Bubble, bubble, toil and trouble
11 March 2021
The Findex Investment Committee continues to tread with caution as potential bubbles grow in certain sectors, like technology, and market valuations are stretched, which is characteristic of periods of low interest rates and low economic growth.
The prevailing domestic and global economic view that there is better growth to come and continued Government stimulus has investors “all in”. Market risk is at a complete opposite to March 2020 when there was significant investor fear, but the risk of investing was much lower. Now, greed appears to have taken over and driven market valuations high.
While there are recent comparisons to the US technology stock bubble of 2000, that bubble was late in the economic cycle when unemployment was low, and the US Federal Reserve was trying to tighten monetary policy with higher interest rates.
Current conditions are more conducive to markets continuing to rise as central banks keep a loose interest rate policy and significant Government fiscal stimulus continues to be delivered.
Global virus landscape
Globally, the virus situation has improved significantly with meaningful reductions in both new confirmed cases and positivity rates since December 2020. We now have five Western vaccines with detailed tests. The results for preventing moderate symptoms range from a stellar 95% for Pfizer/Moderna to a somewhat decent 66% for J&J.
The impact to Australian economy
Australia has been highly successful in managing the COVID-19 crisis as we now observe a relatively rapid economic recovery. With the Government’s JobKeeper program coming to an end on the 28 March 2021, this will be the first major test of our recovery.
We expect unwinding JobKeeper will lead to job losses, particularly in virus-sensitive industries where demand remains soft. The nature of the COVID-19 recession and the effectiveness of the unprecedented fiscal support and current labour market data indicate the situation is likely to be manageable but with risks on the downside.
On the business side there are concerns the recent removal of temporary insolvency relief measures may foreshadow an increase in bankruptcies, potentially slowing the recovery. Overall, we find relatively little evidence of economic scarring across the labour market or business sector, and certainly no evidence of scarring large enough to derail Australia’s encouraging economic recovery.
There has been strong growth in employment and a decline in the unemployment rate to 6.6 per cent. Retail spending has been stronger and many households and businesses that had deferred loan repayments have now recommenced them.
Asset Class Valuations – Long Term
On a relative basis, our analysis remains supportive of Growth Assets.
Equity markets have performed strongly in the fourth quarter of 2020 and most indexes now trade above their long-term valuation measures.
Across regions, yields are supportive of US equities but not supportive of Japanese and European equities. Negative bond yields in Europe and Japan provide a disincentive to invest in bonds.
AREITs (Australian Listed Property) currently trade below their asset values. While valuations look attractive, the asset class remains challenged by COVID-19 related developments. The structural shifts in Australia and globally to a work-from-home environment and online shopping creates some uncertainty as to what sustainable long-term rental yields are.
Cash rates globally are close to 0% (and in some cases negative), while government bond yields are at historic lows. Government bond issuance across developed markets remain well supported but equity market volatility remains elevated and we believe it will continue to be so.
Asset Allocation Indicators – Medium term
Our medium-term fundamental indicators support an allocation to bonds. Despite reported earnings remaining below pre-COVID-19 levels, we have seen upward revisions occur in forward earnings estimates of equities and investor behavior remains supportive of equities. Bond flows indicate institutions retain a mixed approach to risk, favouring government bonds as well as high yield credit.
Asset Allocation Views
Overall, we remain positive on growth assets relative to defensive assets over the medium to long term.
We have seen signs of a fragile economic recovery taking place and an equity market rally over the fourth quarter of 2020 but highlight potential market headwinds in the form of now high equity market valuations. We note that shorter dated bond yields globally remain close to zero but are concerned that further risks could present themselves in terms of delays in the COVID-19 vaccine roll-out, as well as growing geopolitical risk.
Improvements in company earnings have been evident, but the level of earnings have not recovered to pre-COVID-19 levels. The economic recovery taking shape is beneficial for cyclical industries, while low yields and low economic growth will likely continue to fuel a chase for yield.
Findex Portfolio Positioning
Findex’s Investment Committee’s decision for this quarterly update was to retain current asset allocations for client portfolios. Portfolios today remain overweight Growth assets and have benefited from the equity rally in the fourth quarter of 2020.
Despite the benign environment, we remain concerned around the absolute levels of market valuations and note that market sentiment and momentum may shift quickly.