Global Markets Summary
An extraordinary year in global markets ended on a positive note in an eventful fourth quarter, with equities registering very strong gains, led by small cap and value stocks, while a strong credit premium boosted bonds.
The final quarter was dominated again in the news by developments in the global pandemic, including the announcement of at least three new vaccines touted by their manufacturers as highly promising in preventing COVID-19.
Also seizing attention was the US Presidential election, in which Democrat Joe Biden defeated the incumbent Republican Donald Trump by 306 Electoral College votes to 232. While Trump contested the outcome as fraudulent, his numerous court challenges proved unsuccessful.
Many economies showed signs of a rebound from the pandemic-induced recession of early 2020. Australian gross domestic product rose 3.3% in the third quarter.
Equity markets, as they had done since the second quarter, looked past current economic uncertainty and the health crisis to an anticipated recovery in 2021. The vaccine news, announced in November, further cheered investors.
The Australian market rose nearly 14% in the fourth quarter (the best December quarter for the ASX 200 in history) to end the year roughly where it began, an unthinkable result back in the volatile days of March when the index had fallen more than 37% from record highs in the space of five weeks.
The final quarter was marked by a resurgence in value stocks after a long period of underperformance. Small caps, which had rallied strongly in Australia through most of the year, pushed on in the fourth, joined this time by global small caps. Emerging markets outpaced developed markets over the quarter and the full year.
While value contributed in the fourth quarter, it detracted over the year. Across developed markets, Energy and Financials, which had been laggards all year, turned around in the final quarter, although not at the expense of Information Technology, which continued the strong gains of previous quarters.
In Fixed Interest markets, there was a positive term premium overall in the fourth quarter, though there were differences across individual markets. The prime mover was a continuing contraction in credit spreads to pre-pandemic levels. Central banks again maintained easy monetary conditions. In their final meeting of the year in mid-December, US Federal Reserve policymakers upgraded their economic projections but maintained predictions that they will keep interest rates close to zero until at least the end of 2023.
The strong performance in equity markets coincided with a decline in the USD which fell more than 7% over the year against a basket of currencies. Much of this decline occurred in the final months. The AUD ended the year just below US77c, up from 70c at the end of 2019 and well above the 18-year low near 55c hit during March.
The rise in the local currencies meant hedged global portfolios outperformed their unhedged equivalents in the final quarter.
What Dominated the News
The following news summary is not intended to explain the markets’ performance in the quarter, but to provide some perspective about what dominated headlines:
- Donald Trump and Melania Trump test positive for Coronavirus
- Australia Tips into record Budget Deficit as Government accelerates tax cuts
- IMF warns World economy to shrink by 4.4% in 2020
- Germany and France extend restrictions as second Covid wave hits
- Amy Coney Barrett sworn in as a Justice on US Supreme Court
- Biden defeats Trump in US Election With 306-232 Electoral College Votes
- Trump refuses to accept result; claiming widespread fraud
- Pfizer and Moderna trials show vaccines more than 90% effective
- Wall St reaches all-time high; Bond yields soar on vaccine promise
- Australia, NZ and 13 Asian countries sign free trade deal
- Biden names former Fed Chairman Janet Yellen as Treasury Secretary
- Australian and NZ economies post big jumps in Q3 GDP
- Australian exports hit hard amid escalating Trade War with China
- US Regulator lawsuits seek break-up of Facebook
- World ends year with 83.5m Covid-19 cases; 1.8m deaths
Balanced Portfolio Movements
The year to 31 December 2020 started with strong positive momentum carrying through from 2019, however this quickly dissipated in late February as the reality of Covid-19 struck and governments enacted measures designed to curb the spread of the disease. The associated drop off in economic activity precipitated the fastest 30%+ sell off in equity markets the World has seen and a steep decline in portfolio values. However, swift and impactful measures taken through Fiscal and Monetary Policy across the globe triggered a spectacular recovery from late March which continued throughout the remainder of the year.
The surprise emergence of the Pandemic and subsequent collapse in financial markets, followed by an unexpected recovery, again highlighted the danger of using news headlines as an indicator of future investment performance. In January, just prior to the market collapse, there was precious little mention of the imminent threat to markets, and then in March and April media reports suggested markets would be in a multi-year slump.
Despite the year’s gyrations, our Balanced portfolio model (a theoretical portfolio used to guide our decisions managing client portfolios) managed to eke out a return of around +3.1%.
The rolling 12 month return for Balanced portfolios changed considerably through the year, ranging from +14% to -9%, as did the leader board rankings of asset class returns – providing substantial opportunities for portfolio rebalancing between asset classes (i.e. topping up hardest hit asset classes, and selling down those most resilient) through the year.
Further rebalancing opportunities were available in the Australian share market as the returns between the different industry sectors diverged substantially over the year. By way of example, the best performing sectors were Information Technology (up +58%) and Materials (up +18%), while the worst hit sectors were Energy (down -28%) and Utilities (down -17%). Notably, Financials, the largest sector that makes up around 30% of the Australian stock market was down around 6%.
Our ‘Industry Equal Weight’ approach to the selection of direct Australian shares was well positioned for this Covid-19 year as the portfolio is naturally underweight Financials and overweight Technology – a structure that played well. The ongoing rebalancing between stocks also played well as substantial profits were taken from ‘bolters’ such as Afterpay, Xero and Fortescue while underperforming stocks such as banks and utilities were topped up.
Our ongoing belief in the ‘Value Style’ of investing (overweighting cheaper stocks and underweighting expensive ones) has come at a cost over the past three years as value has seen its longest ever period of underperformance. However pleasingly this theme began to reverse in the fourth quarter as a strong rally in value stocks emerged. In part, this was due to the tech rally running out of steam as investors looked to rotate out of expensive growth stocks and into unloved traditional stocks that investors believe may benefit from an unfolding economic recovery in 2021. This trend saw value stocks outperforming the broader market by around 5% in Australia and 1.5% in international markets over the December quarter.
Our ongoing tilt toward small companies also paid dividends in the December quarter, with small caps outperforming the broader market by around 2% in Australia and 9% in international markets.
Relative Returns and Adviser Value
At year end it is common for us to field questions from clients that relate to their portfolio returns. Often, these questions include a request for return comparisons for a client’s own portfolio relative to say “an average super fund”. Sometimes clients ask “why didn’t we have more of that fund or stock this year” (say tech companies), or “why were we holding that stock or fund this year” (say bank stocks).
Whilst there is value in understanding how your strategy is performing relative to others, this line of analysis can miss the forest for the trees.
All prudently managed and diversified portfolios are driven by the same market forces and affected by the same market events. The markets themselves and the events that affect them are typically volatile and unpredictable.
The main drivers of portfolio returns are almost always the portfolio’s asset allocation and the underlying returns of capital markets (ie the returns of equity, property and bond markets). Within this ‘goldfish pond’ returns don’t vary dramatically from one reputable investment manager to another. Whilst there are differences in fees and investment styles that do have an impact – the differences generally aren’t ‘cattle stations’.
Yet, big differences in investor return outcomes regularly do occur. Generally these differences arise because an investor has made a profound change to their strategy during a period of heightened volatility or market turmoil. Typically, the investor changed strategy in an attempt to ‘protect their wealth’ during a time of crisis. Think of all those Australians who withdrew their superannuation during the April lockdowns, or the many investors who shifted to cash amid the turmoil as they thought things could only get worse.
Its always easy to see in hindsight, but at the time these events occur the headlines are alarming and we can all feel vulnerable. Without a well-constructed and properly understood philosophy – investors can lose direction, with catastrophic consequences for their portfolios.
The best long term investor outcomes are generally achieved where the strategy was well thought out in the first place, and the investor managed to stay disciplined through the decades (and particularly through times of turmoil).
It might not be intuitive, but often the greatest contribution a seasoned adviser can make to client long term outcomes arises not from tinkering with portfolio constituents or from providing market timing advice, but rather from ensuring:
- The asset allocation mix and investment program are well suited to the client’s needs and risk tolerance.
- The client deeply understands the way that market works and how their investment program is intended to behave through the ups and downs of the cycle.
- Providing upfront and ongoing education and being present to be a trusted sounding board to help clients manage their emotions and impulses while staying disciplined through periods of crisis.
Comparing returns is human nature, but so is the propensity to believe that ‘the grass is greener on the other side’. Switching from one super fund to another, or one investment fund to another to chase last year’s best performer is rarely the sensible thing to do.
Research published by Standard & Poor’s shows that from June 2015 to June 2020, only 33% of Australian Shares Funds were able to beat the Index in two consecutive years, and over four and five years this figure reduces to 2% and 1% respectively. Persistence of performance is even challenging in relative terms, as only 1% of Funds were able to maintain their position in the top quartile of competitor funds for five consecutive years.