Noisy, chaotic, uncertain, bifurcated… Finding the right words to describe the economic landscape is about as difficult as moderating a petulant 2-year-old.
This quarterly seeks to provide some insight into what is happening in the world of economics and investing. We cover:
Key Metrics
Economic Update
Investment Update
Life insurance industry on life support
Download the Quarterly to read later.
Download 'Amplification of transmission', a recent article we published in September.
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Key statistics
Cash rate remains unchanged at 0.25%
Australian economic growth was -6.3%
G7 GDP growth was -11.9%
Employment growth was -3.2%, unemployment up to 7.5%
Underemployment is up and unemployment remains masked by government income replacement schemes (job keeper and cashflow booster).
Economic update
Noisy, chaotic, uncertain, bifurcated… Finding the right words to describe the economic landscape is about as difficult as moderating a petulant 2-year-old.
Record low interest rates, record high government spending and bank interest forbearance have been, in medical terms, the equivalent of administering blood transfusions to a patient bleeding out. But, has the transfusion bought enough time to slow or cauterize the haemorrhage?
The economic prognosis will not become clear until banks and governments slow their stimulatory infusions and allow market function to return. This momentous stimulus provided the confidence and support necessary to kick-start a recovery that, despite second wave concerns, appears well underway.
With the stimulus packages only beginning to be partially unwound, and with divergent national epidemiological and economic landscapes, uncertainty remains the constant.
An area of greater clarity is the bifurcation of economic hardship. Hospitality & events, discretionary retail, tourism and education sectors, all remain supressed. Professional services, health, primary industry and non-discretionary retail have been largely unaffected.
The industry sectors most negatively impacted are large employers of young people. Industries least impacted tend to be higher salaried with an older labour force. It is the younger workers that are bearing the brunt and burden of COVID induced labour pains.
A biproduct of extended low interest rates to support the economy is asset price inflation. To rub salt into the wounds of young people, the inflation of equity and property values favours existing asset owners who tend to be older. COVID induced economic hardship and the stimulatory responses have amplified generational inequity.
For a more detailed discussion on long-term monetary policy settings and growing government debt, go to our article published early last month called ‘amplification of transmission’. Some of the conclusions from that discussion are well understood, like interest rates being lower for longer, while others are less well understood, like how central banks may adjust their policy tool kit. Worth a read if you are interested in monetary policy.
Government debt
A consistent vacuum in many economic commentaries is the unwillingness to discuss the long-term implications of mounting government debt.
Growing public debt, in our view, is likely to lead to declines in indebted nations currency values and the potential for declines in living standards. Avoiding a politically unpalatable decline in living standards requires highly indebted nations to undertake fiscal repair, without impeding consumer spending and business confidence. This can be difficult to do and necessitates cleverly targeted initiatives that result in productivity growth.
With central bank blunt stimulus (interest rat reductions) essentially fully tapped, the economic management pendulum has swung away from central banks to be ever more reliant on government policy makers, who need to target productivity and immigration programs. Never has so much of our economic fortunes relied on the capabilities of our political class.
Budget comments
The 2020 budget has brought forward personal income tax cuts, expanded instant asset write-offs for businesses and introduced a wage subsidy for the employment of young people, amongst a variety of other announcements.
COVID has also had a dramatic impact on budget fortunes, as the graphs below demonstrates.
The signature announcement appears to be a wage subsidy paid to employers for hiring young people. This is unlikely to create many new jobs but will serve to bolster a business’ bottom line. At best, the extra $200 a week will skew an employer’s focus away from older job seekers to younger ones. This announcement is a confirmation from government that young people have fared poorly.
More promising is a genuine push to revitalise manufacturing, bolster university research funding and the continuation of infrastructure investment. These initiatives can provide a meaningful boost to productivity, ultimately creating more and higher paying jobs for young people. University research investment should be productive, with the potential to unlock new and unexpected growth, particularly if commercialised within Australia.
Final comments
Spare a thought for people in the US, ravaged by the twin challenges of COVID and woeful federal leadership. Partisanship is blocking substantive government stimulus to assist economic victims and should the deadlock continue through November, will hinder meaningful long-term productivity initiatives.
This podcast episode, following a small business’ journey through COVID, sheds light on US inequality, COVID-19 mismanagement and health systems failures.
The pathway back to US fiscal sustainability looks fraught and mountainous. It requires capable political and policy leadership. Trump is the antithesis of capable. The American dream has never looked so fragile.
Investment implications
As indicated in our economic commentary, uncertainty prevails. Investment markets, in response to the extension of low central bank rates for the medium-term future, saw a recovery in asset prices.
Mature businesses that have struggled to grow earnings in recent years fared poorly during COVID volatility. The best source of investment protection has continued to be capital allocation to businesses with organic earnings growth, priced reasonably. However, there are few bargains on offer.
Businesses like major banks, who have struggled to grow earnings since the GFC, saw share prices drop precipitously in March with little participation in the market recovery. This was more fully discussed in our Spring 2019 Quarterly.
A business unable to grow earnings, will seek to maximise shareholder returns by growing profit via cost cutting. Ultimately, cost cutting over time lowers the capacity of a business to service customers and shrinks earnings further, leading to a contraction in business value and share price. Although it may seem like there are bargains available, investors should remain cautious.
We increased allocations to cash in July across client portfolios with the hope of reinvesting later this year. However, with the concerning increase in COVID numbers across Europe and the US, we remain cautious about reinvesting.
Property
The Australian Government appears determined to support the domestic property market through the relaxation of responsible lending rules. Australia is already the second most indebted nation in the world on a household debt to GDP basis (thankyou Switzerland)[1]. More household debt, particularly if irresponsibly lent, will do little to stimulate the economy.
Cashflow predictions (both short and long term) should be the main criteria used in making investment decisions. With rents falling precipitously in the inner-city apartment market, and with wage growth flat and migration halted, encouraging credit fuelled property speculation appears short-sighted.
Residential property is a collection of very different markets across Australia (so apologies for generalising). On a cashflow basis much of the residential property market appears a poor investment, with net yields lucky to get much above 2%. The cost of debt for most will be above this, resulting in cashflow negative properties where debt is used as a primary funding source. The logic often touted when considering property investing is that poor cashflow is offset by capital growth. With rents flat or declining, for property prices to continue to rise, future purchasers (paying a higher price) would be accepting even lower yields of 1% or less. Is that likely?
This does happen in places like central London and Manhattan, where supply constraints and prestige demand results in irrational values paid by unconstrained purchasers. However, apart from highly select pockets of prestige markets in Sydney and Melbourne, further investment (as opposed to home ownership) in residential property appears highly speculative.
A politician will in the same sentence call for housing affordability whilst reassuring property investors house prices will not decline. This alchemy requires greater property supply - a tricky development proposition while migration is low and wage growth is stagnant - and at the same time expecting land and housing values to remain elevated.
Additionally, inconsistent local council planning codes (and bureaucracy) prove a further handbrake to the necessary urbanisation around suburban transport hubs.
Insurance landscape
One of the services we provide is advice on life and disability insurance. There is immense upheaval across the life insurance landscape, making it a worthy first mention in our quarterlies.
Insurers are losing money hand over fist from a decline in investment returns and a mispricing of claims risk. Losses have been so severe that the insurer regulator, APRA, has been forced to intervene.
Capital ratios are being reviewed and uplifted and repricing of premiums is rife across existing policies. In addition, there is a consolidation of insurance businesses with some insurers ceasing to offer products. The sustained period of low and declining insurance company profitability has been exacerbated by COVID.
The return on investment in insurance companies is so challenging that there is negligible Australian investment appetite to support this industry sector. The table below summarises the consolidation of insurance companies, outlining ownership of the top ten life insurer’s in Australia.
The sustained changes across the industry have led to there being enormous value in reviewing personal insurances and comparing what else is available in the market.
Over the coming 12-18 months, we expect unpleasant surprises in many renewal notices, with potential premium increases anywhere from 10 to 50%. Policy holders benefit from a review of contract structures and sums insured. A review by us is at no cost, and may result in saving many thousands of dollars, particularly for longer term policy holders in good health. Default insurance through superannuation is not immune to these pressures with better value contracts typically available (for healthy people) via a financial adviser.
Please contact our office if interested in further information.
Best regards,
Matt Vickers
Snowgum Financial Services
[1] https://tradingeconomics.com/country-list/households-debt-to-gdp