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Economic Update January 2021

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

Recovery continues but short-term uncertainty taints 2021 prospects

  • COVID-19 vaccines rolling out but slower than anticipated – a more contagious strain emerges
  • China trade dispute with Australia showing no signs of easing
  • Brexit deal clinched finally and on terms favourable to the UK

The Big Picture

When we try to look back through the events of 2020, it is hard to see back through to the beginning of the year without getting caught up in the impact of the pandemic. On reviewing our monthly update reports we can get a clearer view about what we and others were writing about throughout the year – and not coloured by opinions as they evolved over time.

Twelve months ago, the big news was that the anticipated China Phase I trade deal might end the tariff war with the US and the prospective impeachment of Trump. Of course, at home we also had massive bushfires and floods to deal with.

In our March issue we noted that COVID-19 had not yet been classed as a pandemic and that the World Health Organization (WHO) proclaimed that the virus was ‘flu-like and would only have a mild impact on most people’.

Come the run-up to the November US presidential elections everyone seemed to believe that they knew back in January what they would have or should have done. Everything is easy in hindsight.

Many countries tried different approaches to containing the virus with very different outcomes. There were no real winners but Australia and New Zealand didn’t fare too badly by comparison.

With vaccines starting to be rolled out in the UK, US, Europe and soon Australia, health authorities can start to get on top of the virus. However, there are likely to be a number of hiccups along the way. We think the markets were a bit too optimistic in the last two months of 2020 given the potential downside risks.

Not all of the vaccines have proven to be effective and some clinical trials were contaminated with miscommunications about dosages. Of course, there are major distribution issues to be dealt with. And we cannot ignore the irresponsible attitudes of some groups of people in Australia and overseas.

In addition to the virus, the China-US trade spat dissipated leaving China’s ire directed at Australia. With very little explanation, China has been refusing significant imports of coal, lobsters, wine, beer, barley, timber, etc. If this situation continues and/or escalates, there will be a significant impact on Australia’s trade balance, with potential consequences for economic growth.

It is too early to tell what impact Christmas and New Year’s celebrations will have on future restrictions to combat the spread of the virus. Our quarter three (Q3) economic growth came in at a solid 3.3% p.a. after the two negative quarters of growth. We could easily slip back into negative growth in the first half of 2021 as the reintroduction of measures such as lockdowns to contain the virus if people are not vigilant in practicing COVID safe behaviours such as mask wearing and social distancing.

Macro-economic data for Australia, the US and China largely finished the year quite strongly but the job is far from done. A new more infectious variant of COVID-19 was identified in London and the surrounding south east of the country. That brought about a fresh lockdown in that region. There are reports of this and other new strains appearing in other countries including Australia. What is not yet known is whether the vaccines will deal with the new strains as effectively as they apparently deal with the original virus.

On top of the uncertainty due to new strains developing, we do not yet know if those who have been vaccinated can still pass on the virus to others. Also, it is not known how long immunity from the virus will last after vaccination. Spokespeople are seemingly confident in their media releases but what else can they say? There is yet no data.

Our research points to markets remaining generally positive in the medium term but we cannot rule out a dip in share markets in the first part of 2021. This assessment is based more on share markets potentially getting ahead of themselves when supported by the ongoing and strongly accommodative monetary and fiscal policy plus the roll out of the vaccines to treat COVID-19.

The Georgia run-off senate elections on January 5th will have a big impact on who will really govern the US for the next period. The initial results announced this morning resulted in a win for both democrat candidates and, in effect handing control to the Democrats as Vice President Harris having the casting vote in Senate now composed of 50 seats to both the Republicans and the Democrats. This result is expected to initially buoy markets as impediments to stimulus spending under a Biden administration are largely removed.

But 2020 did end with one very good piece of news. The UK reached a trade deal with the EU which rules out tariffs and quotas. There has been no reported large-scale migration of the London finance sector to Europe. For the last four and a half years many were predicting a disaster for Britain. It has had a very bad year because of the virus but the longer-run future is now looking somewhat brighter.

In its negotiations with the EU Britain got most of what it wanted. The only real disappointment was EU access to UK fishing resources. The EU’s share will be scaled back over the next five years from a 50% share now to 25%.

Our outlook for 2021 remains largely positive subject to some speed bumps along the way. Vaccines may well eliminate or significantly reduce the main threat of infection by the end of 2021. Some businesses and jobs may have been lost forever but there is also a pent-up demand for certain goods and services that can be satiated in part by rising confidence in the household sector as they drawdown on their increased household savings accumulated over 2020.

Asset Classes
Australian Equities

The ASX 200, not including dividends, finished down  1.2% over 2020 but that statistic doesn’t tell the full story. The index was up +7% to its peak in February 2020, but then plummeted  37% to its March low – and then rose +45% into the end of the year. If we look at the sectors over the whole of 2020, about half were up and half were down. But, at the extremes, the IT sector was up 56% and the Energy sector was down by  30%. It was easy for stock pickers to get on the wrong side. And that’s why prudent investors try to diversify their risks.

We had the market precariously over-priced at the February peak and massively under-priced in March. We believe that the market was over-sold in March because nobody really knew how bad or how long the shutdown would be. So, sell now and ask questions later was the plan for many investors.

We had the market quite over-priced again in December for the opposite reason. Investors were ‘relieved’ that vaccines were at last going to be available and scrambled to get back in for fear of missing out. We have broker forecasts of dividends and earnings pointing to a strong twelve months’ capital gain. But, with the market slightly over-priced by our measures and certain headwinds possibly in the future, caution should, as always, be exercised.

International Equities 

The S&P 500, the Japanese Nikkei, Emerging markets and the world index all posted double digit growth in 2020. Of the other indexes we follow, the German DAX was flat and Britain’s FTSE was down 14%.

The S&P 500 was quicker out of the blocks than the ASX 200 in 2020 posting +15% to our +7% to the February peak. But this index fell a little further than ours at  40% compared to our  37% in March. However, it climbed much better to the end of the year at +67% to the ASX’s +45%.

Many analysts are saying that it is hard to work out what, or by how much, stocks are over-priced when bonds have close to a zero return. We agree, but we are less inclined to brush the problem under the carpet. We prefer to hold a more conservative view that the US market is a bit over-priced.

Much of 2020s gains on Wall Street were due to the growth in big tech companies. At the best of times, these companies are hard to price. We remember the dotcom boom and bust. However, it is a new age and we must take on some additional risk to stay with the trade.

The Yahoo Finance website lists the forecasts of a dozen respected houses for the end-of-year S&P 500 index. The median is 4,150 with the low and the high forecasts being 3,800 and 4,400. Our forecast is between this median and the high value. The end-of-year close for the index was 3,742 making the median forecast being 10%.

Bonds and Interest Rates

The US Federal Reserve cut its ‘Fed funds rate’ three time during 2019 down to a range of 1.50% to 1.75%. At the beginning of 2020 the Fed was predicting one 0.25% hike in 2020 and another in 2021. Instead, it effectively did six cuts in March 2020 down to a zero rate. Further QE (quantitative easing) took place throughout 2020 and it is predicted to continue.

The Fed has repeatedly stated that rates are lower for longer. Not only do they and market participants now expect no hikes in 2021, they do not expect any in the following year.

The Reserve Bank of Australia’s (RBA) overnight cash rate started 2020 at 0.75% and it cut to a ‘creative’ 0.1%. It has been trading bonds to keep the three-year rate at about 0.1% and longer rates lower than they otherwise would have been.

Central banks in the US, Australia and most other countries have done about all they can to help their flagging economies from grinding to a halt. Since the ‘recession’ was wilfully created by public health measures to stop the spread of the virus, it was left to governments (as is their role in such situations) to expand fiscal policy for more economic stimulus.

The US government launched a massive aid programme earlier in the year but it dragged its feet in keeping that initiative going. Eventually, Trump signed a bill for around $900bn of coronavirus aid just after Christmas. The Democrat-led lower house then sought to increase one-off payments in the bill from $600 to $2,000. So far, the Senate has rejected that plan, despite support from President Trump.

The Australian government was far more proactive in providing aid. Various programs such as JobKeeper and JobSeeker have helped those in most financial need. However, these programs are being scaled back as the economy recovers.

We start 2021 with central banks left with little wiggle room on interest rate settings but governments remain willing to create a mountain of debt to prevent economic disaster. Australia is now looking at a one trillion-dollar government debt in 2021.

With interest rates near zero, the debt is less of an issue but steps must be taken to address the problem as soon as the economy improves.

Other Assets 

There were major movements in commodity prices over 2020. The price of iron ore was up about 75%; oil prices were down around 20% to 25%; the prices of copper and gold were each up around 25%.
The Australian dollar (against the US dollar) started the year at 70 cents, plummeted to 56 cents in March and finished the year having gone above 77 cents.

It should be stressed that some of the recent apparent strength in our dollar has been due to the weakness in the US dollar rather than an inherent strength in Australia. If China continues to intensify its trade war with us, our dollar could start to retreat.

Volatility on Wall Street, as measured by the VIX ‘fear’ index, started the year at an average level of 14 but climbed to 82 at the worst of the pandemic crisis. It finished the year moderately above average at 23.

Regional Review
Australia

Australia was unable to avoid a recession using the simplistic definition of two consecutive quarters of negative economic growth. This policy-induced recession was the price of maintaining public health standards. The economy bounced back sharply in Q3 with a growth of 3.3% in just one quarter but that left GDP still 4% below where it was in the last quarter of 2019.

Unemployment was unexpectedly quite resilient in 2020. It was 5.1% in December 2019 and rose to a peak of 7.5% in July and finished the year at 6.8%. The RBA had predicted the unemployment rate would finish 2020 at 9.3%. It, like many other agencies, admitted that, in hindsight, they were far too pessimistic at the height of the pandemic fallout in March. Of course, the cap on the unemployment rate must at least in part be due to the government’s action with jobs programs.

It is too early to tell how big any ‘new waves’ of virus outbreaks will be – following Christmas and New Year celebrations. The federal health minister has predicted 80% of Australians can be vaccinated by October 2021 – with health workers and aged care residents being at the head of the queue.

We think it is quite possible we will see modest or negative economic growth in 2020 Q4 and/or 2021 Q1. But, providing the government keeps doing what it has been doing, the impact on the population will be largely contained. However, the fly in the ointment is China.

For at least two months, China has been refusing imports of various Australian exports: coal, lobsters, wine, barley, timber, etc. Although some vague environmental reasons have been given, these actions are widely interpreted as payback for Australia’s stance against China on its handling of the coronavirus and our close ties with the US.

If the China-Australia trade spat is not resolved – or, indeed, if it escalates – the chance of negative economic growth in Australia increases.

It is for the reasons of possible fresh lockdowns and trade wars that we are pencilling in a possible temporary downturn in the ASX 200 in the first half of 2021 despite our positive forecasts for the longer term. We think it is too hard to try and trade through any market volatility. If one’s investment strategy was appropriate for the longer term before any major volatility begins then riding the waves is the prudent way to go if one believes the long-run is indeed solid.

China 

China was first into the pandemic and arguably the first out. Because of its style of government, it was better able to control lockdowns and fiscal stimulus. In recent months its economic data were consistently strong.

China weathered the trade war with the US. Big tariffs are still in place with much of its trade with the US. It is not clear what Biden will do, if anything, come his inauguration on January 20th.

China certainly turned its attention to Australia later in 2020. Given its size, Australia is a smaller target than the US and it is seen as a close ally to it.

At first, refusing entry of lobsters and some shiploads of coal seemed a bit random. But the list keeps growing without resolving any of the former issues. Since there seem to be no clear guidelines on what will happen going forward, owners of the exports do not know what to do with their cargoes and the shipowners have their capital languishing around Chinese ports. It is a brave (or is it foolish?) person who predicts what China may or may not do.

US

Although the US presidential election result was called some time ago, Trump has not yet publicly accepted defeat. Nevertheless, Biden will be sworn in as president on January 20th. And now, winning both of the Georgia Senate seats has handed control of the Senate and the Congress to the Democrats in turn empowering the Biden administration to govern without the frustration of having to deal with a Republican controlled Senate.

Different US states can have different voting rules. Georgia is not a first-past-the-post state so it must hold a fresh election after no candidate reached 50% of the vote in November. (They do not have preferential voting as we do in Australia)

It is also unusual for two seats to be up for election at the same time. The second seat came into play because a sitting senator resigned before the election and so a temporary senator was sworn in.

US economic data picked up strongly in Q3 but renewed lockdowns of varying intensities lead some to predict negative growth in coming quarters.

Biden is committed to a variety of tax increases (income, company and capital gains) but the fragile nature of the US economy could soften his agenda.

Because Trump delayed in signing the latest COVID relief package, millions of Americans will have gaps in their welfare payments. Many will now get only a $600 relief cheque compared to $1,200 in 2020 and the $2,000 wanted by many for 2021.

No doubt the US will muddle through managing its economy but we do not see the new government moving swiftly through its agenda. Despite now having the balance of power in Congress the majority is slim and there are factions to deal with within both parties – as there are in our governments.

Europe 

Boris Johnson and his team of negotiators pulled a rabbit out of the hat on Christmas Eve. Brexit negotiations which seemed to go nowhere for four and a half years suddenly came to fruition and both sides claim to be winners!

Britain got what it wanted on trade, regulation, competition policy and the movement of labour. They did have to give ground on access to British waters. The deal allows for Europe to have a 50:50 share of fish trawled in 2021 falling to a 25% share in five and a half years.

What is surprising is that the side that was pro-Europe in the referendum and thereafter were calling for all sorts of mayhem including a mass exodus from London’s financial centre. Clearly that is now seen to have been a massive miscalculation.

But Europe has imposed strong travel bans on flights from the UK because of the new strain of the virus. Because there will effectively be free trade between the UK and Europe, and certain drains on UK resources to Europe will cease or be limited, UK growth may recover strongly from its disastrous growth in 2020. However, the transition will not be quick.

Rest of the World 

While vaccines are being rolled out in some of the wealthier economies, it is not yet clear how developing countries will be allocated vaccine supplies. In order to insulate the world from further outbreaks, all countries need access to appropriate healthcare.

Economic Update – December 2020

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

Will COVID-19 vaccines and treatments deliver?

– Peer-reviewed clinical trial data for COVID-19 vaccines not yet published
– Lots of very strong growth data around the world for quarter three as it anticipates a rebound

– Similarly, Australian labour force data are strong pointing to a positive start to 2021

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 your Financial Adviser.

The Big Picture

Much of 2020 has been spent worrying about how the US elections might go and when coronavirus vaccines might be available. The light at the end of the tunnel is now visible but it’s flickering.

Except for Trump, the world acknowledges that Joe Biden will assume office at his inauguration in January. The handover got a bit nasty at times but Biden’s team is now getting access to White House briefings as is normal.

But the election is far from over. The lower house (house of Representatives) is certainly going to remain controlled by the Democrats. The Senate, however, has two undecided seats – both in Georgia. Each state allows for different election procedures and Georgia’s requires a minimum 50% count for the winner. As this figure was not achieved for either seat, partly because of the number of people standing, both seats are up for grabs on January 5th 2021 in so-called run-off elections.

Georgia is traditionally held by Republicans but nothing is normal these days. If both seats go to the Democrats, the Vice President gets the deciding vote in a 50-50 Senate. If either or both are retained by the Republicans, the Senate remains held by the Republicans and Congress is ‘split’, as it has been for some time.

Markets appeared to like the idea of a split Congress as it makes many of the more extreme Democratic policies unlikely to get through into law. In particular, it means the big tax hikes favoured by Biden-Harris won’t get through.

On the downside, a split Congress means that the much needed COVID stimulus package will struggle to get through in any meaningful size.

As in turns out, in the days and weeks following the announcement of a Biden presidency, three different companies announced (by press release) the efficacy rates of their vaccines. Normally people wait for peer-reviewed academic journals to release the results. So, are we jumping the gun?

In a combined election-vaccine euphoria, markets here and around the world charged up in November at a pace not seen since the aftermath of the 1987 stock market crash!

The clinical trials have been running for months with tens of thousands of participants. However, for any one vaccine, such as Moderna’s, the number of cases being used in the efficacy (or effectiveness) calculation is quite small.

There are always two groups of participants – one that gets the actual vaccine, and one that get a placebo (or sugar pill) as a control. Since no one knows who might contract the virus a wide net was cast with 15,000 in each group. It turns out that only 90 people in the placebo group contracted the virus. On the other hand, 5 in the ‘treatment’ group contracted the virus. The efficacy rate of 95% is calculated as (90-5)/90 being the relative gain over the base.

One of the things that causes us some concern is that the rate of infection (90/15,000 = 0.6%) in the placebo group is very much lower than around the 4% witnessed so far in the USA in the general population. Obvious factors potentially explaining the difference include the length of the trial compared to the period the virus has actually been circulating. Less obvious factors might be that the sample might have been accidentally skewed towards regions where lock-downs were effective.

Also, as participation is voluntary, what type of people signed up for the trials? Are they more likely to have socially distanced than the rest? It takes time and effort – not to mention some risk of side effects – to participate in any clinical trial. Participation might have been skewed towards more public-spirited individuals – the sort of people who are motivated to consider the welfare of others. The trials attempt to balance a study for gender, age and other pertinent factors but public spirit is not an easy variable for which to condition.

Another factor coming to light was that the AstraZeneca study included an accidentally-allocated dosage using only half a dose in the first of two shots. This group of less than 3,000 participants showed a 90% efficacy in a group of only under 55’s but 62% in the sample without the mistake – including older people who are thought to be more at risk. We have not seen splits by age in the samples from other companies.

Obviously, protecting someone who might be less affected is less important than saving the vulnerable. Another factor we are considering is that people, when vaccinated, might feel ‘safe’ and no longer socially distance, etc. Therefore, after the vaccines are distributed, infection rates might increase and efficacy rates could fall.

Dr Anthony Fauci, the main medical adviser in the US, stated on 29th November that he expected ‘wave upon wave’ of outbreaks following Thanksgiving (and presumably Christmas) because of families and friends getting together for the holidays.

Fauci also said there is unlikely to be enough vaccine to get even front-line health workers protected by the end of January. When will senior citizens get their turns? It is also largely unknown how long immunity from the vaccines will last.

Renewed lock-downs in the US, the UK and other places will have ramifications for growth in quarter four (Q4) and Q1. It appears from causal observation of news reports around the world that Australia is dealing with the virus better than in many regions.

So, while we join others in applauding the efforts of scientists and medics involved in this vital work, and we rejoice in the success found to date, we feel that the markets have priced in a best-case scenario. Perhaps exhaustion after dealing with markets over 2020 needed some respite.

We think that, although the world is winning the fight against COVID-19, we don’t think it will be plain sailing in 2021. There may well be second dips in economic growth and more volatility in markets.

So far, we have noted big bounce-backs in many economies after the relaxation of behaviours following the first lock-down. For Q3 the following quarter-on-quarter economic growth data have so far been released: US 7.4%; China 2.7%; Japan 5.0%; Singapore 9.2%, etc. These are massive numbers compared to historical averages because Q2 was so bad! Australia’s results will be posted in the first week of December.

Not all news has been good. The UK which didn’t handle the virus well at the start and is just about to come out of its second lock-down, is expected by the government to grow in 2020 by the worst growth in 300 years! JP Morgan, a leading US bank, is predicting US growth in Q1 will be negative.

At home, the Federal and State governments, together with the Reserve Bank of Australia (RBA), have dealt well with the situation at hand. Current Infection rates are very low by international standards and a sensible approach to balancing restrictions with growing the economy is in place.

Our latest labour force data witnessed the unemployment rate at 7.0% when 7.2% was expected and 178,800 jobs were created when a fall was expected. The RBA expects the unemployment rate to have fallen to 6% by the end of 2022 and growth for 2020/21 to be 6%.

In Australia, we do have additional headwinds facing us in 2021. The relations between China and Australia have worsened. Shiploads of coal imports are being held up in Chinese ports due to seemingly questionable objections. And China imposed tariffs on wine imports of around 200% as an anti-dumping measure. An industry spokesman stated margins on wine exports to China are high by comparison to other countries. It has been reported that copper and barley might be targeted next.

Our medium to long-run view of the economy and markets remains strong. We do find the ASX 200 and the S&P 500 to be a bit expensive in the short-term and this may in part have explained a weaker market in the last few days of November. Because of this view, and the health and political headwinds, we do not think that volatility will stay low throughout the first half of 2021. We expect some bumps but nothing too bad!

Asset Classes

Australian Equities

The ASX 200 rose by 10% over November after the index had given up about 2% in the last three trading days. There were major gains in Energy (28%), Financials (15%), Telcos (13%), Property (13%) and Industrials (12%). The Consumer Staples sector (-1%) actually went backwards!

We had the market heavily over-priced on the last Wednesday of November but the slight sell-off in the next three days does not prove anything. Markets are always being bombarded by news and the AstraZeneca flaws in their data being exposed could have been the reason.

Foreign Equities

The S&P 500 (+11%) was on track to have the biggest capital gains in a month since the recovery from the 1987 crash – until there was a slight sell off in the last few days of November.

Most other major international indexes followed suit. Markets rose sharply after the lock-down impact in March of this year. However, at that time, it was easy to argue that, with incomplete information, markets had just sold off by too much. There is no widely accepted suggestion by commentators that markets were very cheap in October. So, from where did the 12-plus percentage rallies come?

We think a large part of November’s gain was due to a euphoric response to ‘Trump gone’ and ‘vaccines here’. While the former is actually true the latter is far from having been confirmed using standard due process. We think any negative news on the vaccine front could give back quite a bit from those gains.

Bonds and Interest Rates

The RBA cut its overnight interest rate to 0.10% from 0.25% in November. It also announced it will continue to attempt to anchor the three-year rate at 0.1% and will spend up to $100bn on keeping longer term rates lower.

The US Federal Reserve appears to be done on its conventional policy initiatives. But it is also talking about possibly doing more to flatten the yield curve to approximately where it was before the election fever started.

Other Assets

The prices of oil, copper and iron ore rose sharply in November. Gold prices fell.

Our dollar against the $US strengthened while the VIX volatility, or fear index, fell sharply to only just above normal levels.

Regional Review

Australia 

In an historic move, the RBA cut its overnight interest rate to 0.1% from 0.25% early in November. It is extremely doubtful that they will move it any lower but the RBA did announce a $100bn programme to keep rates lower at longer rates – with terms over 5 years.

With the December meeting too close to the November cut to expect more central bank activity and no RBA board meeting is to be held in January, we expect little news from the Bank before February at the earliest. Their work has largely been done – and done well.

The unemployment rate climbed by one notch in each of the last two months – from 6.8% to 7.0%. However, there were 178,800 new jobs created in October and the participation rate improved to 65.4% when only 64.7% was expected. This rate suggests workers are being encouraged to enter the workforce in the hope of finding work.

China

China economic data are just fine. The Purchasing Managers Index (PMI) for manufacturing came in at a very respectable 51.4 indicating expansion over contraction. Industrial output, at 6.9%, beat the expectation of 6.4% but retail sales were a miss at 4.3% against an expected 4.9%.

A potential new free-trade zone, RCEP, based in Asia has been signed by a number of nations including China, Japan and Australia but not the US or India. China has been flexing its trade muscles – possibly having been aggravated by the dealings with Trump’s tariffs over the last couple of years.

A number of ships carrying Australian coal are being held up in Chinese ports for what seem like flimsy reasons. At the end of November, China slapped on massive tariffs for Australian wine imports because it claims we were ‘dumping’ wine at artificially low prices. Copper and barley are apparently in the cross-hairs.

With Trump all but gone and Biden the new kid on the block, China might be starting a global confrontation over trade before Biden gets comfortable in the White House, we maintain a watching brief.

US

The presidential election was still being contested by Trump well after the media called Biden as the winner. There are reports that Trump might be considering a second term in office after Biden, as is allowed under US law.

Biden will probably be constrained by a split Congress so the actual changes in policy will be a lot less than that suggested by the election campaign.

Since Biden has stated that he will take action on the coronavirus from day one, he has to do something. But vaccine development has all but been done under Trump – even the planned distribution of the vaccines and the building of manufacturing plants.

It does seem that the World Health Organisation is disputing the clinical results of four treatments for very sick people rather than prevention of all by vaccines. The only difference Biden can try and make is a change in attitude towards the wearing of masks and social distancing. If he tries to shut down the US economy by too much at least the 48% of people who voted for Trump will have a lot to say.

The latest jobs data in the US were quite strong. There were 638,000 new jobs created with the unemployment rate falling to 6.9% from 7.9% over the month when 7.7% had been expected. The ISM index, which is similar to a PMI (a measure of the relative strength in business demand), jumped from a big 55.4 to a massive 59.1. However, retail sales did miss as 0.3% against an expected 0.5%.

Europe

According to the government, the UK is now facing the worst growth rate since George I was on the throne three hundred years ago! And Brexit is far from complete with the due date for the completion of a deal being New Year’s Eve 2020.

Various EU countries are flipping into and out of lock-downs. Europe does not look like a good story for growth in 2021.

Rest of the World

India has just announced a $US20bn stimulus package following on the heels of a $US27bn jobs and manufacturing package.

Singapore reported a good Q3 growth figure and growth is actually up 5.8% over the corresponding quarter in the year before. Japan has also bounced back with a 5% growth in Q3. Its industrial output was also up – by 3.8% against an expected 2.1%.

Economic Update – November 2020

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

US election and COVID-19 dominate market activity:

  • Lock-downs re-introduced in major European economies and the northern hemisphere winter approaches
  • US GDP growth at record level, markets similarly saw reported earnings beat expectations
  • China’s reported economic data remains resilient

The Big Picture

COVID-19 infection rates continue to ebb and flow in different parts of the world. At the end of October Victoria removed some significant lock-down restrictions. But, in Europe and the UK increased infection rates have caused the re-introduction of lockdowns. The US continues to struggle in deciding how best to manage the virus especially as the US presidential election came to a head.

The combined impact of the election and the virus elevated risk towards the end of October but our ASX 200 finished the month in strongly positive territory. The same was not true for the S&P 500.

Since the outsized falls in economic activity observed in the first two quarters of 2020 were caused by public health restrictions on business and consumers, lifting such restrictions was always going to cause seemingly strong growth during the recovery.

US GDP growth in quarter three, released at the very end of October, was a record +33.1% annualised rate. There are two major distortions in reporting this figure. Firstly, the US annualises its quarterly growth using the compound interest formula. This scaling up makes no sense when the quarterly data are volatile as they are at the moment. The ‘raw’ quarterly growth was a more modest, but still massive, +7.4%. The second distortion is due to the apparent amplification of growth rates stemming from recovering from a very low base.

Given that the US election was scheduled to occur five days after the growth data were released, the distorted data might have been able to be misused in the campaign. However, at that point in time more than 80 million postal votes had been received – which translates to about 60% of the total turnout in the 2016 election. Clearly the turnout of US voters this time around will be significantly greater based on the magnitude of the pre poll votes.

While Biden seems to be a clear front-runner we know from recent elections and referenda that the polls can be misleading. But what is unusual about this election is that it is generally agreed that there is a significant chance of the election results being contested. That means that we should reasonably expect market volatility might continue at least through to the mid-January when inauguration of the President takes place.

If Trump is elected and the Republicans hold the Senate, we might expect a continuation of the last four years’ policies. If Trump is elected but the Democrats win control of the Senate it might be very difficult for the US economy to move ahead smoothly as the Democrats use control of the senate to frustrate the policies of president Trump and the Republican congress.

If Biden wins without taking the Senate it might be difficult for him to put his ideas into action as it was for both Obama and Trump. A so-called ‘blue wave’ whereby Democrats keep the lower house, win the Senate and the White House could bring stability more quickly but what of the policies?
Biden has said he “will move to control COVID” on “day one”. He hasn’t given any insight into how he would achieve control other than he would “follow the science”. Given that the virus wreaked havoc across the world, science doesn’t seem to have produced economically and socially-acceptable outcomes in most places. A problem will occur if Biden tries to introduce lockdowns against the public will.

Biden is also likely to increase taxes on both individuals and corporations. That may help counteract income inequality but would probably dampen aggregate economic growth. As a result, he might delay his tax policy or water it down so as not to disturb an economy that hasn’t yet broken free from the impact of COVID-19. US retail sales and labour market data were strong in the latest month. All-in-all the US economy is looking to be almost out of the woods – other than the fact that they haven’t been able to agree on the next stimulus package to offset the impacts of the pandemic. If stimulus does not come soon, the US economy may weaken.

China, from where the coronavirus emanated, has an economy that is more or less back on track. Its September quarter economic growth was +4.9% over the year or +2.7% over the quarter (which would equate to +11.2% using the US-type calculation for an annualised figure).

China’s retails sales beat expectations at +3.3% (compared to +1.8% expected) as did industrial output (+6.9% compared to +5.8% expected}. The Purchasing Manager’s index was also comfortably above the 50-dividing line at 51.1.

In Australia, our unemployment rate went up one notch to 6.9%, 22,900 jobs were lost. Since, in the previous month, there was an impressive 111,000 new jobs created we view the trend in jobs growth to be quite solid.

Our inflation rate did pick up sharply after the childcare subsidy was removed. At 1.6% for the quarter but 0.7% for the year, inflation is still quite weak and will not be a trouble to Reserve Bank (RBA). Indeed, the RBA has cut its overnight interest rate from 0.25% to 0.10%. Despite this, which will be supportive, there is in fact little the RBA can do – it is all down to the fiscal policies the government produces.

The Federal Budget was brought down in October and produced an estimated budget deficit of $213.7 bn. Following a modest surplus in 2019/20, the current deficit flags a big attempt to stimulate the economy on a number of fronts. It also appears that the government may add more stimulus if it transpires that this tranche is not enough.

The government debt is predicted to exceed one trillion dollars during the following fiscal year. With interest rates so low, that is not a serious problem unless rates suddenly start to rise. It is important to try to regenerate economic growth and recoup some of the debt through the natural increase in taxation flowing from growing incomes and profits.

The European economy continues to struggle and the European Central Bank (ECB) is considering adding further stimulus. Brexit remains a problem and the UK sovereign credit rating was downgraded one notch by Moody’s to Aa3 from Aa2.

With the Chinese economy strong and the US economy moderately strong, albeit with heightened coronavirus risk, they provide a reasonable base for the Australian economy. With the co-ordinated monetary and fiscal policy at home, we are modestly optimistic for the medium-term economic future of Australia.

Asset Classes
Australian Equities

The ASX 200 rose during October in spite of elevated volatility sourced from the coronavirus and the impact of the US elections.
Much of this growth was buoyed by the resurgence in the share prices of the big four banks following the government’s relaxation of certain restrictions on lending standards.

Foreign Equities

The S&P 500 had the biggest one-day fall since June on the penultimate trading day of October. However, there was a sharp bounce back the following day. The VIX’ ‘fear’ index also jumped and we do not expect the market to settle down at least until after the US election is over.

There have been a number of spectacular ‘beats’ by companies of their forecast earnings so far in the September quarter reporting season. We believe this situation was caused by companies and analysts being overly pessimistic in write downs of earnings early in 2020. Importantly, December quarter expectations have been revised upwards but some big companies declined to give ‘guidance’ for earnings in 2021.

There has been a lot of focus on the mega-cap tech companies and many of these easily beat expectations. However, the share prices of Facebook and Twitter went in opposite directions on their news. Twitter beat earnings’ expectations but missed on the growth in the number of users, so its share price was hit hard in after-hours trading.

Bonds and Interest Rates

The RBA cut its overnight interest rate to 0.10% from 0.25%. It now has no more ammunition left on that front since negative rates have largely been ruled out. It can, however, attempt to influence longer term rates such as the three-year rate.

The US Federal Reserve is all but done on its policy initiatives. It is accommodating fiscal policy that is needed to combat coronavirus until effective vaccines and treatments are widely available.

Other Assets

The price of oil and our dollar against the US dollar fell in October. Gold prices fell a little as did the price of iron ore.

Regional Review
Australia

The Federal Budget was handed down in the first week of October. It was quite stimulatory with modifications and additions to the previously launched Jobseeker and Jobkeeper programmes. It also cut income taxes for some individuals and announced an increased spend on infrastructure.
The jobs data released in mid-October refer to the month before the budget. It showed that the unemployment rate climbed one notch to 6.9% and 29,500 jobs were lost. The government initiatives might help reverse that soft result and help the labour market continue to recover.
CoreLogic announced that capital city house prices reversed the previous falls, except in Melbourne, which had been in lock-down.
Consumer prices rose sharply in the recent quarter by 1.6% but this gain was largely due to the reversal from the previous quarter resulting from the childcare subsidy being granted and then removed. Over the year, CPI inflation stood at 0.7% which was well below the 2% to 3% target range of the RBA.

China

The economic recovery in China continues. The latest economic growth data was a slight miss at 4.9% compared to an expected 5.2% over the year however the quarterly growth was a very respectable 2.7% for the quarter.
Retail sales and industrial output both exceeded expectations but fixed asset investment met expectations at a very modest 0.8%. With there being excess capacity in China, renewed asset investment is not yet required.

US

The US election has dominated market attention in recent months. Both sides made all sorts of claims in the presidential and vice-presidential debates which might come back to haunt them.
Biden stated that he ‘will shut down the virus” and that this will be his mission “from day one”. While this is a laudable objective it is all but impossible without effective drugs to combat the virus. Trump continued his often-unsubstantiated claims.

It was reported that there were 661,000 new jobs created in the previous month. While this is about three times a typical strong month before the virus it shows substantial slowing down of growth during the rebound. Around 10 million jobs lost in the shut-down are yet to be replaced.

The future of the US economy is still up to how the virus impacts public health and policy – and the outcome of the election, particularly if the outcome is contested. But, thus far, the rebound in 2020 has been considerably stronger than most people predicted in the early months of the pandemic.

Europe

The UK government continues to struggle to resolve the Brexit deal before the end of the year, However, the dire predictions of a ‘hard Brexit’ a couple of years ago are largely gone. The ECB is considering further stimulus measures as France and Germany go back into lock-down.

Rest of the World

South Korea, swift to react to the pandemic, posted a September quarter economic growth figure of 1.9% beating expectations of 1.7%. For the year, growth was down at  1.3% but again better than expected at  1.9%.

Federal Budget Summary 2020

In this special report, our Head of Professional Standards & Technical Services, Craig Meldrum, looks at the key takeouts from the federal budget and what it means for individuals and businesses. It will include a summary of the tax, superannuation and social security changes that may impact wealth creation and retirement funding strategies for Infocus’ advisers and clients.

The macro

The 2020-21 Federal Budget is most notable in that it has been handed down 21 weeks later than it would normally have been delivered as a direct consequence of the unprecedented chaos and drama caused by the COVID-19 global pandemic. The last time we experienced anything similar was the 1918 flu pandemic (known as the Spanish flu) which was prevalent from February 1918 and lasted until April 1920, infecting around 500 million people (about a third of the world’s population) and leading to between 17 million and 50 million (and by some counts as many as 100 million) deaths worldwide.

For most of 2020, the federal and state governments have had the monumental task of managing the health impacts of the pandemic but particularly in this, his second budget speech, Treasurer Josh Frydenberg’s emphasis was on delivering a budget to provide a road to recovery out of the catastrophic economic black hole caused by the pandemic.

Unlike the catch-cry in the 2019 budget of “return to surplus”, the budget deficit is predicted to hit $213.7 billion and then fall to $66.9 billion by 2023-24, representing 36% of GDP. Total net debt is now expected to reach $703 billion this year and is forecast to peak at a record $966 billion by June 2024. It is expected that the national debt will take over a decade to repay with forecasts dependent on companies confidently hiring and investing for growth, consumers returning to work and spending and on a successful vaccine being developed to combat subsequent waves of infection and allow state borders to open and commerce to flow.

This budget is all about business confidence and jobs – jobs, jobs and more jobs. Recognising that particularly women and young people have been hardest hit with losing their jobs during the turmoil, the Coalition’s mantra of “the best form of welfare is a job” was on display as the Treasurer rolled out a range of spending measures designed to encourage businesses to employ and grow.

The Treasurer announced the JobMaker Hiring Credit which is expected to create 450,000 jobs for young people and will be available for businesses for up to a year. It will give $200 a week to employers who hire workers aged 16-30, and $100 a week for workers aged 30-35. To qualify, new employees must have been on JobSeeker and be given at least 20 hours of work a week with all businesses except the major banks being eligible.

The Government reconfirmed its commitment to the already-announced $1 billion JobTrainer program for school-leavers to provide more low-cost training places and $1.2 billion towards wage subsidies for 100,000 new apprenticeships and traineeships. Also unveiled was the new Women’s Economic Security Statement which provides for $240 million of funding measures over the forward estimates that focus on increasing jobs for women in traditionally male-dominated industries like construction, more co-funded grants for women who fund their own start-ups and a focus on encouraging girls and women to pursue careers in the STEM fields (science, technology, engineering and mathematics).

The big boost for small, medium and large enterprises (with a turnover of less than $5 billion) was $26.7 billion allocated to provide 99% of business with an instant asset write off for 100% of the cost of eligible assets.

For individuals, the measures seek to put money back in people’s pockets with a range of personal tax cuts, an extension to the Low- and Middle-Income Tax Offset (LMITO) and instant cash handouts for pensioners and disability carers who will receive two cash payments of $250 — the first from December 2020 and the second from March 2021.

While it waits for the final report from the Royal Commission into Aged Care Quality and Safety (due next year), the Treasurer announced that older Australians will also benefit from a $1.6 billion spend over the next four years to introduce 23,000 additional home care packages, allowing people the option to remain living at home. He also announced Capital Gains Tax (CGT) relief measures for granny flat arrangements.

More detail on a few of the measures

Personal taxation

The Government has announced $17.8 billion in personal income tax relief to get money back into people’s pockets and support the economic recovery (including $12.5 billion over 2020-21) with the majority of the benefit targeted at those on incomes below $90,000.

The Government’s three-stage tax plan was announced in 2018 and enhanced in 2019;

  • Stage 1 amended the 32.5% and 37% marginal tax brackets over 2018-19 to 2021-22 and introduced the Low- and Middle-Income Tax Offset (LMITO);
  • Stage 2 was designed to further reduce bracket creep over 2022-23 & 2023-24 by amending the 19%, 32.5% and 37% marginal tax brackets; and
  • Stage 3 was aimed at simplifying and flattening the progressive tax rates for 2024–25 and increasing the Low-Income Tax Offset (LITO). The Government estimated that around 95 per cent of taxpayers would be on a marginal tax rate of 30% or less (as shown in the tables below).

2019 Budget: Tax plan

Tax rates (2017-18) Thresholds Tax rates (2018-19 to 2021-22) Thresholds
Nil $0 – $18,200 Nil $0 – $18,200
19% $18,201 – $37,000 19% $18,201 – $37,000
32.5% $37,001 – $87,000 32.5% $37,001 – $90,000
37% $87,001 – $180,000 37% $90,001 – $180,000
45% $180,000 + 45% $180,000 +
LITO Up to $445 LITO Up to $445
LMITO – LMITO Up to $1,080

 

Tax rates (2022-23 & 2023-24) Thresholds Tax rates (2024-25) onwards Thresholds
Nil $0 – $18,200 Nil $0 – $18,200
19% $18,201 – $45,000 19% $18,201 – $45,000
32.5% $45,001 – $120,000 30% $45,001 – $200,000
37% $120,001 – $180,000 – –
45% $180,000 + 45% $200,000 +
LITO Up to $700 LITO Up to $700
LMITO – LMITO –

The good news out of this budget is that the Government wants to bring forward the tax cuts from Stage 2 of its plan to begin immediately. The Treasurer announced a 3-stage rollout of the relief such that;

  1. The low-income tax offset (LITO) will increase from $445 to $700;
  2. The top threshold of the 19% bracket will increase from $37,000 to $45,000. This will provide up to $1,080 in tax relief; and
  3. The top threshold of the 32.5% bracket will increase from $90,000 to $120,000. This will provide tax relief of up to $1,350.

2020 Budget: Amended tax plan

Tax rates (2019-20) Thresholds Tax rates (2020-21) Thresholds
Nil $0 – $18,200 Nil $0 – $18,200
19% $18,201 – $37,000 19% $18,201 – $45,000
32.5% $37,001 – $90,000 32.5% $45,001 – $120,000
37% $90,001 – $180,000 37% $120,001 – $180,000
45% $180,000 + 45% $180,000 +
LITO Up to $445 LITO Up to $700
LMITO Up to $1,080 LMITO Up to $1,080

If passed, the tax cuts will be back-dated to 1 July 2020, with refunds of withholding tax collected over the last four months to be built into wages until the end of this financial year.

Taxpayers who earn between $45,000 and $90,000 will benefit with an extra $1,080 and those earning more than $90,000 taking home up to $2,565 extra.

From 2024-25, the 3-stage tax plan is still in effect to reduce the 32.5% marginal tax rate to 30% and more closely align the middle tax bracket of the personal income tax system with corporate tax rates. In 2024-25, the entire 37% tax bracket will be abolished under the Government’s already legislated plan. Therefore, with the Government’s announced changes, from 2024-25, there would only be 3 personal income tax rates – 19%, 30% and 45%.

As mentioned, the Government announced it would extend for another year the non-refundable low and middle income tax offset (LMITO). The reduction in tax provided by LMITO will remain at $1,080 per annum ($2,160 for dual-income couples) with the base amount at $255 per annum for the 2020-21 income year.

Taxable Income (TI) LMITO
$0 – $37,000 $255
$37,001 – $48,000 $255 + ([TI – $37,000] × 7.5%)
$48,001 – $90,000 $1,080
$90,001 – $125,999 $1,080 – ([TI – $90,000] × 3%)
$126,000 + Nil

Superannuation – “stapled” super accounts

Superannuation did not get much of a mention in this year’s budget however the few measures announced were targeted more at the superfunds themselves rather than at members.

The Treasurer noted that Australian’s pay $30 billion a year in super fees and highlighted structural flaws that need addressing. He pointed to unnecessary fees and insurance premiums on multiple accounts, high fees for too many underperforming funds and what he described as a lack of accountability to their members for their conduct and the outcomes they deliver to the members including a lack of transparency on how they spend their members’ money.

The key measure revolves around the concept that a fund “follows” the member, so that a new fund doesn’t need to be opened each time a worker starts a new job. By 1 July 2021, where an employee does not nominate an account at the time they start a new job, employers will need to obtain information about the employee’s existing superannuation fund from the ATO and pay their superannuation contributions to their existing fund.

The Government says that there are currently 6 million super accounts for 4.4 million people costing members $450 million in unnecessary fees. It is expected that consolidating multiple accounts will result in 2.1 million fewer accounts over 10 years and save members an estimated $2.8 billion in duplicated fees, insurance premiums and lost earnings.

The Treasurer announced a new comparison tool called YourSuper, designed to help workers decide which super product will best meets their needs. By 1 July 2021, the YourSuper tool will:

  • Provide a table of simple super products (MySuper) ranked by fees and investment returns.
  • Link workers to super fund websites where they can choose a MySuper product.
  • Show their current super accounts and prompt members to consider consolidating their superfunds if they have multiple accounts.

The Government hopes the ability for members to compare the fees and performance of superfunds will drive competition, reduce cost and improve member outcomes.

In order to hold funds to account for underperformance and to increase accountability and transparency, from 1 July 2021, MySuper products (and from 1 July 2022, other superannuation products) will be subject to an annual performance test and listed on the YourSuper comparison tool as underperforming until they improve.

From 1 July 2021, superfund trustees will also be required to comply with a new duty to act in the best financial interests of their members.

There is no detail on how this measure would be implemented, but under a best interests framework, trustees would need to demonstrate that there was a reasonable basis to support their actions being consistent with members’ best financial interests. Trustees will need to provide members with key information regarding how they manage and spend their money in advance of Annual Members’ Meetings. The Government expects that a reduction in waste in the super system, and improving transparency and accountability, could lead to an increase of $1.1 billion in retirement savings over 10 years.

Social Security and Aged Care

Social security has been in the news for most of this year with the introduction of the JobKeeper and JobSeeker payments to tackle the massive unemployment crisis caused by the economic impacts of the pandemic.

The Government has forecast that unemployment will peak at 8% in the December quarter (2020) but will reduce to 5.5% by 2023-24. And while economic growth is tipped to fall by 3.75% this year, the Government has forecast a sharp turnaround as post-COVID business and consumer confidence kick starts the economic engine with projected growth of 4.75% in 2021/22.

With a strong emphasis on jobs, the Government made no mention of increasing the base rate of the JobSeeker (formerly Newstart) unemployment benefit. The additional coronavirus supplement, currently $250 a fortnight, which is scheduled to end at the end of December, will return the benefit to its pre-pandemic rate. However, Social Services Minister Anne Rushton said there would be more announcements about JobSeeker before the end of the year.

As mentioned, pensioners and disability carers will receive two cash payments of $250 — the first from December 2020 and the second from March 2021.

Specific to retirement living options for older Australians, on top of the announcement of an additional 23,000 home care packages, the Government has announced that it will provide a targeted capital gains tax (CGT) exemption for granny flats (where there is a formal agreement in place). Under the measure, CGT will not apply to the creation, variation or termination of a formal written granny flat arrangement and is designed to address the adverse tax consequences for property owners (where that property is the principal residence of the taxpayer) while providing protection for older parents or people with disabilities.

Business taxation

To add to the solvency reforms to help protect distressed businesses and assist them to work their way through financial hardship and get back to normal operations, the Treasurer announced measures to support small, medium and large businesses with an aggregated annual turnover of less than $5 billion by enabling them to deduct the full cost of eligible depreciable assets. He stated that this measure should help over 99% of businesses to write off the full value of any eligible asset they purchase for their business.

In a measure designed to improve cash flow and to encourage new investment to support the economic recovery, eligible assets (including new depreciable assets and the cost of improvements to existing eligible assets, and for small and medium-sized business, second-hand assets) acquired from 7:30pm (AEDT) on 6 October 2020 and first used or installed by 30 June 2022, can be fully expensed in year of first use.

Further, small businesses can deduct the balance of their simplified depreciation pool at the end of the income year while full expensing applies. Also, businesses that acquired eligible assets under the pre-existing enhanced $150,000 instant asset write-off (IAWO) provisions will have until 30 June 2021 to first use or install those assets.

Conclusion and where to from here?

Unlike the 2019 Budget, the Government has moved from a platform of continued sustainable and responsible economic management and a mantra of “return to surplus” to something much different. The 2020 budget has all the trimmings of a pre-election cash splash, except this is not a pre-election budget. The economic ruin brought about by the worst calamity in the modern age (which has not been a market-driven, debt-driven or geo-political initiated event) has demanded apolitical, bi-partisan action to stave off a potential 1930’s-style depression, so the Government didn’t really have much choice.

Ideological biases aside, a Liberal Coalition government is generally always going to try to create economic activity by appealing to the business community, by creating the economic levers to generate jobs and providing the tax incentives to foster the business and individual confidence to invest and grow. They could always do more and time will tell whether what has been proposed is enough.

As with all budget announcements, the measures are proposals only and need to be enacted by Parliament. This year, the COVID-interrupted sitting dates mean there are limited sitting days for the Government to pass its legislative reforms. The big question is, given it could be a while before many of the measures are enacted, will businesses and individuals have the confidence to start investing and spending to get the economy cranking again?

I urge clients of Infocus advisers to contact your adviser with specific questions.

General Advice Warning

The information in this presentation contains general advice only, that is, advice which does not take into account your needs, objectives or financial situation. You need to consider the appropriateness of that general advice in light of your personal circumstances before acting on the advice. You should obtain and consider the Product Disclosure Statement for any product discussed before making a decision to acquire that product. You should obtain financial advice that addresses your specific needs and situation before making investment decisions. While every care has been taken in the preparation of this information, Infocus Securities Australia Pty Ltd (Infocus) does not guarantee the accuracy or completeness of the information. Infocus does not guarantee any particular outcome or future performance. Infocus is a registered tax (financial) adviser. Any tax advice in this presentation is incidental to the financial advice in it.  Taxation information is based on our interpretation of the relevant laws as at 1 July 2020. You should seek specialist advice from a tax professional to confirm the impact of this advice on your overall tax position. Any case studies included are hypothetical, for illustration purposes only and are not based on actual returns.

Infocus Securities Australia Pty Ltd (ABN 47 097 797 049) AFSL No. 236 523.

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.

US

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.

US

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.

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