We continue to expect equity markets to remain well supported following this period of consolidation, helped by good in-flows and strong earnings growth.

 

US data was mostly robust, with strong gains in personal spending, new home sales, house prices and durable goods orders, and a rise in consumer confidence and a fall in initial jobless claims.

 

Bond yields are the current key issue. The bond sell-off is material in a historical context. The spike in bond yields is providing an increasing challenge for central banks, including the RBA. Rising bond yields are normal in an economic recovery as investors move away from defensive assets and anticipate stronger nominal growth. This has been accentuated by recent good news on coronavirus combined with the ongoing boost provided by policy stimulus (with more on the way in the US) and anticipation of a short-term spike in inflation due to base effects, higher energy prices, etc. The problem for central banks like the RBA is that they have seen this all before and worry that without a much tighter labour market and faster wages growth then the anticipated near-term pick-up in inflation will not be sustained, and so they will continue to undershoot their inflation goals if they raise rates too early or end bond buying prematurely. In other words, central banks worry that the bond market may be jumping at shadows, at least in part and if they follow bond markets into premature tightening they will be too!  At this stage we see the Fed and RBA sitting tight.

 

We saw a bigger move in Australian bonds than US. This has taken our yield curve to its steepest in more than 20 years. The RBA increased Quantitative Easing to hold the 3-year yield. This worked, but also reinforced concerns about the 10-year yield.

 

We have seen a concerted effort by central banks to ease concerns in response to these moves.  The issue for countries outside the US is that they are seeing the rise in yields, but do not have the same degree of stimulus as the US. Therefore, the rise in rates is a negative for any recovery.

 

In the near term the current extreme positioning in terms of bond shorts, coupled with Fed jawboning, could see a relief rally in bonds which would support a rotation back to growth.

 

Beyond this, we think the trend in US 10-year yields towards 2% will remain in pace. The Fed’s aim is not to drive yields down from here, but to make sure the increase is gradual and orderly.

 

A continued accelerated surge in yields would be an issue for equity markets. But we believe the underlying data will allow the Fed to maintain its current approach, rather than being forced into a dramatic U-turn.

 

Shares remain at risk of a further short-term correction after having run up so hard in recent months with the back up in bond yields possibly being a trigger. But looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and still low interest rates augurs well for growth assets generally in 2021.

 

We are likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns - like US shares, technology and health care stocks and bonds - to investments that will benefit from recovery - like resources, industrials, tourism stocks and financials.

 

Australian home prices are likely to rise another 5% to 10% this year and next being boosted by record low mortgage rates, government home buyer incentives and the recovery in the jobs market but the stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney. Outer suburbs, houses, smaller cities and regional areas will see relatively stronger gains in 2021.

 

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.