Olivers Insights

2020 has seen a very noisy start to the year with one major event with significant human and investment market implications after another. For Australia it started with an intensification of the bushfires but moved on to a significant ramping up of US/Iran tensions where, according to President Trump, war came “closer than you thought” and now the coronavirus outbreak is creating fears of a global pandemic and a big hit to global economic activity. These are scary in terms of their human consequences, but also in terms of the potential economic fallout and what it means for investors. The coronavirus outbreak in particular continues to pose significant uncertainty around the short-term economic outlook. In terms of the key things to watch there is some good news with signs of a reported slowing in new cases in China and still limited transmission outside China (which has 99% of cases).  

Source: PRC National Health Commission, Bloomberg, AMP Capital

And the mortality rate at just over 2% remains lower than with SARS. Against this there remains much debate about the true number of cases, it’s common in outbreaks to see periods of stabilisation only to be followed by a spike in cases and the disruption to economic activity in China and from global travel bans remain significant all of which makes it easy to imagine the worst in terms of economic consequences. Each week China remains say 2/3rds shut it knocks 1.3% off its GDP or 0.25% directly off global GDP.

Then again much of 2018 and 2019 saw endless talk about how much the trade war was going to knock off global growth. More fundamentally, the coronavirus outbreak is part of a seemingly never-ending worry list which is receiving an ever-higher prominence as the information age enables the rapid dissemination of news, opinion and noise. But as Frank Zappa warned “information is not knowledge, knowledge is not wisdom”. The danger is that information overload is making us worse investors as we focus on one worry after another resulting in ever shorter investment horizons.

Are the worries more worrying than ever?

When I was a teenager in the 1970s I used to bemoan my grandmother for reading too much gloom into the nightly TV news and telling me that the world is much worse today than when she was young….when there was WW1, Spanish influenza that reportedly killed around 50 million people, the Great Depression and WW2 when her brother was killed. However, now it seems the worry list is even bigger. Yes, there is a fundamental element as global growth is slower, technological disruption is leading to worker anxiety and inflated expectations, and the world seems awash in geopolitical risks.

But there is a huge psychological aspect to this that is combining with the increasing availability of information and intensifying competition amongst various forms of media for clicks, that is magnifying perceptions around various worries.

We all suffer from a behavioural trait that in its financial manifestation is known as “loss aversion” in that a loss in financial wealth is felt much more distastefully than the beneficial impact of the same sized gain. This probably reflects the evolution of the human brain in the Pleistocene age when the trick was to avoid being eaten by a sabre-toothed tiger or squashed by a woolly mammoth. This makes us biased to be more risk averse and on the lookout for threats which leaves us more predisposed to bad news stories as opposed to good news stories. So bad news and gloom find a more ready market than good news or balanced commentary as it appeals to our instinct to look for threats. Hence “bad new sells”. Of course, this has always been the case so there is nothing new here.

The big change though is that we are now exposed to more information in relation to everything including our investments. This is great in the sense that we can check things, analyse them and sound informed easier than ever. But often we have no way of weighing such information and no time to do so. If we can’t filter it, it becomes information overload and noise. This can be bad for investors as when faced with more (and often bad) news we can freeze up and make the wrong decisions with our investment as our natural “loss aversion” combines with what is called the “recency bias” that sees people give more weight to recent events which can see investors project recent bad news into the future and so sell after a fall.

Finally, the problem is being compounded by an explosion in media outlets all competing for your attention. We are now bombarded with economic and financial news and opinions with 24/7 coverage by web sites, subscription services, finance updates, dedicated TV and online channels, etc. And in competing for your attention, bad news and gloom trumps good news and balanced commentary as “bad news sells.”

So naturally it seems that the bad news is ‘badder’ and the worries more worrying than ever. Google the words “the coming financial crisis” and you get 236 million search results – up from 115 million when I did it 18 months ago – with titles such as:

• “World economy is sleepwalking into a new financial crisis”;

• “4 early warnings signs of the next financial crisis”;

• “The coming economic crash”;

• “Why the next global financial crisis may dwarf…2008”; and

• “Financial crisis – Bible prophecy & current events.”

The trouble is that there is no evidence that all this noise is making us better investors. Average returns are no higher than in the past. A concern is that the combination of a massive ramp up in information combined with our natural inclination to zoom in on negative news is making us worse investors: more fearful, more jittery and more short term focussed.

Five ways to manage the perpetual worry list

So here we take another look at five ways to manage the worry list and turn down the noise:

Firstly, put the latest worry list in context. Remember that there has always been an endless stream of worries. Here’s a list of the worries of the last five years that have weighed on markets at various points: deflation; commodity/oil crash; Grexit; China worries; Brazil and Russia in recession; manufacturing slump globally; Fed rate hikes; Brexit; South China Sea tensions; Trump; Eurozone elections; North Korea; Germany; Catalonia; Italy; US inflation and rates; Trade war; China slowdown; Aust Royal Commission; Aust housing downturn; US government shutdown; inverted yield curves; impeachment; Aust recession fears; and Iran tensions. Yet despite this extensive worry list investment returns have actually been okay with average balanced growth super funds returning 7.3% pa over the last five years after taxes and fees. In fact, the global economy has had plenty of worries over the last century, but it got over them with Australian shares returning 11.8% pa since 1900 and US shares 9.9%pa.

Source: ASX, AMP Capital

And while history doesn’t repeat it does rhyme and it’s often useful to look back at previous similar events to the latest worry to see how they panned out. This is where the experience around SARS is useful in relation to the latest coronavirus outbreak.

Secondly, recognise how markets work. A diverse portfolio of shares returns more than bonds and cash over the long-term because it can lose money in the short-term. While the share market is highly volatile in the short-term it has seen strong returns over rolling 20-year periods. So, volatility driven by worries and bad news is normal. It’s the price investors pay for higher long-term returns.

Source: Global Financial Data, AMP Capital

Thirdly, find a way to filter news so that it doesn’t distort your investment decisions. For example, this could involve building your own investment process or choosing 1-3 good investment subscription services and relying on them. Or simpler still, agreeing to a long-term strategy with a financial planner and sticking to it. Ultimately it all depends on how much you want to be involved in managing your investments.

Fourthly, don’t check your investments so much. If you track the daily movements in the Australian All Ords price index or the US S&P 500, it has been down almost as much as it has been up. So, day to day it’s pretty much a coin toss as to whether you will get good news or bad. By contrast if you only look at how the share market has gone each month and allow for dividends the historical experience tells us you will only get bad news 35% of the time. Looking only on a calendar year basis, data back to 1900 indicates that the probability of bad news in the form of a loss slides further to 20% for Australian shares and 27% for US shares. And if you can stretch it out to once a decade positive returns have been seen 100% of the time for Australian shares and 82% of the time for US shares.  

Data from 1995 and 1900. Source: Global Financial Data, AMP Capital

The less frequently you look the less you will be disappointed and so the lower the chance that a bout of “loss aversion” triggered by a bad news event will lead you to sell at the wrong time. So, try to avoid looking at market updates so regularly.

Finally, look for opportunities that bad news throws up. Periods of share market turbulence after bad news throw up opportunities as such periods push shares into cheap territory.

Concluding comment

My long-term experience around investing tells me that it’s far more productive to lean into prognostications of financial gloom because most of the time they are wrong and end up just distracting investors from their goals.

Source: AMP Capital 12 Feb 2020

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

The last few weeks have seen escalating concern that a new coronavirus (called 2019 novel coronavirus or nCoV) originating in the Chinese city of Wuhan in Hubei province will become a global pandemic. Concern has been heightened after the World Health Organisation (WHO) declared the outbreak an “international public health emergency” on 30 January and the number of cases has continued to escalate.

While this is first and foremost a human crisis, there has been increasing concern that the associated disruption to economic activity will trigger a global economic slump. Consequently, share markets have seen falls (ranging from 3% for global and Australian shares to around 7% for Asian shares and 12% for Chinese shares), commodity prices have fallen, and bond yields have collapsed again. While the current situation is highly uncertain, the experience with SARS, bird flu, swine flu & Ebola highlight worst-case pandemic fears don’t usually eventuate.

What do we know about this Coronavirus

Here is a summary of information regarding nCoV:

• Coronaviruses circulate in animals but can be transmitted to humans and affect the respiratory system. SARS in 2003 & MERS in 2012 were examples. Symptoms can be treated but there are no vaccines or antiviral drugs for them (at present). Like SARS, nCoV looks to have originated in wildlife markets in China.

• So far there are over 24,500 confirmed cases worldwide, with 99% of cases in China. But the number of cases is still rising rapidly and more/faster testing could mean many more with spikes in the number of new daily cases.

• So far the mortality rate is running at 2% which puts it above swine flu but well below SARS (which settled around 9%). And of those dying, its mainly been older people or those with pre-existing conditions (as with common flu). 

• Against this, nCoV has been more contagious with total cases well above those for SARS (8000) and patients can be contagious but without symptoms for 1-2 weeks.

Source: PRC National Health Commission, Johns Hopkins CSSE, AMP Capital

Source: PRC National Health Comm, Johns Hopkins CSSE, WHO, AMP Capital

• Containment measures – notably in China – have been more aggressive and started earlier than in the case of SARS. These include restricting travel into and out of Hubei province and various countries have restricted (and in some cases banned) foreign travellers entering from China.

Past experiences

To provide some context it is worth reviewing past pandemics – both real and feared. There were three influenza pandemics in the last century: 1918-19, 1957 and 1968. The 1957 and 1968 pandemics are estimated to have killed up to 4 million people. However, the 1918 Spanish flu pandemic was the most severe. While the mortality rate was low, up to 50 million people died worldwide. With a big proportion of the population staying at home, economic activity was severely disrupted, although this was compounded by the ending of World War I. US industrial production slumped 18% between March 1918 and March 1919. Australian real GDP slumped 5.5% in 1919-20 (but then rebounded 13.6% in 1920-21). The share market impact is hard to discern given the ending of WWI, however US and Australian share markets rose through much of the pandemic period.

The SARS outbreak of 2003 is a more useful guide. After emerging in China around February 2003, SARS infected about 8000 people (mostly in Asia) in 30 countries over a five-month period and had a mortality rate of about 9%. SARS had a big negative impact on the countries most affected as people stayed home for fear of catching it. GDP in China, Hong Kong and Singapore slumped by over 2% in the June quarter of 2003. Growth then subsequently rebounded.

Source: Thomson Reuters, AMP Capital

Reflecting SARS, Asian shares fell in April 2003, even though global shares started to move out of a three year bear market from March. The April 2003 low in Asian shares coincided with a peaking in the number of new cases.

Source: Thomson Reuters, AMP Capital

Most pandemics have taken 6-18 months to run their course and peter out as measures are taken to slow their spread (eg, hygiene, quarantining, banning gatherings, preventing travel). SARS ended quicker due to the nature of the virus and rapid action by authorities. In 2005/2006, there was significant concern that a severe strain of bird flu (called H5N1), which was resulting in human casualties, mainly in parts of Asia where people had contact with chickens, would mutate into a form that was readily transmissible between humans. However, this didn’t really eventuate and as such the economic impact was modest although it did cause bouts of volatility in share markets. Similarly, concern that the spread of swine flu would become a global pandemic rattled share markets for a while around April 2009, and Ebola did the same in 2014, but both quickly faded.

The economic and financial impact of nCoV

After strong double-digit gains over the last year and with investor sentiment pushing up to high levels indicating a degree of complacency, share markets were at high risk of a correction in mid Jan and the fears around coronavirus have provided the trigger. Given their greater sensitivity to Chinese growth, commodity prices like Chinese shares are down by more and the Australian dollar has fallen to October lows below $US0.67. What happens from here depends on how long it takes for the outbreak to be contained. The higher number of cases than with SARS or swine flu suggests a greater economic impact. But given the range of possibilities, the best way to get a handle on the economic and investment market impact is to consider several scenarios. Here we consider two.

1. Containment within the next month or two – the number of cases continues to rise but it remainsmainly contained to China (and Hubei) and the number of new cases starts to peak in the next month or so. This would allow travel restrictions to be removed by the June quarter. Under this scenario:

• GDP in China and parts of Asia would likely take a 2 to 3% hit (taking Chinese GDP growth from 6% year on year in the December quarter to 3-4%yoy in the current quarter) as workers stay home and travel dries up. With the Chinese economy now being four times the share of global GDP it was at the time of SARS, this along with some drag on growth in developed countries would knock world growth to around 2.5% year on year (from around 3%). However, growth would rebound in the June quarter as travel restrictions are removed and things return to normal.

• Australian growth could see a 0.2% hit in the current quarter mainly due to the loss of Chinese tourists (which account for 20% of tourism earnings and 0.2% of GDP) but also lower raw material demand and an impact on confidence. With the bushfire impact this could see GDP contract, but growth would rebound in the June quarter.

• Against this background share markets, commodity prices and the $A could still fall a bit further in the near term but would quickly rebound by the June quarter. Easier than otherwise monetary and fiscal policies – with more stimulus measures already announced in China – would aid this.

2. Global pandemic – the number of cases continues to escalate beyond China and aren’t contained until say mid-year.

• This scenario would see a bigger and longer negative impact on economic activity. Global travel would collapse. Many would simply not come into work – a reasonable estimate is around 20% of workers, although this might be spread over time. This would see a sharp slump in global GDP and the risk of global recession. Australia would not be immune and would likely see two negative quarters of growth with flow on to education exports to China (which accounts for another 0.6% of Australian GDP).

• Share markets would likely fall sharply – maybe by 20% or so – reflecting the huge economic uncertainty. Cash would be the place to be. The $A could fall to around $US0.60.

• However, economic activity would rebound quickly once it’s clear the pandemic is under control. Share markets are likely to anticipate this. But this wouldn’t occur till the second half of the year.

Concluding comment and what to watch

While there is reason for concern and it is easy to dream up nightmare scenarios, the experience with SARS, bird flu (with “predictions” it could kill as many as 150 million people) and the mini panic regarding swine flu and Ebola tell us that the worst case fears of pandemics usually don’t come to pass. Rapid containment measures provide some confidence this will be the case. As such, our base case scenario (with 75% probability) is one of containment over the next month or two. This could still see more downside in share markets and bond yields in the near term, but they are likely to rebound by the June quarter as economic growth rebounds. The key things to watch are:

• The daily number of new cases – the SARS experience saw markets rebound once this showed signs of peaking.

• The spread of new cases and deaths in developed countries – if this remains limited then markets will also get more confident that the economic fallout will be short lived.

Source: AMP Capital 5 Feb 2020

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Our high-level investment view for this year is that a combination of improving global growth boosting profits and still easy monetary conditions will help drive reasonable investment returns, albeit more modest than the very strong gains of 2019. This note revisits five charts we see as critical to the outlook.

Chart #1 – Global business conditions PMIs

Global Purchasing Managers Indexes (PMIs) – surveys of purchasing managers at businesses in most major countries – are an excellent and timely guide to the state of the global economy. Although services sector PMIs held up better than for manufacturers – which tend to be more cyclical – both softened through 2018 and into mid-2019. Since then they have shown signs of improvement suggesting that the global monetary easing seen through 2019 with interest rate cuts and renewed quantitative easing is working. Going forward they will need to improve further to be consistent with our view that growth will pick up this year.

Source: Bloomberg, AMP Capital

But so far, the 2018-19 slowdown in business conditions PMIs (and hence global growth) looks like the slowdowns around 2012 and 2015-16 as opposed to the recession associated with the global financial crisis (GFC).

Chart 2 – Global inflation

Major economic downturns are invariably preceded by a rise in inflation to above central bank targets causing central banks to slam the brakes on. At present, core inflation – ie inflation excluding the volatile items of food and energy – in major global economies remains benign. In the US, the Eurozone and Japan core inflation is well below their central bank targets of 2%. Inflation in China spiked to 4.5% through last year, but core inflation has been falling to 1.4% and is well below the Government’s 3% target/forecast. A clear upswing in core inflation would be a warning sign that spare capacity has been used up, that monetary easing has gone too far, and that the next move will be aggressive monetary tightening. But at present, we are a long way from that.

Source: Bloomberg, AMP Capital

Chart 3 – The US yield curve

The yield curve is a guide to the stance of monetary policy. When short-term interest rates are low relative to long-term rates businesses can borrow short and lend (or invest) long and this grows the economy. But it’s not so good when short rates are above long rates. An inverted US yield curve has preceded past US recessions. So, when this happened last year there was much concern that a US recession was on the way.

However, in recent months various versions of the yield curve – with the gap between the US 10 year bond yield and the Fed Funds rate and the US 10 year bond yield and the 2 year bond yield shown in the next chart – have uninverted as the Fed cut rates and hence short-term yields fell, good economic data provided confidence that recession will be avoided and the US/China trade war de-escalated reducing the threat posed by the trade war.

Source: NBER, Bloomberg, AMP Capital

While the US yield curve has uninverted in the past and yet a recession has still come along, the uninversion seen in recent months coming after such a shallow and short-lived inversion provides confidence that the inversion seen last year gave a false signal as occurred in the mid to late 1990s (as circled).

In addition, it’s also worth noting that other indicators suggest that US monetary policy was far from tight – the real Fed Fund rate was barely positive, and the nominal Fed Funds rate was well below nominal GDP growth and both are far from levels that in the past have preceded US recessions.

So it’s a good sign that the US yield curve has been steepening in recent months. A return to yield curve inversion – which became deeper than seen last year – would be a concern of course.

Chart 4 – The US dollar

Moves in the value of the US dollar against a range of currencies are of broad global significance. This is for two reasons. First, because of the relatively low exposure of the US economy to cyclical sectors like manufacturing and materials the $US tends to be a “risk-off” currency, ie it goes up when there are worries about global growth. Second, because of its reserve currency status and that a lot of global debt is denominated in US dollars particularly in emerging countries, when the $US goes up it makes it tough for emerging countries. 

Source: Bloomberg, AMP Capital

So when global uncertainty is rising this pushes the $US up which in turn makes it hard for emerging countries with $US denominated debt. If we are right though and global growth picks up a bit, trade war risk remains in abeyance and the Iran conflict does not become big enough to derail things then the $US is likely to decline further which would be positive for emerging countries.

Chart 5 – World trade growth

It’s reasonable to expect growth in world trade to slow over time as services become an ever-greater share of economic activity and manufacturing becomes less labour dependent. However, President Trump’s trade wars since 2018 combined with slower global growth saw global trade fall last year. This year should see some reversal if the trade wars remain in abeyance as Trump focuses on keeping the US economy strong to aid his re-election and global growth picks up a bit.

Source: CPB World Trade Volume Index, Thomson Reuters, AMP Capital

US recession still a way away

In recent years there has been much debate about whether a new major bear market in shares is approaching. Such concerns usually reach fever pitch after share markets have already fallen 20% or so (as they did into 2011, 2016 and 2018). The historical experience tells us that what happens in the US is critical to how deep share market falls get. Deep (“grizzly”) bear markets like the 50% plus fall seen in the GFC are invariably associated with US recession. So, whether a recession is imminent in the US, and more broadly globally, is critically important in terms of whether a major bear market is on the way. The next table summarises the key indicators we are still watching in this regard.

Source: AMP Capital

These indicators are still not foreshadowing an imminent recession in the US. The yield curve is most at risk if it inverts again. But other measures of monetary policy in the US are not tight and we have not seen the sort of excesses that normally precede recessions – discretionary or cyclical spending as a share of GDP is low, private debt growth has not been excessive, the US leading indicator is far from recessionary levels and inflation is benign.

Concluding comments

At present, most of these charts or indicators are moving in the right direction, with the PMIs improving a bit, inflation remaining low, the yield curve steepening, the $US showing signs of topping and the US/China trade truce auguring well for some pick up in world trade growth. But to be consistent with our view that this year will see good returns from shares we need to see further improvement and so these charts are worth keeping an eye on.

Source: AMP Capital 15 Jan 2020

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Introduction

The Australian bushfire season that began in September has been horrific with more than 7 million hectares of bush destroyed, more than 25 deaths, significant loss of livestock, estimates of more than a billion wildlife animals killed and more than 1800 homes destroyed. More than 200 fires are still burning. Following the intensification of the bushfires over the Christmas/New Year period attention has now turned to the impact on the economy. This note looks at the key impacts.

The short-term impact on GDP and wealth

Physical disasters invariably cause a brief disruption to economic activity as measured by GDP followed by a boost as wealth destroyed by the disaster is rebuilt. In this sense measured across a year or so they are often seen as positive for economic growth, albeit this seems perverse particularly for those directly impacted.

The damage to property and wealth flowing from the bushfires will likely run into many billions. For example, the Victorian Black Saturday bushfires are estimated to have cost $4.4bn, whereas the current fires have covered an area 15 times bigger. So there will be a very big rebuilding boost to economic activity to come once the fires are brought under control. But the fires have been very widespread, have been going on for several months now and the crisis is continuing, so there will be a significant short-term negative impact and it likely will involve more than a short-term disruption to economic activity.

• Activity related to farming, manufacturing, transport, tourism and business generally in the affected areas will be disrupted – this will involve around 2-3% of the population and will be concentrated around the March quarter. It will also be partly offset as affected people have to undertake spending that they otherwise wouldn’t have had to.

• A bigger impact on economic activity is likely to come via a hit to consumer spending as the constant news of the fires and the smoke haze in several capital cities weighs on confidence. Australians were already very hesitant about the economic outlook after the slowdown in growth seen last year and continuing weak wages growth and high underemployment. A Roy Morgan survey released late last year found that 40% of Australians thought that 2020 will be worse than 2019, which is the worse reading since the early 1990s recession. At the same time a record-low 12% thought it would be better resulting in a net negative reading of 28% which is the worst in the survey’s 40-year history.

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Source: Roy Morgan; AMP Capital

This may exaggerate how bad things really are. The economy is still in far better shape than it was at the time of the early 1990s recession (I was there, I remember!). But a combination of more negative news flow today due to the rise of social media, more divisive politics and expectations rising faster than reality may be altering perceptions of the economy in a negative way and exaggerating the gloom. Nevertheless, a range of other surveys also show that consumers are uncertain and depressed, and this looks to have intensified since Christmas. The constant terrible news since October about the bushfires along with the smoke in cities is likely weighing further on the national psyche adding to weakness in consumer spending as Australians feel less motivated to spend when their fellow Australians are suffering. The hit to household spending power from higher prices for food and a likely rise in insurance premiums flowing from the fires will only accentuate this.

• Inbound tourism is also likely to be impacted by the heavy coverage of the bushfires globally – with ridiculous maps showing much of Australia on fire (including where I am right now) – likely to adversely affect perceptions of Australia. This may be short lived (just as the positive boost from the 2000 Olympics was) but it could still last a year or so.

Taken together we expect a detraction from GDP due to the bushfires of around 0.4% starting in the December quarter but mainly impacting the March quarter before a rebuilding boost kicks in from the June quarter. Given the uncertainty, the range around this negative impact is -0.25% up to a worse case of -1% of GDP should the fires continue on a widespread basis through the rest of summer. The rebuilding boost should reverse much of this drag later in the year, but there is considerable uncertainty around this as the impact on tourism and consumer spending may linger longer.

A big proximate contributor to the severity of the bushfires is the severe drought gripping much of Australia. This has already driven a decline in agricultural production, which has been directly detracting around 0.2 percentage points from GDP growth for the last two years. Unfortunately, the Southern Oscillation Index is still in El Nino territory pointing to ongoing relatively dry conditions in eastern and top-end Australia.

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Source: ABS, Australian Bureau of Meteorology, AMP Capital

More policy stimulus

With the bushfires likely to contribute to a flow of weak economic data for the next several months, questioning the RBA’s “gentle turning point” in the economy and resulting in a movement away from the achievement of the RBA’s full employment and inflation goals, the fires have only added to the pressure for more policy stimulus. We remain of the view that the RBA will cut the cash rate to 0.5% in February (with the market probability now up to 53.4% from a low of 36% before Christmas) and to 0.25% probably in March. The bushfires will push up food prices and insurance premiums but the RBA’s focus on underlying inflation will mean that it should look through this. In fact, increases in such prices will act as a tax on consumer spending power and are negative for spending and so could depress underlying inflation.

The pressure for further fiscal stimulus has also intensified. The Federal Government has already committed an additional $2bn for bushfire recovery to be spent this year and next (which is relatively small at 0.05% of GDP per year) and the NSW Government has committed another $1bn. However, the total hit to government budgets from the bushfires is likely to be much greater than this given assistance under existing disaster programs, extra expenses associated with fighting the fires and the impact of slower growth in the short term on revenue flows.

More broadly given the hit to confidence a circuit breaker is arguably needed to help boost economic growth. Monetary policy alone is unlikely to be enough. So there is a need for a broader fiscal stimulus – maybe in the form of a bring forward of the personal tax cuts, an increase in Newstart and broad based investment allowances. To have an impact it needs to be at least 0.5% of GDP (or around $10bn).

Rightly in the face of the pain caused by the bushfires the Government has relaxed the focus on achieving a budget surplus and it is now questionable as to whether it will be achieved this year and next. That is not a major problem in the relative scheme of things given the relatively good state of Australia’s public finances.

Some longer-term challenges

The bushfires pose a number of longer-term challenges.

First, increased pressure to adopt a tougher stance in reducing carbon emissions. While Australia has always had droughts and bushfires we have been warned for more than a decade now that the world and Australia is getting warmer, that increasing global greenhouse gas emissions are likely contributing to this and that in the absence of actions to reduce emissions the world will get significantly warmer with the outcome being rising sea levels and more extreme weather events – including storms, floods and droughts – with more severe bushfires an outcome of the latter.

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* Number of extreme heat days each year. Source: Bureau Meteorology, RBA

Second, the damage inflicted by the extreme bushfires highlights the need for investors to be aware of industries and businesses that are vulnerable to climate change risk – whether it comes from the physical impact from climate change or via measures to reduce emissions.

Thirdly, the severity of the bushfires and the risk that this is the new normal will necessitate better strategies for reducing the risk to property posed by future bushfires.

Finally, in the absence of policy action the bushfires risk accentuating the decline of some regional communities particularly where key industries have been destroyed by the fires – with some taking their insurance and rebuilding elsewhere. This will only further centralise Australia in its big cities adding to all the costs that entails – notably congestion and expensive housing.

What does it mean for investors?

The likelihood of more RBA monetary easing and continuing weak economic growth in the short term will likely keep Australian bond yields down relative to global bond yields, possibly pushing them lower.

This will also keep the Australian dollar relatively soft.

So far the Australian share market appears to be looking through the short-term hit to economic growth focusing more on the rebuilding boost, but the negative impact of the bushfires risks seeing it remain a relative underperformer versus global shares.

Source: AMP Capital, 10th Jan 2020

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

After the poor returns for investors in 2018, 2019 turned out surprisingly well with average balanced growth superannuation funds looking like they have returned around 15%.

Source: Mercer Investment Consulting, Morningstar, AMP Capital

But can it continue this year? Particularly with an intensification of the US/Iran conflict adding to global uncertainty and the drought and horrendous bushfires further weighing on the Australian economy. Here is a summary of key insights and views on the investment outlook in simple point form.

Five reasons 2019 turned out well for investors

2019 saw slowing growth and weak profits amidst an escalating US/China trade war and tensions with Iran and yet it turned out well for investors. Here are five reasons why:

• Easy money – central banks eased monetary policy in response to the growth slowdown and various threats to growth reversing the tightening seen in 2018.

• Cheap starting point for assets – after the falls of 2018 shares started 2019 cheap and they and other assets were made relatively cheaper as interest rates & bond yields fell. 

• The crowd was very gloomy at the start of 2019 with much fear about the outlook – when this is the case it’s always easier for assets to rise in value.

• While geopolitical threats remained high there was some relief by year end – with the US & China reaching a Phase 1 trade deal; Iran tensions not seeing a major or lasting disruption to oil supplies; and a hard Brexit avoided for now. 

• Global growth was not as bad as feared – despite a mid-year recession obsession as yield curves inverted. In fact, global growth indicators looked to be stabilising by year end.

Seven lessons from 2019

• Don’t fight the Fed, ECB, PBOC or RBA – as long as recession is avoided monetary easing is positive for investment returns from growth assets.

• The starting point matters – when assets are cheap, and the crowd is negative as they were at the start of 2019 it’s relatively easier to get good returns.

• Post GFC caution remains but can be both negative and positive – yes it periodically weighs on growth, but it is keeping economies from overheating and thereby is helping to extend the economic and investment cycle.

• Geopolitics remains a significant driver of markets and economic conditions – but it can be positive whenever there is any relief and things don’t turn out as bad as feared.

• Just because Australian housing is expensive & household debt is high does not mean house prices are going to crash.

• Stick to an investment strategy – 2019 started in gloom and had its share of distractions but investors would have done well if they just stuck to a well-diversified portfolio.

• Remember that while shares can be volatile and unlisted assets also come with risks, the income stream from a well-diversified mix of such assets can be relatively stable and higher than the income from bank deposits.

Five big picture themes for 2020

• A pause in the trade war, but geopolitical risk to remain high. President Trump is likely to want to keep the US/China trade war on the backburner but it could still flare up again and other issues include the escalation seen so far this year in the Iran conflict, a return to worries about a “hard Brexit” at year end if UK/EU free trade talks don’t go well and the US election if a hard left Democrat candidate gets up.

• Global growth to stabilise & turn up thanks to policy stimulus with business surveys recently showing stabilisation.

• Continuing low inflation and low interest rates. Growth won’t be strong enough to push underlying inflation up much and some central banks will still be easing (including the RBA).

• The US dollar is expected to peak and head down as global uncertainty declines a bit and non-US growth picks up.

• Australian growth is expected to remain weak given the housing construction downturn, weak consumer spending and the drought with bushfires not helping.

Key views on markets for 2020

Improving global growth & still easy monetary conditions should drive reasonable investment returns this year but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares & geopolitical risks are likely to constrain gains and create some volatility: 

• Global shares are expected to see total returns around 9.5% in 2020 helped by better growth and easy monetary policy. 

• Cyclical, non-US and emerging market shares are likely to outperform, if the US dollar declines as we expect.

• Australian shares are likely to do okay this year but with total returns also constrained to around 9% given sub-par economic & profit growth. 

• Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.

• Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns. 

• National capital city house prices are expected to see continued strong gains into early 2020. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole. 

• Cash & bank deposits are likely to provide very poor returns, with the RBA expected to cut the cash rate to 0.25%.

• The $A is likely to fall to $US0.65 as the RBA eases further, then drift up as global growth improves to end little changed.

Seven things to watch

• The US trade wars – we are assuming the Phase 1 trade deal de-escalates the trade war, but Trump is Trump and often can’t help but throw grenades.

• US politics: the Senate is unlikely to remove Trump from office if the House votes to impeach and another shutdown is also unlikely but both could cause volatility as could the US election if a hard-left Democrat gets up (albeit unlikely). 

• The US/Iran conflict – which could escalate further with Iran unlikely to negotiate and Trump wanting to sound tough, potentially disrupting oil supplies.

• A hard Brexit looks like being avoided but watch UK/EU free trade negotiations through the year.

• Global growth indicators (PMIs).

• Chinese growth – a continued slowing in China would be a major concern for global growth.

• Monetary v fiscal stimulus in Australia – significant fiscal stimulus could head off further RBA easing.

Four reasons global growth is likely to improve a bit

• Global monetary conditions have eased significantly over the last year. China has also seen significant fiscal stimulus.

• The stabilisation seen in business conditions PMIs in recent months suggests monetary easing is getting some traction. 

• We still have not seen the excesses – massive debt growth, overinvestment, capacity constraints or excessive inflation – that normally precede recessions.

• The de-escalation of the US/China trade war should help reduce a drag on business confidence (at least for a while).

Five reasons Australia is likely to avoid a recession

The bushfires are estimated to knock around 0.4% mainly from March quarter GDP mainly due to the impact on agriculture, tourism and consumer confidence and spending. Coming at a time when Australian growth is already weak it risks knocking March quarter growth to near zero or below. However, while the risk of recession has increased, it remains unlikely:

• Infrastructure spending is strong.

• Mining investment is starting to rise again.

• The bushfires will be followed by a boost to spending from the June quarter as rebuilding kicks in.

• Already weak growth, made worse by the bushfires in the short term will likely force further fiscal stimulus.

• The $A is likely to remain weak providing a boost to growth.

Three reasons why the RBA will cut rates this year

• Growth is likely to disappoint RBA expectations for 2.8% growth this year.

• This will keep underemployment high, wages growth weak and inflation lower for longer.

• Fiscal stimulus is unlikely to come early enough.

We expect the RBA to cut the cash rate to 0.5% in February & to 0.25% in March, with quantitative easing likely from mid-year.

Three reasons why a deep bear market is unlikely

Shares are vulnerable to a correction after the strong gains seen over the last year, but a deep bear market (where shares fall 20% and a year after are a lot lower again) is unlikely:

• Global recession remains unlikely. Most deep bear markets are associated with recession.

• Measures of investor sentiment suggest investors are cautious, which is positive from a contrarian perspective.

• The liquidity backdrop for shares is still positive. For example, bank term deposit rates in Australia are around 1.3% (and likely to fall) compared to a grossed-up dividend yield of around 5.7% making shares relatively attractive.

Nine things investors should remember

• 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 48 years to double an asset’s value if it returns 1.5% pa (ie 72/1.5) but only 9 years if the asset returns 8% pa.

• Don’t get thrown off by the cycle. Falls in asset markets can throw investors out of a well thought out strategy at the wrong time – as some were at the end of 2018. 

• Invest for the long term. Given the difficulty in getting short term market moves right, 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. Increasing social media and the competition for your eyes and ears is creating a lot of noise around investing that is really just a distraction. 

• Buy low, sell high. The cheaper you buy an asset, the higher its prospective return will likely be and vice versa.

• Beware the crowd at extremes. Don’t get sucked into the euphoria or doom and gloom around an asset.

• Focus on investments that you understand and that offer sustainable cash flow. If it looks dodgy, hard to understand or has to be based on odd valuation measures or lots of debt to stack up then it’s best to stay away. 

• Accept that it’s a low nominal return world – when inflation is 1.5%, a 15% superannuation return is very pretty good (and not sustainable at that rate).

Source: AMP Capital 9 Jan 2020

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

For a long time, we have been bearish on the Australian dollar, seeing a fall into the high $US0.60s and revising this to around $US0.65 in May. In early October it fell to a low of $US0.6671. While negatives remain significant for the $A there is good reason to believe that we are close to the low or may have already seen it. This note looks at the main issues.

The negatives for the $A are well known

The big negative for the Australian dollar is that growth is weaker in Australia and spare capacity is much higher than in the US. For example, labour market underutilisation is 13.8% in Australia versus just 7% in the US, on the latest available data real growth in Australia is running at 1.4% year on year compared to 2% in the US and that translates to per capita GDP growth of -0.2% in Australia compared to 1.4% in the US. And the drag on growth from the housing downturn, weak consumer spending and the drought is likely to keep growth relatively weak in Australia for the next six months or so.

Source: Bloomberg, AMP Capital

This will keep inflation lower in Australia than in the US. Ideally more fiscal stimulus is required, and the Government has brought forward infrastructure spending. But combined with extra drought assistance this only amounts to an extra 0.1% of GDP of fiscal stimulus over the next 18 months which is not enough to make a significant difference to the growth outlook. So in the absence of more significant fiscal stimulus soon, the RBA is likely to cut the cash rate further to 0.25% and undertake some quantitative easing (ie using printed money to boost growth). By contrast the Fed is at or close to the low in US rates and is unlikely to return to quantitative easing. This will continue to make it relatively less attractive to park money in Australia. As can be seen in the next chart, periods of a low and falling interest rate differential between Australia and the US usually see a low and falling $A.

Source: Bloomberg, AMP Capital

So the higher probability of further monetary easing in Australia points to more downside for the Australian dollar. Of course, a shift in the policy focus away from monetary easing and towards greater fiscal stimulus would be more positive for the Australian dollar but this looks unlikely in the short term with the Government more focussed on delivering a budget surplus.

Five positives for the $A

However, it’s no longer an easy (in hindsight) one way bet for the $A. There are basically five positives. First, the $A has already had a big fall. To its recent low it’s fallen nearly 40% from a multi-decade high of $US1.11 in 2011 & it’s had a fall of 18% from a high in January last year of $US0.81.

Second, this decline has taken it to just below fair value. This contrasts to the situation back in 2011 when it was well above long-term fair value. The best guide to this is what is called purchasing power parity according to which exchange rates should equilibrate the price of a basket of goods and services across countries. Consistent with this the $A tends to move in line with relative price differentials over the long term.

Source: RBA, ABS, AMP Capital

And right now, it’s just below fair value. Of course, as can be seen in the last chart, the $A could fall sharply below fair value as it tends to swing from one extreme to another. But this depends on the cyclical outlook for global growth and commodity prices. Which brings us to the next positive.

Third, the global economic and commodity price cycle is likely to turn up next year in response to global monetary easing, a bottoming in the global inventory and manufacturing cycle and a pause in President Trump’s trade wars as he refocusses on winning the presidential election.

Source: Bloomberg, AMP Capital

Based on historical experience, this should work against the US dollar as the US economy is less exposed to cyclical sectors than the rest of the world (which tends to see capital flow out of the US when global growth picks up and into the US when it slows). A weaker US dollar would in turn be positive for commodity prices & the $A, which is a “risk on” currency given its greater exposure to cyclical industries like raw materials.

Source: Bloomberg, AMP Capital

Fourth, this comes at a time when global sentiment towards the $A remains very negative as reflected in short or underweight positions in the $A being at extremes – see the next chart. In other words, many of those who want to sell the $A have already done so and this leaves it vulnerable to a rally if there is good news.

Source: Bloomberg, AMP Capital

Finally, the current account has returned to surplus in Australia. The high iron ore price has helped, but so too have strong resource export volumes, services exports and a rising net equity position in Australia’s favour on the back of rising superannuation assets offshore. So the improved current account may be a permanent feature. This means less dependence on foreign capital inflows which is $A positive.

Source: ABS, AMP Capital

So where to from here?

The prospects for weaker growth and more monetary easing in Australia relative to the US suggests short-term downside pressure for the $A remains. But with the $A having already had a big fall to just below long term fair value, the global growth outlook likely to improve, short $A positions running high and the current account in surplus it’s likely that the $A may be close to, or may have already seen, its low. Our base remains for it to fall to around $US0.65 as the RBA continues to ease but at the end of 2020 it’s likely to be stuck around $US0.65-70 (or I’ll be honest & admit I don’t have a strong view either way!).

Of course, if the US/China trade war escalates badly again and the global economy falls apart, causing a surge in unemployment in Australia as export demand and confidence collapses and another big leg down in house prices the Aussie will fall a lot more…but that’s looking less likely.

What does it mean for investors and the RBA?

With the risks skewed towards the $A bottoming soon the case to maintain a large exposure to offshore assets that are not hedged back to Australian dollars has weakened. Of course, maintaining a position in foreign exchange for Australian-based investors against the $A provides some protection should things go wrong globally (say in relation to trade) or in Australia (say in relation to household debt).

For the RBA a shift in global forces towards being more supportive of the Australian dollar over the year ahead would complicate the RBA’s desire to boost Australian economic growth. Stronger demand for Australian exports would be positive, but upwards pressure on the $A would suggest that further monetary easing may be needed to help keep it down.

Source: AMP Capital 25 Nov 2019

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.