Welcome to our Spring edition of On the Marc. In this edition, we will review markets for the first quarter of the 2021 financial year and consider the outlook into the foreseeable future.

Market update 

The world share market index provided a positive return over the September quarter as did the Australian share market. The month of September saw declines as there are some concerns pushing shares around at present. There have been signs of relief in relation to some of them.

The main areas causing uncertainty include:

• The US debt ceiling has been pushed back into early December – this follows an offer by Senate minority leader McConnell. The move shows McConnell does not want a default, but this just means the issue will come up again in December (along with the need to fund the Government) and Republican’s still don’t plan to vote for it as that will be seen as signing up to the Democrats spending boost. This means the Democrats will still have to do it on their own (which they don’t really want to do) via the budget reconciliation process for which they now have plenty of time to do so or with regular legislation if they suspend the ability for Republican’s to filibuster which moderate Democrats are against.

• The Biden Administration’s $550 billion infrastructure spending and $3.5 trillion Build Back Better spending packages – following intervention by President Biden progress on these has been delayed a month or so but it still looks likely that to get moderate Democrat support, the Build Back Better package will have to be cut from $3.5 trillion to around $1.5-$2 trillion. While the debt ceiling delay has taken some of the pressure off the Democrats, tensions between moderate and progressive Democrats are escalating which is slowing progress.

• US tax hikes – the share market is not focussed on these but will as they come into view. But again, to get moderate Democrat support they will be scaled back.

• Fed Chair Powell’s renomination – the Fed’s trading controversies have damaged Powell, but it’s either going to be Powell or someone more dovish who runs the Fed.

• The energy crisis in Europe & China – is adding to supply bottlenecks and stagflation pressures. The good news is that Russian President Putin has offered to increase gas supply to Europe (where prices have risen six-fold since earlier this year) although it may come with some strings attached Likewise, there are some signs China is easing restrictions on coal and electricity supply.

• China Evergrande is yet to be resolved and other developers are having problems – but the Chinese Government appears to be stepping up efforts to limit the fallout and protect healthy developers, home buyers and the property market (but maybe not global bondholders).

• Supply constraints and rising bond yields – this is perhaps the biggest issue. As the world goes back to work and consumer spending rotates away from goods back to services then the bottlenecks should start to resolve but this is taking longer than expected risking higher and more entrenched inflation and hence higher bond yields. Too rapid a rise in bond yields can create problems for shares if earnings struggle to keep up.

It is likely we will see the above issues all largely resolved in a way that does not severely threaten global growth and so with global monetary policy likely to remain relatively easy for some time we continue to see the broader trend in shares remaining up.

The RBA’s Financial Stability Review highlights rising systemic risks around rapid growth in home lending as APRA kicks off macroprudential tightening to cool it down, with more likely on the way. The RBA reiterated concerns about rising growth in household debt, the likelihood that it will accelerate further and the rise in loans with high debt to income ratios. All of which is consistent with APRA’s directive to banks to increase the interest rate buffer used to assess how much borrowers can borrow from 2.5% to 3%, which means that with an interest rate of 2.7% borrowers will need to be able to service the loan even if rates rise to 5.7%, up from 5.2%.

By reducing the amount that can be borrowed may help slow housing credit growth, but the impact is likely to be modest at around a 5% reduction for a typical borrower. The move adds a headwind to house price growth along with worsening affordability, reduced government incentives, a likely rise in fixed mortgage rates and rising listings but is unlikely to be enough to push prices down. Given we had already allowed for macro-prudential tightening AMP’s Shane Oliver is expecting average home price growth to slow to 7% next year from 21% this year.

Coronavirus update - the news on coronavirus is mostly good. New global coronavirus cases are trending down with most regions flat or falling. This includes the US, although Europe is edging up again.

Vaccination rates are continuing to rise, albeit slowly. 48% of people globally and 72% in developed countries have now had at least one dose of vaccine.

The Australian Economic Activity Tracker remains up from its August low and is likely to move higher in the weeks ahead as NSW, the ACT and Victoria gradually reopen. However, given the likelihood of high coronavirus numbers through the reopening and only the vaccinated being able to initially participate, this recovery will likely be more gradual at first than was the case after last year’s lockdowns. The US and European Economic Activity Trackers are stalled, which possibly suggests a loss of momentum in their recovery.

Partly reflecting rising energy (notably gas) prices Eurozone producer price inflation rose to 13.4% year on year in August and German industrial production fell sharply partly reflecting supply constraints. ECB President Lagarde noted the ECB “should not overreact to supply shortages or rising energy prices…[as] monetary policy cannot directly affect these.”

As widely expected, the Reserve Bank of New Zealand became the third developed country central bank to raise rates (after Norway & South Korea) with hawkish commentary suggesting more ahead.

Market returns for major indices

Below is a table showing the percentage returns of the major market indices to 30th September 2021.

The outlook for the year ahead 

Shares remain vulnerable to short-term volatility with possible triggers being coronavirus, global supply constraints & the inflation scare, less dovish central banks, US spending and tax plans and the slowing Chinese economy. But looking through the short-term noise, the combination of improving global growth and earnings, vaccines ultimately allowing a more sustained reopening and still low-interest rates augurs well for shares over the next 12 months.

Expect the rising trend in bond yields to continue as it becomes clear the global recovery is continuing resulting in capital losses and poor returns from bonds over the next 12 months.

Unlisted commercial property may still see some weakness in retail and office returns but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.

Australian home prices look likely to rise by around 21% this year before slowing to around 7% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as poor affordability impacts, government home buyer incentives are cut back, listings return to more normal levels, fixed mortgage rates rise, macro-prudential tightening slows lending and immigration remains down relative to normal.

Cash and bank deposits will continue to provide poor returns, given the ultra-low cash rate of 0.1%.

Although the Australian Dollar could pull back further in response to the latest threats to global and Australian growth and weak iron ore prices, a rising trend is likely over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar. Shane Oliver from AMP Capital forecasts the Australian Dollar to head to around US$0.80.

Did you know?

It is hard to imagine but history shows the largest companies in the world don’t stay at the top for long. The table below shows the top ten companies by market capitalisation for each decade since 1980. The biggest companies rarely remain in the top 10 in the following decade.

Final reMarc

The outlook is overall positive but needless to say there will be volatility (as there always is) in financial markets. We have witnessed an incredibly strong recovery since April last year and while we do expect continued positive outcomes they will not be as strong as those in the past 12 months.

 The headwinds facing global share markets into the foreseeable future are:

• Coronavirus keeps coming back

• China tensions

• Economic recovery will be slower going forward

• There is a short-term spike in inflation

 The positives providing a tailwind are:

• Vaccines are preventing serious illness allowing reopening to continue

• Monetary and fiscal policy remains ultra-easy

• Low rates make shares cheap

• The US is quieter under Biden

• Massive US fiscal stimulus + new Cold War could be a boost to productivity in the short term

• Earnings expectations are still being revised up.

“Worldly wisdom teaches us that it’s better for reputation to fail conventionally than to succeed unconventionally.”

John Maynard Keynes

Key Facts & Figures

1. Australian Cash Rate remains at the record low of 0.10%.

2. The RBA Cash Rate is poised to remain at present levels until 2024 however money markets are pricing in an earlier rate rise.

3. Our annualised inflation rate is 3.8%. This is above the RBA’s target band of 2 - 3% however expected to be temporarily high.

4. Australia’s unemployment rate sits at 4.5%.

5. The Federal Reserve keeps rates at the record low range between 0% and 0.25% in the US.