The big squeeze

The year started well but a confluence of factors set against elevated valuations led markets to give up early January gains. The MSCI World Index fell by 0.7% over the month, driven lower by the 1% fall in U.S. stocks. Emerging markets significantly outperformed, gaining 3.8%, and Australia eked out a 0.3% return. Global bonds failed to come to the rescue as the Bloomberg Barclays Global Aggregate index declined 0.9% over the month (all total returns in local currency).

The positive sentiment in markets was always at risk from the high valuations across assets. Initially, the global roll-out of vaccinations and the promise of further fiscal and monetary stimulus helped the market to overlook pricing concerns and virus-driven restrictions. Stimulus expectations rose after the surprise Democratic sweep in the run-off election for the two Senate seats in Georgia, completing Biden’s blue wave.

However, over the month, concerns about the delay to vaccine supply increased as did worries about their effectiveness against new viral strains of COVID-19, which would delay the economic recovery. Simultaneously, some governments started to question the need for further big budget stimulus. Inflation data around the world also came in higher than expected, adding to fears of higher-than-expected yields and a reversal of easy monetary policy.

The media was gripped by a group of small and relatively heavily shorted stocks which rallied strongly on the back of retail demand and a short squeeze, forcing some hedge funds into heavy repositioning. The influence of retail investors is not new and often not persistent. Longer-term investors should focus on the likely strong rebound in growth that will accompany the wider distribution of vaccines and economic re-opening.

Meanwhile, economic data continues to paint a picture of a better-than-feared economic slump from the rising COVID-19 cases in the northern winter, leading to a revision higher in economic forecasts. It is a similar situation locally. While politicians and health officials remain highly sensitive to new cases and the introduction of potentially more virulent COVID-19 strains, consumer and business attitudes towards the economy are improved and the job market is improving faster than anticipated.

January’s markets may have felt the pressure from a range of concerns and the threat of COVID-19 may still linger, but the message from governments and central banks is that policy will remain supportive for a while yet.

After a strong run in risk assets, a pause for breath is not an uncommon event. Staying cautiously optimistic but with a balanced portfolio seems sensible during this challenging period of the pandemic. 

Economy:

• Low rates are impacting rate sensitive parts of the economy as house prices continue to rise. Nationally, house prices rose 0.7% month-over-month in January even as the year-over-year (y/y) rate of price appreciation slowed to 2.9%. Forward indicators for the housing market suggest more strength to come. Home loans have surged since May (+59%) and increased 31.2% y/y for the month of December, the fastest pace since 2009.
  (GTM AUS P. 10)
• The housing market was not the only bright spot in the local economy. The labour market added another 50,000 jobs in December and the unemployment rate fell to 6.6%. From here, it will be easier for employers to add hours to existing workers rather than employ new workers. This means the pace of improvement in the labour market may slow when it comes to the unemployment rate, but the underemployment rate is likely to show more improvement.
  (GTM AUS P. 8)
• Inflation for 4Q20 was a stronger-than-expected 0.9% quarter-over-quarter (q/q), but largely driven by one-off impacts to child care and excise tax on tobacco. Core inflation was a more subdued 0.4% q/q. The higher inflation rates will be welcome news to the Reserve Bank of Australia (RBA), but unlikely to move the needle on monetary policy.
  (GTM AUS P. 7)
• U.S. and European economic data are improving despite COVID-19 restrictions. Inflation is running faster than expected and the unemployment rate has not deteriorated (6.7%). There has been some slowing in global Purchasing Managers Indices in January but most markets are close to or above the key threshold of 50.
  (GTM AUS P. 15)
• As countries around the world continue to implement various restrictions on mobility, a key determinant of the growth outlook is vaccine distribution. Despite some hiccups, progress is being made. The UK and the U.S. have vaccinated 14% and 9% of their population respectively. However, it is still early in the process, with many other countries only just starting their vaccination programs.

Equities:

• The ASX 200 rose 0.3% in January, a mild gain over the MSCI World’s 0.7% decline. Consumer discretionary (4.7%), communication services (2.7%) and financials (2.2%) were the stronger performing sectors. Meanwhile real estate (-4.4%), industrials (-3.0%) and health care (-1.9%) sectors lagged.
• As earnings season begins in Australia, the biggest question is how fast corporate earnings will return to pre-COVID levels. The earnings upgrades have supported the materials sector and lifted expectations for financials given the improving economic outlook. The late-run in earnings revisions mirrors the catch up performance by Australian equities late in 2020 relative to the rest of the world.
  (GTM AUS P. 35)
• The 4Q20 U.S. earnings season took a back seat to other market developments in January as investors overlooked fundamentals. However, with almost 50% of the market cap reported, 70% of the reported companies are beating revenue expectations and 84% on earnings expectations.

Fixed income:

• Global bond yields rose over the month as inflation expectations rose. The U.S. 10-year Treasury yield rose by 17bps to 1.09% and the Australian 10-year Australian Commonwealth Government Bonds by 12bps to a similar yield. The risk of higher-than-expected inflation is a key one to watch for both bond and equity markets if it elicits a response from central banks, something we think is unlikely.
  (GTM AUS P. 57)
• The first meeting of the year for the U.S. Federal Reserve (Fed) was a stoic one, opting to keep policy unchanged and pushing aside any notion of tapering the current USD 120billion in monthly bond purchases for now. However, the Fed is likely to become more vocal on tapering bond purchase toward the end of the year as the economic recovery gains traction, but it will be a slow process.
• Credit markets had a poor month on rising yields. Global investment grade bonds were down 1.0% and USD emerging markets debt by 1.8%. However, high yield continued to post positive returns, with U.S. high yield returning 0.4% for the month.
  (GTM AUS P. 54)

Currencies and commodities:

• The Australian dollar raced higher over 2020 thanks in large part to rising iron ore prices and a risk-on mentality in markets. However, the Australian dollar peaked at 77.8c against the greenback in January and the U.S. dollar has been on the rise again since the shift in risk sentiment. The Australian dollar fell by 0.6% versus the U.S. dollar over the month.
  (GTM AUS P. 66)
• The price of a barrel of Brent crude oil rose USD 4 over the month to close at USD 56 per barrel. The rising price is a function of both vaccine prospects, rising demand, and a surprise supply cut from Saudi Arabia. Elsewhere, commodity prices pulled back from their monthly highs. The price of iron ore hit USD 170 / Mt before ending the month at USD 168 / Mt. Gold was also lower at USD 1,864 / oz.

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