group.  Overall, balance sheets across the sector are in good shape and within covenants, with increased available liquidity. As investors, our focus is now more on the income trajectory.

One of the key concerns about A-REITs during the lockdown was the impact it would have on rent collections and income. Across the sector, rent collections have varied. The most impacted were large scale and CBD-based retail A-REITs while sectors such as office, industrial and other subsectors were less affected.  Now, with the Covid-19 lockdowns relaxing across Australia, stores are opening, and foot traffic is returning, and this is leading to an acceleration in rent collection.  Encouragingly, despite the drop in rent collection, income yield across many A-REITs has remained strong and, as the situation improves, we see the potential for good upside in income yields. In fact, in some cases, distributions are back to the same levels they were before the Covid-19 outbreak.

Positioning for the recovery – A key question for investors is whether they continue to focus on the ‘stay at home’ theme or whether they start to position themselves for the ‘recovery’.  In our view, some stocks at such extreme levels are over-extrapolating the ‘stay at home’ theme, whereas the reality is that there will be a return to normality as Covid-19 runs its course or when a vaccine is rolled out.  Therefore, we are positioning for the recovery trade, and there are some strong and compelling opportunities in real assets, which are out of favour now that will benefit from the return to normality.

We are also seeing some good opportunities in alternative real estate, such as land lease communities, storage, and childcare centres – which are currently a good source of income, diversification and re-rate potential.  However, we believe it is important to not overlook traditional core real estate in the A-REIT sector because that’s where investors can find the deepest value and some real opportunities in the current market.

Australian Equities

The ‘V’ shaped recovery in the Australian economy was confirmed further by a robust set of jobs numbers. The ABS reported that 50,000 new roles were created last month, which took the unemployment rate down to 6.6% from 6.8% in November. The labour market recovery has certainly been stronger than many expected.

The enticement to invest right now is clear: low interest rates, with governments and central banks globally willing to act as a safety net for demand. The overall jobless rate remains higher than a year ago, but this is as rising confidence in the economy has seen the participation rate climb. The consensus seems to be of the view that further falls in the unemployment rate will be difficult to eke out. While a significant bounce has been seen, I think that the economy can push on further, particularly if there is another leg up in the resource bull market as inflation gets going.

It is also worth pointing out that Australia is seeing its slowest population growth in more than a century. The Treasury has projected that population growth will be only 0.2% this financial year, and 0.4% next financial year, with the proportion of the working-age population set to shrink as fewer skilled migrants enter the country. It will therefore it will only take less than 10,000 job additions each month to bring the unemployment rate down further.

In Australia, the Reserve Bank has lowered the price of money to an all-time low of 0.10% and has signalled it will keep this cash rate for at least the next three years.  The government is underwriting jobs via payments such as Jobseeker and Job Keeper and encouraging a pull forward of investment via capex allowances. We expect these measures to flow through to business investment, Australian house prices and consumer sentiment.  Coupled with stronger corporate balance sheets and relative valuation appeal, versus dwindling savings rates, it’s easy to construct a positive outlook for the Australian economy/equities in 2021.  However, the big risk is also interest rates. As economies recover, if we saw a meaningful uptick in inflation, we would expect markets to react negatively (and sharply).

The key question when considering valuations is whether you’re being adequately compensated for taking risk. The Australian market looks expensive versus history at a headline level, trading at 25 times forward Price to Earnings (PE) multiple, versus a 10-year average of 17 times, which would suggest you aren’t.   However, when you consider the dividend yield of the market (3.3%) versus the cash rate (0.1%), the picture looks less clear – you have never been paid more for putting your money in the share market versus a bank deposit. This presupposes the businesses you invest in pay dividends.

The ASX 200 is expensive on a PE multiple but yields are attractive compared to term deposit rates

Where to for equities? Assuming a modest lift in bond yields, PE valuations could be a modest drag on returns – indeed, if 10-year bond yields hit 1.25% by year-end and the equity-bond yield gap holds at around 4%, the PE ratio would decline to around 19 – implying a 5% decline. Meanwhile, current earnings expectations imply 14% growth in forward earnings over the coming year, which if realised could still produce a net price return of around 5 to 10%, or total return of 9 to 14% including a modestly improved dividend return of around 4%.

All this is consistent with a base case 2021 year-end S&P/ASX 200 target of around 7,000.  We see 2021 as a year to be selective. Valuations and uncertainty are elevated. We prefer companies with solid balance sheets, run by managers with skin in the game, and would avoid loss-making businesses in “hot” sectors that have enjoyed a substantial re-rate in 2020 on a “lower for longer” interest-rate thematic. Today, surging sentiment merely supports my take that this is a late-stage bull market—contrary to what most believe.

Global Markets

There is a growing divide in the investment world: on the one side are believers that the recovery from the pandemic will add extra impetus to stock markets; on the other are those who think that bubbles are inflating to bursting point. There are relatively few investors who do not admit to the existence of speculative bubbles in some parts of the financial markets. The bad news is the U.S. is expensive, the good news is the rest of the world is reasonable.

Though challenges remain, we think this global recovery is sustainable, synchronous, and supported by policy, following much of the ‘normal’ post-recession playbook. The biggest investment decision is not about trying to time the market on the downside but making sure of being fully invested. The “bulls are running this year”, and a 10% to 15% correction in the market from current levels should not be enough for anyone to lose sight of “the bigger picture”.

America

President-elect Joe Biden unveiled his $1.9 trillion economic rescue plan yesterday, an ambitious package of bigger direct payments to Americans, extra funding for coronavirus vaccine distribution and more. The move is a bolder response than the Obama administrations to the 2008 financial crisis.

What’s in the proposal – $1,400 direct payments, a $15 per hour federal minimum wage and more generous unemployment benefits. $400 billion to combat the pandemic directly, including accelerating vaccine deployment and reopening most schools within 100 days of passage. $350 billion for state and local governments to bridge budget shortfalls. The spending would come on top of the $2 trillion relief bill from March and the $900 billion relief program in December. The package would be financed entirely with borrowing. Many economists have urged policymakers to set aside concerns about deficits, and Mr. Biden appears to be heeding those arguments. He acknowledged that his plan “does not come cheaply,” but argued that doing less “will cost us dearly.” Interest rates and inflation aren’t pressing concerns, some economists argue, so more aggressive measures to bolster the recovery could more quickly unlock the pent-up demand and savings built up during pandemic lockdowns. (Biden also announced that Dr. David Kessler, a former F.D.A. chief who has co-chaired his coronavirus task force, would take over the Operation Warp Speed vaccine distribution initiative.)

The Labour Department reported that 1.15 million Americans filed new unemployment claims in the first full week of the new year, the highest level since July 2020. The new spending comes at a critical time for the world’s largest economy. A winter resurgence of Covid-19 sent a partially recovered labour market into reverse last month as employers shed 140,000 jobs, especially low-income positions in restaurants, bars, and other high-touch service industries. Recent heated debate about lofty asset prices – particularly the very expensive US stock market – is a perfect example of the risks in timing a market that is plainly in the grips of excessive exuberance, but which could still enjoy further gains in the coming months.  The debate is fiercer this time round because of two unprecedented forces which, for the time being, provide ammunition for bulls and bears alike.

On the one hand, while vaccines are starting to be deployed, the Covid-19 pandemic continues to rage in Europe and America, with renewed restrictions increasing the risk of double-dip recessions. On the other hand, government bond yields stand at record lows, justifying high valuations of risk assets.  Yet, while the disconnect between frothy markets and a virus-ravaged global economy could persist for some time, signs of speculative excess are glaringly apparent, and have contaminated large parts of the market. Not only are valuations dangerously stretched, but the behaviour of investors also suggests many traders have lost touch with reality.

Europe

Eurozone nations’ escalating restrictions to tackle the coronavirus pandemic have significantly slowed economic activity, fuelling fears that the bloc faces a double-dip recession.  Travel to retail and hospitality venues and workplaces, as well as consumer confidence and spending, have all taken a hit in the first weeks of 2021, according to high-frequency activity trackers.

Measures to contain a second surge in Covid-19 infections have forced many businesses in the bloc’s dominant service sector to limit operations. The damage caused by the second wave of lockdowns is expected to be less severe than that of the first. However, the region is still on track for its first double-dip recession in nearly a decade, which few economists had expected earlier this year. Forecasters now expect the euro area’s economy to shrink by 2.5% in the final quarter of 2020. The bloc was already on the brink of recession before the pandemic struck, thanks in part to Brexit, trade tensions and sagging diesel-car sales.

As a result, economists anticipate that the estimated fall in output in the eurozone in the final three months of 2020 — Oxford Economics and Nomura forecast a contraction of between 1.8 per cent and 2.3 per cent — will be followed by another drop in the first quarter of 2021 in many of the bloc’s major economies, including Germany and Italy. The real fear is that this time, governments will not roll out the big stimulus guns we saw earlier to shield their economies. The European recovery fund is stuck in the bureaucratic pipeline, public deficits have ballooned already, and there is simply less political appetite for huge relief packages if it is only a partial lockdown.

Markets do not seem to fully appreciate all this yet, but they might if the upcoming PMIs reflect a further loss of economic momentum, putting the risk of a double-dip European recession on the radar. That could leave the eurozone in its second recession, defined as two consecutive quarters of negative growth, in less than two years.

United Kingdom

The UK economy has edged towards a double-dip recession after official figures confirmed a renewed slump in November fuelled by the second national coronavirus lockdown in England.  The Office for National Statistics said gross domestic product (GDP) had fallen by 2.6% month-on-month in November, when the government forced the closure of non-essential shops and the hospitality sector in England to combat rapid growth in Covid infections, and as tougher controls in Scotland, Wales and Northern Ireland weighed on growth. Reflecting the renewed controls amid the second wave of the pandemic, the latest official figures end six consecutive months of growth over the summer, when the UK economy was recovering from the first wave of the crisis. The impact of renewed restrictions took GDP in November down to 8.5% below its pre-pandemic level. 

Japan

Japan is considering extending a state of emergency from the Tokyo metropolitan area to other regions as coronavirus cases increase, a move that could heighten the risk of a double-dip recession for the world’s third-largest economy. Though less seriously hit by the pandemic than many other countries, Japan has been unable to rein in the virus, with recorded daily infections exceeding 7,000 for the first time on Thursday 21st of January. The second state of emergency for some areas including Tokyo and Osaka, which account for more than half of the country’s economic output, has darkened the outlook. In Japan, Covid-19 vaccinations have yet to begin.

Unemployment and bankruptcies have been kept under control for now, but that effort is barely being supported by government subsidies and benefits, and there are concerns that they will expand rapidly in the future. Considering this situation, the government announced a massive economic stimulus package on December 8th. Some of the measures include new ideas that have never been seen before, such as a ¥2 trillion Green Fund, mainly for environmental measures and a Digital Fund for digitalization. Financial markets are looking for clues as to the BOJ’s forthcoming policy review. BOJ watchers say the central bank wants to secure wiggle room to respond flexibly when needed, given that the bank is perceived as having little ammunition left, after years of low interest rates and aggressive buying of assets like ETFs have raised concerns about the side effects of its policies.

The Nikkei’s expected rise in 2021 will be led by gains in issues with high exposure to the Chinese market, sentiment among major Japanese manufacturers has already improved in December as exports have shown signs of recovery on firm auto shipments to China.

China

While global trade remains deeply depressed with the World Trade Organization’s latest forecast suggesting a 9.2% decline for 2020, China’s exports have been growing stronger every month since June.

Trade figures show that the value of China’s exports in November was 21% above the pre-pandemic level in the same month in 2019, led by an extraordinary 45% increase in sales to the United States. China’s export-led economy has benefited from lockdowns in western countries. Western demand for services like entertainment and travel may have declined, but demand for household consumer goods and medical supplies has increased. Chinese exports to the US have reached record levels despite the high tariffs imposed by the Trump administration.

China is also expanding its economic influence throughout Asia, with a new free trade area in the Pacific and huge infrastructure projects along its trade routes to Europe and Africa. It is investing in advanced technologies to reduce its dependence on western supply chains for components such as semiconductors. China could now overtake the US as the world’s largest economy within five years, twice as fast as previously predicted.

China’s manufacturers benefit from an immense internal market delivering unrivalled economies of scale. At the same time, productivity gains are coming from the adoption of advanced manufacturing systems, an increasingly educated workforce and fully developed local supply chains.  China’s strong performance over the past year while the rest of the world was mired in managing the pandemic would have increased its dominance.

Rising labour costs, which have been increasing at an average of 15.6% a year, have eroded some of China’s edge in traditional industries. China’s economy has its flaws— burdened by heavy debts, inefficient state-owned enterprises and an ageing population—but it is going into 2021 brimming with economic self-confidence. The pride that Chinese feel about their economic performance will be matched by rising resentment among those displaced by the inroads Chinese goods are making in global markets. It is a recipe for global trade tensions in the year ahead. In the longer term, China’s growth will slow down — a trend that started even before the pandemic hit which is partly a consequence of structural changes in the economy as China seeks to reduce its reliance on external sources of growth. That means China would get less investments from abroad and face greater challenges improving its productivity.

Commodities

Commodity prices have been in a long-term downtrend while stocks have soared for much of the past decade. Given that we are twelve years into this bull run in stocks and historically asset class returns have always reverted to the long-term mean, one might ask: is this the time to buy commodities?

A major factor in the direction of commodity prices is the trend of the US Dollar because most commodities are denominated in Dollars. The Dollar has been in a long-term uptrend for much of the past decade but began weakening sharply last July. As the pandemic roiled the economy, fiscal and monetary stimuli acted to weaken the Dollar, and by extension boost commodity prices. Commodity sector performance is principally driven by the forces of supply and demand. The pandemic has exacerbated price trends through supply shortfalls and stronger than expected demand across the global economy.

As we enter 2021, and the twelfth year of the current bull market in stocks, the ratio of commodities to stocks is near the 50-year low level at 0.54. Historically such extremes have been corrected over time and often sharply. Investors with little or no exposure to commodities in their portfolios might consider revisiting the asset class.

Gold

The outlook has deteriorated sharply. We no longer expect higher gold prices. There are several reasons for this. First, we have changed our view on the Fed. We now expect asset purchases to continue at the current pace at least until the end of 2021, with a tapering and end to purchases in the course of 2022. It could be that a period of higher core inflation later in the year convinces some FOMC members that they are at that point ‘on track’ (as per the Fed’s forward guidance) to overshoot 2% for a time. In that case, we could well get the first hike in 2023, which is much sooner than previously expected. Any hikes would be extremely limited, given the Fed’s new policy framework, which aims to raise long run inflation expectations. A less dovish Fed is negative for gold prices.

Second, we no longer expect lower nominal and real yields in the US. We think that US nominal yields will slightly rise this year and next (we had a decline for 2021). Meanwhile, 10y US real yields have declined beyond the 2012 lows. We think that inflation expectations are toppish. As we no longer expect a decline in the 10y US nominal yields, US real yields will improve, i.e. become less negative. This is a clear negative for gold prices. Because they closely track developments in 10y US real yields.

Third, we have changed our outlook for the US dollar. We expect a modest rise on the back of a strong economic recovery, slightly higher nominal and real yields, wider yield spreads between the US and other countries and a less dovish Fed. Gold tends to weaken when the dollar rises.

WTIS

While the short-lived decline of U.S. oil futures below negative-$40 a barrel is not likely to be repeated in 2021, new lockdowns and a phased rollout of vaccines to treat the virus will restrain demand next year, and perhaps beyond. Fossil-fuel demand in coming years could remain softer even after the pandemic as countries seek to limit emissions to slow climate change. Major oil companies, such as BP Plc and Total SE, published forecasts that include scenarios where global oil demand may have peaked in 2019.

The changing landscape poses a threat to refiners. About 1.5 million bpd of processing capacity has been taken off the market yet worldwide crude distillation capacity is expected to keep rising. With falling demand and weak margins for gasoline, diesel and other fuels has prompted refineries in Asia and North America to close or curtail output, including several facilities along the U.S. Gulf Coast. The next several months are likely to be volatile as investors weigh tepid demand against another potential spike in oil supply from producers, including the Organization of the Petroleum Exporting Countries (OPEC) and allies.

Sector 12 Month Forecast Economic and Political Predictions 2021
 

AUD

 

75c-85c

 

The AUD/USD exchange rate rose to its highest levels on the 6th January, but the new highs have so far been brushed back as commodity prices dropped and as risk sentiment, much of it centred on developments in China, has suffered a setback. This substantial reduction in exports could be due to the latest outbreak of coronavirus on the mainland, with residents in Shanghai banned from leaving the city after six coronavirus cases were detected. An additional 47 cases were also reported in Heilongjian province on Friday 23rd January.

 

 

Gold

 

Reduce

 

1700-2000

 

In short, gold is still a crowded trade and investors are doubting. In 2013 a liquidation of 36% of the total outstanding ETF positions resulted in a decline in gold prices of 30%. These positions remain a risk.

 

 

We change our gold outlook following our changes in US rates, in our Fed view and US dollar. We now expect slightly higher US nominal and real yields, a less dovish Fed and a moderate rise in the dollar. All negatives for gold prices so we think that gold prices have peaked. But concerns about US fiscal deficit will dampen the downside in gold.

 

Commodities

 

Buy selective sectors

 

There are some hurdles before the oil market can assume the worst is over, those who are willing to risk it should take a better look at oil.

 

 

The coronavirus crisis wreaked havoc across the commodities complex in 2020. However, we are already seeing a remarkable recovery which began in the second half of the year. We expect this will strengthen still in 2021 as the global economy recovers from Covid-19.

 

Property

 

BUY

 

A-REITs have strong liquidity, with minimal refinancing risk in the next 12-months.

 

Australia has fared remarkably well during the Covid-19 pandemic which leaves A-REITs well-placed for 2021. Strong balance sheets and improving cash collection should underpin stabilised and growing distribution yields, with low bond rates supportive.

 

Moody’s Investors Service says its outlook for A-REITs is stable. The stable outlook reflects our expectation that rated A-REITs’ aggregate net operating income will grow 2 per cent to 3 per cent in the next 12-18 months.

 

 

Australian Equities

 

Neutral

7200 – 6390

 

We see 2021 as a year to be selective. Valuations and uncertainty are elevated.

 

Short term pull-back expected.

 

 

Historic market cycles have displayed sharp bounces after large falls. Markets also typically run in response to large monetary and fiscal stimulus and we currently have quantities of both. The Australian share market is currently on the highest two-year forward EPS multiple in fifteen years. Those forecasts incorporate a significant recovery from the current crisis and arguably do not fully account for some future disruption.

 

The P/E ratio for Australian markets is now at or nearing record highs. This is an extraordinary outcome whenever it transpires but especially when we are in a recession.

 

 

Bonds

 

Buy Corporate debt and Inflation Linked Bonds

 

Long-term government bond yields are likely to come under upward pressure from a vaccine-led recovery in 2021.

 

 

 

Bond rates may have increased over the Christmas/New Year period. Jerome Powell reminded us the federal funds rate will not be increased until higher inflation rates are entrenched. Additionally, other senior Fed officials said the Fed’s bond purchase programme won’t be tapered until inflation rises further and the US jobless rate is considerably lower.

 

We see the potential for US 10-year Treasury bond yields to trade in a range of 1% to as high as 1.6% in 2021, reflecting the prospects for real economic growth to recover at a faster pace.

 

 

Cash Rates

 

On hold at 0.10%

 

Cash futures prices no longer reflect traders’ expectations of future moves by the RBA with respect to its target cash rate after changes in RBA policy took place in March. However, they still reflect expectations in the domestic cash market of the actual cash rate. Prices of futures contracts implied the cash rate would not change materially through 2021.

 

Global Markets
 

America

 

Underweight

 

Economic expansion will be supported by monetary policy, with the Fed much more likely to ease further than tighten in 2021. The central bank remains concerned about potential scarring from the Covid-19 crisis, as well as long-term secular headwinds to growth.

 

To be sure, Covid-19 is not yet in the rear-view mirror, and the next few months are likely to be very difficult from both public health and economic perspectives. Should the rollout of vaccines or their efficacy go less smoothly than anticipated then growth forecasts could prove to be too optimistic.

 

 

Europe

 

BUY

Stock market indices in Europe have performed less well than counterparts in the US and have not all recovered levels enjoyed before the coronavirus scare gripped markets, which suggests that a poor start to 2021 is factored into share prices.

 

 

While it’s possible that output will start to grow in the first quarter, it’s likely to be muted owing to a cautious approach to the removal of Covid-19 restrictions and the possibility of Brexit-related disruption. A more material rebound is likely set for the spring, especially if vaccines can be rolled out quickly.

 

Europe’s exposure to financials and cyclically sensitive sectors-such as industrials, materials and energy-gives it the potential to outperform in the second phase of the recovery, when economic activity picks up and yield curves steepen.

 

Japan

 

Underweight

 

Bank of Japan tweaks its asset purchases, including its buying of exchange-traded funds. The central bank already made its smallest purchase in more than four years this month.

 

 

The new administration of PM Yoshihide Suga represents continuity from that of former PM Shinzo Abe and has few, if any, macro implications. Monetary policy setting remains unchanged, with Yield Curve Control anchoring interest rates.

 

More fiscal stimulus will help to support the post-restriction recovery facilitated by the Bank of Japan (BOJ).

 

China

 

Underweight.

 

Chinese stocks have rallied to a five-year high after a survey suggested the nation was recovering from the economic blow of coronavirus.

 

The core assets are not cheap based on the historical average, but they have not reached the extreme level in valuation,

 

 

Continued monetary- and fiscal-policy easing should counter downward pressure on the economy, with the focus likely on infrastructure projects and property construction—measures most likely to help stabilise the economy.

 

Chinese stocks are already expensive and are vulnerable to authorities opting for much smaller stimulus and harsher corporate (and) state-owned enterprise reforms.

 

Economic recovery is on track, but it is still not normalised; hence continued policy easing is expected.

 

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