A purple wave
We witnessed three noteworthy macro-economic events over the week: one largely foreshadowed, one largely unexpected and one which likely represents more of what is to come.
These events reflect three policies investors are currently laser-focused on: central bank policy, fiscal policy, and foreign policy.
We explore how they shaped markets this week and may shape them beyond.
Central bank policy: A cup day cut as the RBA hands over the reigns
While not going as far as saying he would do “whatever it takes” (a term coined by Mario Draghi during the European Debt Crisis), on Tuesday our governor committed that the Reserve Bank will do “whatever we (it) reasonably can”.
As foreshadowed, the Reserve Bank of Australia announced a range of cuts to important short-term interest rates in the economy.
The rate cuts deliver a small reprieve for borrowers (household, corporate and government) while exacerbating an already challenging return environment for savers.
However, the most significant news was the $100bn commitment to control longer-term interest rates (5 and 10-year bonds), through the purchase of state and federal government bonds.
Yes, the Reserve Bank has now officially crossed over to the realm of quantitative easing - bringing our policy in line with that which has been implemented for several years globally (admittedly to mixed effect).
And while this action will have an impact on the economy resulting in lower borrowing costs, reducing upward pressure on the currency and supporting asset prices, the commitment to underwrite interest rates and the “passing of the torch” to fiscal policy more significant.
With interest rates approaching their floor (and negative rates ruled out for now), fiscal policy will be the rudder of the economy and recovery. Maintaining an appropriate fiscal response and support therefore remains key.
Fiscal policy: A purple wave - pollsters, postal votes, and the pending outcome of the Presidency
Not quite the blue wave that was expected. The polls were wrong. Very wrong.
The best analysis prior to Wednesday’s US election suggested that Biden would likely be President, even after allowing for a significant polling error. Skip forward to Friday morning and a “definitive” result has yet to be announced.
While we are not as brave as some to label the election a “win” for either party, what is certain is that once again, the “near certainty” that was predicted did not eventuate. This means much more even representation of both parties (with a Democrat House and Republican Senate likely) and a likely extension to the congressional gridlock and filibustering we have seen.
As we highlighted earlier, in a low rate environment fiscal support remains key. With the congressional gridlock continuing we are less likely to see action on the fiscal front and less potential for reform more broadly.
When it comes to fiscal spending, it appears the cheque many had been expecting may be lost in the mail for a little while longer.
A key consequence is the US$2.2t Democratic fiscal expansion partly funded by corporate tax increases is likely to be downsized (potentially to a US$500bn package with no corporate tax increases instead).
What does it all mean for stocks?
Counterintuitively, the US market bolted out of the gates on Wednesday (S&P500 +2.2%, NASDAQ +3.5%).
Some of the reaction was to the prospect of lower corporate taxes - which are a clear win for shareholders. However, with, less fiscal support, monetary policy will likely continue to dominate and be required to provide a backstop for the economy. This means less potential for rate rises and a “more of the same” approach, supporting asset prices.
Secondly, Growth and Technology stocks have regained some of their lustre. As we have mentioned, the share prices of these companies benefit from an environment where there is lower growth and low-interest rates. Furthermore, for the tech giants, the threat of anti-trust action has now significantly diminished. We, therefore, saw the NASDAQ rally sharply on Wednesday (+3.5%).
Conversely, financials and materials are less likely to have the same wind at their backs that they have had over the past few months, with less upward pressure on interest rates and less potenetial demand driven by fiscal spending. This is perhaps more relevant to the Australian market, which is likely to experience less of an upswing than its US counterpart.
Short term movements aside, in the longer term, we see there is likely to be less potential for reform (political, judicial, regulatory or otherwise) and fiscal support than what had previously been anticipated. This somewhat curtails the prospect for stronger nominal growth. While the election may be a shot in the arm for US equity prices in the short term, longer-term economic, social and political impacts remain to be seen (as does the eventual outcome!).
Foreign policy: Pressure from the politburo
Early this week there were reports from China of a ban on seven categories of Australian exports, including wine, coal, barley, copper ore and concentrate, sugar, timber, wine and lobsters.
And while for a greater number of Australian’s, wine and lobster may now be on the menu, they leave Australian industry with a bitter aftertaste.
The ban extends the tit for tat we have seen between the Australian government and China over the past year – with a halt to coal imports early last year, tariffs imposed on Australian barley exports, and an antidumping investigation launched against the Australian wine industry in August.
These rising tensions have been a key consideration, as clients’ will note by recent activity, notably our efforts to reduce our exposure to coal early in the year. As we have mentioned, several positions in the portfolio will benefit under a scenario of rising tensions or the “reshoring” and bolstering of domestic supply chains, such as Lynas and Viva Energy.
Furthermore, the portfolio has been positioned to minimise direct exposure to trade with China, with little exposure to industries heavily reliant on Chinese trade or demand, including the education sector, or “daigou” and discretionary export exposures (wine, baby formula etc).
Given China is our most significant trading partner, a further escalation of tensions remains a risk to the domestic economy, but one we are cognisant of and actively managing.