Now we have got through the excitement of the budget – I know, a gift that keeps on giving – there are a few things that we need to pay attention to in the financial world.
Inflation was a thing in the 70’s and 80’s when we saw average inflation of 9% a year over two decades. Alarmingly inflation peaked at 15.42% in 1974 but by 1990 was a mere 7.33%! https://www.macrotrends.net/countries/AUS/australia/inflation-rate-cpi
Inflation is important as it is a building block in interest rates and when you get inflation (usually wage pressure), there is definitely upward pressure on interest rates. It doesn’t always follow a linear relationship and a floating currency can dampen the effects but the upshot is, it costs more to buy the same goods and services.
We can already see the effects here:
You can see the relationship between interest rates and inflation below.
Interest rates were crippling through this period and peaked at approximately 17% in the 1989-90 financial year.
Now, we have no expectations of seeing these rates again (just getting your attention) but we can definitely see inflationary trends that will put pressure on rates.
A lot of the support for expensive equity prices has been based on the fact that, with interest rates so low and even negative in large parts of the market, the relative risk in equities was diminished. Ratios such as ‘Price to Earnings’ (P/E)* could be much higher as the risk free return was so low – this is part of the rationale for US markets with P/E’s of 38 versus the historical average of 25.
*A quick way to explain P/E is ‘how many years would it take, based on current earnings to get my money back’ – 38 years would seem a long time.
The Australian Reserve Bank has interest rates at 0.1% so anything that can outperform that would seem a better alternative but it does lead investors to look for higher returns by moving up the risk curve.
The question that will now start to be asked is what happens to those equity prices if we start seeing upward pressure on rates. In theory, prices should soften but there are also other factors at play.
Quantitative easing or ‘printing money’ has not slowed and we have seen the US pass a massive stimulus package at the start of this year. Possibly justifiable, if you had high unemployment and you were in a deep recession, but the economy is almost back to pre-Covid levels. The first package in 2020 had done the job it needed to, so adding even more stimulus can only increase the pressures on the existing already stretched resources. Wages are likely to rise.
Australia has done much the same thing. In 2020, the Morrison government provided a huge amount of funding to keep small businesses and devastated industries afloat and we can see that this had the desired effect, with a fast hard shutdown and then a very rapid recovery. With employment numbers higher that pre-Covid numbers in real terms, we are well on the way back to economic recovery so do we need all this stimulus?
So are we heading for a correction?
In truth, we are always heading for a correction. The timing of that correction is the mystery and after the correction, we will have any number of ‘experts’ explaining how they predicted it and what caused it. What we need to be careful of is falling in love with one narrative and ignoring the other side of the story.
Problems are easy to see, especially in the US. Companies have geared up again. The GFC in 2008 led to dramatic de-leveraging (reducing their debt). They wrote off bad debts and took the hit to balance sheets. 13 years later, fiscal prudence seems to be forgotten and US companies have very high levels of debt again, in fact, the corporate debt in the US is the highest it has ever been in real and percentage terms. Forbes- Corporates gorge at the debt trough. You don’t hear about it here but in March 2021, there were 61 corporate bankruptcies (up from 30 in February) and that is in a recovery.
The darlings of the market like Apple, Amazon, Tesla and Microsoft have had a great Covid year, but that does not extend uniformly across the market.
Interestingly, this has not been replicated in Australia. Our companies are definitely debt adverse and our problem with debt is more at the household level. Australia’s-personal-debt-reported-as-highest-in-the-world . The link sounds scary but does explain that property debt is not all bad.
Australian corporates look pretty healthy and the December reporting season was surprisingly positive ABC News/2021-03-03/australia-business-company-reporting-record-breaking-improvement/13203740.
The question is always “how much good news is already baked into the current prices”?
Behind the scenes we have been rebalancing diversified portfolios each quarter so a good portion of your gains after the wonderful rebound we saw from March 2020, have been reallocated to more defensive assets already. Please talk to us if you have concerns and our advisers will be discussing this during your progress meetings.
The Vaccine world.
As suggested back in March, the news about vaccines is driving sentiment and good and bad news is reflected in asset prices.
Many of our clients have had their first dose, as have I, and on the road to vaccination. I had AstraZeneca and was fine but we have heard of some very sore arms and nausea (my wife was not happy and nor was my sister). I am pro vaccine for all the self-interested reasons. I want to see international investment, education, tourism and travel and I don’t want my parents to be at risk because someone didn’t wash their hands. (Incidentally, my parents and parent-in-laws have had their first shots with minimal side effects as well).
I can understand the hesitancy with the amount of conflicting information out there but I would urge anyone with concerns to talk to their GP. Mine was very clear on the risks of catching Covid versus having a vaccine and frankly that is the only real discussion that needed to happen, for me. https://www.healthdirect.gov.au/blog/covid-19-vaccines-thrombocytopenia-and-blood-clots
Two clotting cases out of 700,000 (1: 350,000) vaccinations in April in Australia is what sent the local media into a frenzy about the risks of AstraZeneca. That is a risk of 0.0003% and Pfizer apparently is about 0.0002%
Covid19 is killing anywhere from 0.9% (Turkey) to 9.3% (in Mexico) per 100,000 infections. https://coronavirus.jhu.edu/data/mortality. Even at the low of 0.9%, that would mean 900 deaths (not illness) per 100,000 cases versus a very low probability of a blood clot that we are alert to and would most likely be treatable. That sounds a bit glib – especially if you are the one with the clot – but I think it can be argued the health risk from Covid to our vulnerable is where the more serious risk resides.
Australia will have Covid exposure from overseas by the end of the year or the start of the next but as we are now seeing in the US, UK and Europe, when the majority are vaccinated, the world gets back to normal. covid-vaccinations-tracker
Even those scary ‘variants’ are reported to be having little to no impact on the vaccinated so the protection is there. You might catch it, but with no symptoms, will you care? BBC on variants 23 May
Investment markets seem to have factored in the world reopening and let’s hope they are right.
I do worry that our news channels will have nothing to talk about without Covid19 but I am sure they will find something? There must be another ancient cultures calendar (think Mayan) predicting the end of the world that can grab a headline?
NRL ORIGIN ONE
On predictions, similar to last year, I am expecting a 2-1 win by Qld in the origin series. At least that first game in Townsville, on the 9th of June, will be played in front of a polite non-partisan crowd…!
As always, my opinions are my own, Josh and Chloe in our office (our NSWelshmen) have a very different, some would say erroneous, view.