Every Quarter Counts
From the IMF cutting global growth forecasts to central banks withdrawing stimulus to eye-popping inflation figures and the emergence of a new virulent strain of the coronavirus, the December quarter provided plenty of worrying headlines.
Yet investors with diversified exposure to global equity markets still experienced solid returns in that period. Global developed markets delivered a return for the three months of just over 7% in AUD terms and nearly 30% over the year.
The Australian market posted a quarterly return of just over 2%, bringing its full year return to more than 17%. The New Zealand market bucked the global trend, but this followed a decade of consistently positive returns.
Listed real estate was among the top performing sectors, bouncing back from the pandemic-induced slump of 2020 to rise by about 12% for the quarter and 40% for the year. Energy and IT were also strong performers over the year, alongside financials.
Emerging markets lagged developed markets over the quarter and year, with heavyweight China dragging down the overall market as its economy slowed.
While equity markets had another bumper year in 2021, the global bond market had a rare year of negative returns. For the Bloomberg Global Aggregate bond index (hedged to AUD), this in fact was the first negative year since 1994.
Despite the ongoing challenges from the virus, the world economy continued to recover from the initial shock of the pandemic – helped by supportive fiscal and monetary policies and increased vaccination coverage.
However, the sudden recovery in global demand for goods exerted pressure on strained supply chains, which - together with a run-up in energy prices - contributed to an upswing in inflation in many advanced economies.
Market interest rates rose, particularly among longer term bonds. And it was this development, particularly in the first quarter of 2021, that resulted in the negative result for bonds over the year.
Still, the nature of holding a diversified portfolio of stocks and bonds is that certain parts of the portfolio will underperform as other parts outperform. Holding that diversified portfolio historically has been a good way of outpacing inflation.
While there has been much media commentary about stock valuations being “stretched”, not all stocks have the same expected returns. Recent gains have been concentrated in high-relative price growth stocks, particularly in the IT sector, while low relative-price value stocks are not far from historical averages.
Every day, we expect a premium from value over growth stocks, small over large stocks and more profitable over less profitable stocks. But that does mean that these premiums are realised every day. In the December quarter, the value premium was mixed, but was positive over the full year. While the small cap premium was flat over the year, the exclusion of high growth and less profitable stocks was a winning strategy there.
So because these targeted premiums come and go at different times and in different places, it makes sense to stay focused on them, while diversifying broadly and being mindful about implementation.
Likewise, there is a strong case for pursuing a systematic approach to the long-term drivers of return in fixed income – the term and credit premiums – using today’s prices and adopting a bond mix relevant to the goals of each investor.
A new quarter brings a new set of headlines. At time of writing, there is a lot of talk about what central banks will do this year and whether inflation can be contained. The pandemic is a constant source of uncertainty, plus there are geopolitical risks, including the US congressional mid-terms and a general election in Australia.
But trusting in market prices to embed all this news, information and expectations still remains the best approach in pursuing higher expected returns across stocks and bonds, without having to outguess the market.
It’s why every quarter counts.