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Economic Update – October 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

Labour markets seemingly improve

– Australian unemployment rate fell to 6.8%, still high but better than expected due in part to JobKeeper

– RBA and government are expected to provide more economic stimulus

– US presidential election may cause elevated volatility in financial markets

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact us.

The Big Picture

Both Australian and US unemployment rates fell markedly in their September data releases. However, the data might not truly reflect job status as government programs are being used to retain employees through these difficult times – and those that have lost jobs have been getting some extra assistance.

It is far too soon to suggest that either economy is really healing and more needs to be done from a policy perspective. The prospect of a new wave of COVID-19 infections could seriously send unemployment rates higher again.

October is likely to be a big month for policy announcements in Australia. The federal budget will be announced on the same day (October 6th) as the RBA board meets to announce any monetary policy changes. Traditionally, the RBA does not act on the same day as a federal budget but these are different times.

The RBA had started September keeping its Official Cash rate on hold but it announced $200bn of ‘cheap money’ it was going to make available to the banks to lend to their customers.

It had previously been thought that the RBA would not cut the Cash rate by another 0.25% points to zero in October. Recently Governor Philip Lowe hinted at a ‘partial cut’ to 0.1% was a possibility. It wasn’t until Westpac’s chief economist, Bill Evans, called for such a cut at the October meeting that markets reacted strongly with our dollar depreciating against the US dollar.

The following day, the government announced that it was relaxing its restrictions on borrower credit checks by banks. The big four bank shares jumped sharply in price on the news and our dollar fell even further.

Our dollar reached a recent low of $US0.5571 earlier in the year before climbing to $US0.7412, largely on US dollar weakness. The double finance announcements took the dollar down to just above $US0.70 in only a matter of days!

It is now time for the government to step up to the plate again and see what it can do to keep the economy alive until a vaccine is available to help life return to normal – albeit a new normal.

As is traditional, the government is leaking thoughts to the media before the budget to test the voters’ reactions. Tax cuts and more stimulus along the lines of JobSeeker and JobKeeper are likely.

During September, our national accounts were released. They showed that the economy contracted by 7.0% in the June quarter. A large negative number had been expected because government shutdowns had forced many businesses to shut down or trade for limited hours and/or under strict social distancing rules.

Because it is important for the government to plug the gap resulting from its public health and safety initiatives, the size of the budget deficit this time around should not be compared to past deficits. Indeed, it is probably better for the government to err on the side of generosity.

Any problems caused by too much stimulus can easily be fixed when the economy is back to strength. However, if insufficient stimulus is provided there could then be widespread defaults on loans to consumers and businesses with serious long-lasting ‘genuine’ consequences.

The Westpac and NAB consumer and business sentiment surveys showed us to be less gloomy than in the previous month, but pessimists still outweigh optimists. However, retails sales climbed 3.2% in the month. House prices slipped 1.8% in the quarter.

We also noted from the national accounts that the household savings ratio jumped to 19.8% (or about twice as high as the high point during this millennium)! People are scared to spend in uncertain times. They need a lead from government.

The US unemployment rate surprised many by falling to 8.4% when 9.8% had been expected. The US Federal Reserve (the “Fed”) is expecting 7.6% at the end of 2020, 5.5% the following year and 4.0% (or full employment) at the end of 2022.

The Fed is less confident about getting the inflation rate back up to 2%, its target rate. It expects 1.2% for this year, 1.7% for next and 2% in 2023. Since the Fed is now targeting ‘average’ inflation, it can and will tolerate actual inflation above 2% for quite some time. This new target is widely interpreted as the Fed not considering hiking rates again until at least 2024! In other words, there is good support for share markets until that time – barring other shocks to the system.

With just over a month to go before the US presidential election, the race is hotting up. Trump has fuelled even more ire from the Democrats by announcing his nomination for the vacancy on the Supreme Court caused by the death of the legendary justice, Ruth Bader Ginsberg.

Since US Supreme Court justices have a position for life, it matters a lot which side of politics gets its nomination to sit on the bench. With big issues such as abortion and gun control always at the fore, the approval or otherwise of Trump’s nominee could spark a particularly divisive election campaign.

Biden has largely been standing on the sidelines as the Democrats hope for Trump to lose the election for them. While Biden was well ahead in the polls a few months ago, the gap is much smaller now and almost non-existent in certain key swing states. A recent Reuters poll had the two candidates polling neck and neck in Florida and Arizona.

From an investment perspective, it seems imprudent to ‘bet’ on which candidate will win and what policies would follow. Rather, we believe in managing the risks associated with the outcome rather than the returns. The elder stateman of academic finance research, Wharton Professor Jeremy Siegel, believes the US share market will do well in 2021 under either candidate. Our current analysis of broker forecasts of earnings supports this view.

Although there is much angst between China and the US over big tech and trade, the China economy is doing okay. Recent auto sales were up 12%, exports were up nearly 10% and retail sales posted their first positive month of 2020.

In Japan, Yoshihide Suga has succeeded Shinzo Abe as prime minister after the latter resigned owing to health issues. Suga has stated that he will endeavour to continue the so-called Abenomics policies so little disruption is anticipated.

The UK is struggling with Brexit and looks like trying to overturn its recent agreement. It is fruitless to try and guess how this will all play out. Although the UK is suffering renewed COVID-19 restrictions, its unemployment rate has only climbed to 4.1% from 3.9%.

In summary, the underlying share markets seem reasonably well supported given very accommodating monetary and fiscal policies in Australia, the US and elsewhere. However, the lack of a vaccine for COVID-19, the ferocity of the political campaign in the US and the continuing US-China confrontation over trade and technology mean that there is every chance of more volatility into November. If the US election results are contested, as they were in Bush vs Gore, the volatility could spill over into 2021. For long-term investors, having a well-balanced portfolio through a period of expected volatility remains a prudent strategy.

Asset Classes

Australian Equities

The ASX 200 ended its five-month rally of positive returns. If we look at that as the market taking a breather after a tremendous run, a small loss in September should not be a material concern. This is particularly so since the S&P 500, the World index and Emerging Markets all suffered a similar fate. All rallies come to an end so a ‘breather’ is better than a correction.

Our analysis indicates the market is slightly cheap compared to its fundamentals, though volatility remains elevated to its longer-term average.

Assuming the Federal Budget and the RBA board meeting on October 6th are both stimulatory for the economy, this may act to temporarily at least buoy the local share market. However, the US market is likely to remain a key driver as the US election draws near. It is rare that our market powers on when the US turns down.

Foreign Equities

The S&P 500 had some stronger days near the end of September but there does seem to be mood of caution among market commentators as they contemplate the looming election.

We do not think the US market is over-priced in a short to medium-term sense but these are not normal times. After five consecutive months of strong gains, September was slightly negative. Future trends depend not only on the long-term fundamentals but also in the shorter term, on the existence or otherwise of a broadly available COVID-19 vaccine.

The announcement of an approved vaccine is getting closer. There are at least nine competing vaccines with trials well advanced. In many cases there are (partially) government-funded stock-piles of vaccines being built. The vaccines will not change from the ones at the start of the trials specified many months ago. It is simply that one or another maybe approved for safe use and the other stock-piles will be destroyed. It will still take some time to vaccinate populations in a broad sense but even targeted vaccinations are expected to provide a boost for share markets.

Bonds and Interest Rates

Although most central banks have had their official rates just about as low as analysts thought they could go, there was a lot of action in September.

The RBA put $200bn of cheap money on offer to banks to help lending to consumers and business in these troubled times. They are expected to do even more at their meeting on October 6th.

The RBA continue to act in attempt to keep 3-year government bonds rates lower than they otherwise would be. The official rate might even go down to 0.1% on budget/RBA board day.

The Fed too has thought outside of the box. It changed its target inflation rate from 2% to ‘an average of 2%’. This is important as an odd 2%-plus read will not force the Fed to act, nor the market to anticipate actions.

But with monetary policy taking new, interesting directions, fiscal policy, while now more actively engaged as a result of COVID-19, is still playing catch up. The seemingly broken US Congress system is struggling to get agreement on the amount and structure of additional stimulus for the US economy. We cannot recall such divisive times.

The Australian government also needs to continue to step up to the plate. It seems likely that it will make amends on budget day. So, while central banks are almost universally independent of government, the central banks have gone first and it’s is up to fiscal policy to play catch up.

Other Assets

Most of the major asset prices (oil, iron ore, copper and the $A) fell by a few percent in September. This is not the stuff of sleepless nights. It feels like an organised pause in asset price inflation.

Regional Review

Austrailia

The August labour force data published last month stated that 111,000 jobs were created with many of them full-time positions. The participation rate, being the percentage of the relevant population in the workforce again rose meaning that the drop in the unemployment rate was meaningful. The latest unemployment rate is 6.8% and it was 7.5% in the previous month!

GDP growth was a dismal 7.0% for the June quarter. Since growth in the previous quarter was negative, the simplistic application of a definition of a recession confirms we experienced our first recession in nearly 30 years. However, the 1990 recession was arguably caused by a very high RBA official cash rate.

Because of the lags in monetary policy taking affect, the resultant recession in 1990 was deep and the unemployment rate soared into double figures. Since this current situation is due to a prudent set of public health initiatives, the impact was felt immediately and is anticipated to be less harmful to our medium-term economic prospects.

China

The China recovery continues. Exports again grew strongly at +9.5% but imports fell by 2.7%. Industrial output was up 5.6% and retails sales grew for the first time in 2020. While the Chinese economy has not reached its former glory in terms of its economic growth rate, it was the first major country to rescind pandemic restrictions and its policies are seemingly working.

The saga of intellectual property rights and social media continues. It is not an easy problem to solve and we expect no major resolutions anytime soon.

The US Congress has still not worked out its next stimulus package but it did pass a bill to avert a government shutdown.

While initial jobless claims and nonfarm jobs creation data have improved, there is still a very long way to go before the US gets back to work fully.

It is not clear that the ‘blue wave’ will sweep Democrats into the majority in the senate and there will likely be similar problems to now of passing bills through congress, regardless of who is elected president.

If the election is again close, as many are predicting, there is an increased chance of the victory being challenged. That would cause prolonged uncertainly possibly into 2021.

Europe

The UK government continues to struggle to resolve the Brexit deal. Fortunately for most of us it will not have a major impact on our investment strategies.

Rest of the World

Japan has now elected its new prime minister, Yoshihide Suga, who has vowed to continue Shinzo Abe’s economic reforms – the so-called three arrows. It is far too early to tell how successful the transition will be.

September Economic Update

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

New highs on Wall Street:

Earnings season in US beats expectations, noting that expectations were lower due to COVID-19
The US market buoyed by large Tech companies still leading the charge
Australian jobs data show some strength but not out of the woods yet

The Big Picture

Wall Street’s second quarter (Q2) earnings reporting season, held mainly in August, provided a stronger result than expected on bottom line i.e. profits. Companies usually set a ‘low bar’ but this quarter’s ‘beat’ was much bigger than normal.

Admittedly, the main strength was in the tech sector – and mega-caps at that – but there were plenty of other good results. The Nasdaq (tech dominated) index made new all-time highs. The broader based S&P 500 also hit new all-time highs in August but the Russell 2000, representing smaller companies, did not fare so well.

Wall Street is on a roll but is it sustainable? Many argue that its success is largely due the Fed’s loose monetary policy. That is certainly true in part but it’s not the whole story.

Low yields on bonds and low rates on cash – which both come from the Fed’s policy stance – mean that equities are about the only place to earn income. However, massive improvements in technology and their impact on companies’ efficiencies are also at work.

That US earnings were largely under-predicted goes to the notion that many analysts’ views on over-valuation were partially misguided.

At home, our first-half company reports have also thrown up many upside surprises but our ASX 200 index has struggled to keep pace with Wall Street. Perhaps if we had a few Amazons, Netflix and Facebooks, things would be different. But we haven’t (yet?)! However, that doesn’t mean we can’t maintain growth in equities – but not necessarily at the same pace as Wall Street.

Our analysis shows us that only now does Wall Street start to look a little bit “toppy” but that does not mean a correction, or worse, is necessarily on the horizon. But it might mean the big short-term gains are behind us. In the long haul, we fully expect decent returns on Wall Street and at home. We do not think it is a time to sell – particularly when capital gains tax is included in the mix – but pausing between market entries with any excess cash, or dollar cost averaging, might be the way to go.

A lot is being talked about sector rotation and portfolio styles. Value portfolios (which are usually characterised by being cheaply priced relative to current earnings) have gone nowhere in recent years.

Growth portfolios (which are usually characterised by low dividends because companies prefer to re-invest earnings within the company rather than distribute them as income to the investors) have done well in recent years.

Apart from the relative performance in the steep market decline last March and the steep ascent since then, growth has beaten value by a country mile. However, our analysis suggests that these two aggregated sectors might be more on level-pegging terms in the year to come.

Diversification means that prudent investors shouldn’t take big bets on any stocks, sectors or styles. But prudent portfolio managers who have the flexibility in their mandates should try to anticipate changes in performance – but glide to a new position rather than lurch.

We think it is fair to say that much of the macroeconomic data has been corrupted by the impact of the sharp – but necessary – virus-related shut-downs and the consequent rush back to re-opening.

However, there have been a number of bright lights among the sea of data deluges. The US has witnessed some particularly positive housing data. China looks resilient. Indeed, the CEO of BHP just stated that ‘China is in a V-shaped recovery and looking good’.

The Fed held its big annual international central bank conference virtually rather than actually this year in Jackson Hole, Wyoming at the end of August. Nobody seemed to expect any big announcements this year. It was only going to be lower rates for longer but Fed Chairman, Jerome Powel, came up with a headline!

The ’old’ target for inflation of 2% was replaced by an ‘average inflation’ target of 2%’. The Fed had already baked in some wiggle room over slight breaches of 2% but this new target gives them even more room such that they could take a marching band with them!

The Fed does not want to stunt economic or market growth with a quick rate move. More importantly, it doesn’t want the market to try to second guess them so they’ve put this extra barrier around themselves.

In a previous meeting the Fed said they were ‘not even thinking about thinking about thinking about raising rates.’ Now they are not even thinking about the previous statement.

We think we can reasonably conclude that the Fed will not upset the apple-cart again – as it did a few years ago when Powell hiked rates and then had to recant.

So, with rates low for a very long time, what should we fear? We think there is no reason to expect a pent-up inflation boom to build in the near term at least. The only big changes in inflation since WWII in the US followed the Korean war in the fifties and the OPEC oil prices hikes in the seventies.

And what if there is a boom in economic growth? We should applaud growth – unless it causes inflation. There seems to be reasonable evidence that low rates promote growth (greater than it would otherwise have been) but the link to inflation is tenuous.

Macroeconomics is an uncertain science at best – even compared to microeconomics and econometrics. The accepted linkage between growth and inflation is the so-called “Phillips curve”. In 1958, Kiwi Bill Phillips published a seminal academic paper on the relationship between unemployment and wages growth. He pushed the idea no further than that! But acolytes took this empirical study to the limits, even though new data did not support such a stable relationship.

In truth, academic economists and central bankers cannot find empirical evidence to support a stable relationship between unemployment and inflation and – by extension – between interest rates and inflation.

There has also been a growing following for Modern Monetary Theory (MMT). It didn’t exist a few years ago but the thesis of its proponents appears to be – grow the budget deficit with no consequences (unless inflation builds up). It’s interesting to note that academics who support this theory also seem to cover their tenure (i.e. a life-time job no matter what) which means that MMT proponents are safe from any come back if they are wrong!

So, where do we stand? We think we need a modicum of common sense when it comes to printing money and creating debt and that we are currently on a sensible path. Growth is building and is close to being sustainable without central banks.

We think it will be many years before any problems arising from Fed action surface – if at all – so we choose to think in terms of investing in a stable medium-term strategy.

Unlike in the US, our unemployment rate has not yet started to fall. But the last published increase was only from 7.4% to 7.5% and 114,700 jobs were created (of which 43,500 were full-time) in July. The participation rate continues to climb reflecting that people from outside the workforce are being encouraged to look for work.

James Bullard, president of the St Louis Fed, recently stated that the US growth for Q3 will likely come in at the biggest ever (largely because of the sharp fall in Q1/Q2) as we argued earlier in the year. If it does come in at around 20% (annualised) as Bullard suggests, that might be a big boost for Trump less than a week before the presidential election. Since most people probably don’t understand all of the important data and statistical issues it could be some ‘fake news’ that works in Trump’s favour!

Asset Classes

Australian Equities

The ASX 200 posted its fifth straight month of capital gains in August. However, our analysis does not suggest that it is significantly overvalued.

The Consumer Discretionary, Property and IT sectors were the strongest of the 11 sectors that make up the broader index during August. The Telco and Utilities sectors posted big capital losses in August.

The earnings reports for the first half of 2020 that have been posted so far have overall been better than many expected but there have been a number of quite poor results. This patchy success stresses the importance of appropriate diversification strategies.

Foreign Equities

The S&P 500 and the Nasdaq indexes broke all-time records on a number of days where new highs were reached during August. The S&P 500, like the ASX 200, posted its fifth consecutive month of gains but its August returns over-shadowed our (Australia’s) performance.

In contrast to our analysis of the ASX 200 we do find some evidence of the US market having run too fast. That does not mean that a correction is imminent, inevitable or even likely. Rather, the index might move sideways for a while until the fundamentals grow to catch up and erode any over-pricing.

There is increasing optimism on Wall Street that earnings in 2021 will be as big as, or even bigger than, those in 2019.

James Bullard, the St Louis Fed president, claims that the US recession only lasted two months and so its impact on earnings is likely much less than many anticipated at the start of the pandemic.

The world and emerging markets indexes have performed largely in line with the S&P 500 since the March lows.

Bonds and Interest Rates

The Fed’s contribution to the annual Jackson Hole meeting of central bankers was more interesting than normal – even if it was a virtual meeting. The Fed made it totally clear that it is not even worth thinking about when rates will go up. Indeed, they have even changed the definition of the inflation target to make the intent even clearer.

They are now targeting “average” inflation meaning that inflation above 2%, the current target, could be tolerated for an indeterminate period of time. Moreover, since the employment target will now focus on low and middle-income people, analysts are taking this to mean there is even more wiggle room for the Fed before it feels the need to raise rates.

The US 10-yr yield rose about 10 bps to around 0.65% and this caused the gap to the 2-yr yield (the so-called yield curve) to steepen.

Australia’s RBA is also ‘on hold’ and likely to be so for a similarly long time.

Other Assets

After some massive volatility in the prices of oil in the first half of 2020, there has been little change in either benchmark Brent or West Texas Intermediate (WTI) oil prices for several months.

The price of gold rose to above $US2,000 but then it retreated. The $A against the US dollar has continued its rise. Analysts are largely attributing this move to the weakness in the US dollar rather than in the strength of ours.

Importantly, iron ore and copper prices gained strength in August – possibly on the renewed strength of the China economy.

Regional Review

Australia

The June labour force data published in July stated that 210,800 new jobs were created but the number of full-time jobs was negative as COVID-19 restrictions changed the nature of business in Australia. In July, another 114,700 new jobs were announced but this time they included 43,500 full-time jobs. Perhaps solid economic recovery is underway. In normal times, only around 40,000 to 50,000 new jobs in a month (with half of that full-time) would be considered a big success.

The unemployment rate did go up one notch (0.1%) to 7.5%. Given that the participation rate – measuring the proportion of the relevant population actually in the workforce – was strongly up, an increase in unemployment from 7.4% to only 7.5% is particularly noteworthy. That is, people not either employed or classified as unemployed in the previous month were optimistic about joining the unemployment queue or got a job straight away.

The NAB and Westpac sentiment indexes painted a gloomy picture and the business indicators were sampled before the re-introduction of restrictions in Victoria. Nevertheless, retail sales were up 2.7% for the month of July.

We do not think the data are strong enough to conclude that the Australia economy has turned the corner and started to recover – but it does look that it might be in the process of recovering!

China

China exports grew at 7.2% in July and were much stronger than expected. The difference was largely explained by an unusual increase in medical supplies, no doubt related to COVID-19.

China auto sales were up 16.4% for the month which was the fourth consecutive month of growth.

The official China manufacturing purchasing managers’ index (PMI) came in as a slight miss at 51.0 – but that was well above the 50 mark that separates expansion from contraction. The services PMI at 55.2 was a big increase on the previous month’s 54.2.

Popular opinion among senior spokespeople for major financial institutions interviewed on business TV channels are calling a strong China recovery. In turn, that recovery has already helped Australia’s resources sector.

The US congress is struggling to find a solution to creating the next virus-related stimulus package. Both sides are in favour of a sizeable package but they cannot agree on how the money should be spent. The people who were getting the $600 supplements have received no more cash since the end of July.

If a solution is not found very soon, there will be no new payments until 2021. It is reasonable to conclude that much of the squabbling is due to politicking before the November election.

Trump was doing very badly in the polls a few months ago but he is coming back strongly – but he still has a long way to go. Democrats might well have fired all of their anti-Trump bullets but the Republicans seem to have some salvos in reserve. With a strong campaign and strong economic data (only because it was so bad before) Trump could make the election close.

It is not for us to take political sides or say which party would be better for the economy. One sage commentator on business TV pointed out that it is foolish to position one’s portfolio on the expectation of a particular candidate winning. Lots of proposed policies get lost after the election or defeated by the opposition. Punting on a candidate’s victory and subsequent policies is not a prudent investment strategy!

Non-farm payrolls were again up strongly in July – this time to 1.8m new jobs against an expectation of 1.6m. The unemployment rate fell from 11.1% to 10.2%.

The Citi surprise index – that measures the proportion of times consensus economic forecasts are beaten by the outcomes – continues to be very high. That is, forecasters in recent months were, in hindsight, far too pessimistic about the US economy.

Core inflation came in at 0.6% for July which is the largest number since 1991. However, as with our most recent CPI reads, there are possible statistical aberrations flowing from the impact of the virus (and the Fed need a lot more evidence of rising inflation to act on this reading anyway!)

Europe

News from Europe has largely been swamped by that from the US and Australia in our investing world. German exports did beat expectations but there were also many negative results – but not to the extent that they will impact in any major way on our market and Wall Street.

Rest of the World

Japan’s Prime Minister, Shinzo Abe, has resigned his office owing to health problems. He had brought stability to government after five years of instability during which five people had taken turns at the helm before his term.

Abe had built a policy, “Abenomics”, with three instruments – known as the three arrows. While it cannot be said that his policies have yet solved the problems of Japan’s economy, his presence on the global stage will no doubt be missed. We wish him well.

Economic Update – August 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The rally in equities continues

– The ASX 200 and S&P 500 both posted four months of positive returns

– COVID vaccines are under development and undergoing trials in many countries, expectations are that they may be available in early 2021

– China economic data are getting back to pre-COVID levels

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact us.

The Big Picture

Equities listed on the ASX 200, Wall Street (S&P 500), the world and emerging markets indices all posted a fourth successive month of positive returns in July – although the ASX 200 gave up much of its July gains on the last day.

The S&P 500 just posted its best July gains in 10 years – an impressive +5.5%. Much of the recent gains on this index can be attributed to the mega-cap tech stocks including Amazon and Facebook. Indeed, if the tech stocks are stripped out of the S&P 500, its performance has only been modest.

Reporting season, when companies reveal their latest balance sheets and outlooks for the future, is well under way in the US for the June quarter. Reporting season is just about to start in Australia for the half year.

There have been some blockbuster corporate earnings reports on Wall Street but also a number of big misses. Success and failure have been roughly aligned with the ‘stay-at-home’ stocks like Amazon and Netflix vs COVID shutdown economies such as Airlines and hospitality stocks. Facebook and other internet companies have largely done very well – as have a number of the drug companies. The obvious suspects for entertainment outside of the home continue to struggle.

With many regions re-introducing opening restrictions on restaurants and bars to counteract the second wave, the global economy will struggle to get back to normal anytime soon. However, there are some bright spots.

China posted a massive 11.5% for June quarter economic growth against an expectation of 9.6%. On an annual basis, the outcome was obviously more modest at 3.2%. China trade data beat expectations on both exports and imports. The purchasing managers indexes (PMI) a measure of input demand, for both manufacturing and services were also strong.

While the US posted a widely expected large negative growth figure for GDP, retail sales are almost back to where they were before the COVID virus spread to the US.

Australia created 210,800 new jobs for the latest month but all of these were part-time. Indeed, full-time jobs actually went backwards. The unemployment rate came in at the expected 7.4%. The Reserve Bank of Australia (RBA) stated that its general economic outlook had been too pessimistic earlier in the year. It still expects unemployment to be 9.3% at the end of 2020 which is well below the peak experienced in the last recession nearly 30 years ago.

Australian inflation was reported to be 1.9% for the latest quarter – the lowest result in over 70 years. However, there were very special circumstances to explain this fall in prices. Childcare had become free for many and oil prices plummeted which created a big fall in petrol prices. Since the price of both of these items will likely ‘return to normal’ in the current quarter, a very large positive inflation figure is likely next time around.

It is important to note that the RBA’s preferred measure of inflation, that removes wild fluctuations in some items, was a much more modest 0.1% for the latest quarter – almost flat.

The European Union (EU) announced a 750 bn euro stimulus package to support COVID-affected people and businesses. The US senate republicans laid out a $1 trillion package for a similar purpose. Given their system of government, the republicans must now negotiate with the democrats before it can become law. This will delay the outcome somewhat.

At home, our government is extending economic support under a modified JobKeeper and JobSeeker scheme. One problem that was identified here and overseas is that some people were financially better off by not working. Law makers are trying to address this issue so that people are incentivised to go back to work.

Interestingly, in Australia a large number of people entered the workforce as unemployed in the latest data. The opposite of this behaviour is often referred to as the ‘discouraged worker effect’ as recessions loom and people give up looking for work. Perhaps we should refer to recent moves in data as an ‘encouraged worker effect’!

Also, on the bright side, at least three companies in the US are building up a stockpile of COVID-19 vaccines in anticipation of their drugs being validated by current clinical trials for approval by the US authorities. A similar situation is occurring in Queensland and the highly publicised Oxford university project.

Usually, clinical trials are completed before production commences because of the risk of wasting money on the production of drugs that turn out to be unsuccessful. The current ‘parallel production processes’ have been made possible by government financing. No corners are being cut in developing vaccines. The stocks of ineffective or bad drugs will be destroyed if and when appropriate.

Therefore, the 12-18 months minimum lead-time for vaccines that we reported on a few months ago has been dramatically reduced by these public-private partnerships. Given the number of different vaccines being developed, we think it is quite reasonable to expect one or more vaccines to be on the market from the end of this year. If that happens, we also expect stocks markets to rally from wherever they are at the time.

In the interim, governments are only seeking partial lockdowns; stockpiles of masks and respirators are being built; and medics are better informed about tracking and treating those so infected. We are hopeful that further success in vaccine trials in conjunction with ongoing government support will see the second half of 2020 faring better economically than the experience of the first half.

Asset Classes

Australian Equities

The ASX 200 had a positive month in July (+0.5%) in spite of losing more than 2% on the last day! Normally companies ‘confess’ in the weeks before the reporting seasons of August and February so that they cannot be accused of misleading investors when adverse figures are expected.

Confession season has been relatively quite this time around as much of the ‘confessions’ were made earlier in the year as the lock-down came into force. Therefore, we do not expect as much short-term volatility from any poor results as we might normally expect. Weaker results have largely been priced in.

Growth stocks, as opposed to value stocks, continue to dominate ASX 200 returns. We think that this momentum will continue at least for a little while.

Foreign Equities

The S&P 500, the world index and emerging markets all performed well in July – for the fourth month in a row. Indeed, July’s +5.5% on the S&P 500 marked the best July result in 10 years! The tech sector continues to dominate Wall Street’s performance and this is likely to continue as most of the big tech companies beat expectations at the end of July.

Interestingly, at just over half way through the year and after a sharp sell-off in March, the S&P 500 index is already close to where the consensus expected the market to finish 2020.

Bonds and Interest Rates

The US Federal Reserve (Fed) concluded its major meeting at the end of July with interest rates on hold and a statement that policy will err on the side of expecting poor results. Markets liked this, and initially rallied. The shorter-term US interest rates are now quite depressed with maturities out to 3 years all about the same, close to zero. However, for 10-year government bonds the yelled is 0.55%.

The RBA was also on hold and stated that, in hindsight, it was too pessimistic about the economy earlier in the year. Rates continue to be expected to be lower for longer.

Other Assets

The major commodities did quite well in July. Gold prices rose to close to $2,000 largely on the back of a weaker US dollar. Copper, iron ore and oil prices firmed which bodes well for the Australian resources sector. The Australian dollar firmed against the US dollar but not against other key currencies such as the UK pound sterling.

Regional Review

Australia

210,800 new jobs were created when ‘only’ 112,500 were expected. All of the new jobs were part-time. Full-time jobs were lost in June. These data points are consistent with restaurants and bars re-opening at less than full-capacity.

93,600 more people were unemployed at the end of June compared to the beginning. This figure is not at odds with the 210,800 jobs created. The participation rate, being the percentage of the population in the workforce, jumped sharply. People are classified as unemployed either if they are employed people who lose their jobs or if they enter the workforce from outside in search of work. This increase in participation from the latter source is considered to be a positive for the economy.

The June quarter inflation figure came in at a more than 70-year low at 1.9%. The trimmed mean, preferred by the RBA because it strips out volatile items was less dramatic at 0.1%. As the price of oil and childcare comes back to previous levels, the next read should be strongly positive but of little concern on its own. December 2020 quarter inflation should be a better indicator of underlying demand.

Victoria has re-imposed strong lock-down restrictions on its residents. Queensland has instituted travel bans from most people outside of that state. Hot spots are emerging in parts of Greater Sydney.

China

China’s PMI for manufacturing came in at 51.1 against an expectation of 50.7 and the services PMI continued to be very strong at 54.2. These data, released at the end of July backed up the recent stronger GDP growth data.

China’s March quarter growth was 6.8% on an annualised basis and this jumped strongly to +3.2% in the June quarter against an expected 2.5%. The quarter-on-quarter growth in June was an impressive 11.5%. Both exports and imports beat expectations. It would appear that China is already coming out of its first quarter slowdown.

US June quarter growth came in at a massive 32.9% but some of this figure is due to a statistical aberration. In the US they calculate the quarter on quarter growth rate and scale it up to an annualised figure (using the compound interest formula). It does not mean that GDP is 32.9% less than it was a year before! Rather, Q2 was approximately -9.5% quarter-on-quarter growth. We fully expect a bounce back in the September quarter.

US Non-farm payrolls data reported 4.8 million new jobs created but that leaves a lot of US people who lost jobs in recent months still on the sidelines. The latest unemployment rate is 11.1% but this rate is less than the previous month’s rate of 13.1%.

Of great importance to us is the latest Citibank surprise index. This bank collates consensus forecasts and outcomes for many important economic data series. The surprise index measures the proportion of times the outcomes were better than the consensus forecasts. The index was close to 100% near the end of July indicating forecasters had been far too pessimistic.

We continue to believe that the US and other countries are coming out of the effect of the lock-down more quickly than many, including ourselves, however, there is a long way to go particularly as hot spots flare up and policy responses react accordingly.

Europe

The European Union has agreed on a 750 bn euro package to compensate members for the impact of COVID restrictions. There was an extensive debate because different member states wanted a bias towards loans over grants or vice versa.

Economic Update – July 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery is happening sooner than we expected!

– End of quarter market volatility might have blurred the underlying strength of markets

– There are strong signs that many investors were too pessimistic a few months ago

– The US Federal Reserve continues to support markets

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.

The Big Picture

The bumper rally in Australian equities starting from the March 23rd 2020 low appears to be pausing as we enter a new financial year. There are many unknowns – not least of which include how the COVID-19 pandemic will playout, and how the November 2020 US presidential election will influence markets.

The financial year just ending (FY20) did produce a moderate negative return of -7.7% for Australian shares even after including dividends being re-invested. But, to put that loss in perspective, it is only the second loss in the 11 financial years since the post-GFC rally started in mid-2009! Moreover, it does not appear to us that the longer run rally will end anytime soon as many central banks are still operating under very loose monetary conditions.

It is very difficult to predict how the COVID-19 pandemic will play out given there are no vaccines or cures yet available – and may not be for another 12 months. There are signs in some regions, and some of the southern US states, that a material second wave is taking hold. Australia has fared comparatively well, however the state of Victoria has placed 30 suburbs of Melbourne back into lockdown due to a rapid increase in localised infections.

Since we now have far more knowledge and available resources than when the virus first struck, we think it is reasonable to assume that authorities will be able to better manage the spread and impact of the virus from here without the almost global shut-down of economies witnessed in the second quarter of 2020.

As restrictions are being relaxed, there are signs that economic recoveries are under way. We argued that the sharp negative growth figures we saw earlier this year – and still in some regions – should not be overly dwelt upon. We take the same measured view about the magnitude of the recovery figures.

In June US retail sales grew by 17.7% for the month and house sales by 16.6%. Australian retail sales grew by 16.3%. And China posted a 6% monthly gain in industrial profits – the first positive results since November! These are, of course, historically very high numbers. Our take-away is not the magnitude of these data points, but the timing. The recovery has started a couple of months before we and most others thought likely. And that is very welcome news indeed.

If the pick-up is faster than most expected, it is no surprise that we infer the market sell-offs into March were likely over-done. Some commentators are saying that the June quarter (Q2) rally was too strong. That is only the case if the over-sold notion is not taken into account. Either way, a strong rally into the end of a quarter (and our financial year) tempts fund managers to lock in some gains for window dressing and tax management purposes.

Until our company reporting season starts in August (and the US second quarter results start soon) we do not have much insight as to what companies really think the future looks like.

It is true that the US has called that their economy went into recession in February of this year. With our 0.3% result for quarter one growth and a likely big negative number for quarter two, we can reasonably conclude that we are in recession too.

However, US and Australia unemployment numbers are lower than one might expect in a ‘normal’ recession. These shut-down induced recessions are very different from the traditional ‘standard’ recession. The IMF has predicted global growth for 2020 to be 4.9% but that needs to be analysed in conjunction with the possible speed of the recovery.

With two new relevant COVID-19 drugs announced from Oxford University in June, some sensible re-opening of economies, and the nascent signs of economic recovery, the future is brighter than most thought only a few months ago. The US Federal Reserve has ramped up monetary stimulus and our government has announced further fiscal stimulus. It is often considered unwise, in a market context at least, to ‘fight the Fed’! i.e. don’t bet against the central banks (US Federal Reserve mainly), such is the strength of their influence that their actions can have a material influence on direction or state of markets.

Asset Classes

Australian Equities

The ASX 200 had a strong June posting a capital gain of +2.5% which was in line with the world market. However, capital gains for the financial year (FY20) were down 10.9% or 7.7% when re-invested dividends are included.

While FY20 was poor for the Australian index, two sectors stood out as very strong pockets of growth. The health sector gains were +25.7% and the IT sector gains were +18.0%.

We judge the market to be modestly under-priced but that call must be considered in the light of company earnings forecasts and outlooks seemingly lagging behind actual events. This situation should become clearer as our August reporting season gets under way.

Foreign Equities

The S&P 500 gains in June slightly lagged behind the ASX 200 with a gain of +1.8%. However, the US Dow Jones Index had the best Q2 since 1987; the S&P 500 had the best Q2 for 22 years; the Nasdaq broke through 10,000 for the first time and recorded gains of 24.4% in the last 12 months (our FY20). Europe posted the best quarterly gains for five years. Of course, Q1 (the March quarter) was very bad for most indexes so Q2 should not be viewed in isolation.

Bonds and Interest Rates

There has been little movement in official rates because they are effectively at the floor (at zero or negative). However, central banks have been trying to influence longer rates with quantitative easing (QE).

From June, the Fed is now able to purchase individual corporate bonds and it is committed to at least $120bn purchases per month of Treasuries and Mortgage Backed Securities until the end of 2022. That is much bigger than the QE during the GFC. It has also stated that the reference rate will not be increased at least until after 2022.

The governor of the Reserve Bank of Australia (RBA) stated that the official rate will be low for years to come.

These actions by central banks make investing in equities more appealing than they otherwise would be. Some call it the equivalent to a ‘put option’ (or floor) on the market. Volatility will still persist but money has to find a home that will pay a yield. Equities currently have the best chance of producing a reasonable income stream out of the standard asset classes.

With global official rates in the short term almost locked into near 0% for the major economies and the middle durations (such as 3-year bonds) heavily influenced by QE, the yield curve looks stable and accommodating.

Other Assets

Although there is still price volatility in commodities, prices are far more stable than they were a month or two ago. There has been increased commitment to controlling the supply of oil helping those prices stay well away from the May lows.

Copper and oil prices had a very strong month in June – and iron ore prices were marginally up.

Regional Review

Austrailia

First quarter GDP growth came in at 0.3% signalling the probable start to (at least) two quarters of negative growth which would be enough to call a ‘recession’ using the simplistic rule of two consecutive quarters of negative growth.

However, it should be stressed that growth over the year was still positive at +1.4%! All is not yet lost.

However, the unemployment rate is still only 7.1% which is well below the levels of previous ‘standard’ recessions. With the economy starting to reopen, unemployment may not worsen much more.

With Prime Minister Morrison launching $1.5bn worth of ‘shovel ready’ infrastructure projects in June, and it seems likely that ‘Job-keeper’ and other such schemes in some form are likely to continue, the government fiscal policy is aimed at supporting economic recovery.

China

China is flexing its muscles over Hong Kong and the US is getting involved. While it might be laudable to come to Hong Kong’s assistance (even trying to bring in Europe) there could be some very bad consequences for trade and global growth should this situation escalate.

Industrial production up +6% bounced back in the latest China data – the first positive since November. Hong Kong re-opened its Disneyland facility – albeit with some restrictions.

Both the manufacturing and services PMIs (Purchasing Managers’ Index) beat expectations. The manufacturing sector expanded for a fourth straight month at 50.9. The services sector PMI was up one point at 54.4 over the previous month.

While the impact of COVID-19 on New York seems to have been managed reasonably well, many of the ‘holiday’ and oil producing states that relaxed restrictions are now experiencing a very strong second wave. There seems to be little appetite for a second lock-down so it is unclear how this situation will pan out.

President Trump has slipped well behind Democratic contender Biden in the early election polls. However, Trump leads in ‘dealing with the economy’ so it is hard to predict who will win the election when ‘the chips are down’. If Biden wins, tax increases are on the agenda to address the widening income and wealth inequalities. However, it is unlikely anyone would try to raise taxes while the economy is so fragile.

Europe

There is little doubt that the fortunes of Europe are not as important as they once were considered to be. The possible fallout from a Grexit or a Brexit are no longer major issues. The UK even seems to be in a position to do a trade deal with Europe in July – well before the December 31st 2020 deadline.

Europe’s economic data has been as bad as elsewhere. But Europe is not as key to US and Australian economic success as it was previously. When Europe looked likely to implode (in around 2001-2013), it mattered a lot more.

Rest of the World

Japan was forced to reconsider the re-opening of its economy. The latest industrial output data was 8.4% for the month. Japan has not yet turned the corner as possibly the US and Australia have economically.

China passed laws to control certain aspects of its security relationship with Hong Kong to take effect from July 1st. The US is unlikely to remain quiet on this point and an adverse trade response is quite possible.

Iran has issued an arrest warrant for President Trump and a large number of other US citizens! It is no more than a political statement and it does not reflect well on Iran.

Economic Update – June 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery continues

Equities continue to climb the wall of what appears to be ‘less worry’
Economies are starting to re-open which is providing further support for equities
Central banks and Governments continue to apply rescue measures as COVID-19 continues to see increased infections dampening social and economic activity.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

We started last month’s update with the thought that the worst could be behind us but that volatility might still spook markets for a while to come. A quick look at key equity markets tells a more positive story for May with the ASX 200 adding 4.2% to the 8.8% gained in April. The S&P 500 added 4.5% to the 12.7% gained in April.

We still think it’s too soon to assume normal reliance on macroeconomic data. We expected the numbers to remain volatile and we were not disappointed.

The big picture we are focusing on is the mood in the markets about re-opening economies. In one month, we have gone from dire predictions of nothing opening to what looks like an orderly opening in Australia, the US and Europe. Yes, there are pockets of confusion but the stock markets seem to have been buoyed by the fact that an orderly return to work is already beginning to happen.

So long as there is one person carrying the virus there is a chance for others to contract it. There is a very high probability of a second wave. The question is – what form will that wave take?

In Australia, the shut-downs seem to have been largely successful. When someone in a newly opened bar or café contracts the disease, quickly responding to those exposed can minimise the spread. If left unchecked we can easily get back to the problem we had a month or so ago.

Of course, the systems and equipment we now have in place are better to deal with a new outbreak. Australians, by and large, appear to be reasonably responsible. Contrast that with the situation in the USA. There seem to be large clusters of vocal groups claiming all sorts of rights regarding employment and social mobility. It does not matter whose philosophy is correct, viruses only react to people close at hand. We would not be surprised if the relaxing of containment measures proves to be premature and a fresh outbreak occurred in the US and it might be big enough to unsettle markets. In light of the recent social unrest the potential for further outbreaks has likely increased. This will weigh on investment decisions.

Governments and central banks are still applying fiscal and monetary support in amounts that should assist to avert a further escalation of the economic impacts of the COVID-19 crisis. However, at the individual level some groups might be relatively disadvantaged.

Going forward, we are naturally keeping an eye on fresh outbreaks of COVID-19, potential vaccines and cures. They are all potential games changers.

Given the speed of the re-opening of Australia and the US we might expect to see some meaningful data on unemployment from July (to be reported from August). Until then our focus is more on intuition as meaningful forward looking data remains scarce. As economic data releases and in particular corporate earnings estimates stabilise, we will again be able to produce a more informed outlook.

Asset Classes

Australian Equities

The ASX 200 posted a strong +4.2% gain over May with a few sectors standing out. IT (+14.5%), Materials (+8.0%), Property (+7.0%), Telcos (+6.0%) and Financials (+4.7%) were the strongest sectors.

Based on the growing belief that we at least appear to have COVID-19 contained, then the market from a relative value sense is somewhat attractive but with ongoing uncertainty volatility will remain elevated.

Foreign Equities

The S&P 500 posted a +4.5% gain in May which followed a +12.7% gain in April. However, the S&P 500 is down ?5.8% on the year-to-date.

Many analysts have been quick to point out that the gains in recent years have been mainly concentrated in about 6 or 7 big tech stocks. Without those stocks, they say Wall Street would have just moved sideways.

Index investors need not overly worry about the concentration of strength in stock returns. Others need to be more careful about how they construct portfolios as COVID-19 and the respective Government and Central Bank responses to it have increased the relative attractiveness of some stocks and in particular, some industry sectors over others.

Bonds and Interest Rates

With most national bond rates close to zero, there is not much room for rates to move. We do not expect any of the major countries will be raising official rates any time soon.

With rates low, investors still have to consider deriving some yield from equities.

Other Assets

April was clouded by wild gyrations in the price of oil. West Texas Intermediate (WTI) prices even went negative mid-month as people got caught with the ending of the May futures contract.

We flagged that a repeat situation might occur in mid-May but no such disruption happened. Indeed, WTI oil prices (the relevant US price) were up 88% over May while Brent (the world price) was up 39.8%.

The OPEC problems and shortage of world demand are still big issues but the issue with the futures contracts seems largely contained for now.

After big changes during May the prices of iron ore, copper and oil finished May close to their intra-month highs. It is important for global stability for these commodity prices to stabilise at reasonable levels. At last, that seems to be happening. The Australian dollar (against the US) also finished May at near the intra-month high.

COVID-19 Review

The chart below is the latest from Johns Hopkins University Coronavirus Resource Centre.

The message is quite clear, the reported cases of COVID-19 continues to rise globally while we here in Australia have fared better than most, if not all. The reporting of COVID-19 cases is now escalating in the emerging economies of Brazil, India, Russia and counties in the middle East. Notwithstanding the US has reported circa 1.8 million cases which is in excess of three times that of Brazil in second place at 514,000.

While we in Australia are beginning to see a relaxing of containment measures, the real challenge is that other countries are also heading down this path. Whilst they have achieved apparent containment (i.e. they have flattened the rate of increase in infections), they are still dealing with many actual cases. Consequently, the risk of a second wave is statistically higher for them. While we hope the relaxing of restrictions more generally is successful and does not lead to a second wave of the virus, it is too early to tell and the situation will remain dynamic, despite the more positive experience we are having in Australia.

Regional Review

Austrailia

Australia’s process of gradually returning to work is becoming politicised after several months of apparent bipartisanship. RBA Governor Philip Lowe highlighted that the September quarter proposed unwinding of Job Keeper and Job seeker payments may be premature. The market appears to be running ahead of the economy at this point.

China

China and the US are at it again but Trump’s end-of-month speech did not bring up the possibility of an escalation of the trade war.

China’s relationship with Hong Kong is still being thrashed out. COVID-19 did little to distract the protagonists.

Pockets of the US economy are aggressively re-opening. We are not filled with confidence that the whole process will go smoothly. US citizens seem fixated on their constitutional rights rather than what might be good for the economy at this point.

Europe

The EU has proposed another $1.2 billion recovery fund to assist member countries to weather the recession resulting from the Covid crisis as virtually all member countries have broken EU deficit limits as they support healthcare and businesses to try and sustain their economies.

Rest of the World

Perhaps by next month, news on the rest of the world will match the importance of news on a global pandemic. For now, we focus on how restrictions are relaxed and how lagging economies will be funded.

Economic Update – May 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery begins?

– Equities bounce back strongly in April as unprecedented fiscal and monetary stimulus applied
– Economies in early stages of starting to re-open as the COVID-19 rates of infection have slowed
– Oil prices face turbulent times and demand falls dramatically absorbing OPEC production cuts

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

After a really tough month for stock markets in March, the bounce back in April gave investors a chance to catch their breath. Of course, it is possible a new low will be formed at some time in the future but the news on COVID-19 is starting to get better.

It was quite rational for markets to have fallen as sharply as they did in March. After all, no one knew the extent of the devastation that the virus would cause. As soon as governments and central banks responded with stimuli, lock-downs and social distancing, markets realised that they had sold off too much.

We think the major markets are still cheap based on reported earnings but volatility and fear are elevated. As a result, the rate of price appreciation going forward over the longer term versus what we think of as fair pricing might be slower than what we experienced in April.

There have been so many stimulus packages and healthcare innovations, it is an impossible task to report all. And new changes are coming through with such speed that any attempted comprehensive report would rapidly be out of date. In the space of a month, global sentiment seems to have gone from doom and gloom in markets to ‘it’s not that bad’ after all.

We think the important take-away is that almost all major countries are rapidly responding to the challenges – unlike in the wake of the GFC in 2008 and 2009. Health authorities and scientists are seemingly working tirelessly to develop vaccines and provide cures. We think we are in safe hands! But Trump did take issue with the World Health Organisation (WHO) over their early responses (or lack thereof) to the onset of the crisis.

There are questions about whether or not people who have experienced a COVID-19 illness can be re-infected. As finance experts, we have nothing to offer on that question but we do take this uncertainty into account.

Many countries have already started to relax the lock-down restrictions – mostly in a phased fashion. It makes sense to respond in this fashion as it would be imprudent to run economies into the ground to ensure, like smallpox, the disease has been eradicated. That means that there will be future waves of infection in much the same way that there are usually weaker aftershocks following an earthquake. Because different regions are loosening restrictions in different ways there is a chance to learn from one another.

All economic data will likely be really bad for many weeks and possibly months – so there is no point in dwelling on them. If we look for a medical analogy, economies are experiencing ‘self-induced comas’ to allow doctors to deal with the patients’ needs in a timely fashion – rather than dealing with a recession-like trauma rapid-fire scenario in the ER.

Another point worth noting for less experienced readers is the bias that most forecasters put into some of their forecasts. It is well known that forecasters often indulge in so-called ‘rational cheating’ to use an academic term. It is often not in the best interests of the forecaster to publish their ‘honest’ best forecast but rather modify it in the light of the consequences of being wrong.

In the current situation, a forecaster who believes economies will be back to normal in short order would be well-advised not to say so. If the economy actually takes a longer time to recover, the optimistic forecaster is likely to be the object of much scorn. If the optimist is right, there are no particular prizes to win. On the other hand, a forecaster who overstates the time for recovery (at least by a little) will lose nothing if, indeed, it takes a long time. If a quick recovery happens, everyone is so happy that they ignore that the forecaster was, in fact, wrong.

With this bias in mind, we suggest that the consensus view for recovery that is published might be biased towards the longer run. Recall all of the eminent economists (including Nobel Laureates) who said, following the GFC, that a depression longer than the Great Depression was likely. How wrong they were – but can you now name them?

The impact of COVID-19 was more than enough for analysts to try and work through during April but oil prices also went into a tail spin! The timing of the two phenomena might be related as it is thought Saudi Arabia has been waiting for the opportunity to run the relatively new US shale-oil producers out of business. What better time is there to attempt such a price war than one in which people were already hurting?

There is always the incentive for independent oil producers to compete for market share – which is why OPEC was formed in 1973. Since Russia and the US are big oil producers that are not OPEC members, price control by OPEC is limited. In an attempt to become self-sufficient in oil, the US has turned to extracting oil from shale as well as oil wells. We ‘passed’ on such ‘fracking’ in Australia.

Shale oil is now such an important component of US production that its output had a depressing impact on global oil prices.

OPEC+ (i.e. including Russia and a few smaller independent players) agreed earlier in April to a material supply cut to start from May 1st. However, the massive lack of demand due to COVID-reduced travel on land, sea and air has made even that cut insufficient to stabilise markets.

The US has a massive underground oil storage facility in the centre of the country (Cushing, Oklahoma). It is nearly full so that there is nowhere for more US oil (known as WTI or West Texas Intermediate) to be stored. As a result, many players had to sell their forward contracts at negative prices to prevent being forced to take delivery! This is a phenomenon that is likely to recur monthly as each forward contract nears expiry (the next is due on May 19).

The global price of oil (known as Brent) has been more stable but it has still been impacted through interdependencies. The Saudis reportedly can withstand these price gyrations for many months if not longer. However, the newer shale-oil producers are less cost effective and the first bankruptcy proceedings have already started.

The oil price war is unlikely to have a major detrimental impact on the market in the longer term but these oil price spikes do seem to cause excess volatility in stock market indexes along the way.
With regard to COVID-19 and oil prices, we believe that the prudent investor who started the year with an appropriately diversified portfolio should probably stick with it. Even experienced fund managers find it difficult to pick the right time to buy and sell. And this suggestion brings us to the opportunity many people are now faced with in super funds as some are able to withdraw up to $20,000.

Super is a wonderful, tax-effective way to save and should be preserved if possible. For many people, $20,000 is a sizeable chunk of their savings. Assuming a balanced rate of return of 7% pa on investments with an inflation rate of 2.5% pa, a 30-year old person due to retire at 67 would be forgoing $244,472 at retirement (or $101,937 adjusted for inflation). Compound interest is a powerful force! Early exit can be massively expensive in the long run for the young.

Of course, some people might have no option but to withdraw the $20,000 or part thereof but it would be wise to look for alternative solutions first and, perhaps, not taking out the maximum amount even if alternatives are not available.

The withdrawal is reportedly more problematic with some industry super funds. The TV adverts often point to the superior returns of industry super funds over retail funds. In making such a comparison and in considering the maximum $20,000 withdrawal, it is important to take into account the reported fact that many industry funds are more heavily invested in ‘unlisted assets’ such as property and infrastructure that are not listed on the stock exchange – some funds reportedly have allocations of up to 40% in such unlisted assets.

The price of, say, CBA shares is priced by the second during the time the stock exchange is open and the stock is not in a trading halt. If any average investor sells all of their CBA stock the impact of the sale on the latest price is minimal. However, if the same investor tried to sell all of their stock in a company outside of the top 300, there could be a material price fall. This price fall in ‘illiquid’ stocks should be considered when considering a sale and it is why many investors should only consider the top 50 or top 100 stocks.

An unlisted asset, such as a large (unlisted) building has no transparent market price. Rather, a valuer infrequently makes a judgement as to what price could be realised. Unlisted assets appear to be less volatile because no one is valuing them often enough to detect the true pricing volatility!

Also, when an investor attempts to sell a part of an unlisted asset there is no ready market of buyers. At any point in time, one can view the ‘order queue’ of what potential buyers and sellers will trade a listed share on the ASX.

If one super fund, industry or otherwise, is heavily invested in one particular unlisted asset and a large number of members want to redeem capital, the potential sale of the unlisted asset could destabilise the value of the fund as the price ultimately realised may be less than the value of the asset reported by the super fund. Given that some industry funds are reportedly as much as 40% invested in unlisted assets, those funds might be forced to sell just their liquid assets instead making the resultant asset allocation even more skewed to the illiquid, unlisted side. We think it is important to take proper financial advice whenever possible concerning such withdrawals.

We hope to be able to paint a clearer picture next month as the dust on COVID-19 settles. The current company reports for quarter one in the US are giving little guidance to the future. Therefore, we must rely on our broader macro view of the longer term as we have presented in this section.

Asset Classes
Australian Equities

The ASX 200 posted a strong gain over April (+8.8%) but this should be considered in conjunction with the ‘bear market’ sized fall in March.

Financials did relatively poorly in April in part due to the NAB trading halt – when they announced a cut in dividends and a dilution of capital through a capital raising. ANZ announced that it will defer its dividend. The other big banks also took capital losses as investors anticipated similar behaviour elsewhere in the sector – as we foreshadowed might happen in last month’s newsletter.
In spite of the oil price war, both the energy and materials sectors – making the combined resources sector – performed very well.

Market volatility has fallen sharply since the March high but it is still nearly double what we might expected in normal times.

Foreign Equities

The S&P 500 performed even better than the Australian market (+12.7%). Other major markets moved more in line with the ASX 200.

The VIX so-called fear gauge remains quite elevated but far below its record highs in March.

Bonds and Interest Rates

Several central banks have committed to continue to support government and corporate bonds. The Bank of Japan (BoJ) went so far as to state that it has an unlimited target of what QE (quantitative easing) it is prepared to use.

The US Federal Reserve (Fed) is also being creative in trying to support bonds of all maturities. At its April meeting it reiterated its plan to keep rates low at least until the economy returns to full employment.

We still expect our rates to be lower for longer and for longer-dated bonds to have a higher yield than the short-dated.

Other Assets

The WTI futures contract price of oil for May delivery even went negative at one point during April but both WTI and Brent prices, while highly volatile, have recovered somewhat.
The Australian dollar has continued to be unusually volatile fluctuating in a range from US60.35c to US65.66c in April.

Iron ore prices have been relatively stable but copper prices rose by 6%.

Regional Review
Australia

The rate of new COVID-19 cases has slowed to a mere trickle in Australia. As a result, governments are starting to relax some of the lock-down restrictions. Since the rules vary by state, and they keep changing within states, there is seemingly much confusion about what is legal and/or wise.

Although new cases are few and far between, there are plenty of people with the virus to infect others as restrictions are relaxed. Undoubtedly there will be future (hopefully much smaller) waves of infection.

The March unemployment rate published in April surprised many as it fell from 5.3% to 5.1%. However, the data are gleaned from a survey conducted in the first two weeks of the month (March) – before the lock-down started.

China

The China economy is starting to gear up again but at a slower pace than many expected. One reason could be the lack of demand and logistics in other countries. For the second month in a row the Purchasing Managers Indexes (PMI) for both manufacturing and services were above 50 – the cut-off between expected expansion and contraction.

Both the US and Australia are in heated discussions with China over how it handled COVID-19 during the early stages.

The weekly initial jobless claims have ramped up sufficiently to make some predict the unemployment rate will exceed 16% at some point. Since many of these unemployed people will be receiving additional benefits, 16% does not mean the same at 16% at some other time. Moreover, there will be many more job vacancies than normal in a recession when restrictions are lifted.

Europe

The UK prime minister, Boris Johnson, was in intensive care with COVID but he is already back in the office. The UK is still aiming for completing the exit from Europe by the December 31st deadline.

Rest of the World

Kim Jung-un, the North Korea premier, has not been sighted for over two weeks and fears for his health abound. As they have an unusual hereditary premiership, and he has no son, the choice of a new leader is, indeed, problematic assuming such transition is required.

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