December 2020 | Economic and Financial Market Update
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December 2020 | Economic and Financial Market Update

December 2020 | Economic and Financial Market Update

Written by David Graham, Senior Financial Planner, Mapp Fin CIMA® CFP®

So, as 2020 draws to a close, we can agree ‘extraordinary’ probably covers it. I am not going to even try to summarise the year. Since the bushfires started about a year ago, we have all had a front row seat. This is in itself an interesting perspective. More often than not, we have the luxury of observing disasters at a distance. They tend to effect people that are either small in number or remote in location. This time around the entirety of humanity has been affected to some extent. The ubiquity of the pandemic is truly unique in our lifetime. You would think this common experience would bring us closer together. We will see.

From the perspective of the pandemic, it appears we are turning the corner. Despite the outlook for the Northern winter remaining grim, progress has been made in developing a vaccine. This ought to draw a line under the pandemic through 2021 and gives policy makers a clearer idea of the magnitude of the economic repair work to be undertaken.

Economies around the world have largely recovered from the depths of the early lockdown recession, but there remains some way to go to achieve pre-COVID levels of economic activity. The trick over the short term, is to transition from economies on ‘life-support’ to self-sustaining activities. This is always the case coming out of an economic downturn. In this event, the policy interventions helped us to avoid outright depression. Thus, the need to tread carefully is crucial. The Great Depression was exacerbated and extended by a series of policies that were too restrictive too soon. This was also the case coming out of the GFC, with the recovery proving slow and feeble.

Policy makers are making all the right noises to err on the side of maintaining fiscal and monetary stimulus. Central bank guidance is for interest rates to remain lower for longer. Budget deficits are ‘cool’ again. However, you will start to hear voices calling for fiscal & monetary restraint. These echo the voices who called for lockdown restrictions to be eased too soon. We’ve seen the result of those calls in the U.S. & Europe. It is analogous to the need to maintain policy support for as long as necessary. As the RBA Governor recently observed ‘creating asset bubbles, is a problem for another day’.

Investment markets have reacted to the policy signals accordingly. For the most part, losses on investments since March have been largely recovered. You may recall in our February update, we talked about a market ‘tipping point’ and the risk the pandemic would upset a market hitherto ‘priced for perfection’. Prescient, no? The recovery in equity markets has in many cases exceeded the lofty levels of February. Does this suggest we are again in risky territory? Maybe, but underlying conditions are clearly different. Globally, businesses are not as healthy as they were back then. While company profits are recovering, they still have a long way to recover previous levels.

Nevertheless, with interest rates locked down at virtually nothing for some years to come, the investment options are binary. You can invest safely and earn nothing in real terms, or move ‘up the risk curve’, earning at least something, but needing to endure the volatility endemic in ‘growth’ assets. We would lean to the latter. Volatility is uncomfortable but if you can be relatively certain an investment will recover value and grow over the long term, ‘risk’ takes on a different perspective.

The need to diversify to manage risk has never been more important. While companies that were able to adapt to lockdown dominated most of 2020, we are already seeing markets turn their gaze to what happens next. This is behind the recent rotation from ‘growth’ companies to ‘cyclicals’. A different perspective for a different part of the cycle.

We are relatively positive on the outlook for markets in 2021. We expect the Australian share market to out-perform global markets, as they are generally starting from more conservative valuations. There will be failures along the way. As the tide of economic support starts to recede, companies crippled by the events of the past year (known in the vernacular as zombies), will be exposed.

We expect defensive assets to provide meagre returns. They are still required in a portfolio for capital preservation purposes, but, if we are over the worst of the economic downturn, interest rate markets will be locked hard against the upper limits central banks have imposed.

We also expect to see a significant rise in the number of products offering investors yields that appear too good to be true – AKA scams.

If you take nothing else from this note, know this; returns are always and everywhere a reflection of risk. It is not always obvious where the risk lies, and indeed it is not always the case that the risk results in failure. Sometimes you bet on red and red comes up. If you are offered a ‘safe’ high yielding investment, approach with scepticism (or not at all).

Thank you to all who have provided feedback on our various communications over the year. Thank you also to all of you who have put your faith in our ability to steer you through such conditions. We take our responsibilities to you seriously and consider your success, our success.

Best wishes for the season and a peaceful 2021.

Information current as at 8 December 2020.

This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.