The investment environment in the first quarter of 2021 was favourable, with the Balanced Growth Investment Option returning 3.15% and the Pension Balanced Growth option returning 3.58%.
Governments and central banks continue to provide considerable support to the global recovery. With the US Democratic Party gaining control of Congress, another stimulus package (worth USD1.9 trillion) was passed in March and the Democrats have recently outlined a USD2.2 trillion infrastructure proposal. Recent data suggests the efforts to reflate the US economy seem to be working. For example, the US unemployment rate has fallen from a peak level of 14.8% in April 2020 to 6.0% in March 2021.
In Australia, the economy grew by 3.1% in the final quarter of 2020, which was faster than expected. Activity in that quarter was only 1.1% below that in the last quarter of 2019. The economic impact of COVID-19 on Australia has been much less than most other countries to date. This mainly reflects the benefits of tighter restrictions that have been used to control the spread of the virus.
With vaccine rollouts well underway in some parts of the developed world, investors are contemplating a path to “normality”. The percentage of the population that has received a first dose of a COVID-19 vaccine is around 50% in the UK and 30% in the US. In Europe and Australia, the progress with vaccination deployment has been slow so far.
The recent US stimulus and vaccines have resulted in investors becoming more confident about the outlook. Reflecting this, money has continued to move out of sectors that benefited from COVID-19 (e.g. technology) into sectors that are more sensitive to improvement in the economy (e.g. energy, financials and industrials).
Greater confidence in the global recovery has resulted in increasing bond yields, with the Diversified Bonds Option returning -3.02% during the quarter (Pension Diversified bonds option returning -3.36%). When the yields of bonds increase, their prices fall. During the first quarter of 2021, rising yields provided a headwind for some equities. This headwind was more pronounced for high growth companies as the current value of their future earnings is more sensitivity to changes in interest rates. As the Innovation and Disruption Investment Option invests in high growth companies, the return from that option (0.08%) (0.48% in the Pension Innovation and Disruption option) was materially lower than that for the International Equities option (5.66%) (Pension International Equities option returned 6.40%).
Our base case involves a continuation of the recovery in global activity, underpinned by a progressive boost from the deployment of vaccines as well as policy support. We expect that economic and earnings growth globally and in Australia will be well above average in 2021, with economies and companies moving closer to their potential operating levels. Equity markets are expected to rise over this period, although at a slower pace than the strong gains experienced since March 2020.
While many measures of equity valuations are high in absolute terms, they are currently supported by low interest rates. Based on their guidance, central banks are expected to increase interest rates much later than is typically the case. While this allows higher equity valuations, it makes equity markets vulnerable to an eventual change in policy. We are monitoring for changes in US Federal Reserve policy very closely, as this central bank can have a large impact on investment markets.
The current key downside risks to our base case view are rising bond yields resulting in falling equity markets and lower effectiveness of vaccines in controlling COVID-19. In terms of upside risk, policy may eventually be too stimulatory for economies that are operating closer to potential, resulting in stronger than expected growth. If central banks do not adjust their forward guidance, this may initially result in strong gains in equities before inflation concerns eventually emerge leading to equity market falls.
Past performance is not a reliable indicator of future performance.