A TURBULENT PERIOD
Before we launch into this month’s update on the economy and financial markets, we would like you to know that our focus remains on our Clients, Family and Friends, and the impacts that this crisis can have during such an uncertain time. Placed in context, it would be hard to argue broadly, we have seen such a threat to our feelings of security and way of life post World War II. For many of us under the age of 70, we will never have experienced such a widely challenging and disruptive period as the current one and that which will follow.
Our message is a simple one – Lets continue to support each other now and into the future and let’s keep focusing on the things within our control, as this is all we can do if we are to influence the outcome.
In this vein, we would like to convey a big Thank You to all our clients who have been unwavering in their commitment to the individual plan they have in place. This commitment does not always come without periods or angst, uncertainty or the need to occasionally re-route part of the course when the terrain changes.
Interestingly, conversations with clients in recent months have centred on familiar themes;
- spending more time at home with the ability to focus on hobbies and attend to ‘jobs that have been waiting to get done’
- becoming ‘part-time teachers’ for children now schooling from home
- necessarily reduced expenditures with the ability to make many discretionary purchases or take holidays paused for the time being
- some frustration in the fact that visits with family and close friends are not possible
- becoming much more IT savvy with the use of applications such as Zoom and Teams
- looking forward to the other side of this current health and economic challenge and a return to a more ‘normal’ life including the activities and experiences we all enjoy
- the roller coaster ride investment markets have been on March through June
Which leads us to our markets update, which we hope you find informative…
ECONOMIC & MARKETS UPDATE
Households tapped out, Governments and Central Banks do the heavy lifting
Long before this current Covid-19 crisis hit the global economy, Australian households were running out of steam when it came to increasing individual levels of debt and retail consumption. Debt and credit growth have been weak for some time now and from late 2017 through most of 2018 house prices experienced declines across the eastern seaboard.
The Reserve Bank of Australia pre-empted this trend as an issue and for some time has been aggressively cutting the overnight Cash Rate in order to have the flow on effect of reducing the ‘cost’ of funding mortgages and personal loans for Australian households. Most recently interest rates have hit record all-time lows, house prices and debt levels have stabilised.
It is now common for us to see clients achieving home loan interest rates under 2.50%pa.
While house prices have stabilised and the cost of servicing household debt is manageable in the current ultra-low interest rate environment, the Covid-19 situation has dealt a sizeable blow to the Australian economy, unemployment rates and consumer confidence.
Step in the Australian Commonwealth and State Governments
In true Keynesian economic fashion, the Commonwealth Government (primarily) has stepped in to soften the blow to millions of Australian workers, small business people and unemployed with Government expenditure measures not seen in our lifetimes. Packages such as JobKeeper 1.0 and 2.0 and JobSeeker (payment boost) have meant that the Government budget has necessarily been obliterated in the near-term, with gross Government debt increasing from around $500 billion at the start of 2020 to a forecast $850 billion by the end of the current fiscal year.
These enormous spending measures to prop up the economy are funded via the Government issuing bonds through the Treasury department to the private market (large pension funds, commercial banks and individuals). The Government’s contention is that debt levels present no raise for concern while the ‘cost’ of servicing debt is at record lows (10 year bond yield now sits at around 0.80%pa). It also argues that Australia is exceptionally well placed with Net debt at around 35% of the economy versus the average global advanced economy peer at around 100%. This may be true, however the relative attractiveness of being a purchaser Government issued debt is fast diminishing (more on this later).
We have a lot to thank Western Australia for…
One of the key reasons the Australian Government balance sheet remains in good order relative to global advanced economy peers is that commodity prices remain high, and many of our large mining companies such as BHP Billiton (Iron Ore and bulks), Rio Tinto (Iron Ore and bulks), Fortescue (Iron Ore), Evolution Mining (Gold) and Newcrest Mining (Gold) have continued to operate throughout the recent shutdown and are selling super high quality grade products which are in high demand globally – this has helped our terms of trade (what we sell minus what we buy in) stay strong.
Share markets bounce aggressively
Contrary to popular belief, share markets are not the economy and often move inversely to the underlying trend in broad economic statistics such as unemployment rates, government debt levels and even consumer confidence. After experiencing initial falls of up to 37% during the initial phases of the pandemic (February-April), Australian and US Share markets have snapped back, with major indexes such as the technology heavy NASDAQ making new all-time highs in July.
What to make of all of this?
The global economy has many stress points at present, yet there are several themes that are likely to offer interesting investment opportunities over the medium term and there will be others which should simply be avoided.
Some of our thoughts….
- US Dollar denominated assets are king – the economic standing of nation States and the investment opportunity sets within them are a relative equation. Right now, Europe faces significant political, demographic and economic headwinds and there is little agreement in the Eurozone on how to fix many of these issues. Japan is showing little sign of emerging from 30+ years of deflation, China remains an economy which is shrouded in lack of transparency and investment opportunities despite its economic progress over recent years, and Latin America, Africa and Russia still lack the strong governance and transparency required to invest in such markets with any degree of confidence.Leading US companies such as Amazon, Alphabet, Microsoft and Apple are the benchmark in a world shifting further towards technology and automation in our everyday lives. The US dollar is the global reserve currency and there is no imminent threat of this position being displaced – as such we are of the view the United States and the USD will continue to see significant capital inflows over the period ahead.
- ‘Real’ assets should outperform in a world where most currencies are being de-based – with every additional dollar that is ‘printed into existence’ by Governments and Central Banks the purchasing power of existing ‘money’ is watered down. With world wide debts at extended levels, there is a high probability this printing of money (quantitative easing) will continue in the belief debts can be inflated away over time. The best way to protect (hedge) against monetary policy such is this is to own Real assets (Property, Shares, Collectables, Commodities) as these typically rise is purchasing power against currency over time.
- Sovereign Bonds are largely unattractive – as touched on in this client letter, Government Bond yields in advanced economies now sit between a Negative return (you are guaranteed to lose money holding a bond to maturity) and less than 1%pa, there is little or no reward over cash rates to invest in Government Bonds at this point in the cycle. There will of course be limited pockets of Government and Corporate debt which offer interesting investment cases.
- Commodity prices may surprise on the upside – in a world where currencies are being devalued and Government’s will be called on to boost economic activity through public projects such as Roads, Ports, Public Transport Networks and other infrastructure needs a strengthening commodity demand and price cycle is likely to return and surprise many who think recent prices may not be sustainable.
Sam Adams and Glen Orbell