Author: Britt Ambrose

Introduction

Six things that went wrong in 2021

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

But there were three big positives

• 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.
• As a result, the broad trend was towards global reopening.
• Monetary and fiscal policy remained ultra-easy.

As a result, global growth is estimated to have been nearly 6% and 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

• 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.
• Shares climb a wall of worry – particularly if earnings are rising and interest rates are low/monetary policy is easy.
• Timing market moves is hard and the key is to have a well-diversified portfolio – despite lots of worries share markets overall surprised with their strength but some share markets (eg in Asia missed out) and bonds performed poorly.
• Turn down the noise – investors are getting bombarded with irrelevant, low quality and conflicting information which confuses and adds to uncertainty. So, the best approach is to turn down the noise and stick to a long-term strategy.

Seven reasons for optimism on economic growth

• Coronavirus could finally be moving from a pandemic to being endemic – more on this below.
• Excess savings of around $US2.3trn in the US and $250bn in Australia will provide an ongoing boost to spending.
• While Fed and likely RBA monetary policy will tighten this year it will still be easy. It’s usually only when policy becomes tight that it ends the economic cycle & the bull market and that’s a fair way off.
• Inventories are low and will need to be rebuilt which will provide a boost to production.
• Positive wealth effects from the rise in share and home prices will help boost consumer spending.
• China is likely to ease policy to boost growth.
• 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 wave resulting in a brief set back in the March quarter. We have revised down our March quarter Australian GDP forecast by 1% to 0.6%, but revised up subsequent quarters by the same.

Four reasons for optimism regarding coronavirus

The current situation is quite worrying. Global and Australian coronavirus cases have surged over the last month. Australia managed the first 22 months of the pandemic highly effectively with a suppression strategy that minimised deaths and supported the economy. Following the further relaxation of restrictions since November, significant pressure has been placed on the health system. Overseas experience showed a reopening rebound in Delta cases in even highly vaccinated countries (eg, Singapore). And the Omicron variant arrived in late November with clear evidence it was far more transmissible than Delta. All at a time when much of the population has yet to have a booster shot. The end result looks like being another hit to the economic recovery in the current quarter as people self-regulate to avoid covid or have to isolate. However, each covid wave seems to be having a smaller negative economic impact. More fundamentally, despite the short-term uncertainty there are four reasons for optimism regarding coronavirus:

• Vaccines are still providing protection against serious illness – particularly once booster shots are administered.
• New coronavirus treatments are on the way which will aid in the treatment of the more vulnerable.
• 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.
• Past covid exposure is providing 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 & 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.

• 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.
• 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%.
• Still very low yields & a capital loss from a rise in yields are likely to again result in negative returns from bonds.
• Unlisted commercial property may see some weakness in retail and office returns, but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.
• 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.
• Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
• Although the $A 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

• Inflation – while its likely to moderate this year as production rises & goods demand subsides it is likely to be associated with ongoing scares and the risk that its higher for longer.
• 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.
• 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.

Source: Strategas, AMP

• China/Russia/Iran tensions – a partial Russian invasion of Ukraine could lead to even higher European gas prices.
• 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

• Coronavirus – new variants could set back the recovery.
• Inflation – if it continues to rise and long-term inflation expectations rise, central banks will have to tighten aggressively putting pressure on asset valuations.
• 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.
• China issues are likely to continue – with the main risks around its property sector and Taiwan.
• Russia – a Ukraine invasion could add to EU energy issues.
• The Australian election – but if the policy differences remain minor, a change in government would have little impact.

Nine things investors should remember

Yeah – I put these in most years!

• 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%pa (ie, 72/0.5) but only 14 years if the asset returns 5%pa.
• 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 & risk tolerance & 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 its often hard to stick to a long-term investment strategy on your own

Closing comments

We send out economic updates like this one to provide our valued clients with a so much needed perspective. Not to create headlines, not to forecast, but instead, to give you a balanced update of what we’ve been doing behind the scenes. To let you know that we’re monitoring this stuff, so you don’t have to.

Mainstream and financial services media make it very attractive to capture our eyeballs. They want us to think that whatever the crisis du jour is, it’s something we really need to know. The difference between you and other people around you is that you have a plan in place, and you have someone to talk to. Someone who knows you and your plan and someone who understands what’s important to you and your family. It’s what really matters – knowing if one’s on track with their long-term plan. Everything else is commentary. If you review your progress and strategies with us yearly, you maximise your chances to achieve your desired lifestyle.

You and I are long-term, goal-focused, plan-driven equity investors. We believe that the key to lifetime success in equity investing is to act continuously on a specific, written plan. Likewise, we believe substandard returns and even investment failure proceeds inevitably from reacting to (let alone trying to anticipate) current economic/market events. We’re convinced that the economy cannot be consistently forecast, nor the markets consistently timed. Therefore, we believe that the only reliable way to capture the full long-term return of equities is to ride out their frequent but historically always temporary declines.

We look forward to seeing all our clients face to face or via video link depending on what works best at the time. The important thing is when your financial planner says we need to talk, make sure you put time aside as it’s about your future.
Goodbye and good riddance to 2021, wishing all our clients a healthy and prosperous 2022.

Bill and the team at SFP.

What does your long-term strategy and investment opportunity for 2022 look like?

Speak with one of our Financial Planners about the best approach for your circumstances, either book a meeting or get in contact with us on 02 9328 0876.

This article was prepared by William Bracey and Dr Shane Oliver. Dr Shane Oliver who provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

General Disclaimer: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. Please seek personal financial advice prior to acting on this information.

The global rebound was led by China but looks like being led by the US this year reflecting rapid vaccine dissemination and massive fiscal stimulus. Expect stronger growth in Europe and Japan in the second half as vaccine dissemination there speeds up.

Are vaccines working? What about new variants?

Yes. There are now five western vaccines along with vaccines from Russia and China. The evidence from numerous trials and results from Israel (where 58% of the population have received at least one dose) and the UK (where 45% have received at least one dose) indicate that the various vaccines are around 75% plus effective in heading off infection and 100% or near effective in preventing serious illness, hospitalisation or death (including for new variants).

This is evident in a sharp fall in new cases, hospitalisation and deaths in Israel, the UK and US (where “only” 29% have received at least one dose but about 3 million people a day are now being vaccinated).

Will the ending of JobKeeper derail the Australian recovery?

This is doubtful. The best guide to those vulnerable to job loss from JobKeeper’s end is those working zero hours and this was only running around 70,000 above normal in February which is down from 720,000 in April last year – the loss of 70,000 jobs would push unemployment up but only by around 0.5% and from a much lower than expected level of 5.8% in February and don’t forget that nearly 90,000 jobs were created in February; another 100,000 above normal were working reduced hours but they are more likely to see a reduction in income rather than job loss; various measures of job vacancies are running around 15% above year ago levels suggesting that job losses in travel and CBD-related service businesses should be made up elsewhere; JobKeeper’s injection into the economy has already dropped from $12bn a month last September to $2.5bn a month in March and yet the economy has continued to recover; and its removal will be partly offset by other forms of stimulus such as personal tax cuts and investment incentives. We expect the Australian economy to grow by around 5% this year.

What about the ongoing snap lockdowns in Australia?

These are disruptive and a huge barrier to making domestic travel plans, but providing they remain short, the overall economic impact will be minor (as they have been lately). Faster vaccine rollout (with CSL production kicking in) should end them later this year once herd immunity is reached. Of course, if the Brisbane’s snap lockdown (or any other) turns out to be long then the Government may have to consider reinstating JobKeeper or something similar for areas affected.
The new travel bubble is another sign of recovery and a positive outlook.

Is inflation going to become a problem?

Annual inflation is likely to rise towards 4% in both the US and Australia in the months ahead as last year’s price falls drop out, higher commodity prices along with goods supply bottlenecks impact and flood driven rises in fresh fruit and vegetable prices in Australia impact. However, this is likely to be temporary as distortions drop out, goods supply picks up & demand swings back towards services and as wages growth likely remains low.

Beyond the next 2 to 3 years though the risks on inflation are likely to swing to the upside as spare capacity is used up and ultra-aggressive monetary policy ultimately pushes up inflation at a time when the disinflationary impact of globalisation is starting to fade, and governments are becoming more interventionist in their economies. In other words, we appear to be at a similar juncture to the peak in inflationary pressures seen in the early 1990s – but in reverse.

What is the best protection against higher inflation?

Sustained higher inflation will ultimately mean upwards pressure on the yield structure in the economy which could be negative for investments that have benefitted from years of low and falling interest rates like high PE tech stocks. Share market is generally the best protection against sustained higher inflation as it provides higher than inflation total returns. In the next couple of years we also expect inflation linked bonds and real assets like commodities and infrastructure to provide quality yields.

When will interest rates start to rise?

Both the Fed and RBA are signalling no rate hikes until 2024 at the earliest as they see it taking this long before labour markets are tight enough to sustain inflation at or just above target. We think it could come a bit earlier in 2023 but that’s still a long way off. Europe and Japan are even further away from raising rates.

Note though that fixed mortgage rates take their que from long term bond yields and so have already started to bottom out.

Will massive levels of public debt cause a problem?

This could become an issue, but a major crisis should be avoided.

First, public sector borrowing costs are still ultra-low.

Second, Japan has had high public debt for years without a major problem.

Third, it’s conceivable that if a problem did arise, governments could cancel the bonds that their central banks now own. Finally, in Australia public debt is relatively low.

What is the risk of next share market ‘crash’?

Shares have had a strong rebound from their pandemic lows a year ago and are always vulnerable to a decent correction, this could be triggered by an ongoing sharp rise in bond yields or new coronavirus waves ahead of heard immunity. While a correction is always a risk, as you (hopefully) know, it’s not something to fear.

First, it’s normal for share market returns to slow in the second 12 months after a bear market low as markets are no longer cheap and they become dependent on higher earnings.

Second, while the rise in bond yields this year has been sharp it reflects the bond market playing catch up to the economic recovery that share markets started to anticipate last year.

Third, share market offers strong earnings yield premium relative to bond yields in contrast to in the year 2000 when bond yields rose were above earnings yields. So, shares are not overvalued. Fourth, earnings expectations have been revised up sharply so far this year on the back of the improving growth outlook. Fifth, we are still not seeing the sort of economic overheating, monetary tightening and investor euphoria seen at major market tops. Finally, in relation to the US share market being at a record high – markets are often at all-time highs as shares rise over time.

Will the $A resume its upswing?

After briefly hitting $US0.80, the rise in the $A has stalled as the $US rebounded. But with non-US growth likely to accelerate with vaccine deployment, Chinese growth likely to remain strong and some US stimulus leaking globally commodity prices are likely to be strong and safe haven demand for the $US will continue to fall so the upswing in the $A is likely to resume, seeing it end the year above $US0.80.

Should investors invest in Bitcoin?

How big a threat are tensions with China?

For now, the impact on the Australian economy (as opposed to individual sectors) by the tensions with China has been muted by strong commodity prices, the ability to redirect some exports to other markets and China’s practical short-term difficulties in replacing Australian iron ore (there is basically not enough other supply sources). But it’s an issue to keep an eye on.

Why is there another boom in Australian house prices?

Several things are likely to eventually slow it down though, particularly from the second half:

• Government housing incentives are likely to be curtailed;
  • the RBA and APRA are expected to reach yet again for macro prudential controls to slow housing lending. While they don’t target house prices, past experience indicates that surging house prices leads to a deterioration in lending standards and increasing financial stability risks, so it makes sense to start taping the lending standards’ brake soon. First thing to do would be to increase interest rate buffers
  • the recovery in immigration once international borders are reopened is likely to be gradual, resulting in an underlying oversupply of dwellings;
• it’s likely that the 30-year tailwind for the property market of falling interest rates has now run its course and longer dated fixed rates are starting to rise; and
• poor affordability is starting to become a constraint again.

Closing comments

There is a lot to digest here but if you think about where we were this time last year, a lot of these headlines are what we were hoping for back then. Having faith in the future is crucial in investing and this recovery was a good example of what happens when we stick to our plans and we don’t abandon this important investment principle. Big congratulations to all our clients who listened to our guidance and rode out another bear market via disciplined dollar cost averaging. You and your families have benefited from the correction’s discounted prices, not because we’re smarter, not because we have better investment skills, but because of the faith in the future.

The value of the advice you have received is paying off, please make sure you respond to our annual progress review calls, as this is where we will address your individual situation and plan and help you navigate the times ahead.

Bill and the team at SFP.

Is your investment strategies for your 2021 portfolio in need of review?

Speak with one of our Financial Planners to help you navigate the best approach for you, either book a meeting or get in contact with us on 02 9328 0876.

This article was prepared by William Bracey and Dr Shane Oliver. Dr Shane Oliver who provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

General Disclaimer: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. Please seek personal financial advice prior to acting on this information.