The ASX 200 total return of 1.4% for 2020 belies a sense of resolute calmness. For 2020 the Blended Australian Equity Portfolio returned 3.61% (+4.46% inclusive of franking credits).
Yet, the year was characterized by almost equally imposing forces of crisis and recovery. The ASX 200 recorded one of the fastest bear markets in history falling 36% over a month, to be followed by a remarkable rally with equity prices rising circa 50%. By the end of the year the Australian bourse was almost back to its previous peak, despite a 15% decline in earnings per share (EPS) and a deeper deterioration of dividends declining ~25%.
The remarkable re-rating in 2020 suggests a V-shaped recovery in profits over the next 12 months. Undoubtedly, the sheer scale of fiscal and central bank support has been effective
in inoculating the economy from the worst ravages of the pandemic. Expectations of a robust recovery in corporate earnings hinges on a return to normal activity after the mass
rollout of Covid-19 vaccinations. Undoubtedly, the global recovery from the pandemic will rely heavily on the successful rollout of vaccines. After an initial wave of optimism late last year, the challenges of implementing a mass rollout have become clearer. A central risk to a recovery is that infections continue to rise, and vaccine distribution is hindered by logistical problems and people’s reluctance to be immunized. So, does 2021 extend equity prices further? Or will high valuations weigh on returns? Much of the answer rests with the scale of the anticipated earnings recovery and the continued support from governments and central banks to feature prominently again in 2021.
Encouragingly, recent economic indicators reflect a V-shaped recovery in profits over the next 12 months. Global manufacturing PMIs have exhibited continued strength into
December reaching a 36-month high, reflecting a broadbased improvement that is taking place with output and new orders remaining close to the cycle-highs.
For 2021, an earnings rebound is critical with valuations sitting well above their long-term average levels. The 12-month forward PE for the ASX 200 is 20 times which compares to its long-term average of ~ 14 times. With Australian government 10-year bond yields at ~1%, equity valuations have been persistently supported at higher levels. These forces explain why equity valuations have been buttressed and why dividends remain an important source of income for yield hungry investors. Nevertheless, we remain vigilant that ongoing accommodative fiscal and monetary policy combined with a sharp increase in corporate profits in 2021 could fuel a rise in bond yields thus weighing on equity valuations.
In anticipation of a recovery in corporate earnings, the December quarter was notable for investors starting to rotate toward stocks more sensitive to a recovery in the economic cycle, with cyclical/value stocks recovering. The portfolio has progressively added to a basket of ‘recovery plays’ including: Ampol (ALD), News Corp (NWS), Qube (QUB), Santos (STO) and Westpac (WBC).