Economic Update April 2020 – The Blackest of Swans

We are in the midst of a global pandemic. It is the blackest of black swan events. Conservatively over 1.3 million have been infected globally with more than 70,000 deaths. Infection rates globally continue to rise.

In Australia the Governments response has been to go hard and go early.  The first mandatory measures were introduced on March 15^th and in less than two weeks we have moved from bans on gatherings of more than 500 people to bans on indoor and outdoor gatherings of more than 2 people.  Overseas travel is banned, and QLD, WA and Tasmania have closed their borders.

The first priority is a health one with the objective of saving lives, slowing the rate of infection and ensuring our health system can cope and continue to deliver quality care.  To date there are encouraging signs that the measures are working.  The latest data (April 6^th) from the health.gov.au website shown in the chart below shows there have been 5795 confirmed cases of COVID-19 in Australia and 39 deaths. The number of new cases was 181.  The trend in Australia is encouraging. The number of new cases is falling, and the curve is flattening.  Australia is doing much better than most of Europe and the USA in both the number of cases and the death rate relative to population.

The second response is an economic one. In a matter of weeks vast swathes of our economy have been shut down with millions overnight losing their livelihood. Sectors most impacted include entertainment and recreation, cafes and restaurants, travel and tourism, tertiary education, discretionary bricks and mortar retailers, shopping centres and many personal services such as hairdressing, beauty treatments and religious services to name a few. Many more businesses that remain operational are experiencing major revenue declines forcing layoffs and reduced working hours.

In response to the shut down and economic fallout the government has announced a broad range of fiscal and other policy measures to support individuals/workers, businesses, the broader community and the stability and functioning of financial markets. Three major fiscal packages have been announced.   The latest and largest is the JobKeeper payment with about 6 million workers to receive a fortnightly payment of $1500 before tax for up to 6 months through their employer. The objective is to keep employers and employees connected in preparation for a quick restart once the crisis is over.  Other initiatives include two automatic payments of $750 to social security recipients to support domestic demand and the introduction of extra income support payments to eligible individuals affected by COVID-19. This time limited Coronavirus supplement is to be paid at a rate of $550 per fortnight.  All up the three major packages are expected to cost around $200 billion or around 10% of our economic output or GDP. 

Monetary policies to help support the economy were also announced after a specially convened Reserve Bank of Australia meeting on March 18^th. including reductions in funding costs and ensuring liquidity and credit availability.  The RBA reduced the cash rate by a further 0.25bps to 0.25% and introduced a term funding facility for the banking systems with particular support for credit to Small and Medium sized businesses. The RBA has launched its first quantitative easing program.

Other initiatives most relevant to you our clients in areas such as reduced drawdown rates in account-based superannuation pensions and rental reductions and deferrals impacting property investments are provided at the end of this update.

This level of stimulus is unprecedented and designed to keep the economy and businesses on life support until the crisis passes.  In this sense the health response is also an economic one.  The sooner the virus is contained the sooner the economy can be taken off life support. To date the speed, quality and quantity of the response from both the health sector and all levels of government has in our view been impressive and appropriate.

We do not need to wait for official statistics to confirm what we already know. Our economy is now in recession with economic growth forecast to contract by about 4% year on year in CY2020. GDP growth is likely to be negative for the year. The underlying unemployment rate has conservatively tripled to above 15% but the official rate is expected to rise to around 10% with the introduction of the JobKeeper package.  How deep and how long the recession will last and how fast and robust the recovery will be is simply too early to call.  There are still many unknowns around how this crisis will play out globally and domestically. The reverberations particularly in highly indebted developed countries (eg Italy and Spain) and emerging economies dependent on commodities and tourism are likely to be felt over years not months.

What we can say is that just as was the case in the Global Financial Crisis (GFC) Australia is better positioned than most to weather the storm on a number of fronts.  Firstly, most of our trade is with Asia. China, Japan and South Korea our three largest trading partners. (see December update).  There are early signs China is recovering and to date somewhat surprisingly the impact on our mineral and energy exports to China has been minimal.  Our agricultural sector is also recovering from years of drought with the prospect of stronger sales to Asia. Japan and South Korea are also doing better on containing the virus than the US and Europe. In short it appears likely our traditional primary industries will help cushion the impact of the sharp fall in services and services exports such as education and tourism.

Secondly our Government debt to GDP ratio is low by global standards.  Government debt to GDP is expected to rise from about 18.5% in 2019 to 28% post the stimulus package and possibly higher as GDP and government revenue contracts. This compares the UK and the USA where debt to GDP is over 100% and rising. In short as a country we are in a much better position to fund such a massive stimulus program.

Thirdly Australia has a world class health system. Australia’s heath workers we salute you!

The sudden and global nature of the shutdown has reverberated across financial markets.  Stocks have seen the fastest monthly and quarterly falls in history with markets domestically and internationally down by around 30% in March. As noted in recent updates markets were overvalued in our view by about 30% and were long overdue for a correction. We are now back in fair value range but with increased uncertainly around future earnings. Domestically most of the companies that provided future earnings guidance during the February reporting season have withdrawn it. Given the level of uncertainty it is probable recent lows could be retested and markets could go lower. Interest rates have been lowered ending any prospect of rising yields on government bonds and other interest-bearing securities in the short term.

Major market corrections and heightened levels of uncertainty almost always provide long term investors like ourselves with relatively rare opportunities to buy quality companies and securities at significant discounts to underlying fair value. It is our job to use these periods to capitalise on opportunities and set the portfolios up for the next phase of long-term outperformance. In the Australian equities portfolio, we have been reducing our exposure to banking in favour of quality stocks with both growth and defensive qualities in sectors such as health care and this correction should enable us to reposition the portfolio faster than anticipated.  It is also our intention to improve the diversification in the portfolio, lower the risk with continued focus on our investment philosophy. It is pointless to try and predict when the market will bottom and/or the timing of the recovery. Our strategy is simply to average into the market over the coming weeks and months as opportunities present themselves.

This crisis as always will pass and our highest quality companies will emerge stronger, leaner and better positioned to capitalise on the recovery phase.   

Legislative Update

Changes announced to Account Based Pensions

As part of the Coronavirus stimulus package the government has announced the reduction in the minimum drawdown requirements for Account Based Pensions.  The changes will apply for the current year (2019-2020) and 2020-21.

Other changes

Other changes include the increase to the cap for Financial hardship access to super from $10,000 to $20,000 pre tax.

There are several other measures announced for Employees, Small to Medium Business and Centrelink. We will not cove them here but are happy to answer questions.

Impacting the direct property syndicates held by clients and directly owned commercial and residential property is the unprecedent issue of tenants not paying rent. The Federal Government has draft policy for the State Governments to implement:

The Prime Minister announced the mandatory Code of Conduct that imposes good faith leasing principles on landlords of commercial tenancies that are suffering financial stress or hardship due to COVID-19.

KEY POINTS:

• Tenant is covered by the Code if they qualify for the Job Keeper Payment.
• Tenant must have an annual turnover of no more than $50M.
• Code applies from 30 March 2020 to 27 September 2020.
• Leases must not be terminated due to non-payment of rent.
• Landlords must offer rent reductions in proportion to reduction in tenant’s trade in two forms:
  • At least 50% of the rent reduction must be a rent waiver.
  • The balance must be a rent deferral which is amortised over the greater of 2 years or the lease term.
• Landlords must pass on to tenants a proportionate share of benefits received from the deferral of loan payments.
• Landlords cannot charge fees or interest on waived or deferred amounts.
• Landlords cannot draw on tenants’ bonds.

How a tenant reports a drop in turnover to their landlord is possibly going to be a an issue. The words ‘good faith’ have been used quite a lot on aspects of the stimulus packages. How the ATO reports to a business they qualify for JobKeeper remains to be seen as well.

The Code of Conduct is available here: https://www.pm.gov.au/sites/default/files/files/national-cabinet-mandatory-code-ofconduct-sme-commercial-leasing-principles.pdf  

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Sources:  Commbank Global Markets Research, RBA, Morningstar.