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01 Dec 2020

We look to 2021 with optimism, and maintain an edge of caution

By Peter Moussa, senior investment strategist for Citi Australia We need the good news to continue for forward looking markets to keep posting gains - and watch for cross-winds

I think it’s safe to say most people are looking forward to 2021 being a better year over the one just ending. This year has certainly tested most of us in ways we could not have expected.

While individuals were impacted on different scales, as a nation we have been physiologically tested, medically challenged, financially stressed and faced great uncertainty.

We all know the negatives that have emanated and continue to flow from the COVID-19 pandemic. But there has been some positives to emerge.

On the technology front government’s, telco’s and online service providers have scrambled to upgrade internet infrastructure and speeds and services to enable enhanced and expanded work-from-home technologies like video conferencing, streaming and cloud services. Remote medical diagnostics have leapt ahead, and logistics companies learnt how to service populations locked down in their homes across the world.

Not surprisingly, there are still many challenges ahead. An interesting one is that governments will likely want their populations to return to their places of work. Cities and all the infrastructure and businesses that service them are predicated on large workplace populations.

There is no doubt en masse working-from-home due to the pandemic has created societal conversations about how a better life-work balance could potentially be achieved by spending less time in the office post-COVID.

It’s too early to tell where that conversation will end, but if it does entail significant change we may see cities morph more towards leisure centres with hubs of work environments, and more businesses may shift offices closer to where their workers live.

Such transformations would take years, even decades to evolve, and certainly it would create investment opportunities along the way, and even an investment thematic.

What’s ahead for the next 12 months for investors?

It’s an interesting scenario to ponder, but investor’s will also be wondering what’s in store for the next 12 months.

As we prepare to enter 2021 we are witnessing significant market impacts from optimism stemming from an expected COVID-19 vaccine.

It’s a reasonable assumption, but it still remains an area of caution as there are many challenges to rolling out a vaccine to billions of people globally, and dealing with any side-effects that may emerge. As of mid-November the World Health Organization had listed 48 vaccines in clinical trials, including 24 in final stage 3 trails.

But it’s not the only factor driving positive sentiment. Other sources of optimism include:

  • A growth supportive US Federal Reserve potentially engineering even lower US real yields and underwriting any fiscal road blocks arising from gridlock between a democratic President and a Republican Senate.
  • China’s sustained recovery.
  • Potential subsidence of the unpredictability President Trump engendered during his tenure.
  • Hopes for a more benign relationship between US and China under a new US administration.

Euphoric sentiment is particularly strong in the US, where the Dow Jones Industrial Index, which tracks 30 large publicly listed US blue chips, reached a new all-time high in late November.

The ASX has been a bit more subdued but followed the same trend as the Dow. According to ASX data, since 27 March 2020 the index had increased 36 per cent to the end of November, with the global economic recovery only in its early days. With the index close at the end of November at 6517.8, it remains 8.6 per cent below its pre-COVID high.

If we revert to the US, in effect, COVID-19 and its impacts have been wiped from the “consciousness” of the market, which in itself sounds a note of caution as we know there is still a long road ahead to restore global economic growth and business profitability to pre-pandemic days.

There is no crystal ball but there are risks we feel the market is ignoring, including;

  • Uncertainty on how long it will be before we return to normal, even with a vaccine.
  • The current rotation from growth to value sectors mutes the impact on indices.
  • A lot of positive news has already been priced into the market.
  • The continuing push from China to exert its economic might.

However, there remains a lot of cash sitting on the sidelines, which will flow into markets during dips and cushion the downside. There is also room for economic fundamentals to improve, and coupled with loose monetary policy, it paints a positive outlook as we prepare to enter the New Year.

Are valuations a concern at these levels?

  • From a valuation perspective lower cash rates mean a lower discount rate for shares. This means you can expect above average valuations as long as the cash rate stays low.
  • Even with this in mind, many stocks still look stretched. So we are seeing investors taking profit from equities and moving to bonds and hybrids to ensure their allocations are rebalanced.
  • We know that governments and central banks will do everything they can to create jobs and improve the economy, which means spending combined with currency devaluation to lower the purchasing power of cash and create inflation, as well as boosting export revenue.

How are clients investing as we wait for the vaccine roll out?

  • It is clear that as fundamentals improve, clients who are over exposed to cash are seeking to put some of that money to work.
  • We hear a lot about a rotation from value to growth stocks, however, buying discounted stocks in sectors such as travel can be scary, and our conservative investors are choosing to play the vaccine recovery through bonds and hybrids over equities.
  • An example is Qantas. The positive vaccine news means investors are willing to invest in the company as a recovery story, but prefer the additional security of an investment grade bond over the potential volatility of shares.

The bottom line

There are good indications that 2021 is shaping up as a recovery year but the cautionary tale is markets have already priced in an improved outlook. It means markets should head higher if the recovery proceeds apace, but could turn skittish if any of the current risks take on greater prominence. Government and central bank intervention through expanded spending programs and quantitative easing remain vital to keeping the global recovery story on track, and markets aligned to that narrative.

Wealth Solutions  >

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