Investment Matters

Looking ahead of a recovery

The GameStop-induced volatility and uncertainty we have witnessed was quelled over the week, which saw markets recover.

The focus now turns to upcoming profit updates from companies as we begin reporting season for the first half of the 2021 financial year. We will provide updates on how your companies are faring over the coming weeks.

The February 2021 profit reporting season follows a series of crucial reporting periods: the conclusion to FY-20 in August - when companies updated the market after the pandemic hit, and subsequent updates during Annual General Meetings in October and November as economies began to recover.

Australia is yet to complete an economic recovery; however, markets are forward-looking and have largely recovered from their February 2020 lows. Valuations have returned to and in many cases now exceeded pre-pandemic highs.

The next few weeks will be crucial in assessing the trajectory of the recovery in earnings and how companies have adapted to significant structural and cyclical change.

Embedded in current valuations are expectations of a swift economic recovery and continued monetary and fiscal support - expectations that were buoyed by the announcement of renewed policy support by the RBA.

In a speech on Wednesday, Governor Lowe recapped the success we have had domestically in overcoming the challenges of the year that has passed. The economy is faring far better than expected.

However, challenges remain, with the central bank renewing its commitment to continue to keep interest rates lower for longer.

We dissect the RBA’s review of the year that has passed and their prognosis for “The Year Ahead”.

“The Year Ahead”

The economy has recovered with a rapidity that was not anticipated by the Reserve Bank. Unemployment and GDP are both tracking well ahead of the expectations set in August 2020.

This has resulted from success in suppressing the virus, strong fiscal support and the adaptability of households and businesses during this period.

In a speech entitled “The Year Ahead” RBA Governor Lowe outlined how it now expects GDP to return to its end-2019 level by the middle of this year. Expectations are that the economy will grow by 3½ per cent over both 2021 and 2022. This, of course, hinges on continued success in suppressing Covid transmission, and a vaccine rollout.

Unemployment rate

The RBA has assisted over the past year by implementing measures that have kept interest rates and funding costs low (both short term and longer term) for corporations and households.

Given the resilience shown, economists had expected the RBA to begin withdrawing some of the support it has provided over the past year. Against consensus, the RBA signaled it would extend its recent asset purchase program and funding support to banks.

Why? Because the RBA sees that challenges remain, and that their actions have unique power in our economy.

We didn’t agree with the move but were not surprised by it.

The economy is still operating below its productive potential, unemployment is still high relative to recent history and more importantly, wage growth has continued to be anaemic.

 

Wage Price Index

Private sector investment, which was already problematic prior to the virus, remains very weak. This would be devastating for the economy were it not for:

  • policy-assisted rebound in housing activity, and
  • the enormous level of public sector investment catching up on decades of under investment in infrastructure.

Furthermore, the country faces a headwind in reduced population growth, which has been a key driver of GDP growth as per capita GDP has stagnated. Should population growth remain muted, and the combination of fiscal and monetary support continue, we see enormous capacity for our nation to invest in a range of transport improvements, clean energy, and public services such as health and education.

Higher quality construction and related professional services jobs growth will also support wage growth, otherwise battered by the pandemic.

For investors, the distinction between GDP growth for its own sake, and GDP growth per capita where individuals are better off through higher productivity and wages, could not be starker. Share markets rise and sustained wealth is created when per capita growth is strong; Bigger pieces of the pie rather than a bigger pie, is the best analogy.

The Years Ahead

There have been some key changes in the economy over the past year that may have an enduring influence in meeting these challenges.

The strong fiscal support provided to businesses and households alike over the past year has been an unequivocal positive.

Unprecedented support for households has seen an increase in the savings rate which has led to the strong levels of consumption. These savings have been redirected towards electrical goods, homewares, and the residential housing sector as evidenced by home sales and renovation activity.

This has been one of many changes to habits and preferences that we have seen over the past year.

As Governor Lowe highlighted in his address on Wednesday, “the world has changed tremendously.”

To see this, we look no further than retail sales, with the online share of retail sales growing by almost 100% over the past year.

Retail sales online

We operate with the ethos that there is great peril in assuming “nothing will change.”

The last 12 months have set in motion the wheels for structural change, most notably growing acceptance of the critical role of the public sector and fiscal support.

We see that changes during this period, the fiscal response to them and the social license given to implement them leave economies better positioned to tackle the challenges ahead.

These include not only imminent economic challenges, but also the enduring environmental challenges, growing social tension arising from inequality, stubbornly low inflation, and stalling growth.

As history has demonstrated, the maintenance of fiscal support provides a strong foundation for finding a solution to many of these challenges.

The subsequent potential for growth in nominal activity, rise in inflation and eventual normalisation of interest rates is something we see as underappreciated in the current market.

This potential for change is likely to be a critical consideration in protecting and growing wealth in the years ahead.