“Alphabet Soup” – May 2020 Economic Update

Australia and Australians are emerging from hibernation.  The early positive signs on the number of infections and infection rates outlined last month have continued.  As a nation we have been one of the most successful at flattening the curve and containing the spread of COVID-19.  We have through a combination of good management, good luck and possibly our status as an island continent earned the title yet again of the ‘lucky country.’ On May 8^th Prime Minister Scott Morrison outlined a three-stage plan for the nation to reopen for business with the potential for most restrictions to be lifted by the end of July provided the containment success continues.  The intention is to have almost all businesses up and running by July end, unrestricted intra and interstate travel, gatherings of up to 100 people and potentially unrestricted air travel between Australia and New Zealand.

The states have endorsed the plan, but disappointingly, with differences in the pace of the rollout.  Western Australia has been the fastest at reducing restrictions around the size and location of gatherings with the first restrictions removed on April 27^th while Victoria has been the slowest on the timing and size of gathering restrictions with the first restrictions removed on May 12^th. Hopefully, common sense will prevail and in the absence of any major new outbreaks all or most of the states will align across key areas such as education.  The current status by state at the time of writing is provided below.

Attention must now turn to the economic toll of COVID-19. Economists have presented us with an alphabet soup of economic outcomes and recovery scenarios. The letters V, U, L and W have all been used to describe possible recovery scenarios along with the Nike ‘swoosh’  and a range of other symbols.  There should be some excellent new economist jokes on the horizon. Unfortunately, economic modelling like the COVID-19 modelling is rarely accurate.  The issue is this time we just do not know. We have nothing to go on. Flicking the off switch on the global and national economy for many months has never happened before so this time we have nothing to base any assumptions on.

The reason economic models often get it so wrong is it is very difficult to model human behaviour especially in periods of heightened fear and uncertainty. One of the key questions is whether COVID-19 will lead to short, medium and potentially long-term changes in behaviour. Will COVID-19 change our lifestyles, our spending and working patterns permanently?  

The optimists are forecasting a V shaped recovery where the economy quickly rebounds once restrictions are lifted and unemployment falls from a peak of around 10% (excluding job keeper recipients) and falls back to more manageable levels of 6-7% over the next 6-12 months. The middle group are forecasting an extended U with unemployment staying at over 10 percent for over 12 months with the potential to rise further once the job keeper payments and other economic life support measured are removed. The pessimists are forecasting an L or an extended period of economic stagnation and two plus years of high double-digit unemployment. Again, we just don’t know.  We are only now starting to see a range of data points that are providing some insight to the economic impact both domestically and internationally. And this is just the first round of measurable economic impacts. Geopolitical tensions are also likely to rise as the world counts the human and economic cost of this pandemic. We are already seeing signs of a renewed trade war between the USA and China (some are saying the beginning of a new cold war) and trade tensions elsewhere including Chinese threats against Australian agricultural exports.  That said, for reasons outlined last month Australia is likely to fare much better than most of the developed and developing world.

So many known unknowns remain. As advisers we focus on what we do know and respond accordingly through our asset allocation across and within asset classes. Interest rates and the outlook for interest bearing securities has changed. It was only a few months ago that a strengthening US economy combined with the end of the US/China trade war was expected to see the winding down of QE (quantitative easing) in the USA and the potential for rising interest rates in the second half of 2020.  Today, the world is again awash with liquidity as central banks the world over, including our own, were forced to pull the QE lever to keep financial markets functioning and many governments initiated major fiscal stimulus to keep economies on life support. The net result is a massive increase in government borrowing/debt and in turn the necessity of interest rates staying at historic lows for the foreseeable future and longer than anticipated just a few months ago. This favours equities in relative terms. 

Staying the course is always difficult during periods of uncertainly, particularly when markets fall by over 20% but history reminds us it is always the right decision.  There are two things I look forward to each year on the investment calendar that can provide reassurance and confidence in equity markets.  The first is the release of the Credit Suisse Global Returns Yearbook which analyses the long run returns on stocks, bonds, bills and currencies over the last 120 years globally and across 23 individual markets and stock exchanges  The yearbook is usually released in February and is always a good read regardless of your level of interest in investing.  It is available at  www.credit-suisse.com under the publications tab.  The key takeout which hasn’t changed since the publication began is that Australia over the last 120 years has been the best performing stock market globally.

The second is the Berkshire Hathaway annual general meeting in early May in Omaha Nebraska USA where Warren Buffett (now aged 89) and his side kick Charlie Munger (now aged 96) report on the performance of Berkshire Hathaway. This took place on May 2^nd. Known as the Woodstock of capitalism each year the event fills an auditorium of over 40,000 to hear the investing insights of two of the world’s greatest ever investors. This year COVID-19 saw Buffett address an empty auditorium without Charlie and the webcast is readily available on Yahoo Finance and YouTube. It is always worth a listen. In his usual folksy, home spun style Buffett put the pandemic in the context of the many events that have shaped America and at times caused major disruptions in its stock market.  His key takeout ‘never bet against America and that in my view is as true today as it was in 1789.’

We have cash to deploy in our model portfolios for Interest-Bearing Securities and Core Australian Equities and it is our intention to remain overweight Australian and US equities subject as always to sensible and COVID-19 adjusted company earnings and valuations.  

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Sources:  Commbank Global Markets Research, RBA, Morningstar.