NEWS ARTICLES

Investor Update
Jun 4th, 2021
THE COVID RECOVERY

Through a combination of social distancing, more effective treatment, and vaccines, we find the number of new COVID-19 cases has been declining around the world. Of course, there are some notable exceptions like India where the virus continues to ravage communities and is currently responsible for more than 3500 deaths every day. Other exceptions include Argentina, Iran and, Iraq where the number of new COVID-19 cases continues to rise.

While the stories of the pandemic in these more affected locations are heart-wrenching, the impact on the Australian economy, and global financial markets, has been limited for the time being. More important for Australia is the containment of the virus in economies like the US, UK, China and, New Zealand. In the US and UK we find the inoculation programs are well progressed and populations are on the verge of herd immunity. In China, there has been almost 300m vaccines administered but there is also much less incidence of the virus. Meanwhile, in New Zealand we find just 4% of the population has received at least one dose of the vaccine. Still, the domestic economy has been recovering strongly with the help extraordinary stimulus measures and containment of the virus.Relative to the rest of the world, Australia has so far had a ‘good-pandemic’. The early closure of borders and the draconian measures taken during outbreaks have been jarring, but have served the community well. There are virtually no locally transmitted cases in Australia.

However, early success in dealing with the virus could have delayed our governments haste in preparing for the vaccine roll-out which has stalled. When compared to say the US, Australia was too slow in ensuring doses of the vaccines and have taken a too narrow a focus in which vaccines to use. Previously we expected herd immunity in Australian to be achieved in the September quarter. Now this could be too ambitious and early 2022 could be more likely.

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A BOOMING GLOBAL RECOVERY…IN PARTS

In aggregate, the global economy appears to be booming. However, the strong headline growth mask a mix of momentum around the world. Economic activity in both China and US has recovered to above pre-pandemic levels. China surpassed this level in 2020 and the US in 1Q21. In both economic superpowers the recovery has been fueled by uber accommodative policy and control of the virus. The growth in the US economy has been focused in consumption. Households, flush with savings built up during the pandemic and handouts from the government, are spending at a ferocious rate. This includes spending on houses and housing products.

While China and the US are leading the world recovery, Continental Europe is lagging. The euro-zone region has endured a double dip recession — that is four quarters of GDP contraction in the last five — and has been weighed down by a slow vaccine roll-out. The virus has also compounded structural impediments to European growth which includes a financial system which has not really recovered from the financial crisis 10-years ago and, weak population growth.

INFLATION FEARS ARE OVER-DONE

Recent consumer price inflation readings have been strong in some economies, but we do not think it will be the start of a sustained period of high inflation. Some of the recent surprises in consumer prices have come from components which we think are either unlikely to repeat or poised to reverse. For now, it appears to be base-effects and bottlenecks driving prices higher but these are unlikely to be sustained. There remain structural headwinds to inflation and these include an aging population, globalisation and technology.

An older population is an especially powerful headwind for prices. Older people are not retiring as early as they once did and instead remaining in the workforce. This has been to detriment of the promotion prospects and wage increases of younger people. The current rise in consumer prices will prove to be fleeting, in our view.

STRONGER RECOVERY IN AUSTRALIA
The economic recovery in Australia has been considerably stronger than policy makers previously forecast and will be enough, in our view, to begin to wean the economy off crisis period stimulus efforts. While the RBA’s current backward focus on the labor market and consumer price inflation will mean it is unlikely to raise cash rates for some time, it will more likely back away from other crisis-era measures like term funding and quantitative easing. The term funding facility, where the central bank provides the banks with cheap funding, is set to end in June and we expect quantitative easing to stop in September. Meanwhile, the RBA has made it clear that policy rates will not rise until inflation is sustainably within its 2-3% band. For this to happen the central bank believes wage inflation needs to be materially higher than current levels of 1.4%. The Aussie dollar has rallied hard since March 2020. Supporting the gain has been the 230% increase in the iron ore price driven by excess liquidity conditions in China, and weak supply of the commodity from Brazil. Supportive conditions for the commodity are now reversing. We know Chinese money supply growth is slowing and will continue to do so. Meanwhile, Brazilian iron ore exports are now recovering. We expect weaker commodity prices in the medium term will be a moderate headwind for the currency.
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SIDEWAYS EQUITY MARKETS FOR NOW

While the current bull market remains in its early stages, when compared to the 22 others in Australia over the last 100 years, we expect a period of consolidation in stock indices ahead. Checking our bullishness is a combination of unwinding policy support, equity valuations back to fair and, a level of complacency forming in equity markets. Investors should also expect bond yields to rise further and this will be a moderate headwind for stock markets. We stick to our view that the ASX 200 will finish the year at 7000. We expect sideways markets during the months ahead.

Within the market we continue our tilt to value stocks. These companies generally trade on lower valuation multiples and we expect rising bond yields and discount rates will not be major impediment here. We also remain over exposed to companies expected to benefit as economies continue to reopen after the pandemic. In Australia this includes Qantas, Ramsay Healthcare, REA, Downer, SkyCity Entertainment and United Malt.

The banks have been an area we have avoided and we have preferred to gain our ‘COVID-recovery’ exposure in other areas. While the banks have been a good trade, we think they will make poor investments. The companies remain over exposed to housing finance and Australian households continue to be some of the most financially leveraged in the world. High financial leverage should impinge on loan growth which we think will remain anemic. Instead of the banks, income seeking investors should consider companies like Macquarie Group and Amcor where the dividend yield is sold and set to grow sustainably from current levels.

US EQUITIES TO CONSOLIDATE

US equities are more vulnerable in a world of rising bond yields, in our view. The US equity market is the most highly valued major market on Cyclically Adjusted PE of 40x (vs 21x for Australia) and may also be most susceptible when discount rates rise. There is a period of
consolidation ahead for global equities and the US market could struggle to outperform. To mitigate the risks, US focused investors should tilt towards cheaper companies and/or those which enjoy strong EPS momentum. The mega-cap technology stocks are awesome cash machines that continue to grow so the dangers here are perhaps more moderate than less proven business models.

METHODOLOGY & DISCLOSURES

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GENERAL DISCLAIMER
INFORMATION

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DISTRIBUTION

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ACCESS & USE

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OTHER IMPORTANT DISCLOSURES

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