If you were to draw a straight line between where equity markets started the year and where they ended, it would appear that risk markets had a reasonable year of low-ish returns. This is a truly remarkable outcome given the market capitulation in March and the uncertainty surrounding the future state of the global economy.

The unusual part of the current rally is the magnitude of the earnings growth expectations and the very high market valuation, leading to speculation of an equities bubble. Whilst valuations on an absolute basis have risen above long-term averages, relative valuations (i.e., compared to expected returns on other assets) indicate that equities are closer to fair value – see figure below.

With interest rates likely to remain lower for a lot longer, investors will be willing to pay more for the yields provided by risk assets leading to sustained higher average valuations.

We believe that policy settings will support good returns in 2021, however, we are somewhat more cautious as we enter 2022 and onwards. For the year ahead, we see four key themes that are likely to support risk markets by reducing the downside risks that would lead to a double dip recession:

1. Supportive Fiscal and Monetary Policy
   The appetite of policy makers (and voters) to pursue austerity measures, “a la” the post–GFC recovery, is negligible. Having invested heavily to avoid the worst of the recession there is now a vested interest to ensure a fast recover (and return to pre COVID growth rates and employment levels).

2. Strong Household Balance Sheet
   Government handouts combined with limited opportunities for discretionary spending and low mortgage rates has increased the savings rate in most developed economies. We expect a proportion will continue to be retained for caution, but a good portion to be spent, which would be positive for economic growth.

3. Inflation to Remain Subdued
   Most central banks have indicated they will allow inflation to run above trend before increasing interest rates, meaning the next rate rise will be years away. Accelerating growth underpinned by public spending and interest rate suppression is a potent combination for risk assets.

4. Cyclical Rotation
   The planned spending on infrastructure projects and strong household finances will all support higher demand for durable goods in 2021. This will accentuate a rotation away from non-secular growth stocks towards cyclical good manufacturers, which are best placed to benefit from fiscally-driven reflation.

Read more about our Equity Outlook, in our 2021 Equity Investment Strategy Guide

Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.

For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.