No doubt we’re all thankful to put 2020 behind us and hope for better things in 2021. Which begs the question, is there cause for optimism, given that much of the rest of the world is still struggling with the pandemic? In our view there is!
There will always be some unforeseen event that causes some short-term market volatility but there are some significant drivers of long-term market appreciation. In no particular order, here they are.
Low interest rates
Regular readers of our newsletter will be familiar with our thesis that low interest rates are supportive of increasing asset values. When professional investors value a security or asset they use a technique called Discounted Cash Flow analysis. In simple terms, this means that estimated future cash flows are divided by a discount interest rate. The lower the cash rate is, the lower the discount rate is. And if you recall your high school arithmetic, the lower the value of the denominator, the higher the resultant answer will be.
Of course, the other impact of low interest rates is that money is cheap, thereby increasing the ability of investors to borrow to invest. We’re not alone in thinking that house prices in metro and major regional areas will increase by 5-10% this year.
The new Biden Administration
The new Biden administration has previously indicated a very ambitious spending program (with a big focus on green infrastructure). Now that the Democrats have secured a majority in the Senate this program is reasonably certain to proceed without much modification. This stimulus will have a positive impact on US markets but will most likely have positive flow on benefits to markets around the world, including Australia.
Biden is likely to increase corporate tax rates, which ordinarily might be seen as a dampener on asset valuations, however, this intention has been well flagged and markets have already factored the potential increase into current market pricing.
Post vaccine economic rebound
Although markets around the world recovered steadily after their March lows, the same cannot be said of the underlying economies, which dipped into government induced recession. Now that the vaccine rollout has commenced around the world, economies will begin to recover. The consensus amongst the fund managers we have spoken to this year is that Australian GDP will lift by 4-5% this year. Most years, countries in the developed world would be happy with a 1-2% increase so this needs to be viewed in the context of coming of a low base. Nevertheless, an expanding economy will provide further support to increasing asset prices.
In Australia, much of our economic growth is driven by migration. This tap was turned off in 2020 which should have made our recession much worse, however, in somewhat of a surprise the lack immigrants was at least partially compensated by the unexpected number of Australians wishing to return home. Assuming that vaccine rollouts go to plan, we should see migration numbers start to increase when travel restrictions are eased.
Weight of money
Since December 2019, the amount of money in the Australian economy (as measured by the RBA’s M1 money supply) increased from 1.06 trillion to 1.354 trillion (a thousand billion). That’s a lot of extra cash that needs to find a home. Given the Cash rate is 0.1% and will stay low for the next three years, it’s reasonable to assume that some of that money will be used to purchase higher yielding assets. This increase in demand will support an increase in asset prices. This is known as the “weight of money” argument.