Welcome to our Spring edition of On the Marc. In this edition, we will review the markets for the first quarter of the new financial year and consider the outlook into the foreseeable future.
Market update
Australian data has been mainly positive. Business conditions and confidence improved in September, according to the NAB business survey. On the employment front, job advertising rose again in September. The unemployment figure is currently 6.9% which is well below the 10% figure forecast in March. One disappointment was the surprisingly weakened trade surplus in August due to a fall in exports due to a sharp drop in gold exports.
Housing finance commitments surged another 12.5% in August, with owner-occupiers and investors seeing substantial increases and an 18% rise in finance for first home buyers. The surge in housing finance partly reflects the catch up to the low processing of loans in April and May, but is also being driven by record-low rates and various incentive schemes and is occurring before the watering down of responsible lending rules. The surge in housing finance taken in isolation points to a potential rise in house prices. Working against this, though are a likely increase in distressed sales (as bank payment holidays and various income support measures end) and the vast reduction in underlying demand flowing from the collapse in immigration.
The Reserve Bank of Australia’s (RBA) latest Financial Stability Review noted that the Australian financial system can withstand the downturn and support the recovery, but that “business failures will rise substantially” as loan deferrals and income support end. While the finances of most households are faring well “the number of households in financial stress has increased and will increase further.”
The RBA left the cash rate on hold at its October meeting. It did however, strongly hint for further easing to come by noting that it “continues to consider how further monetary measures could support jobs as the economy opens up further.” Our base case remains that the RBA will cut the cash rate, the Term Funding Facility rate and the three-year bond yield target to 0.1% and will likely do this at its November meeting after it has updated its forecasts.
Over the next six months, it is likely the RBA will be moving towards inflation average targeting and therefore tweaking its forward guidance to say that it won’t raise the cash rate until full employment is reached and inflation is well into the 2-3% target band. We also see it adopting a more traditional quantitative easing program and extending bond-buying beyond the three-year bond. In a nutshell, what this means is the RBA are comfortable for asset prices to grow at levels where they would have tried to dampen by increasing interest rates. This means the level of debt as a percentage of asset prices reduces. For example, a home has a $500,000 mortgage and is the property’s value is $1m (a loan to value ratio of 50%). House prices increase by 2.5% a year for two years and are now worth $1.05m. Ignoring any reduction in the loan, the new loan to value ratio is 47.6%.
Interesting to compare the global Covid stimulus responses across countries/central banks, particularly as the northern hemisphere deals with a second wave. If Canada was removed from the following chart, the RBA would look very aggressive!
Major global economic events and implications
US data was mixed, with a decline in job openings and flat initial jobless claims, but an ongoing decline in continuing jobless claims and an unexpected rise in the services conditions ISM index to a strong 57.8. Meanwhile, the minutes from the Fed’s last meeting hinted that it may be heading towards firmer guidance in relation to its Quantitative Easing (QE) program. Ramped up QE would likely be necessary if there is no agreement on further stimulus in the US.
European Central Bank (ECB) President Lagarde highlighted the shakiness of the recovery and reiterated that the ECB is prepared to use all tools to support growth. Looks like more easing coming.
The UK warned that it would quit Brexit talks unless a clear deal is in sight next week. There is far less at stake in this for the EU, for which only 5-10% of its exports go to the UK and which has become more united through the coronavirus crisis than the UK, for which nearly 50% of its exports go to the EU.
Japanese wages continued to fall in August and household spending remained weak, but the Economy Watchers survey for September showed a continuing recovery in household and corporate conditions.
Market returns for major indices
Below is a table showing the percentage returns of the major market indices to 30th September 2020.
Source: Bloomberg
The outlook for the year ahead
Shares remain vulnerable to further short-term volatility given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. On a 6 to 12-month view; however, shares are expected to see good total returns helped by a pick-up in economic activity and stimulus.
Low starting point yields are likely to result in low returns from bonds (fixed interest products) once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield. Still, the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
Australian home prices at present are being protected by income support measures and bank payment holidays, but higher unemployment, a stop to immigration and rent holidays will likely push prices down by another 5% into next year. Melbourne is particularly at risk on this front, as its Stage 4 lockdown has pushed more businesses and households to the brink.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25% which is likely to be heading lower in November.
Although the Australian Dollar is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and US/China tensions, it is likely to continue rising to around $US0.80 in 2021 supported by rising commodity prices and a cyclical decline in the US Dollar.
Despite the better than expected earnings season in Australia, we’re still to learn what ‘COVID normal’ will look like and how that might impact businesses, large and small. This is why sticking to an investment approach that’s underpinned by a disciplined, active and value-based methodology is important.
Did you know?
Given the increasing likelihood of a Biden victory in the upcoming US elections below are some of the potential consequences of that outcome:
Higher taxes over time, which would be negative for markets
More aggressive fiscal stimulus, which would support cyclical parts of the market
Acceleration of environmental spending, which likely supports renewables but would be negative for the oil sector
Regulatory oversight of Wall Street, which would be negative for investment banks
Regulation of ‘big pharma’
Potential regulation of large tech.
Final reMarc
Globally, the pace of economic recovery from COVID-19 is uneven, with the US tracking at the optimistic end-of-expectations but economies such as the UK are lagging behind forecasts. Here in Australia, the impact of the virus differs greatly depending on the suburb/region and each state/territory’s restrictions. This uncertain environment makes the future opaque.
What we do know is the huge stimulus by governments and central banks is very accommodating for the economy to continue to recover, and this should result in rising asset values.
Economic growth in the US has returned at a quicker-than-expected rate partly as a result of less-stringent lockdowns helping to boost the near-term economic outlook. Longer-term, US economic growth won’t return to pre-COVID levels until the end of 2021. The US remains the largest single-country economy in the world, so it is a key piece of the work economy.
There are signs international trade is picking-up after the lows of May and June with China as a stand-out in global trade. China’s export position has benefited from its dominance in the global production for COVID-related products such as protective gear, pharmaceuticals and office equipment.
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Warren Buffet
Key Facts & Figures
Australian Cash Rate remains at the record low of 0.25% with no change since being reduced twice in March.
Interest rates are poised to reduce from current record low level in November (Melbourne Cup Day) when the RBA next meet.
Our annualised inflation rate is -0.3%. This remains well below the RBA’s target band of 2-3%.
Australia’s unemployment rate sits at 6.9%.
In the US, the Federal Reserve is keeping rates at the record low range between 0% and 0.25%.