Friday, 15 January 2021

Will the 2020s be a 'lost' decade for equities like the 1970s?

Having recently switched our superannuation asset allocation back to our long term strategy of being 100% in 'growth' assets (via the Vanguard High Growth fund), I am of course now worried about the prospect of poor market returns, and the lack of a viable asset to 'rotate' into as a viable alternative. An article in the SMH described how any increases in interest rates by the US Federal Reserve in 2021 and beyond to combat possible inflation could pop the US equity bubble. Our Vanguard investment is about 60% International (mostly US) : 40% Australian equity exposure, so a bear market in US equities would impact our retirement savings considerably. And while there seems little immediate prospect of high inflation or increasing rates by the Australia Reserve Bank for next few years, the Australian share market tends to reflect movements in the US market most of the time.

The strength of the share markets during 2021 was a bit of a surprise in light of the economic impact of Covid-19, but can be explained by the higher p/e ratios being justified in comparison to drops in the 'risk free rate'. But as economies start to recover in 2021 and beyond, central banks will look to move back towards more 'normal' interest rates. Increasing interest rates would induce equity market 'corrections' to more normal p/e ratios even while company profitability may be on the rise. And increasing interest rates would drive up bond yields, which in turn will reduce bond values. So both equity and bond markets could experience poor capital growth over the coming decade.

And while cash rates are close to zero, shifting asset allocation back into cash isn't particularly attractive (our V2 'high interest' savings account is only paying 0.42% interest). An increase in the central bank rates from 0.25% to 1.5% might be a six-fold increase in interest rates, but that is still a poor rate of return (especially if inflation moves back towards the desired 1.5-2.0% target band).

So investors could see poor total returns from stocks, bonds and fixed interest during the 2020s. I can't see any obvious asset reallocation, so perhaps we'll just stick with the High Growth fund and see how things pan out.

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