Risk assets added to bumper gains in November in December, completing a year that ran from deep losses early on to sharp gains for much of the rest of the year. The drivers of the extraordinary change in market sentiment during 2020 were the negative market influence of deep economic recession in the first half of 2020, caused by global pandemic containment measures quickly ameliorated and reversed, initially by massive fiscal stimulus reinforced by complementary monetary expansion, and then by unusually quick development of COVID-19 vaccines.
The rally in risk assets extended and intensified in November and December, notwithstanding sharply rising COVID-19 infection numbers in many countries, especially in the United States and Europe, as well as steps backwards and re-imposition of some restrictions in Australia – albeit with still extremely low infection numbers by international comparison. At the start of 2021, the global pandemic is worsening in terms of daily infection numbers and the early roll-out of vaccinations in worst-hit US and Europe are experiencing early logistic problems, inevitable when trying to vaccinate many hundreds of millions of people as quickly as possible.
What continues to go right with a wobble or two is the economic policy response. The latest US fiscal stimulus measures involving $US600 cheques in the post and extension of unemployment benefits were legislated a few days ago. European economic support measures were legislated more than a month ago. Even if the global pandemic is worsening at present, the policy measures to counter the negative economic consequences are falling into place.
Also, the roll out of vaccinations is likely to become more efficient over the next month or two, providing real hope that the global pandemic will be contained and diminish in 2021. Setbacks to the rally in risk assets from bleak near-term pandemic news are likely to be short-lived in our view as market focus turns to the continuing massive policy support for economic recovery, combined with what will be better news on the vaccination front over time.
Returning to December, major share markets extended large November gains. During the month increases ranged from 1.1% for Australia’s ASX 200 to 3.8% for both the US S&P 500 and Japan’s Nikkei. Over 2020, share market changes ranged from –14.3% for Britain’s FTSE 100, weighed by Brexit issues and poor pandemic control, to up 16.3% for the US S&P 500 where poor pandemic control in the final months of the Trump administration was offset by one of the world’s most pronounced bounces out of recession. Australia’s ASX 200 was down 1.5% in 2020, denied a rise for the year in the closing days by the return of community COVID-19 infections in New South Wales and Victoria.
Credit markets rose again in December, adding to strong November gains. Throughout 2020 credit markets have been supported by central banks maintaining extremely easy monetary conditions with no end in sight. Most central banks, including the US Federal Reserve, the European Central Bank and the RBA, have committed to maintaining growth accommodating monetary conditions for several years. Housing activity is likely to benefit from persistently low borrowing interest rates. Potential problems for Australian banks’ housing borrowers are diminishing as housing continues to strengthen. Australian home borrowers are returning to regular repayment schedules faster than expected and with less-than-expected negative repercussions, a positive influence on Australian credit markets showing no signs of diminishing in 2021.
Notwithstanding the COVID-19 setbacks in December, Australia’s economy remains on the brink of starting to out-perform by international comparison. A strong Q4 GDP report is in the bag given October and November readings of housing activity and retail sales. In particular, the sharp surge in retail sales, up 1.4% m-o-m in October followed by an out-sized 7.0% rise on preliminary reading in November, points to a significant increase in Q4 household consumption expenditure. The increases in retail sales in recent months in Australia contrast with falling sales in Europe and the United States.
Australia’s economic outperformance may be masked briefly in the near-term. Some setbacks to improving Australian economic numbers in January may result from disrupted holiday plans through the summer holidays because of sudden changes to state border restrictions. Given Australia’s success isolating and containing outbreaks quickly, the negative impact on the economy may not last beyond January.
Another increasingly positive development is that Australia’s vaccine rollout, by starting later than in the US and Europe, will learn from their teething problems and should benefit from better planning and organisation.
Australia’s continuing economic recovery through 2021 seems likely to occur with interest rates staying low. Better economic numbers placed some upward pressure on longer term bond yields in December. The 10-year government bond yield rose by 8 basis points to 0.97% although was down 40bps from the start of 2020. Australia’s shorter-term government bond yields remain capped at 0.10%, the RBA’s target for the three-year bond yield and a target yield that is unlikely to change in 2021 and 2022 on recent RBA commentary.
Longer term bond yields have potential to move but are limited by the RBA’s plan announced back in November to purchase longer-term bonds from time-to-time in a quantitative easing program that can change as required. Even though Australia’s economic recovery has been stronger than expected so far, the RBA still expects a lot of bumps ahead. Also, the deep recession in the first half of 2020 left substantial excess capacity and high unemployment. The RBA aims to restore the economy to full-employment and will use monetary policy to complement the efforts of the Government’s fiscal stimulus.
In 2021 we see the RBA maintaining the cash rate and three-year bond yield target at 0.10%. We also see the RBA working to keep the 10-year bond yield below 1.00%. Low interest rates will remain a factor in pricing risk assets in 2021 and least line of resistance remains upwards.