3 Minute Market Update 6th December 2020
Markets up again but a few interesting shifts under the surface, especially for Australian investors
Rates edging up, when do markets start to mind?
There is still value in many markets where long-term high single digit returns should be possible
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The Week and The Month That Was
This was the kind of week when it didn’t seem like much happened at a headline level but underneath the surface was another matter. Global markets were up again by around 1% as investors weighed worsening virus data in the US with the prospect of more vaccines being rolled out and perhaps quite quickly. Investors are also looking to fiscal policy to take over from monetary policy and there is an element of trust that the powers that be can and will 'do whatever it takes'. In the last 10 years or so when monetary policy (the cost and quantity of money) was the dominant lever we had 'the bad news is good news' dynamic whereby weak economic data presaged looser monetary policy and markets rose. On Friday we had the fiscal equivalent where markets rose strongly into the US close despite weak data because the very likelihood of the economy stalling increased the likelihood of a larger stimulus deal in the US happening sooner rather than later. Clearly markets want to go up.
At a sector level though we witnessed larger ripples of uncertainty. Energy was the biggest mover down 5% globally on Monday before finishing the week up almost 4%. Actual oil prices were a little less volatile but followed a similar pattern while industrial metals were up sharply (led by Iron Ore) as were both Gold and Silver. Perhaps this points to a resurgent China (the dominant importer of Iron Ore) and a mixed outlook elsewhere. Still, most other global sectors continued to grind higher, up by between 1% and 2% or the week apart from defensive and interest rate sensitive utilities which fell by 2%. At a country level the US, UK and China were the best performers while most other major countries ended up but by less than 1%. Long-term interest rates continued to drift higher – ten year rates got back above 1% last week in Australia and were just short of 1% in the US on Friday. Credit spreads were stable and if anything tightened in some areas.
The thing that has really caught our eye in the last week though was just how influential the recovery of the banks and the rise in Iron Ore prices has been domestically. Last week the local market’s performance of around 0.5% and lagged the rest of the world slightly. However, every sector apart from Materials was down during the week (although Banks were only slightly negative). This is the culmination of a trend that started in the last week of October and since then the US is up over 10%, world markets outside of the US are up over 15%. Australia is up by 12% during that period but over half of that is due to 4 banks and three iron ore producers. If we had a more moderate weighting in those sectors we would probably be talking about the degree to which Australia was underperforming countries that have had a less fortunate COVID experience. In only a few instances can this be directly attributed to trade tensions with China but maybe this could be giving the marginal overseas investor pause for thought about investing investing in Australia as, for many, we are seen as a developed world proxy for Asian growth exposure. Looking at the year to date that means that Australia has actually lagged all other markets quite considerably which many will find counterintuitive.
The Week Ahead
We will be looking at:
A Dashboard Update – A few things came up this week so we haven’t quite published our interim valuation update but the work we have done so far points to solid expected returns from the sectors, countries and styles that have lagged for the last decade (think small value ex-US and advanced Asia as well as other emerging markets) while large US tech stocks still seem to be priced for perfection. Australia also comes into the former category, especially when you consider the dynamics above – the flip-side of lagging share price performance is that the rest of the market outside of the iron ore majors and banks now enjoy quite solid long-term valuations and are reasonably well-positioned for a stop-start 2021 recovery. We had a good meeting with Cambridge Global who manage a global small cap portfolio that we use and that conversation had a very similar feel to it. We were actually able to record some of that on Zoom and we so we should be able turn some of it into a podcast during the week.
Interest rates – We have been asking every manager we speak to about long-term valuations and we have also been asking some pointed questions about expected interest rate levels. Without exception every market participant we talk to is of the view that short-term rates are anchored near zero and that long-term rates above 2% would break the system (as so much debt has been issued). Yet there are increasingly tangible signs of inflation (not least in house prices) and central banks are pushing hard to get to 2%. At some point something might have to give and, while the strength of this consensus could be cause for comfort, alarming things can happen in markets when a strong consensus is suddenly challenged. With long-term rates stealthily creeping up over the last few weeks we’ll be talking to some of the bond managers that we use about potential signs of stress in the system in the lead up to Christmas and the dwindling liquidity that usually entails.
Geopolitics – We had thought that we would be thinking more about this, and specifically trade relations with China, once Biden got his feet under the Oval Office desk. However, things move apace and this has become the ‘issue du jour’ in Australia. Andrew Hunt actually wrote about this on Friday and he has done some work on how it affects Australia in particular so we are looking forward to having a chat with him about that next week. Tentatively though, and despite the awful headlines, there are perhaps worse positions to be in the the dominant (and somewhat irreplaceable) supplier of one of the most important inputs to the world’s fastest growing economy.