Five key questions for investors in 2021 - Market Insight Report - Milford Asset ...
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A note from our The questions are: 01. Will distribution of vaccines end Chief Investment the COVID-19 pandemic in 2021? Officer 02. Will governments withdraw fiscal support now a vaccine pathway is more certain? 03. Will central banks maintain loose monetary policy even as economies recover? 04. Will the housing market continue Wayne Gentle to appreciate? Chief Investment Officer 05. How will investors respond to very low interest rates? After a tumultuous 2020, we turn our thoughts The answers to these questions will be key to what 2021 might bring for investors. As the inputs into our asset allocation discussions, past year showed, evolution of events can i.e. where we choose to increase or reduce quickly render forecasts and expectations investments. Importantly, they will also worthless. Furthermore, even if we knew the inform our company selection decisions as details of how the pandemic was going to the winners of the past year may not be the unfold, picking the correct response of asset winners of next year. markets would have been very difficult. After a year of huge uncertainty, the next year With this in mind, we take a humble approach is unlikely to see such upheaval. The global to forming an outlook – there will be no economy will hopefully continue to recover forecasts of financial markets that quickly and normalise after a pandemic disrupted become obsolete. However, learning from the year. However, this does not mean a straight experience of this year, we have identified line for financial markets and fund returns what we think will be the major drivers of - we will see further volatility. As active financial markets over the course of 2021. managers, we continually reassess the outlook and reposition our funds accordingly. These key drivers are posed as questions. We don’t presume to know the answers, We look forward to meeting the investment but we instead outline why each question is challenges that 2021 brings. We hope that important for investors and what we will be you find this insight into our thought process looking for to determine the answer over the informative, useful and thought provoking. course of the year. Wishing you all the best in 2021. Utilising the depth of Milford’s investment team, these questions have been posed to subject matter experts across the team. As we move through the new year, we will be looking to these experts to help guide our internal investment decisions, particularly Wayne Gentle as new information comes to light. Chief Investment Officer Milford The material contained herein is based on information believed to be accurate and reliable although no guarantee can be given that this is the case. This is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Before making any financial decisions, you may wish to seek independent financial advice. Past performance is not a reliable indicator of future performance. Read the relevant Milford Product Disclosure Statement at milfordasset.com. 2
01 Will distribution of vaccines end the COVID-19 pandemic in 2021? Compared to what was anticipated six months ago, the timeline and efficacy of COVID-19 vaccines has far exceeded expectations. We’ve identified three key factors we believe will materially influence the trajectory of the pandemic in 2021. Firstly, how many doses of the vaccine This leads to a second important can be produced? question – once the vaccine is made Marissa Rossi The eight leading vaccine developers are available, what percentage of people Head of projecting they will together deliver 37 million will choose to be vaccinated? Sustainable vaccine treatments in 2020 and a further Recent surveys in the US suggest up to Investment 5.6b in 2021 – enough to vaccinate 70% of one-third of respondents do not believe the global population. Perhaps unsurprisingly COVID-19 is real. One in six British people given the astronomical scale and expedited surveyed say they are unlikely to agree timeline, estimates from Pfizer and to COVID vaccination, while a similar AstraZeneca for the initial quantities of doses proportion remain undecided. Vaccine to be delivered have slipped significantly hesitancy is unfortunately likely to increase from what was promised only a few months as the impact of side-effects such as fever ago. Pfizer has cited issues with raw material and soreness at the injection site become supply and AstraZeneca is having challenges additional deterrents. And, as was the case with its UK manufacture. While this likely 20 years ago with the roll-out of Merck’s results in delays of only a few months, it cervical cancer vaccine, there will likely be highlights the logistical challenge in terms of isolated, but widely reported, terrifying scale, distribution and timeline for vaccine tales of more severe adverse reactions. delivery in 2021. Five key questions for investors in 2021. 3
01 Will distribution of vaccines end the COVID-19 pandemic in 2021? Pleasingly, in Australia and New Zealand, The third critical piece of the 2021 puzzle evidence suggests almost 80% of the we’ve identified is, will vaccines protect population would be willing to receive a against infection and transmission, or COVID-19 vaccination if it were available, only against the symptoms of disease? which, together with a highly efficacious If protection against severe disease symptoms vaccine, puts our countries and is enough to reduce hospitalisations and economies in a very strong position. deaths, does it even matter? Perhaps surprisingly, in the short term, the answer to this question has meaningful implications for Percentage of people willing to how long COVID-19 restrictions will be in place. get vaccinated if a vaccine were Take the example of healthcare workers who available (as of October) are rightly first in line to be vaccinated. While those doctors and nurses can be safe in the India 87 knowledge that even if infected, they are China 85 highly unlikely to develop severe symptoms, if COVID-19 infection and transmission S. Korea 83 remain possible despite vaccination, they Brazil 81 must continue to take precautions such as mask wearing and social distancing, to avoid Australia 79 becoming super-spreaders. We know this will UK 79 be true for all early vaccine recipients, but raises further questions – at what point will a Mexico 75 large enough portion of the population have Canada 76 received vaccination so that social distancing Germany is no longer necessary? What if only 50% of 69 the population are prepared to be vaccinated Japan 69 at all? As a population, can herd immunity S. Africa 68 ever be achieved if vaccine recipients remain vulnerable to infection and are still capable of Italy 65 passing it on? Spain 64 The answers to these questions will unfold US 64 over the coming months. But two things are certain. The scale of human endeavour France 54 that went into developing, testing and Total 73 manufacturing highly efficacious vaccines in such extraordinary quantities, just twelve months from the discovery of a novel human Source: Ipsos, virus, is awe inspiring. Secondly, as 2020 draws J.P. Morgan economics. to a close, we can be confident that, from the perspective of the pandemic, the year ahead will be an easier one than the year we are leaving behind. Five key questions for investors in 2021. 4
02 Will governments withdraw fiscal support now that a vaccine pathway is more certain? In 2020, governments around the world rolled out ad-hoc wage subsidies, business grants and loans, and even universal cash handouts. Notably, GDP (gross domestic product) of developed economies saw +4.5% points uplift from fiscal stimulus, alleviating about half of the pandemic hit. Importantly, meaningful, decisive policies arrested a potential collapse in confidence that could have led to other dominoes Felix Fok falling as uncertainty rose. While not completely out of the woods, Portfolio government action has helped avert the worst possible outcomes. Manager Looking forward, the expectation for 2021 misallocation of taxpayer funds. For this is for total government spending to decline reason, policymakers prefer automatic year on year – a ‘fiscal drag’. Aid packages buffers, such as unemployment benefits. typically have end dates. Non-renewal of If the anticipated recovery takes hold an expiring programme would be a natural in 2021, government spending on cause for spending to decline. Historically, benefits should decline through rising the ‘three Ts’ have guided the design of employment. emergency aid: Timely, Temporary, and Still, the threat of second virus waves is Targeted; with the first two criteria proving real and countries in Europe and Asia easier to achieve than the last. Indeed, poorly have reverted to near full lockdowns designed early stimulus programmes could in recent months. Governments will hold back approval of future packages be sensitive to pain on ‘Main Street’ as opponents seize upon the narrative of Five key questions for investors in 2021. 5
02 Will governments withdraw fiscal support now that a vaccine pathway is more certain? and could reinvigorate spending even if a Governments round the world vaccine is forthcoming. The question is ‘how will be threading a fine needle; much pain is needed?’ The answer depends in large part on the politics of that country. early removal of support could For example, at time of writing, the split threaten the recovery. Conversely, US Congress continues to haggle over the too much stimulus could lead proposed third COVID-19 aid package that to economies overheating with started negotiations in July. Nonetheless, acceleration of spending on infrastructure adverse impacts of inflation and in the widest sense with promise of future subsequent monetary policy productivity gains appears to be likely in tightening. Consequently, fiscal most countries. policy will be a key area of focus Fiscal spending has historically buffered for investors in 2021. economies in downturns and tends to be counter cyclical. It is natural to expect fiscal spending to be a drag if economies rebound. Things to watch would be reacceleration in virus cases and job losses, which could lead to the passage of new spending programmes. Otherwise, surprises could come from proponents of left-leaning concepts like universal basic income. “Historically, the ‘three Ts’ have guided the design of emergency aid: Timely, Temporary, and Targeted.” Five key questions for investors in 2021. 6
03 Will central banks maintain loose monetary policy even as economies recover? Most developed world central banks operate in the context of a set of policy targets. These targets differ between central banks, but the overarching common denominator is stable consumer price inflation (typically CPI in the region of 2%), but also now increasingly, maximum sustainable employment. To contemplate how monetary policy may develop as economies recover, we must therefore consider how Paul Morris inflation and employment will likely develop. Portfolio Manager Targeting inflation The initial phase of the COVID-19 pandemic recovery. Historically that has led to central was undoubtedly disinflationary (lower bank policy tightening. Now however, CPI). As time progressed some sectors (e.g. after years of lower than target inflation, goods) experienced a recovery in inflation central banks appear willing for inflation to as demand improved but logistics networks run higher than target (albeit temporarily) and manufacturing remain strained. Looking before tightening policy. Indeed, the US into 2021, a successful vaccine deployment Federal Reserve earlier in 2020 changed its into a backdrop of potential pent up inflation target to reflect this, specifically demand could further broaden this inflation targeting average inflation of 2% over time. Five key questions for investors in 2021. 7
03 Will central banks maintain loose monetary policy even as economies recover? Targeting maximum employment Policy to remain extraordinarily The crisis caused a dramatic increase in accommodative unemployment. Some sectors recovered In the near term, many central banks will as economies reopened but many remain remain more concerned with downside deeply scarred, especially services economic risks than the threat of emerging such as tourism and hospitality. It is inflation. That means predispositions remain also proving difficult to determine true for more, rather than less policy action, even levels of unemployment given myriad if the efficacy of further accommodation government payroll support schemes. is arguably waning. Many central banks Pre-crisis, central banks were already have provided clear guidance that official revising lower expectations of the cash rates will not rise for several years sustainable unemployment rate that and that quantitative easing programmes would be inflationary. Since the pandemic, will continue well into 2021. Most believe central bank rhetoric has increasingly financial stability risks, another objective emphasised policy will be driven by actual for many central banks, from elevated unemployment, rather than its expected asset prices (in part caused by low future path. Combined with an acceleration rates) is less than the risk from elevated in structural employment changes in some unemployment (which could cause stress sectors (e.g. retail ecommerce) central due to bad debts). banks may therefore err on the side of This all points to central banks retaining caution, waiting for unemployment to extraordinarily loose policy settings, even as fall across a truly broad demography. economies recover, which should continue to be supportive for asset prices. Investors will however be extremely sensitive to even the inference that central bank policy settings could change. “In the near term, many central banks will remain more concerned with downside economic risks than the threat of emerging inflation.” Five key questions for investors in 2021. 8
04 Will the New Zealand housing market continue to appreciate? The New Zealand housing market proved to be incredibly resilient in 2020, contrary to many predictions when COVID-19 first appeared. Our median house price is at record highs nationally (and across several regions), and total volume transacted in recent months has also been at historically high levels. Sam Median property price change (%, year on year): Trethewey 30.0% Portfolio Median property price Y on Y change Manager 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% New Zealand -5.0% Auckland New Zealand -10.0% ex. Auckland 2013 2014 2015 2016 2017 2018 2019 2020 Source: REINZ Five key questions for investors in 2021. 9
04 Will the New Zealand housing market continue to appreciate? What are the drivers of the market appreciation? In our view, the housing market has been supported by three key factors: 1. L ower interest rates: the RBNZ Looking ahead into 2021 reduced the official cash rate from 1.00% Looking ahead, we will be watching to 0.25% in March and banks have since closely for signs of change. This means followed with mortgage rate reductions closely monitoring the housing market and lower term deposit rates. This has strength, its flow-on impact on the improved affordability for many first economy, and considering how that is home buyers and forced some investors likely to influence the RBNZ’s decisions who may have previously held term on interest rates. There is a risk that the deposits to look for alternatives like RBNZ may decide to try and take the housing. steam out of the market with renewed lending restrictions (e.g. officially imposing 2. Pent-up demand: Largely first higher LVR limits on investors) or via other home buyers who have struggled to macro prudential measures. In addition, enter the market for many years have continued first home buyer participation sought to purchase following the March is also important to see growth in value lockdown. The demand has likely been remain a feature. Finally, on the issue of compounded by some New Zealanders limited supply, any material changes to returning home from overseas due to land availably and possible changes to COVID-19. the Resource Management Act should be 3. Limited supply: This is a well-known watched; however we would not anticipate issue in New Zealand. Housing stock a quick fix solution to supply issues. growth has not kept up with population growth, particularly in the major centres, in recent decades. As active fund managers, the housing market provides important signals for us about the health of our economy and investor appetite for risk. A strong housing market has significant flow-on effects to the wider economy, supporting confidence and spending by consumers and businesses. Five key questions for investors in 2021. 10
05 How will investors respond to very low interest rates? Investors need to look for alternatives Lower interest rates boost short-term to cash and term deposits market returns but lower long-term Low and close to zero interest rates mean returns investors need to look for alternatives When interest rates fall, the valuations to cash to generate decent returns on investors are willing to pay for shares their savings. These alternatives include generally increases. For example: if a shares, company debt (corporate bonds) company was paying a dividend yield of or investments into managed funds that 7% and because of a fall in interest rates, Jonathan invest in company shares and fixed income investors were happy to receive a yield of Windust securities. 5%, the value of the company would need Portfolio to rise by 40%. Manager To achieve those higher returns, investors will need to take more risk Unfortunately, once the capital gain has Unfortunately, investing in these alternatives been received, the future return from requires taking on more risk and complexity. holding the investment will be lower by The returns from shares and managed around 2% p.a. funds are not fixed - they are reliant upon Following strong gains in share markets in company profits and the value that share recent years we expect returns to be lower markets place on these profits. Accordingly, in the future – dividend yields are already investors must be prepared for ups and lower. However, we believe that shares downs in the value of their investments should still generate a higher return than and be willing to take a longer-term view. cash over the medium-term. Investors should carefully consider their tolerance for risk when selecting their investment strategy. Five key questions for investors in 2021. 11
05 How will investors respond to very low interest rates? For share markets, ultra-low rates Low rates increase the importance of potentially increase volatility good active investment management Given a large part of share market returns We believe lower rates increase the has been created by lower interest rates importance of active investment (and therefore higher valuations), markets management. In an environment of low may be vulnerable to sharp rises in interest returns, any additional returns above rates. Additionally, given the current low passive investment returns become level of rates, the ability of central banks increasingly valuable. Additionally, the to lower rates further to help cushion ability to manage risk becomes more future economic and market falls has important when asset valuations are fallen. Global central banks have looked high and growth is low. Investors in well to address this by using other tools such managed active funds should take comfort as buying longer-dated bonds – however that the manager is monitoring the risks of these solutions are less proven. their investments and investing where they believe they will be rewarded for taking risk. However, it is important that investors in actively managed funds carefully consider the credentials of the manager they choose and the risk profile of the fund they invest in. “Low and close to zero interest rates mean investors need to look for alternatives to cash to generate decent returns on their savings.” Five key questions for investors in 2021. 12
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