Where is Noah and his ark when you need him! This deluge of rain of biblical proportions hitting the eastern board of Australia, has been unrelenting! We hope that any flood damage has been as minimal as possible for you. We have had several native animals,  being a kookaburra, two magpies, and a bandicoot ‘move in’ under the protective roof of our backyard balcony, in a desperate move to get dry and find some safety from the incredible rains and winds. Poor critters.

This natural disaster has arrived just as the remaining Covid-19 restrictions of the past two years have been, in the main, finally removed. Alas, more indoors confinement because of the severe weather, but this will recede, and life will go on. It has been a tough and frustrating couple of years for all, both physically and mentally, with a lot of challenges, changes and inconveniences. In saying that, it does not compare to the unjustified destruction and personal misery that the Ukrainians are being subjected to by the madness of the invading Russians. Although the ‘conflict’ will hopefully end soon either outright or via a valid ‘truce’, the Ukrainians can and will rebuild. However, the cost to Russia of the serious imposition by the world with the deserved and severe sanctions against Russia, not to mention the reputational damage to Russia, will be enormous. Russia (certainly Putin should) will be asking itself, why did we do this in the first place. Its people, its economy will suffer immeasurably, and its self-isolation caused by ostracisation, will be crippling.

Given the present high focus on the geo-political events in the Ukraine and given the negative impact on global markets from concerns of this, whether real or just fear, I have included below a couple of current articles detailing some succinct commentary on the situation and its likely impact ahead.

Nevertheless, as disciplined long-term investors, we must bear in mind the strength of underlying economic fundamentals that preceded this Ukrainian conflict have not gone away, but just appear partially absorbed and ignored by the noise and fears of this geo-political event. We should not become distracted by such, but rather see it as an opportunity to build our quality investments, and income streams.

The first related article, is from JP Morgan Asset Management, ‘On the Minds of Investors’ about the Russian/Ukraine conflict. Below are key points from its paper:

• “Energy prices face asymmetric risks as tight demand/supply balance would keep prices elevated, even if tension de-escalates.
• Indirect impact on growth from high oil prices should be manageable and prompt central banks to temper their hawkish stance.
• Despite the fluid geopolitical situation, we expect investor focus to return to global growth fundamentals and policy. Avoid sharp knee-jerk swing in allocation”.

“As the events in Ukraine continue to unfold, this note seeks to answer the economic and market questions from investors around the world.

How will the crisis affect global energy prices? Russia accounts for 13% of global oil production and 17% of global natural gas production. However, the European Union’s (EU’s) reliance on Russian energy sources is far greater: around a quarter of EU crude oil imports and 40% of natural gas imports currently come from Russia. There is only limited scope for the EU to offset any disruption in supply by accelerating imports from other sources, and recent price swings have been exacerbated by the fact that EU energy stocks started winter at depleted levels after an unusually cold autumn. Sanctions imposed to date have been designed to minimise the impact on energy supply, but energy prices will remain highly sensitive to further developments.

The risk to energy prices is asymmetric. We could see significant moves higher in the event that concerns around supply disruption worsen. If the situation calms, we would expect energy prices to decline but the tight supply/demand balance in the market is likely to keep prices at elevated levels relative to history. There are other possible sources of supply that may help to restore demand and supply balance in the long run. This includes sanctions against Iran being lifted if the nuclear agreement is restored, release of global strategic reserves and an increase in production capacity by other oil-producing countries, including the U.S. However, this would still take time and would be unable to address the short-term disruptions.

Will central banks have to hike more rapidly in the face of higher commodity-driven inflation? In our opinion, no. We expect central banks to prioritise growth and thus see central banks normalising policy more gradually as they acknowledge the downside risk that higher commodity prices present to growth. Market pricing for a 50-basis-point hike from the Federal Reserve (Fed) and the Bank of England (BoE) at their next meeting (in mid-March) has fallen to 20%, whereas in previous weeks it had been as high as 80%. (The most likely outcome Market pricing for policy rates by the end of the year has also fallen, with investors now expecting at least one fewer hike from both the Fed and the BoE than they did a few weeks ago.

For Asian central banks, the urgency to follow the Fed was low before the Ukraine crisis. Inflation in the region is manageable and many Asian economies are still at an early stage of pandemic recovery. The latest rise in commodity prices should reinforce their cautious tone.

Which regions are more vulnerable? The European economy is the most exposed given its high dependency on Russian energy. We see the extreme scenario where Russia cuts off all gas supplies as unlikely given the effects it would have on Russia’s income. Europe’s banking system is also exposed. But according to the Bank for International Settlements the total exposure is USD 89billion, which appears manageable. Our judgment is also that the European Central Bank (ECB) has the most scope to slow the pace of monetary tightening because wage pressures are less acute, which should cushion economic activity and spreads in the periphery.

The U.S. consumer can be sensitive to rising gasoline prices, but the oil and gas sector tends to benefit from increased activity. The U.S. became a significant net exporter of energy in 2019, so periods of higher oil prices are not as detrimental to activity as we saw historically.

In the emerging world, there are winners and losers. Commodity exporters (such as Australia) are benefitting from higher prices. However, unlike in the developed world, central banks may be forced to tighten policy in the face of rising inflation which would slow activity. There is therefore a significant dispersion of market performance amongst emerging market (EM) benchmarks.

Investment implications: Historically, geopolitical events, even those involving major energy producers, have not had a lasting impact on markets. Looking back at equity market sell-offs relating to geopolitical events, they have tended to be short and sharp, with sell-offs not lasting much longer than a month as markets react to the sudden event. The size of the market reaction can be considerable, as it has been in this instance, with equities sometimes falling more than 10%. But in most previous geopolitical incidents, markets have tended to recover to their prior levels in under a month, after investors assess that the macro environment has not materially changed. Of course, if the growth backdrop has materially changed, as it did with the 1973 oil shock, then it can lead to a more material sell-off and a longer period to recover losses.

One thing does seem abundantly clear: in the short term and long term, we expect the crisis to intensify the investment in the transition towards renewables as higher energy prices and fears of energy security add to existing climate concerns”. 

The second related article, is from MFS Investment Management, ‘Russian Invasion Fuels Market Volatility’, and some other macro items. Below are key points from its paper:-

“With the humanitarian crisis resulting from Russia’s invasion of Ukraine growing, we wish to express our sincere concern and support for the people of Ukraine and our hopes for a swift de-escalation of hostilities and a peaceful restoration of the country’s national sovereignty.

Russia- has been isolated from the global financial system.

Sanctions imposed by Western governments in response to the invasion took hold this week, including the planned cut-off of seven Russian banks from SWIFT, the communications system that facilitates global money transfers. Additionally, foreign currency reserves held by the Central Bank of Russia have been frozen, limiting its ability to support a weakening rouble. Index providers MSCI and FTSE Russell announced on Wednesday that they will remove Russian equities from all their indices, effective next week. MSCI is changing its classification of Russia from an emerging market to a standalone market. According to Reuters, the country had a weighting of just over 3% in the MSCI emerging market index and about 0.3% of its global benchmark. This week, credit rating agencies S&P, Fitch and Moody’s each downgraded Russia’s sovereign rating, putting it in the high-yield category. S&P, after the second downgrade in a week, rates the country just two notches above default. The agencies said Western sanctions call into question Russia’s ability to service its debt. In retaliation for the sanctions, Russia announced capital controls that will block coupon payments to foreign owners of Russian bonds.

Commodity prices soar. 

Since the start of the invasion, the broad Goldman Sachs Commodity index is up about 16%, to a 14-year high. Oil futures breached $115 a barrel this week for the first time since 2008 as sanctions limited market access to Russian raw materials. Russia has been forced to offer steep discounts on its crude but is still having trouble finding buyers. To the extent that dollar-denominated export revenues become unusable or illiquid, Russia could see less of an incentive to sell energy to the West, analysts at Goldman Sachs said this week. Oil prices eased from their highs on Thursday amid reports that Western nations are close to a deal with Iran over its nuclear program. The recent widespread surge in commodity prices and disruption of existing supply chains is exacerbating already high global inflation. One outgrowth of the sanctions is fear that higher global natural gas prices will push up the costs of fertilizers, ultimately resulting in food price inflation and shortages.

Germany, others, undertake major policy shifts in defense and energy. 

The German government’s announcement that it will dramatically increase defense spending in response to national security threats posed by Russia is expected to help offset some of the economic drag stemming from higher energy prices. Shortly after the invasion, German Chancellor Olaf Scholz laid out a number of major policy shifts, including halting the approval of the Nord Stream 2 gas pipeline from Russia while announcing the construction of two terminals to allow for the importation of liquified natural gas. Scholz also announced Germany will build a strategic natural gas reserve to reduce the country’s reliance on Russian gas supplies. In addition, the German chancellor floated the once-heretical idea of extending the life of several coal- and nuclear-fired power plants. Germany is not alone in reacting strongly to Russia’s attack on Ukraine. Switzerland broke with its centuries-old policy of neutrality, sanctioning Russia, while Sweden and Finland are said to be considering joining NATO. Sweden parted ways with tradition by exporting 5,000 antitank weapons to Ukraine, an active combat zone, this week. Meanwhile, Ukraine has applied to the European Union for immediate membership.

Putin-allied oligarchs feel the pinch. 

The US, EU and United Kingdom are ramping up pressure on Russian oligarchs closely allied with Russian President Vladimir Putin. Many were sanctioned after Russia’s seizure of Crimea in 2014, and sanctions have been stiffened in the wake of the invasion of Ukraine. Several yachts and other properties have been seized, and trophy assets such as the Chelsea Football Club have been put on the market.

OTHER MACRO NEWS

Powell signals that the Fed will hike rates a quarter-point. 

In testimony on Capitol Hill this week, US Federal Reserve Chair Jerome Powell indicated that he is inclined to propose and support a 0.25% increase in the federal funds target when the FOMC meets March 15 and 16. “The bottom line is that we will proceed, but we will proceed carefully as we learn more about the implications of the Ukraine war for the economy,” Powell said, but added that if inflation stays hot, the Fed would be prepared to raise rates more than 0.25% per meeting. It is too soon to assess the impacts of Western sanctions on Russia on the US economy, the Fed chair said. North of the border, the Bank of Canada began its tightening cycle on Wednesday, raising its policy rate to 0.5% from 0.25%. Multiple additional hikes are expected.

Despite eurozone inflation soaring to a record 5.8% in February, markets have lowered expectations for multiple rate hikes from the European Central Bank this year. 

Fears of slower economic growth as a result of surging energy prices and the fallout from sanctions on Russia combined to push the yield on the benchmark 10-year German bund back into negative territory this week. Bund yields peaked at 0.33% in mid-February, prior to Russia’s attack, in anticipation of tighter ECB policy. US rates have fallen as well amid the highest bond market volatility since the early days of the pandemic. Markets forecast the Fed will now tighten slightly less aggressively than before the invasion”.

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Disclaimer for information provided in this Commentary: This document, and the information contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

The Russians are coming! The Russians are coming! You may remember the title of a movie many decades ago. Quite an apt one in today’s ‘news of the day’. This cry has certainly been the focus of late around the world (media assisted, of course).

The actual ‘invasion’ this week by Russia of its neighbour, Ukraine, was probably not quite expected to the extent just seen. Many experts thought surely Putin would not be bold (and dumb) enough to do what he has just done. But he has, and now Russia faces, as it should, the condemnation and the ensuing wrath of the world via sanctions, bans, and sheer separation. I doubt if many Russian people support the aggressive action of their autocratic and dangerous leader, but sadly they will suffer through shortages of many things if this saga goes on.

The other reason this neighbour war is of focus is that there generally has been peace from mini-wars around the globe during the past years, especially is the case in Europe. Alas, this outbreak is now becoming the new televised war, as were the Gulf and Iraq conflicts of 1990 and then 2003. Although, the Ukrainian situation will probably, and hopefully, be just a short one; although the sceptic in me belies that the media will drag and exaggerate this as much as they can and do with headings on this being the start of the new WWIII. No wonder young people are fearful of what is being portrayed by the media.

Understandably, the new conflict in the Ukraine (there was a similar one there in 2014 too, which we sadly also remember for the downing of MH Flight17 during that affair) is creating some nervousness and market volatility.

This macro uncertainty is despite seeing most restrictions and having nearly all countries with their borders now open and a ‘back to normal business’ approach after the two hard years of Covid-19 and the uncertainty and adverse impacts it brought around the world. Yet, people are fatigued from the pandemic’s duration. We have learnt to ‘live with the virus’ and in the main we have combatted it, but people are probably sensitive and even fearful of any new concerning events or happenings, even if such events are really of no direct and even minimal, if any, indirect effect on them!

Putting the Ukrainian situation aside, the fundamentals for improving domestic and global economic advancement, and in investment growth appear well in stride, as anticipated. Fundamentals are looking good. Rising inflation and higher interest rates are factored in to the main. This risk does remain that these may be a bit higher than first thought. With the US Fed expected to move on increasing official interest rates next month, this should provide more tangibility on further increases. The days of ‘free money’ are effectively over, and with rising interest rates, we are seeing a change in how things will look ahead. Although this is all quite anticipated, there remains some uncertainty which can, and does, make markets jumpy in the short term.

Nevertheless, as true investors, we know and understand that we must not forget facts and fundamentals are what matters, as does having a dedicated long-term outlook.  We are seeing a return to normality. However, the markets were somewhat volatile even before the sudden Russia/Ukrainian event this week and the lead up to it. One benefit, of course, there are cheaper and good quality investment assets now available to buy in such a period of volatility that we are seeing the markets in now!

As the fund manager, Hyperion Asset Management, recently stated in its report on this; “The current (six-monthly) global and domestic reporting season has delivered some truly remarkable results. However, with markets trading on short-term momentum, non-fundamental macro news flow and self-reinforcing negative feedback loops, short-termism and fear have pushed fact and fundamentals from a rational market”. Yes, short-termism and fear are the enemies of true investing. And, so, what does media always sadly (and irresponsibly) focus on, yep, and we know it is rarely on facts and fundamentals!

Importantly, as investors we do remember what really matters is what price you pay for an asset, what price you receive if/when you sell the asset, and what net returns/income the asset delivers to you while you own it, which may be for a very long while. The price of an asset today is not relevant if you are not buying or selling it today, is it? Really, most of the rest we see and hear is avoidable noise. The key to successful investing too is to build a diverse mix of quality assets that will, overall, deliver growth and income to you over time. Sprinkle that with some patience and with courage in times of volatility, and it presents very well for a reliable and rewarding wealth strategy!

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To my above commentary, I have also included below a punchy article published this month by the Dr Shane Oliver, Head of Investment Strategy and Chief Economist with AMP Capital. His words provide short and sharp insights into the past year and what the year ahead has in store. Here is Dr Oliver’s simple point-form summary of key insights and views on the investment outlook. Worth the read and it makes good sense.

Investing in 2022: a list of lists

By Dr Shane Oliver  

Six things that went wrong in 2021:

1. Several Coronavirus waves disrupted economic activity.
2. Inflation took off as Coronavirus boosted spending on goods and disrupted production and supply chains.
3. Some key central banks started to remove monetary stimulus earlier than expected, with some raising rates.
4. Bond yields surged.
5. Chinese growth slowed sharply.
6. Geopolitical tensions with China, Russia and Iran stayed high. 

But there were three big positives:

1. Science and medicine appeared to offer hope of getting on top of Coronavirus. This saw less severe illness through the mid-year Delta wave compared to the 2020 waves.
2. As a result, the broad trend was towards global reopening.
3. Monetary and fiscal policy remained ultra-easy.

As a result, global growth is estimated to have been nearly 6%. This drove strong profit growth and, along with low rates, saw strong returns from shares and other growth assets offsetting losses in bonds. 

Four lessons from 2021:

1. Inflation is not dead – a surge in money supply under the right circumstances, in this case, massive fiscal stimulus and supply shortages, can still boost inflation.
2. Shares climb a wall of worry – particularly if earnings are rising and interest rates are low/monetary policy is easy.
3. Timing market moves is hard, and the key is to have a well-diversified portfolio. Despite lots of worries, sharemarkets overall surprised with their strength but some sharemarkets (eg in Asia) and bonds performed poorly.
4. Turn down the noise – investors are getting bombarded with irrelevant, low-quality and conflicting information that confuses and adds to uncertainty. So, one of the best approaches is to turn down the noise and stick to a long-term strategy.

Seven reasons for optimism on economic growth:

1. Coronavirus could finally be moving from a pandemic to being endemic – more on this below.
2. Excess savings in the US and Australia will help to provide an ongoing boost to spending.
3. While US Federal Reserve and likely RBA monetary policy will tighten this year, in AMP’s opinion those policies will still be easy. It’s usually only when policy becomes tight that it ends the economic cycle and the bull market – and in our view, that’s a fair way off.
4. Inventories are low and will need to be rebuilt, which will help boost production.
5. Positive wealth effects from the rise in share and home prices will help boost consumer spending.
6. China is likely to ease policy to boost growth. 
7. While business surveys are down from their highs, they remain strong and consistent with good growth.  

Global growth is likely to slow this year but to a still strong 5%, with Australian growth of around 4%, despite the Omicron virus wave resulting in a brief setback in the March quarter, in AMP’s opinion. 

We have revised down our March quarter Australian GDP forecast by 1% to 0.6%, but revised up subsequent quarters by the same amount. 

Four reasons for optimism regarding Coronavirus:

1. Vaccines are still providing protection against serious illness – particularly once booster shots are administered.
2. New Coronavirus treatments are on the way, which should aid in the treatment of the more vulnerable.
3. Omicron is more transmissible but less harmful (evident in far lower levels of hospitalisations and deaths relative to the surge in new cases compared to past waves) and so could come to dominate other variants.
4. Past Covid exposure is likely to provide a degree of herd immunity. 

Combined, this could set Coronavirus on the path to being endemic where we learn to “live” with it.  South Africa, London and New York are possibly already seeing signs of a peak in Omicron. 

Of course, the risk of new variants that are more transmissible and more deadly remains – which is why it’s in the interest of developed countries to speed up global vaccination.  

Key views on markets for 2022:

Still-solid economic growth, rising profits and still easy monetary conditions should result in good overall investment returns. 
 

1. Global shares are expected to return around 8% but expect to see a rotation away from growth and tech-heavy US shares to more cyclical markets. 
2. Australian shares are likely to outperform, helped by leverage to the global cyclical recovery and as investors continue to search for yield in the face of near-zero deposit rates but a grossed-up dividend yield of around 5%.
3. Still-very-low yields and a capital loss from a rise in yields are likely to again result in negative returns from bonds.
4. Unlisted commercial property may see some weakness in retail and office returns, but industrial property is likely to be strong. Unlisted infrastructure is expected to see solid returns.
5. Australian home-price gains are likely to slow with prices falling later in the year as poor affordability, rising fixed rates, higher interest-rate serviceability buffers, reduced home-buyer incentives and higher listings impact.
6. Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
7. Although the Australian dollar could fall further in response to Coronavirus and Fed tightening, a rising trend is likely over the next 12 months, helped by still-strong commodity prices and a decline in the $US, probably taking it to around $US0.80. 

Five reasons to expect more volatility:

1. Inflation – while it’s likely to moderate this year as production rises and goods demand subsides, it is likely to be associated with ongoing scares and the risk that it’s higher for longer. 
2. The start of Fed and RBA rate hikes and quantitative tightening – monetary policy is unlikely to get tight enough to threaten the economic recovery and cyclical bull market, but monetary tightening could still cause volatility. 
3. The US mid-term elections – mid-term election years normally see below-average returns in US shares, and since 1950 have seen an average drawdown of 17%, albeit with an average 33% gain over the subsequent 12 months, according to AMP analysis. 
4. China/Russia/Iran tensions – a partial Russian invasion of Ukraine could lead to even higher European gas prices.
5. Mean reversion – shares are no longer cheap. The easy gains are behind us and calm years like 2021 tend to be followed by volatile years.

Six things to watch:

1. Coronavirus – new variants could set back the recovery. 
2. Inflation – if it continues to rise and long-term inflation expectations rise, central banks may have to tighten aggressively, putting pressure on asset valuations.
3. US politics – political polarisation is likely to return to the fore in the US, posing the risk of a deeper-than-normal mid-term election-year correction in shares.  
4. China issues are likely to continue – with the main risks around its property sector and Taiwan.
5. Russia – a Ukraine invasion could add to EU energy issues. (In play as we know!)
6. The Australian election – but if the policy differences remain minor, a change in government would likely have little impact.

Nine things that investors should remember:

• Make the most of the power of compound interest. Saving regularly in growth assets can grow wealth substantially over long periods. Using the “rule of 72”, it will take 144 years to double an asset’s value if it returns 0.5% per annum (ie 72/0.5) but only 14 years if the asset returns 5% per annum.
• Don’t get thrown off by the cycle. Falls in asset markets can throw investors out of a well-thought-out strategy.  
• Invest for the long term. Given the difficulty in timing market moves, for most it’s best to get a long-term plan that suits your wealth, age and risk tolerance and stick to it. 
• Diversify. Don’t put all your eggs in one basket.
• Turn down the noise. 
• Buy low, sell high. The cheaper you buy an asset, the higher its prospective return will likely be and vice versa. 
• Avoid the crowd at extremes. Don’t get sucked into euphoria or doom and gloom around an asset.
• Focus on investments you understand offering sustainable cash flow. If it looks dodgy, hard to understand or has to be justified by odd valuations or lots of debt, then stay away.  
• Seek advice. Investing can get complicated and it’s often hard to stick to a long-term investment strategy on your own.

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As always, should you have any queries please do not hesitate to contact us.

Wishing you all a Healthy and Happy 2022!!

It is quite incredible to look back on the years 2020 and 2021 and to see over that time the strong investment markets in growth-oriented investment assets combined with the residential property market propelling at super speed throughout this period. Remembering that his is said in the context of what has been the biggest global pandemic for over 100 years causing adverse business and social conditions rarely seen before.

Across Australia, and the rest of the world, there have been city, state and country lockdowns and curfews; businesses, offices and factories closed on and off; working from home being accepted way of life (the new plan B!); border closures; travel bans; sports cancelled; weddings and funerals restricted; hotel and home quarantines; and the ritual of protective face masks being worn daily by billions of people. And, of course, in the past six or so months, billions of people getting much needed vaccinations of one, two or ideally, three doses. We now carry records of vaccinations on our iPhones like we do for a Drivers Licence!

It has been a very strange, very challenging, and a seemingly long period of time for all, indeed. Much of the past two years has been stop-start-stop-start but, although the impact of the virus remains with us, the damage caused by the ongoing virus scenario is lessening.  I think it is fair to say we are all fed up with it and just want to get on with life. Regain control, we say! Hopefully, more and more normality will occur in our lives in the coming months. In saying that, the Covid-19 pandemic has changed many things, probably some permanently, but not all bad.

In the initial stages of the Covid-19 virus and the quickly increasing awareness of it in early 2020, there were predictions that unemployment levels would be similar to those seen during the Great Depression; stock market crashes; property price collapses; horrific mortgage defaults; and untold millions of deaths globally from the virus. Panic was to be the new norm. Well, these fears did not really happen, and fortunately so.

The depth of the human spirit, businesses adapting to and improving change, technology advancements and its increased usage by all, massive government financial support and spending programs, near zero interest rates and, of course, the success of aggressive vaccination programs, all have helped take us to the higher ground where we are today. As 2022 now begins, and an acceptance that we must live with the virus but will overcome its presence, we are with an upbeat approach and, I believe, quite a positive outlook ahead.

As noted above, over the past two years, growth asset investors have received strong total returns, some of these stellar returns! And yes, higher markets do mean higher valuation levels. Conversely, defensive assets have had very low to negative real returns. It would be nice for this trend of very good returns on growth-oriented assets to continue for this new year of 2022, however, it is probably realistic that growth asset returns overall will be return more to normalised levels. Defensive assets returns can only be projected to be flat at best. Bonds may even be adversely impacted, as the Financial Times reports that globally many companies have increased their debt funding notably since Christmas as they rush to secure funding at the (still) low rates before rates rise. Increased issuance tends to mean higher interest rates occur.

In the past couple of newsletters, we have discussed in detail the increasing impact of the faster than anticipated rising global inflation, supply shortages and logistical restrictions, and staff shortages, that many developed countries are experiencing. This is becoming more obvious and is challenging, as we all know. However, as Australian Fund Manager, Ausbil, notes in their most recent Economic Outlook report, that the OECD December Economic Outlook Report forecasts global growth continuing on an above trend glidepath, slowing to a brisk 4.5% pace in 2022, then moderating to a sustainable 3.2% pace in 2023. Ausbil adds that, for Australia, it expects two exceptional quarters for growth, followed by above-trend growth throughout 2022 and leading into 2023.

In his recent address, the Federal Treasurer, Josh Frydenberg, stated that in the Mid-Year Economic and Fiscal Outlook that Australia has performed more strongly than any major advanced economy amid the greatest economic shock since the Great Depression. Presuming that this is true, not a bad platform for us. The Treasurer said, “Having performed more strongly than any major advanced economy throughout the pandemic, the Australian economy is poised for strong growth underpinned by Australia’s high vaccination rate and unprecedented economic support to households and small businesses”. Political speak, yes, but it does appear to make good sense and, overall, Australian corporate balance sheets appear overall as strong.

When looking at just where official cash rates may be heading, the yield curve can provide market implied expectations. We know that for the past year or so, the yield curve has been steadily steepening, that is becoming more normalised. This means that as you move out in duration, interest rates are higher. Longer dated bonds are getting higher in yield. It is still relatively flat from a historic point of view but there certainly is movement at the station. JP Morgan Asset Management reported that implied expectations show official US cash rates up from near 0% now to be around 75 basis points by the end of 2022, and for Australia at around 50 bps. Not big moves by historical standards but the risk is inflation rising higher than expected, which certainly appears it could happen. (US inflation is now at a 40 year high!). Its report shows that the implied expectation two years from now will have the US and Australian cash rate both at 1.50%. And it shows going higher thereafter. Certainly, that will see increased mortgage rates.

The global consequence of all these above variables will very likely see interest rate rises sooner than even recently predicted (particularly in the US); and have central banks further, but cautiously, continue tapering off their bond buying programs, causing probable bouts of market volatility in the months ahead. Yet, this is expected to be managed carefully given large debt levels because of the extreme measures taken over the past two years.

Anticipated market corrections may well happen during this adjustment period of the more back to ‘normal conditions’. Such corrections or pull backs could well provide good buying opportunities for long-term buyers of quality growth assets for both income and growth returns! When looking at just where official cash rates may be heading, the yield curve can provide market implied expectations. We know that for the past year or so, the yield curve has been steepening, that is being more normalised. This means that as you move out in duration, interest rates are higher. Longer dated bonds are higher in yield. It is still relatively flat from a historic point of view but there certainly is movement at the station. JP Morgan reported that the implied expectations show official US cash rates up from near 0% now to 75 basis points by the end of 2022, and Australia at around up 50 bps. Not big moves by historical standards but the risk is inflation rising higher than expected, which certainly could happen. The report shows that the implied expectation two years from now will have the US and Australian cash rate both at 1.50%. And it shows higher thereafter too. Certainly, that would see increased mortgage rates coming.

Interesting times we live in. I strongly believe that sensible investing is good for both your health and wealth! Investing is the foundation for our futures, especially when considering preparing for our non-working lives! Investing and having a commitment and focus to doing it is also a good example to show to our children! This is vital for their long-term futures!

As always, should you have any queries please do not hesitate to contact us.

Indeed, we are all learning Greek! But we must sympathise with the Greeks who are having their alphabet letters picked off one by one. As s a new variant of Covid-19 emerges, it is given a new Greek name by way of its alphabet. We are now up to Omicron, as we know.

Although the media is having its usual field day with being able to keep the headlines going for near two years now (yep, two years!) rattling on about the Covid-19 ‘crisis’ as the daily headline news. Variants have always been expected but, so too is the increasing percentage of vaccination rates happening around the globe. The remaining challenge is still to properly tackle the issue of getting vaccinations into the populations in the undeveloped world. If travel and border openings continue to increase, as they have in the past couple of months, then this means greater vaccination must happen in those particular, more vulnerable countries. Covid-19 does not recognise country borders!

With more time and research, you would believe that future variants will be swiftly tackled and mitigated more quickly. Positive developments and actions combating the virus have come a long way in the past six or so months. The virus, even with its variants, should become less virulent in impacting our lives and economies. I think this is in common agreement now.

Certain economic factors affecting the major global economies seem to be playing out pretty much as outlined in our recent newsletters. These factors include seeing the continued economic growth and progressive activity; consumer and business demand exceeding supply availability; cash galore to be spent (primarily because of the excessive cash holdings from cash savings built up in lockdowns); rising global inflation, and pressure on global interest rates to rise in the nearer future.

 As the global Covid-19 lockdowns and restrictions have, or are, being ‘unwound’, the world economies are responding positively. Economic fundamentals are also improving. As world supply chains do open up, the labour market flows do improve, and with cash and liquidity abound, it certainly appears that economic momentum is gaining its continued strength, which is certainly not surprising. Australia is about to see a much-needed influx of overseas workers’ and students’ imminently. The shortages of goods, materials and workers’ still remain but these ‘bottlenecks’ should be eased somewhat over next year as the global engine of activity increases and supply chains resume more to normality.

The underlying economic impetus is gaining faster traction, which augurs well for 2022. Yet, this is predictably what is causing the market volatility of late, as we observe that central banks’ are, or will be, reducing Quantitative Easing programs (which were very necessary to be implemented for stabilisation purposes, during the first few months’ of the Covid-19 pandemic last year). In addition, these central banks are having more ‘hawkish’ talk about the need to raise official interest rates sooner (possibly in 2022 rather than later). This is particularly the case in the US, the world’s largest economy. The Eurozone is closely following this trend too. We are also seeing incredibly strong US$ gains on rate hike expectations. The US Fed’s meeting this month will be an important one for the markets and rate outlooks.

All this is not a surprise. The slashing of interest rates and the voluminous QE measures made from early 2020 and during the ensuing months’, were done so to avert what could have been an economic calamity from the initial panic and uncertainty caused by the swift impact of the Covid-19 pandemic in March last year. (Of course, as true investors, we understand that reacting negatively to panic is not a good long term investment strategy!).  Now, with the world coming out of this pandemic mode, we should reasonably expect the ‘return to more the norm’, and therefore to see less government QE and to have more standard i.e. have higher interest rates at normalised levels. Near zero cash and bond rates are not normal. The level of dependency on these measures is not needed ahead. I believe we are seeing this adjustment period underway, hence this intermittent volatility.

Again, rising interest rates are not good for those investors with traditional bond holdings. As for those with people with excessive debt, rising intertest rates will be an obvious serious cash flow challenge. Roaring property prices are great for people with property, but you can’t use bricks to repay loans and increased repayments when interest rates rise, which they will.

It is likely that the heightened market volatility, which really began last month, probably will continue in December. However, presuming that the economic rebound proves to be sustainable, as it seems to be, then strong global growth will continue forward into 2022, and should lead to further market gains. If so, any market pullbacks would represent good buying opportunities for the long-term investor looking to add quality growth assets to their portfolio.

We, as investors, need to remember that the recent company reporting season here in Australia was very positive. The Fund Manager, Ausbil, notes in its latest Economic Outlook that “…confirming a full rebound in earnings, strength in balance sheets, and optimism across management teams, despite ongoing lockdowns. Moreover, this earnings rebound has been nothing short of astounding…from the (Covid-19 induced) decline in FY20 earnings.” It adds that, “…inflation impacts on costs were noted but not as a major concern, though we maintain a watching brief on any persistent inflationary impacts on balance sheets and earnings. The balance sheets of Australian listed companies are strong, and capable of supporting expansion in investments ahead as opportunity arises”.

For investors in growth-oriented assets, typically equities, property and infrastructure, 2021 has been a good year with good investment returns. For people in general it has been a tough year with lockdowns and other restrictions it has been a hard year. However, we can take solace and have real hope in that the future is looking brighter for us as people and for us, as true investors.  

Let this Christmas be a wonderful time for all, and a launching pad for a successful and happy year in 2022. And make your number one New Year’s resolution to keep up good long-term financial habits; they make for a strong and happy financial future!

As this year of 2021 draws to a close, all of us at FMA Wealth, sincerely wishes everyone a very Merry Christmas and a truly great New Year ahead!

There was little surprise in the ‘throw in the kitchen sink’ too approach taken by the Morrison Government when it formally announced its 2020 Federal Budget this week. Much had been deliberately ‘leaked’ (as is common practice) before the official publication. The artillery barrage of more spending and tax cut measures was the showpiece that was expected, and it certainly was delivered to continue the fight against the adverse Covid-19 consequences that have hit the economy over the past six months, essentially because of the self-induced economic shutdowns.

The Budget was very specific and brief in its content really, as was its intention. It appears to have been well received by economists and by the market alike as a continued commitment of action shown by the Federal Government to get the Australian economy back on track, albeit it at a high cost as we know.

As usual, there are numerous economic releases the morning after a Budget night. I think the release below from Deloitte Access Economics provides a succinct description and interpretation (with the economist-style overlay!) of what this important Budget means.

Federal Budget: Jobs, jobs, jobs

On 6th October 2020, Treasurer Josh Frydenberg handed down a Federal Budget that reflects an extraordinary year in Australia’s history. The unprecedented spending program to support health and livelihoods in the face of the global pandemic, together with the associated economic fall-out, has resulted in an anticipated Budget deficit in 2020-21 of $214 billion with further deficits anticipated over the medium term.

This year’s theme is about jobs and investment, and the necessary steps Australia must take on the long road back to restore employment to pre-pandemic levels.

The key announcements were:

• Stage 2 personal income tax cuts to be brought forward from 1 July 2022 to 1 July 2020*.

(Note: These cuts are proposed and will still need to be passed and legislated in Federal Parliament but, once in place, these cuts will be backdated to 1 July 2020).

*Proposed Personal Income Tax Thresholds from 1st July 2020

(This table added here by FMA Wealth)

• Businesses with turnover of less than $5 billion can write off the full value of eligible assets used or installed by 30 June 2022.
• Companies with turnover of less than $5 billion can carry back losses incurred in the 2019-20 to 2021-22 years.
• New JobMaker Hiring Credit measure to encourage employers to hire young workers.
• Proposed Research & Development amendments refined and deferred to 1 July 2022.
• Government to invest additional $14 billion in new and accelerated infrastructure projects over the next four years.
• Record funding for hospitals, schools, childcare, aged care and disability services.
• 100,000 new apprenticeships and $1 billion in university research funding. 
• Aged care funding up $2.2 billion, including $1.6 billion for 23,000 additional home care packages.

The 2020-21 budget is focused on driving unemployment down as fast as it can. That has seen a raft of decisions to tip new dollars into the economy, covering everything from the ‘bring forward’ of personal tax cuts, to subsidising the wages of the unemployed when they get a job back, through to allowing most businesses to immediately expense their capital spending.

The underlying cash deficit is forecast to be $214 billion in 2020-21, $29 billion worse than forecast in the July 2020 Economic and Fiscal Update, and a staggering $220 billion worse than the pre-COVID forecast released in late 2019 in the Mid-Year Economic and Fiscal Outlook (MYEFO).

The budget unveiled massive hits to the tax take, both in company tax (as profits dive) and personal tax (with jobs lost and wage growth virtually halting). 2020-21 revenues are forecast to be $55 billion lower than the (pre-COVID) projections in MYEFO.

Yet the moves in spending dwarf those in taxes. The increase in spending is four times bigger relative to national income than in the global financial crisis (GFC).

In response to the GFC, spending rose by 2.4 percentage points of income in the two years to 2009-10. Now, spending is rising by 9.5 points of income in the two years to 2020-21.

Chart: Federal government spending as a share of the economy

Net debt is forecast at $900 billion in 2022-23, while in the MYEFO released pre-COVID, Treasury had projected net debt to be $361 billion in the same year.

Yet it’s what that debt costs that’s much more important. Treasury now forecasts $17.3 billion in interest payments in 2022-23. Strikingly, that’s less than the $19.0 billion we paid in 2018-19.

So, the defence of our lives and livelihoods is much cheaper than most realise.

Treasury has also pencilled in a rapid economic recovery, with a late 2021 vaccine allowing the economy to average growth of 3.5 per cent in the next three financial years. That rebound in growth is forecast to generate enough jobs to bring the unemployment rate down to 5.5 per cent as soon as mid-2024. And it is at this point that the government will start to worry about the deficit again.

Yet the economic costs will linger. With international borders set to be closed for some time yet, Treasury now projects Australia’s population in mid-2024 to be more one million people smaller than its pre-COVID expectations.

And, largely because of that, it now sees the economy in mid-2023 as around 5.0 per cent smaller than its pre-COVID expectations.

COVID has affected us all, and it has certainly come at a big cost to the economy.

IMPORTANT NOTICE

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), its global network of member firms and their related entities. DTTL (also referred to as “Deloitte Global”) and each of its member firms and their affiliated entities are legally separate and independent entities. DTTL does not provide services to clients. Please see  www.deloitte.com/about  to learn more. Liability limited by a scheme approved under Professional Standards Legislation. Member of Deloitte Asia Pacific Limited and the Deloitte Network. © 202 Deloitte Touche Tohmatsu (ABN: 74 490 121 060).

If you would like more detail about the 2020 Federal Budget or, as always, should you have any queries or wish to talk about what is going on in these unusual and testing times, please do not hesitate to contact us at FMA Wealth.