A year of two halves

Like any good sporting game, this past financial year was a game of two halves, according to managers.

The first part coincided with the COVID-19 pandemic and tumbling markets with Australia falling into a recession, its first in 30 years. But the second, from November onwards, was characterised by the development of a successful vaccine by multiple firms which caused markets to rocket upwards on the good news. 

Alongside this was the rotation from growth stocks into those focused on value, the strongest rotation between the two styles since World War II, and a rotation from short to long duration in bonds.

COVID-19 PANDEMIC AND VACCINE DEVELOPMENT

According to FE Analytics, the ASX 200 was largely flat with returns of 0.08% from 1 July, 2020, to 1 November, 2020, and the country fell into its first recession in 30 years in September. 

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The Reserve Bank of Australia (RBA) also cut rates multiple times, eventually settling on the record low rate of 0.1% in expectation of high unemployment numbers.

However, the development of a successful vaccine by Pfizer and BioNTech in November sparked a shot of growth for markets with the ASX 200 returning 25% from 1 November, 2020, to 30 June, 2021. Over the whole financial year, the ASX 200 returned 27%.

Performance of ASX 200 over one year to 30 June 2021

The Pfizer drug was followed by other vaccines from Moderna, Johnson and Johnson, and AstraZeneca and the share prices of these companies rose, particularly the smaller biotechnology firms. Between 1 November, 2020, to 30 June, 2021, the share price of German biotech BioNTech rose 156%. 

Anthony Gowolenko, portfolio manager at MLC Asset Management, said the performance had been so strong during the past financial year that it had helped long-term numbers.

“It has been a cracking financial year and it smoothed the profile of the two and three-year numbers as well, before that they looked quite dire,” he said.

Shane Oliver, chief economist at AMP Capital, added: “Australian shares were helped by a sharper rebound in the Australian economy, a surge in profits and numerous companies reinstating or increasing their dividends. Of course, this followed a 7.7% loss the previous financial year. 

“Bonds performed poorly as bond yields rose and cash had a near zero return reflecting the near zero cash rate.”

As well as the vaccine, November also saw the culmination of a tumultuous US election between Donald Trump and President Biden. After several nervous days of vote counting, Democratic candidate Joe Biden was crowned victorious which put an end to fears of four more years of Donald Trump in the White House. In the US, the S&P 500 rose 29% over the financial year while the MSCI World index rose 28%.

According to Bank of America (BofA) global fund manager survey, November also saw respondents make their “most bullish” allocations to equities all year while cash sank to pre-COVID levels and technology saw a sell-off.

Looking at ASX 200 sectors, the best-performing sectors over the year were consumer discretionary (44.7%), financials (39.2%) and information technology which returned 37.6% while the worst was utilities which lost 18.6%.

Performance of best and worst sectors versus ASX 200 over one year to 30 June 2021

However, the “trillion-dollar question” during the second half of the year was what the impact would be from rising inflation and whether it would be transitory or permanent. While inflation remained low for now in Australia, it had risen to the highest level since 2008 in the US at 5.4% in June. 

Matt Peron, director of research at Janus Henderson, said: “We continue to believe US inflation will run high for some time but ultimately will not cause the Fed to have to act too aggressively as to bring an abrupt end to the cycle. So, while this may cause the market to consolidate recent gains as market participants take a ‘wait and see’ approach, we think the economy will keep expanding for the foreseeable future and thus the set-up is for continued market gains later this year”.

This had led investors to position themselves in areas of the market which would offer inflation-protection in a high inflation environment and rotate from growth into value equities for the first time in a decade as value stocks and commodities tended to perform better in an inflationary environment. According to BofA, allocations to commodities in February were at the highest level since 2011. 

Gowolenko said: “Inflation and the resurgence of inflationary forces present challenges and yields might go lower so capital is at risk. In the US, they have been able to maintain quantitative easing for several years whereas the RBA is already starting to taper its bond purchases”.

“We believe it is likely to be more transient than permanent – however, ‘transient’ is open to interpretation: are the supply bottlenecks months or longer than that? On balance, we expect higher inflation prints to moderate as the year unfolds,” said John McIlroy, executive director at Crystal Wealth Partners.

NEXT YEAR AHEAD

However, managers were cautious that the next year could be more difficult than the past. This was further complicated by lockdowns across Australia which developed in early July and had an unknown end date, potentially damaging earlier gains. Global returns were also likely to be affected this year by countries, including Australia and emerging markets, which lagged behind in the vaccine rollout.

“For those countries further behind in reaching herd immunity – like Australia – it likely means a continuing reliance on snap lockdowns to keep case numbers down and head off bigger outbreaks that overwhelm the hospital system and send economies backwards,” Oliver said.

“The evidence so far is that snap lockdowns don’t derail the recovery. And global production schedules point to plenty of vaccines being available later this year enabling Australia and other vaccine laggards to proceed down the same path as other advanced countries later this year or early next in terms of avoiding lockdowns.”

From a property prospective, an extended lockdown could have a negative impact on the office market, as many firms had started to return to reduced capacity for many of its workers. The Australian listed property market had returned 28.1% over one year to 30 June, 2021, according to FE Analytics, compared to returns of 19.2% by the global property sector within the Australian Core Strategies universe.

Steven Ralff, managing director at LaSalle Investment Management, said: “It depends on the company – firms will largely move to hybrid working but others will need to be there five days a week. But offices have the longest leases in the industry so that will to have be worked through. 

“The tenant is definitely in the better position than the landlord, there is space up for grabs at flexible prices.

“But we are cautiously optimistic on property, central banks are being as accommodative as they can be, balance sheets are in good shape and the pricing is fair.”

Anthony Doyle, cross-asset specialist at Fidelity, said: “Thematics are being challenged in 2021, it will be very uncertain and will be difficult to analyse as a lot of good news is already priced in. The next six months especially will be difficult. 

“Before lockdown, we were pretty much back to normal but now we are in a different scenario. Maybe the last six months will be as good as it gets.”

Looking at how clients should be positioned for this environment, managers suggested allocations such as being overweight cyclicals, high-quality industrial equities and positions in higher-yielding debt.

“We are overweight cyclicals but not dramatically so, we think they can do well,” Stephen Bruce, senior portfolio manager at Perennial Value Asset Management, said.

“Highly-valued stocks will struggle and so will defensive ones which see a lack of growth, bond yields will put pressure on defensive sectors and very expensive sectors.”
Gowolenko said: “I would allocate to high-quality industrial shares that are exposed to the global economy and have pricing power, those parts of the commodities complex with a low cost of production. They are the ones that can still be profitable and cash generative in an uncertain time”.

McIlroy said: “We’d all be delighted if the market performed as well as it has done over the next year, but in reality, we’d be very fortunate if it did. 

“Ensuring a mix of domestic and international shares and property assets underpin growth returns can offset some more defensive positions, given the difficulty with trying to ‘market time’. With international exposures it is important to diversify what is typically a US large-cap centric position with other regional positions such as emerging markets.

“Having a position in commodities, energy, floating rate securities and higher yielding corporate debt as well can be used to support risk adjusted returns with some core fixed income as ballast. This includes within the mix having some exposure to some assets that can reset their ongoing cash flows to any unexpected inflation outbreak – where costs can be passed onto consumers.”