Good news – All Aon Kiwisaver Scheme funds have recouped their losses incurred during the February/March Covid related share market turmoil, producing strong positive returns for the calendar year.
A strong recovery in NZX shares, following the lead of global shares, drove returns. Notable was the initial share rally after the lockdown, alongside bond yield falls (which generates capital gains for investors) as the RBNZ lowered the cash rate and implemented aggressive actions to manage NZ bond market liquidity.
The last quarter of 2020 saw global shares achieving new highs, as the efficacy of the first vaccines became known and northern hemisphere vaccination roll-out plans were put into motion. However, longer maturity government bond yields started to track back upward with the belief that vaccinations can support the fragile economic recovery, alongside the prospect of government stimulus expansion, notably for the US.
Source: FactSet, Period 31/12/2019 to 12/2/2021
Key Reserve banks around the world implemented very supportive monetary policies in 2020 and reduced interest rates – with New Zealand rates at their lowest ever level of 0.25% at present. For part of 2020 it seemed possible that the RBNZ could move its cash rate negative, although the market views this possibility as much more remote now.
One implication of Reserve banks’ supportive monetary policies is the risk of future inflation (a general increase in prices of goods). This risk has helped longer maturity bond yields (such as 10-year government bonds) creep back up because investors have an expectation that future interest rates may rise. Nevertheless, interest rates are expected to be very low for a very long time which is a challenge for conservative investors seeking a reasonable level of income from bonds.
Global share returns were focused on technology
The recovering investment environment created winners and losers with a very wide spread of returns. Growth companies that focused on disruptive technology performed strongly, while old economy businesses, particularly financial services performed less well. As the largest companies in the world are predominantly focused on technology, global shares rose even though the laggard firms were numerous.
Source: FactSet, December 2020. Depicts the MSCI World Index and certain MSCI World sector indices in A$
How did these trends and events affect returns?
As noted before, full year returns for the Aon Kiwisaver Scheme multi-asset funds were strong, particularly for strategies having a high exposure to growth assets. Cash fund returns have remained positive but future results will reflect the current low interest environment. As a guide the two Aon KiwiSaver Scheme cash funds provided a 0.0% return in the month of December 2020. The performance of the funds shown net of tax and fees can be viewed here.
Outlook in 2021
For the moment the global economy continues to recover, although the pace has slowed. Unemployment rates have been lower than anticipated and the degree of government response seems to have been a key factor, and seemingly a decisive difference in this recovery compared to previous crises.
We see the roll-out of an effective set of Covid-19 vaccines as essential to drive a bullish global economic recovery narrative for 2021. Encouragingly, Bloomberg reports more than 172 million doses have been administered at a rate of 5.92 million doses per day globally (as at 13/2/2021). While both New Zealand and Australia are yet to start their vaccination programs, they may catch up quickly due to efficiency lessons already learnt overseas and their relatively small populations.
Note: Vaccinating roughly 70% to 85% of a country’s population would enable a return to normalcy, according to top U.S. infectious disease doctor Anthony Fauci. Current vaccines require two doses for full protection. Source and data: Bloomberg’s Covid-19 Vaccine Tracker.
Economists with a positive outlook believe that the 2021 global recovery should be strong as the pent-up demand from consumers unable or afraid to spend in 2020 is released. As examples, US and German household savings ratios are currently at 16% and 15% respectively, 2-3 times the pre-Covid-19 levels. In our view these savings levels add support to the bull case.
Whilst we agree the consumer in the large western economies are well placed to spend, we think the government stimulus and policy environment that arrested the losses, and started the recovery rally, in late March must continue. The key policy of low cash rates and bond yields are vital to maintaining confidence, which will allow government borrowing to remain affordable. We expect that this path will continue even if inflation starts to seep in.
Markets have a more challenging, although still positive, story. Even though economic activity remains way below year-ago levels and corporate profits in developed countries have declined 15% or more during the 2020 calendar year, global share prices are up strongly, and above previous peaks in many markets, including the US. Corporate bonds are expensive again compared to government bonds (at 2019 levels) even though defaults are higher now. If we are lucky, stimulus and vaccines will allow markets to sustain these levels, providing time for the economy to catch up.
We believe the risk is low that government stimulus will be withdrawn prematurely. Thus, we do not expect large share market falls to materialise. In our view, a more likely scenario is too much stimulus is applied, leading to inflation and eventually price risks for assets such as shares which tend to be supported when bonds yields are low. This could mean challenges arrive for the most expensive shares, in areas which have seen huge growth during the recovery rally, such as technology names and the consumer discretionary sector.