Australian Bond Exchange

It is fair to say 2020 was a year of extremes. It felt like COVID-19 came out of left field and hit the world stage with such force it sent world economies spiralling down and Governments into panic mode. Not since the GFC in 2008 have we seen such violent moves and dislocation in financial markets. The level of Government stimulus was also unprecedented and to this day continues. Fast forward 12 months and the world look’s completely different and the outlook more positive. It seems the bounce back has almost been as dramatic as the initial fall, a statistic that beggar’s belief. Is this a possible concern? As we go to print cases of a new strain of COVID-19 are emerging in Europe.The UK has just entered its 3rd full lockdown since the pandemic began and back here in Australia, there is renewed concern of another wave. Both Federal and State Governments are on the front foot, putting in place strict measures to prevent another outbreak.

Let us not forget that the US has a new president about to take office on Jan 20. This doesn’t look like it will have much of an impact on financial markets given performance to date and most of the expected policy changes already flagged. In any case this is likely to take a back seat to a resurgence of COVID in the US and condition of the US economy.

It is almost counterintuitive to think that the outlook for economies and earnings is looking brighter. We are almost out the other side of this recessionary cycle which implies an extended period of low inflation and flat interest rate growth. That said we believe investors have perhaps become overly optimistic and complacent on the back of expected vaccine releases, exposing markets to possible shocks to the downside should these not transpire.

Given the performance of equity markets over 2020 – US market was up 12% year on year – and in the context of the earnings outlook, this asset class is looking more and more expensive and overstretched. An excess of liquidity on the back of relentless stimulus has been a major factor behind this together with fear of missing out. One must accept that both these factors could add air to an already inflated bubble.

The biggest problem facing investors this year will be the lack of available investable options. With an excess liquidity not seen before and interest rates at record lows investors are being forced to take on more and more risk when weighing up investments.

Given continued pressure on bond yields globally we believe a new fixed-income asset class will start to emerge, that of alternate fixed-income, or yield-enhanced securities.

The Australian Bond Exchange (ABE) has been working closely with multiple product issuers to fill a massive hole in the demand for higher-yielding fixed income securities. Whilst not traditional and relatively new to the broader investing public, these securities offer better than average rates of return typically between 5%-10%. When you consider that 3YR Australian Government Bonds are yielding 30bps, these securities represent real (post inflation) income generating alternatives. Of course, these are at opposite ends of the risk spectrum but, on a risk adjusted basis and post meeting ABE’s qualifying criteria, these securities will prove to be the staple of fixed income going forwards.

Outlook. Costs across global economies to remain low supporting business and industry. And investable options remain limited. Risks continue to be on the high side going forward. Margins remain under pressure. Equities to continue trading at the high end of valuations. Long term the outlook for financial markets will remain uncertain and on the higher end of the risk curve.