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Author: Provision Wealth

2022 – a list of lists regarding the macro investment outlook

Date: Jan 12th, 2022

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • 2021 saw strong investment returns with low volatility.
  • 2022 is likely to see more constrained returns with increased volatility.
  • Watch: coronavirus and vaccines; inflation; the US mid-term elections; China issues; Russian tensions with Ukraine and the west; & the Australian election.

Introduction

Despite a wall of worry with coronavirus and inflation, 2021 was a great year for diversified investors, with average balanced growth super funds looking like they have returned around 14%, after just 3.6% in 2020. Balanced growth super fund returns have averaged around 8.5%pa over the last five years, well above inflation and bank deposit rates.

Balanced growth superannuation fund returns

Source: Mercer Investment Consulting, Morningstar, AMP

But can strong returns continue? Here is a simple point form summary of key insights and views on the investment outlook.

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.

Us mid-term election year share market drawdowns

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.


Source: AMP Capital 12 January 2022

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.

Review of 2021, outlook for 2022

Date: Dec 13th, 2021

– recovery to continue as we hopefully learn to live with covid

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • 2021 was again dominated by the coronavirus pandemic, along with concern about higher inflation and monetary tightening but shares, unlisted assets and balanced growth super funds saw strong returns.

  • Continuing solid economic growth, rising profits and still easy monetary conditions should result in good overall investment returns in 2022, but they are likely to be more constrained and volatile than in 2021.

  • The main things to keep an eye on are: coronavirus; inflation; US politics; China tensions; a possible Russian invasion of Ukraine; inflation; & the Australian election.

2021 – another year of covid

Just as 2020 was dominated by coronavirus so too was 2021. But 2021 turned out to be a far better year for investors. The big negatives of 2021 were of course dominated by coronavirus:

  • Coronavirus mutated into more transmissible variants, drove 3 new waves of cases globally, saw more cases & deaths than in 2020 & saw long lockdowns in east coast Australia.

  • Inflation in the US and some other countries rose to levels not seen in decades as the pandemic drove a surge in demand for goods, but left supply struggling to keep up.

  • Related to this energy prices – notably gas in Europe and coal in China – surged as a result of energy shortages.

  • Bond yields surged and many central banks moved to reduce monetary stimulus (by slowing bond buying) and some actually raised interest rates.

  • Chinese growth slowed sharply as a result of policy tightening and an associated property downturn.

  • Geopolitical tensions continued to simmer – notably between the US and China but also involving Russia & Iran.

  • Political uncertainty around the transition of power in the US from President Trump gave way to relative calm with most of the action being in the Democrat party itself.

  • And there was plenty to distract long term investors with meme stocks, cryptos and SPACs attempting moon shots and calling into question traditional ways of investing. We have seen it all before though, but cryptos (or rather blockchain) remind us that technology is a regular disruptor, there is lots of spare cash & many are happy to speculate.

However, despite the dominance of coronavirus and other sources of worry and noise there were significant positives:

  • Science and medicine started to get the upper hand against coronavirus: vaccines were rolled out with 55% of the global population (75% in developed countries and 79% in Australia) having had a first dose substantially reducing serious illness; and several new treatments further holding out the promise of reducing serious illness from covid.

  • This in turn enabled an easing in restrictions (or gradual reopening) albeit it was like 2 steps forward and 1 back.

  • Fiscal stimulus, pent up demand and ultra-easy monetary policy helped support household and business spending.

As a result, global GDP is expected to have grown nearly 6% in 2021, in comparison to 2020’s slump of -3%. And in Australia GDP is expected to have risen by 4.5% despite a setback in the September quarter after slumping -2.2% last year. This in turn underpinned strong gains in profits and dividends. As a result, investment markets also performed better than feared, despite covid, higher inflation and higher bond yields.

Investment returns for major asset classes

Total return %, pre fees and tax

2020 actual

2021* actual

2022 forecast

Global shares (in Aust dollars)

5.7

27.4

4.0

Global shares (in local currency)

13.8

19.5

8.0

Asian shares (in local currency)

22.8

-7.6

10.0

Emerging mkt shares (local currency)

19.1

-1.7

10.0

Australian shares

1.4

14.1

10.0

Global bonds (hedged into $A)

5.1

-1.1

-2.0

Australian bonds

4.4

-3.0

-2.0

Global real estate investment trusts

-13.5

23.2

7.0

Aust real estate investment trusts

-4.6

20.3

7.0

Unlisted non-res property, estimate

-3.0

9.0

8.0

Unlisted infrastructure, estimate

-5.0

12.0

8.0

Aust residential property, estimate

6.0

23.0

5.0

Cash

0.4

0.0

0.1

Avg balanced super fund, ex fees & tax

3.6

12.2

5.8

*Year to date to Nov. Source: Thomson Reuters, Morningstar, REIA, AMP Capital

  • Global shares had a few pullbacks as a result of covid and inflation fears, but they were relatively mild and stocks were boosted by strong profit growth, low interest rates and optimism vaccines would allow a more sustained reopening.

  • However, US shares remained a surprising outperformer and emerging market shares fell, perhaps as payback for strong gains last year and as Chinese growth slowed.

  • Australian shares underperformed with tensions with China not helping – but they actually did better than we expected.

  • Government bonds had poor returns as yields rose as central banks moved towards the easy money exits.

  • Real estate investment trusts had spectacular rebounds following last year’s hit to property space demand and rents.

  • Unlisted property & infrastructure returns rebounded.

  • Home prices surged thanks to ultra-low rates, incentives and FOMO. That said, monthly price gains have slowed.

  • Cash and bank term deposit returns were poor.

  • After rising to our end 2021 forecast of $US0.80 in February the $A fell as the iron ore price fell, the Fed became more hawkish and China tensions persisted.

  • Due to solid share and property returns offsetting soft returns from bonds and cash, balanced super funds have seen strong returns – providing payback for a weak 2020.

2022 – from pandemic to endemic

First the bad news: uncertainty over covid remains high and a new variant (Omicron or another) could cause an upset; inflationary pressures will be high for a while; the Fed is expected to raise rates three times; the RBA is expected to start hiking in November taking the cash rate to 0.5% by year end as the conditions for higher rates (inflation sustained in the target range, full employment & a 3% pace in wages) are likely to have been met; and political risk may have more impact.

In terms of politics: the mid-term elections in the US will likely see the Democrats lose control of Congress; French and Australian elections have potential to cause volatility (although Macron is ahead in France and the policy differences between the Government and ALP in Australia are minor compared to 2019); and tensions with China (over Taiwan), Russia (with a risk that it undertakes an invasion of southern Ukraine) and Iran (over its nuclear ambitions) are likely.

However, there is good reason for optimism about continuing economic recovery in the year ahead. First, while coronavirus remains a threat it appears to be having a far less negative impact on economies as vaccines and treatments get the upper hand. While uncertainty remains around Omicron and booster vaccines may need to be tweaked – it appears to be more transmissible but less deadly and if this is confirmed and if it comes to dominate other variants it could help hasten a progression to learning to live with coronavirus like the flu.

Second, excess savings of around $US2.3trn in the US and $250bn in Australia will provide an ongoing boost to spending.

Third, while monetary policy will start to tighten it will still be easy. Some easing in inflationary pressure as production increases and consumer demand swings back to services will provide central banks with breathing space and rate hikes in Europe and Japan are still years away. It’s usually only when monetary policy becomes tight that it ends the economic cycle and the bull market in shares and that’s a fair way off.

Fourth, inventories are low and will need to be rebuilt which will provide a boost to production.

Fifth, positive wealth effects from the rise in share and home prices will help boost consumer spending.

Sixth, the Chinese Government looks to be becoming more focussed on boosting growth, so more policy easing is likely.

Finally, while business surveys are down from their highs, they remain strong consistent with good growth.

Global Composite PMI vs World GDP

Source: Bloomberg, IMF, AMP Capital

Overall global growth is likely to be around 5%, down from 2021 but still strong. In Australia, recovery from the recent lockdowns supported by excess saving, strong business investment & high confidence levels suggest growth of around 5.5%. This is likely to support profit growth albeit at a slower pace than in 2021.

Implications for investors

Still solid economic growth, rising profits and still easy monetary conditions should result in good overall investment returns in 2022 but they are likely to be more constrained and volatile.

  • Global shares are expected to return around 8% but expect to see the long-awaited rotation away from growth & tech heavy US shares to more cyclical markets in Europe, Japan & emerging countries. Inflation, the start of Fed rate hikes, the US mid-term elections & China/Russia/Iran tensions are likely to result in a more volatile ride than 2021. Mid-term election years normally see below average returns in US shares and since 1950, have seen an average top-to-bottom drawdown of 17%, usually followed by a stronger rebound.

  • Australian shares are likely to outperform (at last) helped by stronger economic growth than in other developed countries, 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%. Expect the ASX 200 to end 2021 back around 7,800.

Australian shares offer a very attractive yield versus bank deposits

Source: Bloomberg, AMP Capital

  • 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 rising 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.

What to watch?

The main things to keep an eye on in 2022 are as follows:

  • 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 correction in shares. However, US political gridlock is usually good for 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.


Source: AMP Capital December 2021

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.

Five reasons to expect a cooling in the Australian property market

Date: Dec 01st, 2021

– and falling prices in 2023

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • After a 22% rise in Australian home prices this year, they are expected to slow to 5% growth in 2022 with prices likely to fall 5-10% in 2023.

  • The main drivers behind the slowdown are: worsening affordability; rising supply; rising rates; macro prudential tightening; & a rotation in spending away from housing.

  • The main risks on the downside are another big covid set back or faster rate hikes & the main risk on the upside would be a fast return to pre-covid immigration.

Fastest home price gains since 1989

Australian home prices have boomed this year. They are up 22.2% over the 12 months to November according to CoreLogic with Hobart ( 28%), Sydney ( 26%), Brisbane ( 25%), Canberra ( 25%) and regional prices ( 25%) leading the charge. This is the fastest annual increase since 1989. Average capital city prices are now up 18% compared to their previous record high in 2017.

The surge has been driven by a combination of record low mortgage rates, multiple government home buyer incentives, government income support measures, pent up demand from the lockdowns, activity associated with a desire to “escape from the city”, a switch in spending from services to goods (including housing) and an element of FOMO (fear of missing out).

But momentum is continuing to slow

However, while the surge in prices has been big, the puff is coming out of the property market. Average dwelling price growth peaked at 2.8%mom in March and has slowed to 1.3%mom in November. Price growth in Sydney has slowed to 0.9%mom and in Melbourne to 0.6%mom. See the next chart.

Average capital city home prices

Source: CoreLogic, AMP Capital

Consistent with this loss of price growth momentum, while auction clearance rates are still very strong, they have fallen around 10-15 percentage points from their October highs in Sydney and Melbourne.

Sydney auction clearance rates and home price growth

Source: Domain, CoreLogic, AMP Capital

Of course, the slowing in national average price growth masks a divergence with previous laggard cities of Brisbane and Adelaide seeing their strongest monthly gains of 2.9%mom and 2.5%mom in November since 2003 and 1993 respectively. And average regional prices rose another 2.2% in November.

Five reasons to expect a cooling in the property market

At a national average level there are five reasons to expect a further slowing in average home price growth next year, followed by a peak in prices sometime in the second half of next year and falling prices in 2023.

First – worsening affordability is constraining more buyers. Affordability has long been an issue in the Australian property market. The next chart shows real Australian home prices (average property prices after removing increases in consumer price inflation) indexed to start in 1926 at 100 (the red line) against their long-term trend (the blue line).

Aust house prices relative to their long term trend

Source: ABS, AMP Capital

Over the last 100 years real property price growth averaged 3% per annum which is in line with long term average real GDP growth (which is a rough proxy for long-term real income growth). Real Australian property prices have gone through 3 major long-term booms (highlighted with green arrows) and two major long-term busts or weak periods over the last century.

The current long term bull market in residential property has seen real prices rise from 23% below their long-term trend in 1997 to now being 26% above it. Over this period wages have increased by 106%, but home prices are up by 317%, which is nearly three times more. The property slump from 2017 provided a bit of a breather and saw prices fall back to nearer their long-term trend. This along with last year’s rate cuts and various first home buyer assistance measures enabled first home buyer demand to surge. But the rebound in prices over the last year has more than reversed this with prices up 22% but wages up just 2.2%. While interest rates are still low the surge in house prices relative to wages has gone hand in hand with a surge in the level of debt relative to incomes. That now means that it takes 8 years to save for a deposit in Sydney and 7 years in Melbourne. This is now squeezing out first home buyers yet again (which has seen their share of new housing finance fall from 25% to 18% since December) and increasingly existing owners looking to trade up are being squeezed out as well. This is particularly an issue in Sydney and Melbourne and partly explains their slowing relative to other cities.

Second – the supply/demand balance is starting to improve. Rising listings are at last adding to supply in the home buyer market. According to CoreLogic national auction numbers over the last week exceeded 4,000 for the first time. Supply is on the rise again reflecting pent up selling, the end of lockdowns and high prices. This could start to reverse the chronically low level of listings seen over the last 18 months. More fundamentally strong levels of home building (the red line in the next chart) over the last two years following the unit building boom since 2015, combined with the absence of immigrants – which has resulted in a slump in underlying housing demand (the blue line in the next chart) – have started to see the underlying supply/demand balance come under control (the green line). As such, we may at last be heading into a period of housing oversupply after years of undersupply. This of course assumes only a gradual return to pre-covid levels of immigration by 2025. A faster ramp up could reverse this.

Home construction and underlying demand

The cumulative stock position shows the accumulated gap between underlying demand & completions from when the market was roughly balanced. Source: ABS, AMP Capital

Third – rising interest rates will reduce the amount new borrowers can borrow and hence pay for dwellings. Fixed mortgage rates are already on the rise (with several banks increasing them by 0.5% or more) and the RBA is expected to start raising the cash rate (and hence variable mortgage rates) from late next year. Rising interest rates are likely to be a big dampener. The collapse in fixed rates to 2% or less played a big role in the recent boom. Fixed mortgages have accounted for 50% or so of new loans recently, so are far more significant than they used to be in impacting new buyer demand (even though there is no impact on existing fixed borrowers until they roll off current terms which may become an issue next year).

Fourth – macro prudential tightening is reducing the amount new borrowers can borrow and pay for homes. So far APRA has told banks to increase the interest rate serviceability buffer they apply to borrowing rates in assessing borrowers from 2.5% to 3% and are now moving to require banks to hold more capital for higher risk loans. The former will reduce the amount borrowers can borrow and the latter will raise the interest rate on or reduce the supply of higher risk loans. Further tightening measures are possible.

Finally – a rotation in consumer spending back towards services as reopening occurs (covid and the Omicron variant permitting) may reduce housing demand.

House price outlook – expect falling prices in 2023

With national average home prices up by 20.9% year to date they are on track for a 22% rise this year. Prices in Sydney are up 25% year to date and are likely to be up by 26% this year. However, as noted earlier, this masks a sharp loss of momentum since March as a result of worsening affordability, rising supply, rising rates, macro prudential tightening and some eventual rotation in spending away from housing. We expect a further slowing in home price gains to 5% in 2022, with prices likely to start falling from around September/October next year resulting in a 5 to 10% decline in prices in 2023.

Concluding comments

First, with Sydney and Melbourne home prices having led the charge over the last decade (see the next chart) and suffering from worse affordability, they are likely to come in a bit weaker than average over the next two years. Whereas laggard cities like Brisbane and Adelaide and possibly Perth and Darwin are likely to be relative outperformers. Regional prices may also continue to benefit from the work from home phenomenon and desire for a better lifestyle.

Australian residential property prices – the great catch up?

Source: CoreLogic, AMP Capital

Second, the main downside risks to our price forecasts would be if a renewed deterioration in covid (due say to Omicron or another variant) results in a more debilitating economic slump of if a faster pick-up in inflation necessitates rapid interest rate hikes next year. The main upside risk would be if immigration is quickly ramped up to above pre-coronavirus levels resulting in a renewed property supply shortfall – this could result in another year or rising prices in 2023.

Finally, we remain of the view that we may be getting closer to the end of the 25-year bull market in property prices: the 30 year decline in mortgage rates is likely over so this tailwind for property prices thats enabled people to keep borrowing more to pay more for houses is likely over; strong home building in recent years, the collapse in immigration over the last two years & only a gradual recovery in immigration ahead could remove the chronic undersupply of property; and the work from home phenomenon may take pressure of capital city prices.

Source: AMP Capital December 2021

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.

The longer-term legacy of coronavirus – nine implications of importance to investors

Date: Nov 24th, 2021

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • Likely key longer-term implications flowing from the coronavirus pandemic are: bigger government; increased money supply and excess saving; increased geopolitical tensions; reduced globalisation; a faster embrace of technology; a greater focus on lifestyle; and a potential post-pandemic boom.

  • The biggest risk is of significantly higher inflation, reversing the long-term downtrend in interest rates.

Introduction

The magnitude of the coronavirus shock means it will have implications beyond those associated with its short-term economic disruption. Possibly a bit like a world war – where the post war period is very different to the pre-war period.

Of course, coronavirus has not yet released its grip as its resurgence in Europe and the US highlights – with a very high risk of the same elsewhere. But there is good reason for optimism – vaccines are 85-95% effective in preventing serious illness and there are now several effective treatments that are useful for those for whom the vaccines are less effective and for the unvaccinated. Vaccines are less effective though in preventing infection (at 60-80%) and their efficacy fades after about five months – so when 70% or less of the population is vaccinated (as in Europe and the US) that still leaves a high proportion of the population who can get sick and overwhelm the hospital system, particularly as colder weather sets in and efficacy wanes resulting in the return of restrictions in some places. And vaccination rates remain low in poor countries running the risk of new waves and mutations. The only way to avoid this is to get vaccination rates to very high levels (with the help of vaccine mandates), quickly roll out booster shots and only remove restrictions gradually. This includes Australia too.

But the key is that vaccines and new treatments provide a path out of the pandemic and long hard lockdowns and as a result it’s likely that 2022 will be the year we will “learn to live with covid” and it goes from being an epidemic to being endemic. So it makes sense to have a look at what its longer term legacy may be (beyond of course associated medical advances that have been big). Here are 7 key medium to longer term impacts.

#1 Bigger government and bigger public debt

The GFC brought an end to support for economic rationalism and was associated with a leg up in public debt levels. Fading memories of the problems of too much government intervention in the 1970s added to this. The coronavirus crisis has added to support for bigger government intervention in economies and the tolerance of higher levels of public debt. Particularly given that the pandemic has enhanced perceptions of inequality and that governments should do more to boost infrastructure spending & bring production of key goods back onshore. And it’s now combining with a desire for governments to pick and subsidise climate “winners” rather than rely on a carbon price to achieve net zero emissions. IMF projections for government spending in advanced countries show it settling 1% of GDP higher in five years’ time than pre-covid levels.

Public spending as a share of GDP

Source: IMF, AMP Capital

And net public debt is also expected to settle at levels around 15% of GDP higher – more so in the US.

Net public debt as a share of GDP

Source: IMF, AMP Capital

Implications – while increased infrastructure spending is positive for productivity, the trend towards bigger government generally is more of a negative for longer term growth.

#2 Increased money supply and excess saving

The combination of quantitative easing (which saw money injected into economies) along with government spending through the pandemic to support household and corporate income boosted broad money supply measures (like M2 and M3 – which include bank deposits) well above their long-term trend. This is evident in excess household savings (savings above their long-term trend built up through the last two years) of $US2.3 trillion in the US (10% of GDP) and $180bn in Australia (8% of Australian GDP).

This is radically different to the post GFC period that saw QE boost narrow money (mainly bank reserves) but was offset by fiscal austerity.

Implications – the pool of excess saving provides a boost to spending & a potential disincentive to work (until it runs out) and with increased money supply risks an ongoing boost to inflation, beyond the pandemic driven boost currently being seen.

#3 Increased geopolitical tensions

Geopolitical tensions were on the rise prior to the pandemic with the relative decline of the US & faith in liberal democracies waning from the time of the GFC. This has seen various regional powers flex their muscles – Russia, Iran, Saudi Arabia and notably China, which was facilitated by its own economic rise. The pandemic inflamed US/China tensions, particularly over the origin of coronavirus and as the US’ poor handling of coronavirus reinforced China’s shift away from economic liberalism. Russia and Iran are now seeking to take advantage of the global energy shortage, which itself is partly pandemic-related. The summit between President’s Xi and Biden offers hope for a thaw in tensions but it’s not clear how far that will go.

The pandemic has also arguably inflamed political polarisation – with the hard left tending to support lockdowns & vaccines and the hard right against them. This is perhaps more of an issue in the US and parts of Europe than in Australia.

Implications – increased geopolitical tensions could act as a negative for growth, work against multinationals and be negative for shares. It also poses a threat to Australia – with restrictions on imports of various products into China – so far this has been masked by first higher iron ore prices and then higher energy prices. And more political polarisation risks policy gridlock. Fortunately, it’s not as much of an issue in Australia.

#4 Reduced globalisation

A backlash against globalisation became evident last decade in the rise of Trump, Brexit and populist leaders. The coronavirus disruption has added to this. Worries about the supply of critical items have led to pressure for onshoring of production.

Implications – Reduced globalisation risks leading to reduced growth potential for the emerging world generally. Longer term it could reduce productivity if supply chains are managed on other than economic grounds and will remove a key source of disinflationary pressure from the global economy.

#5 Digital world

Working from home and border closures have dramatically accelerated the move to a digital world. Workers, consumers, businesses, schools, universities, health professionals, young & old have been forced to embrace new online ways of doing things. Many have now embraced on-line retail, working from home & virtual meetings. It may be argued that this fuller embrace of technology beyond Netflix will enable the full productivity enhancing potential of technology to be unleased.

Implications – there are big ongoing implications from this:

  • Pressure on traditional retail/retail property has intensified.

  • The decline of the office – some sort of happy medium (eg 2 days in and 3 days at home) will likely be arrived at trading the need for collaboration and team building against the need for quiet time and getting things done. But it has huge implications for office space demand and CBDs.

  • An ongoing reinvigoration of economic life in suburbs and regions – as work from home continues (albeit not necessarily for five days for all).

  • Virtual meetings may see less demand for business travel.

#6 Greater lifestyle focus & the “Great Resignation”

It’s conceivable that the lockdowns have driven many to rethink what’s important in life and that pent up saving through the pandemic along with the ability of many to work from home has provided flexibility for some to refocus and a reluctance to the fully return to the old grind. In fact, the term “Great Resignation” has been coined in the US as labour force participation remains below pre pandemic levels and the proportion of workers “quitting” their jobs is at record levels. This in turn (and the absence of skilled immigrants and backpackers in Australia) may be contributing to labour shortages (which given the boost the pandemic provided to goods demand has created supply shortages and a surge in inflation). Of course, some of this may fade as excess savings are run down, people return to work as the pandemic fades and there is less evidence to support a “Great Resignation” in Australia where jobs turnover is normal. And it seems like only yesterday there was talk of automation wiping out lots of jobs – so it could all just be another beat up. Then again, its likely some of it will linger as work from home has shown a way to a higher quality lifestyle.

Implications – this will provide an ongoing boost to relative demand for lifestyle property, albeit it risks driving higher wages in the short term. And labour supply in some countries may take a while to get back to what it used to be.

#7 A post pandemic boom?

It’s conceivable that elation once the pandemic is finally over, the spending of pent up demand and excess savings along with the productivity enhancing benefits of new technology unleashed by the lockdowns will drive a re-run of the “Roaring Twenties” much like occurred after Spanish flu. Time will tell.

Implications – growth may turn out stronger than expected.

#8 More Europe

Each new crisis seems to bring Europe closer together. The ECB’s response to the pandemic which has seen it buy more bonds in problem countries and the economic recovery fund where Italy and Spain will receive a disproportionate share highlight that Europe is getting closer and the impending change of government in Germany may add to this. The pressures to keep the Eurozone together (safety in numbers, a high identification as Europeans, support for the Euro, Germany benefitting from the EU & Germany’s exposure to Italian bonds via the ECB) remain stronger than the forces pulling it apart.

Implications – I still wouldn’t bet on the Euro breaking apart.

#9 A smaller Australia?

Given the hit to immigration by 2026 Australia will be 1 million people smaller than expected pre coronavirus. And the Federal Government appears to have rejected the idea of a catch up in immigration levels to make up for lost arrivals.

Implications – the hit to immigration if sustained could mean a more balanced housing market in the years ahead with less upwards pressure on prices and reduced potential growth in the economy as a result of skilled shortages and lower population growth. But of course, this could reverse if the Government rapidly ramps up immigration after next year’s Federal election.

Concluding comments

Some of these implications will constrain growth & hence investor returns – bigger government, reduced globalisation, lower population in Australia and a possible longer-term threat to labour supply. And increased geopolitical tensions could add to volatility. Against this, the faster embrace of technology boosting productivity and a potential post pandemic boom will work the other way and is positive for growth assets.

The biggest risk is high inflation. Just as World War 2 and expansionary post-war policy ultimately broke the back of 1930s deflation, so to the pandemic and its monetary and fiscal response is likely to have broken the back of the prior disinflationary period. This in turn means the tailwind of falling inflation & interest rates which provided a positive reflation and revaluation boost to growth assets is likely behind us.

Source: AMP Capital November 2021

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.

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