The first week in November had a very different feel this year for most Victorians. In the past, the excitement of the Melbourne Cup long weekend meant a big weekend of plans and socialising with family and friends. The first week in November 2020 was less about the social happenings and more about what was happening in politics and financial markets.
So why is the first week in November so important?
The November Reserve Bank Board (RBA) meeting provides our central bank with the last genuine opportunity to influence the broader economy with interest rate changes before the Christmas break. The big show in town is the fact that once every four years it also the week of the US Presidential election. In 2020, the week was particularly noteworthy, with the following outcomes:
What is the impact this time around?
Following a period of weakening in equity markets and rising global bond yields over October, the above events appeared to have reset markets with equities rallying again and bond yields shifting lower. Expectations are that interest rates will have to remain low for an extended period due to the continuation of the COVID crisis, combined with the new US administration more limited in its ability to add substantial fiscal stimulus. Central banks now appear primarily focused on restoring employment and economic growth. Domestically, this sentiment was highlighted by the RBA’s latest policy announcement.
In equity markets, the extension of the period of low interest rates and COVID related restrictions has a somewhat disparate effect. Companies with above average earnings growth prospects tend to benefit the most from low interest rates as there is less “penalty” for the time delay applied in the valuation of future earnings that skewed to future years. In addition, although some businesses are clearly negatively impacted by lockdowns and broader implications of COVID, others have thrived and using the events of 2020 to change business models or accelerate changes that were already in train.
Information technology (IT) is a high growth sector and sits at the intersection of the positive influence from low interest rates as well as the business model changes caused by COVID. IT has led most major markets higher over recent years, particularly in the US where it is the largest sector and has appreciated by 23% per annum over the past three years – dwarfing the overall US share market increase of 10% per annum.
Potential risks to the groundhog day scenario
The current scenario reads as constrained economic growth, low interest rates, and disparate sharemarket growth where specific sectors such as IT and healthcare are the big winners. Sound familiar? I could forgive you for thinking you are reading news from 2018-2019, as the events of the past week are delivering a groundhog day vibe from the past few years. Having said that, there some risks to the continuation of this scenario:
Where to from here?
So while financial markets have in the short term had a positive reaction to the events of the past week, the base case assumed by markets is far from guaranteed. With local cash rates now virtually zero, investors will be seduced into following the momentum of markets and shift portfolios to those investment categories and styles that have performed better in the past. <<insert rant that last years winners are often not this years winners, and following the herd is a recipe for frustration>>. However, given the heightened valuations of some of these investments and the potential for the broader economic scenario to shift rapidly, investors should consider diversifying well beyond “yesterday’s winners” to build a robust strategy for the years ahead.
In short, the fundamentals of good investing remain in play. If you are unsure how your portfolio might be impacted, or if a change needs to be made then get in touch via email@example.com
Pete is the co-founder and oversees the investment committee for Pekada. He is a qualified financial planner with 14 years of experience. Based in Melbourne, Pete is on a mission to help everyday Australians achieve financial independence and the lifestyle they dream of. Pete has been featured in Australian Financial Review, Money Magazine, Super Guide, Domain, American Express and Nest Egg.