Article written by George Carter, Nikko AM – 2020

At first glance, the performance of financial markets during November was exactly what you may expect when there’s an announcement of a successful vaccine during a global pandemic – namely, that equity markets soared, bond returns were anaemic, the price of gold fell whilst oil prices lifted and “risk-on” currencies (such as the NZ dollar) appreciated.  It is arguably therefore no surprise that the NX50 index was up nearly 6%, and that appears quite modest with the double digit returns on a number of global stock market indices.  The French market was a notable high performer with the CAC40 up more than 20%, but that still wasn’t enough to turn the 12 month return positive with the market still being 7% lower than it was 12 months ago.  This highlights the divergence between different markets over the past year where the US S&P500 is up 15% over the past 12 months, and at the bottom of the table is the UK FTSE 100 (down nearly 15% since December 2019).

The surprising aspect of this is that following the COVID sell-off in equity markets in March this year, one of the main reasons that equities have performed so strongly is that bond yields have been manhandled ever lower by central banks.  During November we saw bond yields stay largely flat (although they did rise in NZ for other reasons) which means that equity markets lifted on the prospect of an economic uplift.  In other words, equity markets rose from April-September on the back of falling bond yields and then rose in November on the back of improving economic data.  The consequence of this is that financial markets are increasingly dependent on interest rates staying low to support current valuations, and with huge Government debt burdens needing to be financed for many years to come, most commentators are predicting that central banks have effectively no choice but to keep yields suppressed, and hence we see markets looking through this risk of interest rate increases.

As yields will almost certainly be forced to stay low for a considerable period, returns from portfolios will be much lower than they have been, and in portfolios more weighted towards cash and bonds, it is likely that returns won’t keep up with inflation, and so their role in portfolios is increasingly about managing volatility rather than providing income.  So with both bonds and equities exposed to the risk that yields rise earlier or more quickly than expected, it becomes increasingly important to have non-traditional sources of return in portfolios, and hence we remain highly supportive of our allocation to alternatives in the diversified portfolios.