Global Economic Risk

• The greatest risk to the global economy is that economic activity surprises on the upside in 2021.
• Currently consensus forecasts are for the global economy to grow 5.8% in 2021, lead higher by the US 5.7%, China 8.5%, and India 9.4%.
• Global economic consensus forecasts are likely to move higher as the year progresses, reflecting:
  • economic activity surprises on the upside post COVID-19 vaccination reopening,
  • which will be supported by very low interest rates and the expected continuation of accommodative policy by central banks for some time to come, and
  • the very large government spending packages being rolled out. For example, the recently proposed $2.2 trillion spending package on infrastructure and other benefits over the next 10 years by President Biden in the USA, this is addition to $1.9tn spending stimulus he announced earlier in the year (American Rescue Plan).
• The size of the US government spending program is huge, $5 trillion in measures have been announced since March 2020, over 80% of this will be “spent” by the end of 2021. This does raise economic risks for the future and $2 trillion in tax increases is being planned.

Concerns over inflation overdone……………for the time being.

• Global interest rates have moved higher over the first three months of 2021 due to optimism over the rollout of the COVID-19 vaccine, better than expected economic data, the highest level of US government spending outside of war times, and the US Federal Reserves’ commitment to maintaining easy policy settings until higher inflation is sustainable.
• Arguably interest rates have risen on a growth scare, rather than an inflation scare.
• For the time being inflation is not a major issue and is probably not likely to be so for some time given “under-employment” (spare capacity) within the US, and global, economy.
• Inflation in the US is expected to spike in the months ahead, this will reflect base effects from the shock to measures of inflation 12 months ago.
• Albeit the risks to inflation are rising and higher inflation is likely to be an issue by the middle of the current decade, resulting in central banks raising interest rates.
  • From a portfolio construction perspective, investors with a longer-term view should reduce portfolio duration and start considering the allocation to inflation linked bonds and real assets (such as property and infrastructure).
• Either way, the outlook for fixed income is not encouraging in either the short or longer term, and particularly relative to returns experienced over the last 10-20 years.
• In the US, the 10-year government bond yield recently reached its highest level since January 2020, trading at 1.77%, this compares to 0.62% a year ago and a low of 0.55% in August of 2020.
• In New Zealand, the 10-year Government Bond yield finished March 2021 at 1.76%, the highest month end level since May 2019, and over 1% higher than the May 2020 low of 0.6%.

US 10-Year Government Bond Yield

Vaccine and Economic Data

• By the end of the first Quarter of 2021 61% of the population had received their first vaccine shot in Israel, this compares to 46% in the UK, 30% in the US and 12.6% across Europe.
• The daily pace of new doses administered is approximately 1.5m in the European Union, 2.8m in the US, and 0.5m in the UK.
• Economic data has surprised on the upside, particularly in the US where the reopening of the economy is accelerating economic activity:
  • The number employed in the US grew by 916k in March, well above consensus forecasts. The unemployment rate dropped to 6.0%, from 6.2%, with an increase in the participation rate restricting a larger decline in the unemployment rate.
  • US Consumer confidence also increased by a much larger amount in March than anticipated.
  • Expectations for US manufacturing activity increased by more than expected and reached the highest level since 1983.
  • A measure for US services sector activity also exceeded expectations.
  • Likewise, measures of economic activity in the Euro Zone and China have recorded stronger than expected numbers.
  • European measures of expected manufacturing activity are at all-time highs.
  • China’s industrial profits have grown by 179% from last year, reflecting the low base of 2020 but also the very strong increase in revenues and profits over the last 12 months.
• While China is further advanced in its economic recovery, Europe lags both China and the US, nevertheless, the ongoing vaccine roll out and an increase in government spending should see the Euro Zone’s economy strengthen over the second half of 2021.
• The US Federal Reserve (Fed), unsurprisingly, has upgraded their economic forecasts significantly reflecting the above factors, specifically larger than expected government spending and the improving public health situation.
• The Fed also see inflation temporarily rising above 2% in the near term and then to settle to around 2% until 2023, they see the risks to inflation as balanced.

Market Performance

• The above environment has been good for global equity markets, but not so good for global fixed income markets.
• Base effects are also impacting Global Equity Market returns, as highlighted in the Table below.
• As can be seen, global equities have returned nearly 50% over the last year, in part reflecting markets reached their lows in March 2020 amidst the global COVID-19 pandemic.

• The strength of the rebound since last year is very evident in the following graph.

• Emerging markets have outperformed developed markets over the last year despite underperforming over the first quarter of 2021.
• Over the first three months of 2021, European markets climbed 8.7%, the US 5.8%, Australia +4.3% and New Zealand fell 4.0%.
• In the fixed income markets, the NZ Government Bond Index fell 3.2% for the March Quarter, Aussie fixed income declined 3.5%. Smaller declines were experience in global fixed income.
• As a general trend, value continued to outperform momentum and the financial and energy sectors did well. The Real Estate and Utilities sectors tended to lag the broader market.
• The US dollar has been stronger relative to most currencies recently, reflecting firmer US economic growth and rising bond yields.
• Commodity prices have also been strong, the Dow Jones Commodity Index return 8.4% over the first three months of 2021.

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The most recent Monthly Financial Markets Commentary and Performance is for March 2021.

David vs Goliath

• GameStop dominated headlines over the last week of January and distracted market participants from key fundamentals.
• In a sign of our times, encouraged via social media platform Reddit retail investors brought into GameStop, one of the most heavily shorted stocks in the market.  This led to a “short-squeeze”.  As the stock price of GameStop rose, rising by over 1,500% in January, short-sellers had to buy back the stock to cover their loses, pushing the stock price higher.  Loses from the short-squeeze are estimated to have totaled $6 billion at one stage, mainly incurred by hedge funds.
• A Goldman Sachs’ index of the most heavily shorted stocks rose close to 30% in January, ouch!  This is the index’s best monthly return since 2008, a painful month for short sellers. See graph below.
• The GameStop short-squeeze is considered one of the largest in US history and resulted in increased market volatility. 
• Another Goldman Index of the most popular hedge funds stocks fell by over 5% in a week as hedge funds sold stock positions to cover losses on their shorts, double ouch!!
• The events surrounding GameStop are not expected to derail global equities markets, which are best characterised as at the early stages of a new bull market run.  Pull backs and corrections can be expected along the way.

Economic Fundamentals

• The GameStop event detracted from developments earlier in the month and improving fundamentals in relation to the fight against the Coronavirus.
• The US Democratic party took control of the US Senate by the slimmest of margins after winning both seats in the Georgia run-off elections held in early January.  They now control the Presidency, Senate, and House of Representatives.
• President Biden released his $1.9 trillion (over 8% of the economy) Covid-19 Relief package, this is in addition to the $900 billion of spending approved by Congress in December.  The plan includes $1,400 in additional direct payments to individuals (raising checks to $2000) and aid to small businesses. 
• Although there are political risks around getting the complete packaged passed, a significant percentage of the package is likely to be passed into law.  This will represent a sizable stimulus for the US economy in the months ahead.
• The extra spending along with ultra-low interest rates argues well for the global and US economy in 2021 and 2022.
• Interest rates are likely to remain low for some time.   Many Central Banks, for example the US Federal Reserve and Reserve Bank of Australia, are unlikely to raise interest rates until annual inflation has run above 2% for some time.  This is not expected to occur until late 2024.
• Over the later part of January, the daily rate of global coronavirus cases and hospitalisations began to decline, particularly in the US, Europe, and Japan.
• At the same time the global vaccine rollout continues to gather pace, approximately 4.5 million vaccine doses are being administrated daily.
• In total, more than 100 million vaccine doses had been administrated in 56 countries by early February 2021.  Israel is leading with over 57% of their population vaccinated.  America has vaccinated over 32 million people, 9.6% of their population.  The UK has reached 14% of their population.
• Goldman Sachs predict: The UK is expected to vaccinate 50% of its population in March, with the US and Canada following in April. The EU, Japan, and Australia reach this 50% threshold in May.
• Once the vaccine rollout gathers speed the reopening of economies will accelerate around the world.

Economic data

• Although global economic activity slowed over the last few months of 2020, due to rising covid-19 cases and associated lock down measures, the global economy is on track for a V-shaped recover.  The US and China are leading the way.  Europe is at risk of a double dip recession.
• The consensus forecast for world economic growth in 2021 is just over 5%, and approximately 4.0% for 2022.  The global economy shrank by around 4.0% in 2020.
• For the first time in over 10 years, we are likely to see strong and synchronised global economic growth over the years ahead.
• The Chinese economy rose 6.5% in the last quarter of 2020 from a year earlier.  A strong outcome to finish the year and resulted in the Chinese economy growing 2.5% last year, the only major economy to report positive economic growth for 2020.  Albeit this is the country’s weakest annual economic expansion since the late 1970s.
• Based on first estimates the US economy grew 4.0% (annualised rate) over the 2020 December Quarter, which is below consensus forecasts and down on the 33.4% annualised rate in the third quarter of last year.
• The Euro area economy contracted 0.7% over the final three months of 2020, this was a little bit better than expected.
• Economic activity in New Zealand and Australia is exceeding expectations.  Most notable was the surprise fall in New Zealand’s unemployment to 4.9%, levels not seen since 2017 and much lower than the 5.6% anticipated.  The export and housing sectors drove employment growth.

Market Performance

• Reflecting the volatility arising from the GameStop short-squeeze the US sharemarket fell 1.0% in January.  In the US smaller sized companies continued to outperform.
• International sharemarket benchmarks performed a little better than the US market. Markets across Asia performing well, particularly China (+4.8%).  Latin American markets underperformed.
• Overall, Emerging Markets continued to outperform Developed Markets, EM markets returning over 3.0% in January.
• The Australian and New Zealand sharemarkets eked out positive returns, +0.3% and 0.1% respectively.
• Commodities performed well, +4.8%, oil outperformed in January (+7.5%) and the price of Gold fell (-2.5%).
• By and large fixed income underperformed in January, particularly longer dated securities as interest rates drifted higher.  In New Zealand, the Government Bond Index fell 0.3% and Australia’s -0.7%.

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The latest monthly commentary, for January 2021, can be found here.

Vaccine Recovery

• Risk assets (e.g. equities and commodities) performed strongly in November following encouraging Covid-19 vaccine trial results from Pfizer-BioNTech, AstraZeneca, and Moderna.
• Global equities returned 13.3% in November, many markets had one of their best monthly returns in several years. Some markets reached historical highs, including New Zealand and the US. European markets outperformed, Spain and Italy returned 28.3% and 26.3% respectively.
• US Food and Drug Administration (FDA) approval of a Covid-19 vaccine could be as early as 10th December 2020.  Europe is likely to approve a vaccine(s) by the end of the year.
• A great way to finish a very challenging year.
• Expectations are for widespread vaccinations in the US by April 2021, high-risk individuals will receive the vaccine earlier, as early as mid-December 2020.
• Likewise, it is anticipated large proportions of the population in the UK, European Union, Japan, and Australia will be vaccinated by May 2021.  It is estimated New Zealand will get their first doses of the vaccine in March 2021.
• In addition to the widespread public health benefits, global economic activity is expected to pick up in the second quarter of 2021, underpinning the V(accine)-Shaped Recovery, as expressed by Goldman Sachs.  They forecast 5% growth in the US over 2021, and 6% for the global economy.
• In the interim, global economic activity is expected to weaken over the last quarter of 2020 and into the first quarter of 2021 due to the rise in Covid-19 cases over the last couple of months in Europe and the US, and as the northern hemisphere heads into the winter months (a high risk period). 
• There has been a softening of European high-frequency data recently, such as truck milage data in Germany, UK retail sales, and cinemas and restaurants have witnessed declining revenues due to the tightening of lockdown measures.  Although less severe than actions undertaken in Europe, State and Local restrictions have increased in the USA.
• The outcome of the US elections buoyed markets at the beginning of the month.  Although Biden has been elected the 46th President of the United States of America, congress will likely remain divided.  A divided government means regulatory risks have decline, taxes are likely to remain lower, some pro-business policies will remain in place, and government spending to be less relative to the Blue wave outcome.  A $1 trillion dollar US Government stimulus package is now expected, less than half of what was previously anticipated.
• Recent US earnings have also surprised on the upside, supporting markets, as US companies managed to maintain profit margins better than expected despite the large hit to revenues.
• November was characterised by a “pro-cyclical” trade, where those stocks that have lagged the market for some time and will benefit more from an opening of economies outperformed.  From a sector perspective Energy, Financials, and Consumer Discretionary performed well.  The “Covid” trade sectors, Consumer Staples, Healthcare, and Utilities lagged the broader market.  Likewise, value and high beta stocks outperformed, low volatility, momentum, and growth underperformed – this will be reflected in relative manager performance in November.
• In other asset classes, commodities returned 8.6% in November, crude oil was up 25.7%, surpassing pre-covid-19 highs, and gold fell -5.6%.
• Fixed income performed well, particularly corporate credit and high yield, both returning over 3% in the US.
• Emerging markets equities underperformed developed markets, returning 8.9%.  (above returns based on S&P Index data.)
• The US dollar continued to weaken over the month.  This saw the New Zealand dollar (Kiwi) trade at a two and half year high versus the Greenback, rising from 66.25 cents to 70.41 cents (+6.3%).  
• The strength in the Kiwi partly reflects a scaling back of expectations the Reserve Bank of New Zealand (RBNZ) will move the Official Cash Rate (OCR) into negative territory, given rising house prices e.g. house prices in New Zealand’s largest city, Auckland, have risen 10.8% since June averages based on sales by New Zealand’s biggest real estate business, Barfoot and Thompson.
• Key risks include ongoing uncertainty over transition of power in the US, global economic activity slows more than expected due to recent rise in covid-19 cases, US government stimulus package disappoints, and vaccine roll out is slower than anticipated.
• Albeit the medium-term outlook for equities is well supported by an eventual roll out of a vaccine and ultra-low interest rates.  Low interest rates are expected to remain in place for some time, the US Federal Reserve is not expected to raise interest rates until 2025.
• Equities remain attractive relative to bonds.  Although longer-term interest rates are likely to drift higher over the next few years, a significant move higher is unlikely given an absence of inflation.  Therefore, higher interest rates are not expected to be a threat to global equity markets for some time. 

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Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.