Investment Matters

Macro Matters

This week came with a flurry of economic data, all of which pointed to the Australian economy continuing towards better recovery than expected.

We provide a summary and what to make of it.

The economy: Australia leading the recovery

The release of the National Accounts on Thursday pointed towards a continued recovery in the Australian economy over the March quarter.

GDP rose by 1.8% (from the December quarter in 2020 to March of 2021) - which was broadly higher than most economists expected.

Year on year comparisons of GDP growth are, of course, tainted by the COVID downturn.

However, the March quarter GDP now exceeds pre-GFC levels, 0.8% above levels seen in the December quarter of 2019.

Australia’s GDP now above pre-covid levels

Australias GDP

This puts Australia’s economic recovery in rarefied air relative to other economies on the global stage:

Australian recovery shines on the global stage

Australias recovery shines on global stage

This can be attributed to our handling of the health crisis (putting aside recent fumbles) and the strong government and monetary support provided in response.

The charts below break down the drivers of growth this quarter:

Housing, business investment and consumption grew strongly
Drivers this quarter
Source: UBS
Rebuilding of inventories and rebounding consumption drove overall growth.

Rebounding inventories and consumption

These charts broadly point to the private sector beginning to rebound with government spending a much smaller direct driver of growth (although still a substantial contributor to GDP overall).

Some highlights included:

- Household consumption continued to recover as lockdown measures unwound.

  • While still largely driven by purchases of goods, the consumption of services (e.g. arts, recreation, hospitality etc.) has slowly begun to recover (up 2.4% in the quarter) as the economy opened up and consumers had more opportunities to spend.
  • Looking forward, a continued recovery will likely be driven by households drawing down on the substantial savings they have accumulated during COVID.

- Business investment began to improve after many quarters of stagnation.

  • Businesses took advantage of the Federal government’s instant asset write off scheme and spent more on business machinery and equipment, increasing 2.9% in the quarter.
  • Business investment stagnated post-COVID as companies deferred or cut investment decisions: the return to investment speaks to rising business confidence.

- Housing investment boomed on the back of stimulus measures such as homebuilder, mainly driven by alterations and/renovations.

As we have stressed before, the National Accounts are a backwards-looking report card: a story of “what has happened”.

Clearly, Melbourne’s most recent lockdown will put a damper on the recovery in the coming quarter.

The March quarter does however provide optimism about the path forward.

There are signs that private consumption and business investment are recovering, helping the economy regain lost ground.

This of course will hinge on continued fiscal and monetary support and a (hopefully much more) successful national vaccination program.

Monetary policy: move along, nothing to see here (for now)

Reserve Bank meetings over the past months have become a muted affair, with the board largely maintaining their patient “wait and see” stance when it comes to any changes in policy.

In June the Reserve Bank reiterated that it will continue to maintain accommodative policy, continuing to pin interest rates at their current lows (0.1% for both the overnight cash rate and 3-year government bond yields).

It does not expect the overnight cash rate to move anywhere until at least 2024.

However, changes to its current quantitative easing program are likely to be announced when it meets in July.

While this may spell winding back of ultra-easy policy, we are of the view that this will be a measured and slow rollback, with rates to remain accommodative in the medium term.

Financial markets: waiting for Godot?

Over the past few months, markets have remained vigilant for any changes in highly accommodative fiscal and monetary policy.

The belief is that wage growth and falling unemployment are likely to signal winding back of accommodative policy which will flow through to lower asset prices.

We have already seen some central banks talking about peeling back support (such as the Bank of Canada, Bank of NZ).

We have therefore seen markets gyrate based on a neurotic scrutinization of central bank and government discourse.

So far, all indicators show that strong support will continue, however, all eyes remain on labour markets – with central banks shifting their focus to accommodating a robust recovery and full employment.

For us, the risk of higher inflation is a much more important consideration.

Looking at the Australian economy, we are in an interesting position.

Our economic recovery has been strong.

Furthermore, as the chart below highlights, the response to COVID-19 has injected an unprecedented amount of cash into the economy.

This week’s GDP figures showed that there is still large latent potential for household spending: the household savings ratio continues to remain high, with a lot of cash from COVID stimulus measures continuing to sit on the sidelines.

The economy continues to be flush with cash

Flush with cash

Added to this, closed borders and reduced migration are shrinking Australia’s workforce.

With borders shut, the working Age population and population growth have plummeted.

Plummeting population

Source: Minack Advisors

In this environment, we are already seeing wage growth beginning to tick upwards, with reports of labour shortages and with continued border closures likely to provide further acceleration to wage growth.

Leading indicators point to rising wages

Rising wages

Source: Minack Advisors

We see the combination as providing an upside risk to inflation.

On this basis, we had expected market vigilance and tempered returns in the near term.

However, they have continued to climb higher. We are holding higher levels of cash in this environment, as we ultimately see the market as incorrectly assessing this risk of inflation. Our focus continues to be on buying companies that we see as cheap that will benefit from such a shift.