Economic Update January 2021

by Infocus Author

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

Recovery continues but short-term uncertainty taints 2021 prospects

• COVID-19 vaccines rolling out but slower than anticipated – a more contagious strain emerges
• China trade dispute with Australia showing no signs of easing
• Brexit deal clinched finally and on terms favourable to the UK

The Big Picture

When we try to look back through the events of 2020, it is hard to see back through to the beginning of the year without getting caught up in the impact of the pandemic. On reviewing our monthly update reports we can get a clearer view about what we and others were writing about throughout the year – and not coloured by opinions as they evolved over time.

Twelve months ago, the big news was that the anticipated China Phase I trade deal might end the tariff war with the US and the prospective impeachment of Trump. Of course, at home we also had massive bushfires and floods to deal with.

In our March issue we noted that COVID-19 had not yet been classed as a pandemic and that the World Health Organization (WHO) proclaimed that the virus was ‘flu-like and would only have a mild impact on most people’.

Come the run-up to the November US presidential elections everyone seemed to believe that they knew back in January what they would have or should have done. Everything is easy in hindsight.

Many countries tried different approaches to containing the virus with very different outcomes. There were no real winners but Australia and New Zealand didn’t fare too badly by comparison.

With vaccines starting to be rolled out in the UK, US, Europe and soon Australia, health authorities can start to get on top of the virus. However, there are likely to be a number of hiccups along the way. We think the markets were a bit too optimistic in the last two months of 2020 given the potential downside risks.

Not all of the vaccines have proven to be effective and some clinical trials were contaminated with miscommunications about dosages. Of course, there are major distribution issues to be dealt with. And we cannot ignore the irresponsible attitudes of some groups of people in Australia and overseas.

In addition to the virus, the China-US trade spat dissipated leaving China’s ire directed at Australia. With very little explanation, China has been refusing significant imports of coal, lobsters, wine, beer, barley, timber, etc. If this situation continues and/or escalates, there will be a significant impact on Australia’s trade balance, with potential consequences for economic growth.

It is too early to tell what impact Christmas and New Year’s celebrations will have on future restrictions to combat the spread of the virus. Our quarter three (Q3) economic growth came in at a solid 3.3% p.a. after the two negative quarters of growth. We could easily slip back into negative growth in the first half of 2021 as the reintroduction of measures such as lockdowns to contain the virus if people are not vigilant in practicing COVID safe behaviours such as mask wearing and social distancing.

Macro-economic data for Australia, the US and China largely finished the year quite strongly but the job is far from done. A new more infectious variant of COVID-19 was identified in London and the surrounding south east of the country. That brought about a fresh lockdown in that region. There are reports of this and other new strains appearing in other countries including Australia. What is not yet known is whether the vaccines will deal with the new strains as effectively as they apparently deal with the original virus.

On top of the uncertainty due to new strains developing, we do not yet know if those who have been vaccinated can still pass on the virus to others. Also, it is not known how long immunity from the virus will last after vaccination. Spokespeople are seemingly confident in their media releases but what else can they say? There is yet no data.

Our research points to markets remaining generally positive in the medium term but we cannot rule out a dip in share markets in the first part of 2021. This assessment is based more on share markets potentially getting ahead of themselves when supported by the ongoing and strongly accommodative monetary and fiscal policy plus the roll out of the vaccines to treat COVID-19.

The Georgia run-off senate elections on January 5th will have a big impact on who will really govern the US for the next period. The initial results announced this morning resulted in a win for both democrat candidates and, in effect handing control to the Democrats as Vice President Harris having the casting vote in Senate now composed of 50 seats to both the Republicans and the Democrats. This result is expected to initially buoy markets as impediments to stimulus spending under a Biden administration are largely removed.

But 2020 did end with one very good piece of news. The UK reached a trade deal with the EU which rules out tariffs and quotas. There has been no reported large-scale migration of the London finance sector to Europe. For the last four and a half years many were predicting a disaster for Britain. It has had a very bad year because of the virus but the longer-run future is now looking somewhat brighter.

In its negotiations with the EU Britain got most of what it wanted. The only real disappointment was EU access to UK fishing resources. The EU’s share will be scaled back over the next five years from a 50% share now to 25%.

Our outlook for 2021 remains largely positive subject to some speed bumps along the way. Vaccines may well eliminate or significantly reduce the main threat of infection by the end of 2021. Some businesses and jobs may have been lost forever but there is also a pent-up demand for certain goods and services that can be satiated in part by rising confidence in the household sector as they drawdown on their increased household savings accumulated over 2020.

Asset Classes
Australian Equities

The ASX 200, not including dividends, finished down  1.2% over 2020 but that statistic doesn’t tell the full story. The index was up +7% to its peak in February 2020, but then plummeted  37% to its March low – and then rose +45% into the end of the year. If we look at the sectors over the whole of 2020, about half were up and half were down. But, at the extremes, the IT sector was up 56% and the Energy sector was down by  30%. It was easy for stock pickers to get on the wrong side. And that’s why prudent investors try to diversify their risks.

We had the market precariously over-priced at the February peak and massively under-priced in March. We believe that the market was over-sold in March because nobody really knew how bad or how long the shutdown would be. So, sell now and ask questions later was the plan for many investors.

We had the market quite over-priced again in December for the opposite reason. Investors were ‘relieved’ that vaccines were at last going to be available and scrambled to get back in for fear of missing out. We have broker forecasts of dividends and earnings pointing to a strong twelve months’ capital gain. But, with the market slightly over-priced by our measures and certain headwinds possibly in the future, caution should, as always, be exercised.

International Equities 

The S&P 500, the Japanese Nikkei, Emerging markets and the world index all posted double digit growth in 2020. Of the other indexes we follow, the German DAX was flat and Britain’s FTSE was down 14%.

The S&P 500 was quicker out of the blocks than the ASX 200 in 2020 posting +15% to our +7% to the February peak. But this index fell a little further than ours at  40% compared to our  37% in March. However, it climbed much better to the end of the year at +67% to the ASX’s +45%.

Many analysts are saying that it is hard to work out what, or by how much, stocks are over-priced when bonds have close to a zero return. We agree, but we are less inclined to brush the problem under the carpet. We prefer to hold a more conservative view that the US market is a bit over-priced.

Much of 2020s gains on Wall Street were due to the growth in big tech companies. At the best of times, these companies are hard to price. We remember the dotcom boom and bust. However, it is a new age and we must take on some additional risk to stay with the trade.

The Yahoo Finance website lists the forecasts of a dozen respected houses for the end-of-year S&P 500 index. The median is 4,150 with the low and the high forecasts being 3,800 and 4,400. Our forecast is between this median and the high value. The end-of-year close for the index was 3,742 making the median forecast being 10%.

Bonds and Interest Rates

The US Federal Reserve cut its ‘Fed funds rate’ three time during 2019 down to a range of 1.50% to 1.75%. At the beginning of 2020 the Fed was predicting one 0.25% hike in 2020 and another in 2021. Instead, it effectively did six cuts in March 2020 down to a zero rate. Further QE (quantitative easing) took place throughout 2020 and it is predicted to continue.

The Fed has repeatedly stated that rates are lower for longer. Not only do they and market participants now expect no hikes in 2021, they do not expect any in the following year.

The Reserve Bank of Australia’s (RBA) overnight cash rate started 2020 at 0.75% and it cut to a ‘creative’ 0.1%. It has been trading bonds to keep the three-year rate at about 0.1% and longer rates lower than they otherwise would have been.