On the virus front, new cases and new deaths numbers are declining globally, and particularly so in those countries with strong vaccine rollout (assisted by levels of herd immunity), with Israel, the UK, and the USA leading the charge. Whilst the vaccine approval process is different in each country, there are 5 vaccines that have passed phase 3 trials, with 3 of those currently being used around the world – Pfizer, Moderna, and AstraZeneca. Johnson & Johnson and Novavax round out the 5. Vaccine production and distribution problems will always exist and are currently playing out in various jurisdictions around the world, with the Europeans (ex-UK) doing their best to excel here. This has meant that most governments and health authorities have adopted a policy path that seeks to maximise the number of people who receive a single dose, in order to obtain some protection, rather than maximising the number of people who are fully protected (ie. 2 doses).
There has been significant discussion and concerns regarding different strains of the virus and the vaccine effectiveness against these different strains. It’s worth remembering that there are always different strains in the coronavirus family and always different vaccine effectiveness to those strains. That’s nothing new. What is new, which is not based on any science, is government and health authorities treating vaccines as the only solution to getting back to normal life, and particularly so for a virus that has a 99% survival rate. From the data we’ve seen, which is mostly over small sample sizes, there is an average decline in vaccine efficacy of around 20-25% for various strains. There are 3 important things to note here:
- if a vaccine is starting at 90-95% efficacy, then they are still effective enough at 70- 75%;
- the new types of vaccines produced (mRNA) can very quickly be re-calibrated to account for these different strains;
- and those in our population who are immuno-compromised and/or have 2 or more comorbidities will always be at significant risk from any virus regardless of whether vaccines are available and/or effective.
There are 3 other things worth noting here before we move on. The testing methods, therapeutics, and death classifications remain a problem. The commonly used PCR testing was never intended to be used to identify a single virus and was also designed to be used at a particular threshold setting, which has resulted in a significant number of false positives (and false negatives for that matter). The use of therapeutics has largely been completely ignored by governments and health authorities globally which is plain stupidity given most of these therapeutics have been in use for decades and therapeutics are largely virus-strain agnostic. Ignoring therapeutics is akin to swimming with your hands tied behind your back. Lastly on death classifications, most countries around the world have adopted fairly “odd” criteria for how they classify Covid deaths including some of these pearlers:
- in the UK, if you had Covid in March 2020, survived and recovered, but later passed away in the 2nd half of the year, that would be a Covid death;
- in the USA, if you die of any cause, but have Covid in your body when you pass, that would be a Covid death as well………
VIRUS / HEALTH POLICY RESPONSE / THERAPEUTICS / VACCINES
Without getting into too much of the science, which is both rather technical but also rather contentious (which it shouldn’t be except for the fact that science has become politicised), Covid-19 sits somewhere closer to the common flu that it does the Spanish Flu or the bubonic plague. That’s not to downplay its significance or it’s risks, but it’s worth providing some context. That context includes that 0.02% of the world’s population has died with or from the virus; a very large proportion of those who died were in aged care or over 80 years of age or had a terminal illness or had more than two comorbidities; currently, 0.5% of people who have Covid are in a serious or critical condition.
Lockdown, as a policy response, has been shown to scientifically aid in stopping the spread of a virus but specifically so the first time around. Its usefulness thereafter is less proven given the health policy response should be refined and perfected thereafter so as to protect those most at risk. It appears we did a rather poor job, and disappointingly so, at seeking the assistance of therapeutics throughout the year as we bet the farm on vaccines and only vaccines. Both would’ve been good.
On the vaccine front, we now have three that have passed phase-3 trials, are in production, and are already being administered. That is an incredible feat in such a short period of time, helped not only by eventual information sharing, but mostly by the sheer amount of money and bodies involved in developing vaccines, which saw us start manufacturing facilities well before phase-3 trials had ended. Technology was the game changer which saw the creation of totally new vaccines which trigger the body’s immune response to target and neutralise the virus before it can spread. The only concerns remaining now are broader safety (looking good at this stage), pace of rollout and access (will depend on which country you’re in), and likely take-up (given anti-vax movement, general safety concerns, religious beliefs, vaccine apathy). Given both governments and health officials have bet the farm on vaccines, it’s incredibly important we get a large degree of distribution and take-up sooner rather than later. The longer lockdown exists as a policy response, the worse current and future generations will be for it.
US GOVERNMENT POLICY
INFLATION – Outside of virus and virus-related issues, US government policy, particularly budgetary measures, have contributed mostly to the bout of whip-sawing volatility we’ve seen in markets over the last month or so. Front and centre of the issue is inflation, or more specifically, the potential for stimulus-induced inflation. Whilst the rest of the developed world struggles to get inflation sustainably near long term targets set by central banks, US inflation is likely to print higher over the coming quarters. That increase in inflation is largely a function of base effects (ie. really low inflation readings dropping out of the annual figure) but also ably assisted by higher commodity prices, higher costs from onshoring some production, and housing related dynamics. Most of these are temporary effects and/or a function of recovering US economic growth.
However, higher inflation concerns are being stoked by the extraordinary Biden “Covid relief” (very little actual Covid relief in it) budget bill of US$1.9 trillion which has just passed the US Senate. That sort of spending might have been relevant and appropriate in the 1st half of 2020, but it’s clearly not now, unless the plan is to lock-down America for another 12 months or longer. This sort of reckless spending is synonymous with stoking inflation in the past, however, most of the spending is one-off in nature and for inflation to remain sustainably higher, you need significant wages growth (via full employment – long way away from) and/or significantly higher velocity of money (ie. the pace at which money moves around the economy – at very low levels currently). Absent these latter two effects, inflation is not a right-now problem, but could be in the years to come depending on how central banks play their cards over the next 3-4 years.
BOND MARKET – Right now, we aren’t overly concerned with inflation remaining sustainably higher (absent significant wages growth and/or velocity of money, which are both low probability events), but we are concerned with what expectations of higher inflation are doing to the bond market. The US 10-year government bond yield has moved from around 0.9% to 1.6% (the Aussie equivalent has doubled!!), with most of that move coming in the last 4-5 weeks, which is an incredible move in such a short period of time.
What’s wrong with higher bond yields?
Whilst higher bond yields mean higher income levels in the future, there are 2 main issues to note:
- as bond yields rise, bond prices fall, which causes capital losses for holders of bonds;
- government bond yields are largely used to price all other investable assets, and particularly so for equities, so higher bond yields usually means lower allowable valuations on equities as it becomes more expensive for corporates to finance their debt, as well bond yields becoming more attractive versus dividend yields on equities (notoriously low in the US).
Rising bond yields are what caused the market correction in the 4th quarter of 2018, so it’s definitely something everyone should be concerned with. However, most are looking at the rise in bond yields in isolation without taking a step back and looking at the broader picture.
- Will central banks continue to print money this year (putting downward pressure on bond yields)? Yes
- Will central banks print more money if needed? Yes
- Will central banks raise rates this year? No
- Will economic recovery efforts this year remain hampered by government-imposed virus restrictions? Yes
- Is inflation likely to get out of control this year? No
- Are there parts of investment markets that are trading with irrational exuberance (ie. pure stupidity in layman’s terms)? Very much so.
What does this mean for my portfolio?
Broadly speaking it means that bond yields will settle at higher levels in quicker fashion than anyone really expected, which means:
- short-term negative returns on bond investments but likely better returns ahead;
- the frothiest parts of investment markets will come under some pressure (particularly US tech);
- broader equities can continue to do well, particularly those equities that have been unfairly unloved by investors for some time (ie. Value);
- growth assets (equities, property, infrastructure) will continue to be well supported considering government and central bank stimulus, along with low cash rates, whilst those concerned about inflation will seek out assets that provide some protection against rising inflation.
It’s almost impossible to write something these days without involving China. China’s economic recovery has been nothing short of spectacular, with plenty of dry powder remaining, and this strength will continue over the course of this year. Historically, that would’ve meant that those countries and companies closest to China would benefit significantly, but the world is a changed place post Covid, with US-China tensions likely to remain high and with no end in sight for Australia-China tensions. Particularly close to home, almost every Australian industry outside of iron ore has been negatively impacted by worsening relations with China. This is likely to continue as China’s communist regime (ie. playing the long game plus the ability to withstand economic pain), and our relative sizes, clearly disadvantages Australia in this disagreement. We’re partly to blame given decades of over-reliance on China (more than 40% exports, plus tourism and education), but we’re not to blame when it comes to standing for something (morals/principles). Without ally support, it’s difficult to see an end to the current stoush any time soon, which will continue to hamper Australia’s economic recovery and long-term economic growth. Away from home, we’re paying more attention to Taiwan given the ease at which China “took” Hong Kong, with Taiwan home to the largest semi-conductor company in the world. Remember years of foreign wars fought over oil supply…….semi-conductors may well be the new oil…..
Our outlook for 2021 remains positive at this juncture, assuming better virus outcomes, less government impositions on our daily lives, continued government and central bank support, improving corporate earnings and profits, and relatively stable and low bond yields. However, we continue to be mindful of rising inflation risks, central bank policy (and rhetoric) missteps (they are humans after all), continuing geopolitical risks and trade tensions, and the temptation for governments to continue to assert themselves into our daily lives this limiting our ability to get back to normal.
What is normal anymore? That is the 64-million-dollar question. It’s fair to say we’ll be devoting a large amount of time in 2021 trying to figure out which changes are temporary, and which are permanent, and each of these impact household, business, and government behaviours.
This Market & Economic Update has been written and published by Insight Investment Services.
CB Wealth Australia Pty Ltd T/as HH Wealth is a Corporate Authorised Representative No. 001283595 and Christopher Holme is an Authorised Representative No. 001004793 of Insight Investment Services Pty Ltd AFSL no 309996. Financial Services Guide (FSG) and Adviser Profile contains important information about Insight Investment Services Pty. Ltd., any authorisations and the services we provide. The following link will take you to an electronic copy of the FSG, if you would prefer to receive it another way please contact our office. Please click here to read the FSG– www.insightinvestmentservices.com.au/financial-services-guide/.