28th January 2021
“If opportunity doesn’t knock build a door” – Milton Berle
Joe Biden’s election as the US new president was nowhere near as exciting as perhaps a Trump victory would have been, however it should bring a little more stability to the investment landscape. It may sound a little bit like a broken record but, the reality of the situation is that short of a black swan event, markets around the world are simply tied to the whims of central banks and how much stimulus they’re prepared to inject.
Recent Housing Start numbers in the US came out slightly better than expected earlier this week 1669 vs forecast 1560. The markets immediate interpretation was that the economy has levelled out and was building a solid foundation which in turn suggested that we may be at the bottom of the interest rate cycle. This translated into a steepening of the yield curve (with the long end of the yield curve rising).
On the domestic front, the RBA continues to take a very pro stimulus approach especially when coming out of a damaging recession. At the same time the RBA is targeting a 3-year bond rate of 0.1% clearly suggesting that rates are to remain on hold for the next 3 years at least. It now appears that the RBA will not adjust rates until actual inflation is within 2-3%. For this to occur wages growth, which has been almost non-existent the last few years, will have to be materially higher if this is to occur. The chart below illustrates just how well contained inflation has been over the past 20 years.
Putting into context low rates and over-valued risk assets, we still find it hard to understand the reluctance of investors to seek out high yielding fixed income products. Despite having a slightly higher risk profile it really comes down to need more than anything else, and when you consider just how negligible term deposit rates are, the case for alternate products remains very convincing.
The chart below is also very relevant as it illustrates the benefits of diversification over the last 90 years, and the importance for investors of having a balanced portfolio. A quick glance at the table below shows that a portfolio of 30% equities and 70% bonds had the greatest average annual return. This is very relevant to the current state of retail portfolios in Australia where the average investor holds a mere 10-15% of assets in fixed income, a statistic we feel will revert to the OECD average of 40% in years to come.