What's driving the current market rally and will it continue?

What’s driving the current market rally and will it continue?

The COVID-19 health crisis continues to cause immeasurable human tragedy and suffering with virus numbers remaining stubbornly high. Thankfully, improved testing and treatment and better protection for the most vulnerable means that the death rate for developed countries is well down when compared to the peak of the outbreak earlier this year.

While the virus persists, with a devastating impact on society and economies, recent data shows that there are signs of recovery and we may be starting to emerge from one of the deepest, but also one of the shortest, recessions of the last century.

In November both the Australian (ASX 300) and US (S&P 500) markets both rose over 10%, a standout performance particularly when considering how challenged markets have been during the year to date. What’s driving this rally?

There are four key factors at play:

• A lift in economic data
  In Europe the services sector has softened on the back of additional lockdowns, but manufacturing appears to be holding steady. In contrast, the US, which has more limited COVD-19 restrictions is bearing up across both the manufacturing and services sectors. In China, the news remains solid with forward looking economic indicators strengthening and the recovery broadening. Australia is emerging strongly from the Victorian lock down with very few COVID-19 cases and strong policy support driving a solid recovery.
  
  We consider that some areas of the economy will continue to fare better than others. The reinstatement of lockdown measures to control the virus spread may have ramifications for economic growth in the remainder of 2020 and into 2021, but markets seem to be looking through these possible dips for now.

• Positive vaccine news
  The conclusion of successful vaccine trials for both Pfizer-BioNTech and Moderna are mixed, although positive, and signs for AstraZeneca has seen the UK approve a vaccine (Pfizer-BioNTech) and rollout has already commenced starting with key groups such as healthcare workers and the elderly. Subject to approval, we expect the US to start a vaccine rollout very shortly. The Australian government has secured 134.8 million doses of the AstraZeneca vaccine and is on track to obtain the initial lot of vaccines in the first half of next year.
  
  There’s no doubt that the vaccine reports have provided a tremendous boost to markets, however it’s likely that this news has now largely been built into the expected earnings forecasts for 2021, which are what ultimately drive markets going ahead.

• Biden gridlock
  Markets were boosted by the outcome of a Biden presidency and the prospect of a gridlocked Congress where the Democrat program of tax hikes and regulatory measures will likely be constrained. Biden’s nomination of Janet Yellen to be Treasury Secretary was also seen as encouraging.
  
  We think that Biden may also be a more conciliatory and steadier President, particularly on the trade and foreign policy issues that have bothered markets under Trump’s presidency, so we expect this to be a positive for markets going ahead.

• Unprecedented levels of fiscal and monetary support
  In contrast to the hesitant response to the Global Financial Crisis (GFC), policy makers and central banks have responded swiftly to the pandemic recession with very large stimulus packages.
  
  In October, the Australian Federal Budget delivered a raft of spending and tax cut measures, designed to grow businesses and create jobs. This has been backed up by central bank support with the Reserve Bank of Australia (RBA) cutting the cash rate to an all-time low of 0.10% and the announcement of $100 billion in spending designed to keep longer rates lower. It's a similar story in the US with stimulus spending now at an extraordinary 14% of GDP and interest rates set at the 0.00 – 0.25% range. This has seen expectations of new housing construction in the US go to record highs, which is good news for the US economy, and along with China, is typically the ‘engine room’ that drives the world economy.
  
  We expect that ultra-low interest rates should continue to provide meaningful support to share markets.

What’s the 2021 outlook?

While the outlook has improved, markets have already largely built in a lot of improvement. Until vaccines are significantly rolled out, we may see markets vulnerable to resurgences in uncertainty.

Although the earnings outlook is brighter, low bond yields may persist for some time as central banks are emphasising getting rather than pre-emptively fighting inflation. This will act to prolong the recovery with jobs, rather than a lift in inflation, likely to be the main focus of central banks for some time.

The stand-off between the US and China will likely continue although it may be less overtly confrontational under the Biden Administration. Closer to home, relations between China and Australia appear to be worsening. In November shiploads of coal imports were held up in Chinese ports and huge tariffs placed on Australian wine imports. This could see Australia’s export trade suffer.

Key considerations

While it’s clear that the worst of the initial decline in economic growth is now passing, it’s still an uncertain time and markets do remain vulnerable to setbacks on the COVID-19 vaccine roll out. Seeing the balance of your superannuation/investment balance go up and down can be unnerving but it’s worth remembering that superannuation is generally a longer-term investment with time in the market much more important than shorter-term swings in sentiment.

Expert guidance can support you to navigate through this increasingly challenging market environment. Speak to your financial adviser if you’d like some support with your financial strategy.

Dan Farmer
Chief Investment Officer

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