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The next move in the RBA cash rate likely remains down later this year

Posted On:May 21st, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

It’s now two years since the RBA first started to raise interest rates resulting in the biggest tightening cycle since the late 1980s. Rates have gone much higher and stayed high for much longer than I thought would be the case as Australian households proved more resilient than expected thanks to a combination of a boost to demand from reopening

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Introduction

It’s now two years since the RBA first started to raise interest rates resulting in the biggest tightening cycle since the late 1980s. Rates have gone much higher and stayed high for much longer than I thought would be the case as Australian households proved more resilient than expected thanks to a combination of a boost to demand from reopening after COVID, saving buffers, a greater proportion of borrowers on fixed rates and the strongest population growth rate since the early 1950s. So where to now?

Australian interest rates

Source: RBA, AMP

The rollercoaster ride in interest rate expectations

This year has seen a bit of a rollercoaster ride in interest rates expectations – which may be what you would expect at a turning point in the cycle. Early in the year, the money markets had priced in nearly three RBA 0.25% cash rate cuts for this year, with around seven Fed rate cuts. After the March quarter inflation scares in Australia and the US, the money market in the US had scaled back to just 1.5 cuts and the local money market started to price in rate hikes. The last two weeks have seen money markets become dovish again with two cuts priced in by year end for the US and one partly priced in for Australia. The renewed dovishness reflects better April inflation in the US, a less hawkish than feared Fed, a less hawkish than feared RBA, the Budget being seen as neutral, and softer data for local wages and jobs. The minutes from the last RBA meeting confirmed it considered another hike and didn’t consider a cut and it warned that “the risks around inflation had risen”. This suggests the RBA retains a tightening bias. However, its guidance that it’s difficult “to rule in or out future changes in the cash rate” along with its unchanged forecasts for inflation to fall into the target range next year suggest the tightening bias is mild.

Number of RBA rate hikes/cuts priced in for the…

Source: RBA, AMP

The case for another rate hike

The main arguments for further rate hikes are that:

  • services inflation and trimmed mean inflation (a measure of underlying inflation) remained sticky at 4.3% yoy & 4% yoy in the March quarter;

  • wages growth could have another leg up, keeping services inflation high as the labour market remains tight with risks flowing from strong increases in wages for aged care and childcare workers & if the coming Fair Work Commission (FWC) decision for awards comes in high;

  • the Budget provided additional stimulus to the economy on top of the Stage 3 tax cuts from July; and finally

  • the RBA cash rate is below that in comparable countries – with the ECB at 4.5%, Canada 5%, UK at 5.25%, US at 5.25-5.5% and NZ at 5.5%.

The case for rate cuts later this year

However, while the risks at the next few RBA meetings are still on the upside for rates, the RBA’s hurdle for another hike looks to be high requiring future data to threaten its forecasts for inflation to return to target in 2025 and 2026. We see the most likely outcome as being the RBA holding at current levels, ahead of rate cuts later this year.

First, the economy has slowed to a crawl and likely remains in a per capita recession. Real retail sales fell again in the March quarter & are down 5 of the last 6 quarters with per capita retail sales down 7 consecutive quarters.

Australia real retail sales

Source: ABS, AMP

Consistent with this household spending data suggests real consumer spending is flat to negative on a year ago. While the stage 3 tax cuts are worth $1929 a year for those on average earnings, this only offsets a very small portion of the extra $15,000 or so a household with an average mortgage is paying each year so it’s hard to see it causing a big rise in spending. The next chart shows a mix of economic indicators that lead (like building approvals, consumer and business confidence and the yield curve), are coincident with (like employment and retail sales) or lag (like unemployment and delinquency rates) the economy. While none are at recessionary levels and leading indicators have become a bit less negative, both leading and coincident indicators remain below normal levels.

Australia Economic Indicators

Source: Bloomberg, AMP

Second, weak demand means inflation is likely to resume its downswing. We have been seeing a quarterly pattern of higher than expected then lower than expected inflation lately which suggests the June quarter could see lower than expected inflation; the Melbourne Institute’s April Inflation Gauge points to a resumption of the falling trend; and similarly the NAB business survey points to a falling trend in cost and selling price inflation.

NAB Survey: Price Indicators

Source: NAB, AMP

Our Australian Pipeline Inflation Indicator points down.

Australia Pipeline Inflation Indicator

Source: Bloomberg, AMP

Thirdly, the labour market is cooling, and this points to slower wages growth which will lower services inflation. While the labour market remains tight the trend is up in unemployment & underemployment and falling job vacancies & hiring plans point to slower jobs growth ahead, as evident in our Jobs Leading Indicator which is pointing down.

Australian employment vs Jobs Leading Indicator

Source: ABS, ANZ, NAB, Bloomberg, AMP

Consistent with this our Wages Leading Indicator points to slower wages growth ahead reflecting softer increases in new Enterprise Bargaining Agreements and lower labour cost surveys.

Australia Wage Growth Leading Indicator

Source: ABS, NAB, Bloomberg, AMP

Fourth, the March quarter global inflation scare appears to be receding. US inflation came in weaker than feared in April and inflation elsewhere is continuing to fall. Both Switzerland and Sweden have now cut rates, the ECB, Canada and UK look on track to start cutting around mid year and the US Fed looks on track to start cutting in September.

Fifth, while the RBA has not raised rates as much as in other comparable countries, the rise in average outstanding mortgage rates exceeds that in other countries (reflecting the higher reliance on short-dated borrowing here in Australia) implying a much bigger hit to households. While average outstanding mortgage rates have increased by 3.3% in Australia, in the US its just been 0.5%, UK 1.6%, Canada 2.5% and NZ 3.2%.

Finally, while the Budget was more stimulatory than ideal, the extra stimulus was relatively modest. The impact on inflation from cost-of-living measures (about 0.5% over the next 12 months) likely means a downwards revision to RBA inflation forecasts. That could result in a potential flow on to underlying inflation measures as various government charges indexed to the CPI go up by a smaller amount and help keep inflation expectations down. So, we have concluded that the Budget did not warrant a change to our prior expectation for inflation to fall to 2.7% by June next year and for the RBA to start cutting rates by year end.

Concluding comment

The risk for interest rates in the next few meetings is still skewed to the upside, particularly if inflation comes on the high side again. However, with the economy weak, the labour market cooling and inflation likely to keep slowing, our base case is for the RBA to remain on hold ahead of rate cuts starting in November or December. We now only expect one rate cut this year (taking the cash rate to 4.1%) and are allowing for two cuts next year, Key to watch will be monthly inflation data, the upcoming FWC decision regarding award wages, unemployment and household spending.

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Source: AMP Capital May 2024

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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The 2024-25 Budget

Posted On:May 14th, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Another surplus, but bigger medium term deficits with more big spending, including on a “Future Made in Australia” Introduction

The Budget is aimed at trying to lower inflation in the near term but supporting Government priorities including formally launching a “Future Made in Australia” (FMIA) over the medium term. In terms of the former, there is another round of cost-of-living subsidies designed

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Another surplus, but bigger medium term deficits with more big spending, including on a “Future Made in Australia”

Introduction

The Budget is aimed at trying to lower inflation in the near term but supporting Government priorities including formally launching a “Future Made in Australia” (FMIA) over the medium term. In terms of the former, there is another round of cost-of-living subsidies designed to reduce measured inflation. In terms of the latter, it further cements bigger government and sees bigger deficits for the medium term.

Key budget measures

Key measures, many of which were announced prior, include:

  • $5.4bn in a broader round of cost-of-living relief, including broadening energy bill relief for all households and extending rent assistance.

  • A renewed focus on the benefits to all households from the Stage 3 tax cuts that were rejigged in January (worth an average of $36/wk).

  • $3bn for community pharmacies for cheaper medication and $6.2bn on Medicare and expanding the Pharmaceutical Benefits Scheme.

  • $9.6bn on housing & crisis accommodation and extra on related infrastructure (although much is a continuation of existing programs) and $89m to train home builders (although the planned 20,000 new tradies are only 1.7% of the existing construction workforce).

  • Prac payments for nurses, midwives and social workers.

  • A change to student debt indexation which cuts the value of debt with no near-term budget cost as it won’t involve a handout to students.

  • A mix of subsidies, tax breaks, cheap loans, relaxed foreign investment rules & less red tape to boost investment in government chosen industries as part of the $22.7bn “FMIA” policy.

  • Caps on international student arrivals by each university which can be raised if they build more student accommodation.

  • Extra spending on aged care & childcare to cover wage rises.

  • Freeze on deeming rates for low-income households.

Budget savings include:

  • Further savings in areas like consultants, compliance and efficiencies and reducing spending on the National Disability Insurance Scheme.

Economic assumptions

The Government left its growth forecasts unchanged for this year but revised them down slightly for the next two years. Notably it has revised down slightly its inflation forecasts and still sees wages growth slowing from here as does the RBA, but an obvious risk to this is that its support for wage increases in certain industries has a flow on effect to other industries (just as the aged care wage rises last year seems to be leading to higher wages for childcare workers). It also sees lower inflation this year and next than the RBA and this is partly due to a continuation of cost-of-living relief measures that it sees as lowering measured inflation (by 0.5% in 2024-25), whereas the RBA assumed the measures lapse.

The Government now sees net immigration of 395,000 this financial year (MYEFO was 375,000), falling to 260,000 in 2024-25, taking population growth down to around 1.4% from 2.4% in 2022-23. The Government kept its medium-term iron ore price assumption at $US60/tonne. With the iron ore price well above that (>$US100 as of May 2024), it’s still a potential source of revenue upside.

Economic assumptions

 

 

2022-23

2023-24

2024-25

2025-26

2026-27

2027-28

Real GDP 

Govt

3.1

1.75

2

2.25

2.5

2.75

  % year

AMP

 

1.5

1.7

2.4

2.5

2.5

Inflation

Govt

6.0

3.5

2.75

2.75

2.5

2.5

  % to June

AMP

 

3.6

2.7

2.5

2.5

2.5

Wages

Govt

3.7

4

3.25

3.25

3.5

3.5

  % to June

AMP

 

4.1

3.1

2.8

3.5

3.75

Unemp Rate

Govt

3.6

4

4.5

4.5

4.5

4.25

  % June

AMP

 

4

4.4

4.3

4.25

4.25

Net migration

Govt

528,000

395,000

260,000

255,000

235,000

235,000

Source: Australian Treasury, AMP

Another budget surplus then bigger deficits

This Budget like all of those since 2020 has again benefitted from extra revenue flows coming from higher personal tax collections due to stronger jobs growth and higher commodity prices (and hence mining profits) than assumed. This is not smart management but good luck flowing from conservative forecasts. This windfall (see the line called “parameter changes” in the next table) is estimated to reduce the deficit this financial year by $10.6bn compared to last December’s update, with a total benefit over the five years shown of $12.6bn. But this table – a more detailed version of which appears in the Budget papers and is nicknamed the “table of truth” – also shows how much of the windfall has been spent (see the line called “new stimulus”). Last year only 14% of the windfall through the forward years was spent but this budget nearly twice the windfall (i.e. $24.4bn) is being spent. As a result, while the budget now looks better for this financial year (with another surplus – which could turn out to be even bigger), because of the extra spending in subsequent years it now looks worse from 2024-25.

The “table of truth” – underlying cash budget balance projections

 

2023-24

2024-25

2025-26

2026-27

2027-28

May 23-24 Budget,$bn

-13.9

-35.1

-36.6

-28.5

 

Dec 2023 MYEFO, $bn

-1.1

-18.8

-35.1

-19.5

-26.5

Parameter chgs, $bn

10.6

0.0

2.6

-4.0

3.3

New stimulus, $bn

-0.2

-9.5

-10.3

-3.3

-1.2

Projected budget,$bn

9.3

-28.3

-42.8

-26.7

-24.3

       % GDP

0.3

-1.0

-1.5

-0.9

-0.8

Source: Australian Treasury, AMP

Due to new spending & structural pressures from interest costs, the NDIS, defence, health and aged care spending as a share of GDP is expected to average 26.2% over the longer term, well above the pre-Covid average of 24.8%. Despite a blip down with tax cuts, revenue trends up reaching its 1986-87 record of 26.2% of GDP in 10 yrs. So bracket creep, not spending restraint is assumed to do the work in getting us back to a budget balance.

Federal Government spending and revenue

Source: Australian Treasury, AMP

After a surplus this year, there are bigger deficits over the next few years.

Australian Federal budget deficit

Source: Australian Treasury, AMP

Gross public debt is projected to remain elevated at around 35% GDP before falling next decade.

Winners and losers

Winners include: low and middle income households; pensioners; women; medicine users; aged & child care workers; low income renters; students; apprentices; home builders; students; defence; critical mineral projects; and clean energy manufacturers. Losers include: consultants, universities, foreign students, backpackers and dodgy NDIS providers.

Assessment

The positives in the Budget include: another surplus; the cost-of-living measures will help ease pressure on the most vulnerable and some will lower measured inflation with a second round flow on to lower indexed price rises and inflation expectations; tax breaks & streamlined approvals should help boost medium term business investment; & there is still scope for revenue to surprise with commodity price assumptions.

However, the Budget has several significant weaknesses in relation to:

  • Inflation. The cost-of-living measures will help lower measured inflation. But the new stimulus (shown in the “table of truth” above) risks boosting demand. Federal and state fiscal positions point to a sharp shift from fiscal contraction (which helps lower demand and inflation) to expansion over the year ahead (see the next chart). And Government support for high wage increases for some sectors risks adding to wages growth given the flow on and influencing effects at a time when wages growth is already at its maximum level consistent with the inflation target. All of which risks making the RBA’s job harder.

Australian Fiscal Stimulus (Federal and State)
(change in budget balance estimates)

Source: Australian and state treasuries, AMP

  • Structural deficits. The Budget has added to medium term structural deficits. This leaves it vulnerable if the economy weakens and sees no money put aside for a rainy day over the forecast period.

  • Bigger government. Spending as a share of GDP is seen settling well above that seen pre pandemic thereby locking in a bigger government sector which risks further slowing medium term productivity growth.

  • FMIA. While “made in Australia” is popular and there is talk of a “new growth” model, its reliance on protectionism and government picking winners has been tried and failed in the past with a long-term cost to productivity & living standards. Moving to net zero is one thing, but this doesn’t mean we need to make solar panels or quantum computing or that we have a comparative advantage in them. Just because other countries are deploying subsidies is no reason for Australia to do so. We should just take the subsidised products!

  • Productivity. Beyond the hopes of FMIA there is not a lot here to improve Australia’s medium term productivity performance. This is the key to growth in living standards but needs urgent reform in terms of tax, competition, the non-market services sector, industrial relations, education and training and energy generation. Fortunately, the Government is moving on the last two at least.

  • Housing. The latest housing measures are welcome, but are unlikely to be enough to hit the 1.2 million new homes over five years objective with the supply shortfall set to remain unless immigration plunges.

Implications for the RBA

The direct lowering in measured inflation from cost of living measures will be welcomed by the RBA, but it will be wary of the rise in new stimulus. The net effect adds to the risk of higher for longer interest rates, but is probably not enough to change our forecast for a rate cut later this year.

Implications for Australian assets

Cash and term deposits – cash and bank deposit returns have improved substantially with RBA rate hikes and the Budget won’t change this much.

Bonds – another surplus takes pressure off bond yields, but this is offset by higher medium term deficits…so there is not much in it.

Shares – the Budget is positive for spending and hence retail shares, but this may be offset by higher than otherwise rates. Some manufacturers may benefit from FMIA. Overall, it looks neutral for shares.

Property – the housing measures are unlikely to alter the home price outlook which is dominated by supply shortages & high rates. We see modest home price growth this year.

The $A – the Budget is unlikely to change the direction for the $A.

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Diana MousinaDeputy Chief Economist, AMP

My BuiEconomist, AMP

Source: AMP Capital May 2024

Important note: While every care has been taken in the preparation of this document, neither National Mutual Funds Management Ltd (ABN 32 006 787 720, AFSL 234652) (NMFM), AMP Limited ABN 49 079 354 519 nor any other member of the AMP Group (AMP) makes any 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. This document is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

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Seasonal patterns in shares – should we “sell in May and go away”?

Posted On:May 06th, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

Coming out of the roughly 10% correction into October last year, share markets saw strong gains on hopes that lower inflation will allow central banks to cut interest rates and as global profits have remained strong. The going seems to have become tougher though with share markets falling in April amidst interest rate and geopolitical concerns begging the question as

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Introduction

Coming out of the roughly 10% correction into October last year, share markets saw strong gains on hopes that lower inflation will allow central banks to cut interest rates and as global profits have remained strong. The going seems to have become tougher though with share markets falling in April amidst interest rate and geopolitical concerns begging the question as to whether it’s maybe now time to “sell in May and go away” given the old saying, in reference to seasonal patterns in shares.

Seasonal patterns in shares

Seasonal patterns have long been observed in share markets. The “January effect” was perhaps the most famous, where January typically provided the best gains, but anticipation of it has seen it morph into December and now November. However, it’s really part of a broader seasonal pattern, which over long periods has been positive for shares from around October to around May and then weaker to September. This can partly be seen in the pattern of average monthly share prices changes since 1985 shown in the next chart.

The seasonal pattern in shares

Source: Bloomberg, AMP

The broader seasonal pattern can be seen in the following chart which shows a monthly index for US and Australian shares after the longer term fundamentally driven trend is removed. The general picture of weakness into September often continuing into October – which is known as a “bear killer month” given the tendency for some bear markets to end in October – also gels with the historical tendency for many financial crises to occur around the August to October period – e.g. the 1929 crash, 1987 crash, the LTCM hedge fund crisis and the GFC.

The seasonal pattern in US and Australian shares

Source: Bloomberg, AMP

Or another way to look at it is to break a 12-month period into two halves. Since 1985, the average total return (from price gains and dividends) from US shares from the end of November to the end of May is nearly double that from the end of May to the end of November. Elsewhere the gap has been bigger.

A story of two halves

Source: Bloomberg, AMP

Observation of the seasonal pattern gave rise to the old saying “sell in May and go away, buy again on St Leger’s Day” which has its origins in the UK as St Leger’s Day is a UK horse race in September. In fact, it may have its origins in crop cycles with grain merchants selling their shares at the end of the northern summer to buy the summer crop (which depresses shares around August/September) and then buying back in after they sold the crop on to mills. Of course, that’s not so relevant today. The principal drivers in the seasonal pattern in the key US share market are likely to be:

  • investors and funds selling losing stocks to realise tax losses (to offset against capital gains) towards the end of the US tax year in September. This is also normally when capital raisings are solid;

  • investors then buying back in the final quarter of the year at a time when capital raisings wind down into year-end;

  • which then combines with the tendency for investors to invest bonuses early in the new year and new year optimism as investors refocus on the year ahead at a time when capital raisings are low. The illiquid nature of investment markets around late December and January makes these moves more marked.

Since 1985, November, April and December have been the strongest months for US shares. August and September have been the weakest. Consistent with US shares’ global influence, this pattern is also discernible in other countries. The strongest months of the year in the Australia have been April, July and December, with September the weakest.

But seasonal patterns appear to have weakened

However, there are several reasons to be cautious of relying on seasonal patterns to drive investment decisions.

Firstly, while the period from the end of May to the end of November may have provided weaker returns on average over the period since 1985, they have still tended to be positive, so getting out of the market in May in anticipation of weakness may not be justified on seasonality alone.

Secondly, the seasonal pattern has altered and softened a bit over time. The next chart compares the monthly pattern in returns over 2005-2023 to the period 1985-2004 for the Australian share market. May and June now appear to be weaker months, October’s weakness has been brought forward into September which is now the weakest month of the year (mainly because the October 1987 share crash drops out of the data for the latter period). But April, July and December remain the strongest months of the year, so some seasonal patterns still remain.

Seasonal patterns in Australian shares

Source: Bloomberg, AMP

There has also been a change in the seasonal pattern in the US with July looking stronger in recent times and December and January weaker as strength has been pulled forward into November. September has remained the weakest month of the year on average though.

Seasonal patterns in US shares

Source: Bloomberg, AMP

The change in seasonal patterns has weakened the concept of relative strength from end November to end May versus weakness from the May to end November. Over the period since 2005, the second period has actually been stronger than the first in the US and the gap has narrowed sharply in Australia, Asia and globally so it’s no longer so significant.

Average six month % equity return

Source: Bloomberg, AMP

Given the ongoing tendency for weakness in August and September though, and the clearer strength in July, perhaps the saying should now be, “sell in July and go away, buy again in October”. But that is a much shorter period which is arguably not worth timing for investors.

Thirdly, averages can be deceiving. The next chart looks at the proportion of positive returns in each month for the period since 2005. Again, the tendency for weakness in September is evident with less positive months. However, in the US, 50% of Septembers since 2005 have still been positive and in Australia 39% have been positive – so having a fall in September is no sure thing. And while April ranks as one of the strongest months of the year since 2005, 22% of Aprils in Australia have been negative and 11% in the US, as we have just seen in the past month with Australian and global shares down around 3%! So seasonal tendencies don’t always pan out as they can be swamped by other influences.

Percentage of months with increases – US & Australian shares, 2005 – 2023

Source: Bloomberg, AMP

What does it all mean for investors?

There are three key points here for investors: First, seasonal influences shouldn’t dominate an investor’s portfolio decisions – they appear to have changed a bit over time, such that there is less support for selling in May and they can be overwhelmed by fundamental influences, so they don’t apply in all years.

Second, they do provide some guide though to the pattern of markets through the year which investors should ideally be aware of in terms of decisions to buy and sell. In simplistic terms, around May or July is perhaps not the best time to be piling into shares and around September is not the best time to be selling them.

Finally, we continue to see shares having reasonable returns this year as inflation falls enabling central banks to ultimately cut interest rates. But they have had good gains since their lows last October and because of somewhat stretched valuations, uncertainty about the growth outlook and prospects for interest rate cuts, along with various geopolitical risks, are likely to see a more constrained and volatile ride over the remainder of the year than was the case in the first three months of the year. Of course, long term investors should look through all this.

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Source: AMP Capital May 2024

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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The art of happiness – economics and the “hedonic treadmill”

Posted On:Apr 29th, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

On a recent road trip, I was listening to a bunch of Taylor Swift and Andy Williams’ CDs and what struck me was how different the topics of the songs were. Andy’s covers were far more upbeat (with songs like ‘Happy Heart’ and ‘For All We Know’) whereas Taylor has lots of ‘somebody done me wrong’ songs. Of course, it’s

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Introduction

On a recent road trip, I was listening to a bunch of Taylor Swift and Andy Williams’ CDs and what struck me was how different the topics of the songs were. Andy’s covers were far more upbeat (with songs like ‘Happy Heart’ and ‘For All We Know’) whereas Taylor has lots of ‘somebody done me wrong’ songs. Of course, it’s dangerous to generalise but then I saw a study from the University of Innsbruck finding that songs have become “gloomier” and “angrier” compared to 50 years ago – which made me think about what it tells us about the wider concept of happiness.

Pursuing happiness is at the centre of our existence. There’s lots of evidence happiness is good for us – happy people live longer, are healthier, more resilient, more creative, are better leaders and are more sociable. Which is where economics comes in. Despite often being portrayed as the “dismal science”, economics is in fact all about happiness. The economic problem is about how to maximise utility (or happiness) with limited resources. So, economics can be thought of as the “art of happiness”. But measures of happiness have been flat or falling in developed countries. So, what gives? Is economics failing us? This became a big issue in the 2000s with lots of books on happiness. There is now even a regular “World Happiness Report using Gallup surveys attempting to gauge happiness.

Rampant prosperity

The 19th century saw the start of rapid global economic growth.

The 20th century saw a surge in material growth

Source: Angus Maddison, AMP

This really took off in the 20th century as technological innovations such as electricity, the internal combustion engine and silicon chips came together to rapidly boost productivity. Consequently, real income or Gross Domestic Product (GDP) per person surged globally. This in turn led to a massive rise in material prosperity with, eg: large climate-controlled homes; high speed affordable travel; high quality & variety of food; a huge array of goods; a massive increase in lifespan, and instant communication & entertainment.

But stagnant happiness in recent decades

Despite the huge surge in material prosperity there is little evidence that happiness levels in developed countries have improved in the last fifty years. This is illustrated in the chart below for the US which shows the percentage of people who say they are “very happy”, versus real GDP per person. As income has gone up over the last 50 years, happiness has fallen.

GDP per capita and happiness in the US

Source: US General Social Survey, IMF, AMP

It’s a similar picture for Australia, although we only have Australian happiness data (from the World Happiness Report) for the last 20 years.

GDP per capita and happiness in Australia

Source: World Happiness Report, ABS, AMP

Stagnant or falling happiness is confirmed by rising trends in crime rates, depression diagnoses, suicide rates & drug abuse. This doesn’t mean there is no link between income and happiness. The next chart compares income levels and happiness across countries. At low levels of income, extra income can have a big positive impact on happiness. But for countries beyond a certain level (around $US50,000), extra income has little impact.

Income has little impact on happiness beyond about $US50,000

Source: World Happiness Report 2024, IMF, AMP

This is not to say that happiness is not high in rich countries. In fact, according to the World Happiness Report for 2024 Finland ranks #1 as the most happy and Australia ranks #10 with the US at #23. Lebanon and Afghanistan rank at the bottom at #142 and #143. It’s just that in rich countries variations in income across countries have little impact on happiness. Other findings from the happiness studies are as follows:

  • Rich people are happier than poor people. This does not mean that society as a whole becomes happier as aggregate income for everyone rises. This has become known as the Easterlin paradox.

  • People compare themselves to others (keeping up with the Joneses) in determining their happiness so if average incomes rise they may feel no happier, which may explain the Easterlin paradox.

  • Women tend to report higher life satisfaction than men, but also experience more negative emotions, suggesting they are less happy.

  • Married men are happier than unmarried men, but it’s less clear for women with some studies showing the opposite.

  • Younger people in the US, Canada, Australia and NZ are the least happy age group. This is a major change from 20 years ago and may be due to the rise of social media giving rise to increased anxiety and depression amongst the young, particularly young girls. Poor housing affordability may also be impacting.

  • Progressives are sadder than conservatives – possibly because they are more empathetic and focussed on a more negative world view.

  • Physical & outdoor leisure, shopping, reading books, seeing relatives, listening to music and attending sporting and cultural events are associated with higher happiness. Time on the internet and TV is not.

  • People in individualistic societies are happier and freedom to make life choices contributes to happiness.

  • People adapt to their situation with evidence we are born with a genetically pre-set level of happiness to which we return to after good events (like winning the lottery) and bad (like having an accident).

Some have claimed that most people are on an “hedonic treadmill” of working ever harder to attain material wealth in the belief this will make them happier only to find it doesn’t but resolving to work even harder.

From GDP to Gross National Happiness?

Many argue these findings present a challenge for economists. Economics is about maximising “utility”, or happiness. But since happiness is hard to measure, economists assume a good proxy is income and consumption. If consumption is positively correlated with happiness, then policies to boost economic growth will boost happiness. But, if not, this may be misplaced. There are two schools of thought in relation to all of this. The first is to argue economic policy needs to be refocused on broader measures of wellbeing such as Gross National Happiness. The second argues that it is up to the individual to learn how to become happy. The first approach would mean a radical change in economic policy with proposals to boost happiness like these: tax excessive work (as it doesn’t lead to happiness); re-distribute income (because inequality leads to envy and keeps people on the “hedonic treadmill”); reduce the focus on competition and rivalry; spend more money on public goods such as parks; refocus on community; limit advertising to information to avoid creating demand for stuff we don’t need; and switch to focussing on Gross National Happiness.

This would have big implications for investors, as these policies would lead to slower profit growth and lower returns from growth assets.

Legislating for happiness makes little sense

However, there are good reasons to be sceptical of proposals for government policy to target happiness:

Firstly, happiness is very hard to measure, making some of the findings referred to above questionable, and impossible to define objectively. Nationally determined concepts of happiness, such as Bhutan’s Gross National Happiness concept, depend critically on subjective judgements that governments (or ethnic or religious majorities) may define to suit them. This can be used to justify religious or ethnic persecution and can be used to advance authoritarian aims.

Secondly, just because we get used to something doesn’t mean we should stop doing it. Rising material wealth may not permanently boost happiness beyond a certain level because we adapt to it. It would have been expected that the huge increase in healthy lifespans or the increase in measured leisure time would have boosted happiness, but it hasn’t. That does not mean we should cut back on health spending or reduce leisure. Policies to increase happiness by cutting work effort or income by redirecting people to other activities may flounder as those activities have the same problems as money, ie, people just get used to them.

Thirdly, while material progress may not be boosting happiness it is doubtful stagnation will either. Curiosity and the desire to advance are fundamental to humanity. Introducing policies to reduce work effort may reduce happiness by suppressing a sense of achievement. Oppression of individual advancement may explain low happiness in socialist countries.

Fourth, restricting choice in favour of officially mandated happiness guidelines may actually reduce happiness as evidence suggests that freedom to make life choices contributes to happiness.

Finally, we are partly dealing here with the outworking of success. The rise in affluence has given people in rich countries the time and money to search for happiness. It should also be recognised that the problems with social media and the decline in happiness it may be contributing to is also a problem of the economic success that gave rise to the technology, wealth and time that facilitate their use. Finding better ways to live with the success that has given rise to social media – a bit like the rules we set around driving cars – is arguably better than threatening to reverse it.

This is not to say that governments should not attempt to measure and boost wider measures of social welfare beyond GDP. But there is a danger in trying to legislate for happiness. There is nothing new in the concept that material wealth won’t lead to lasting happiness. Most religions have long been pointing it out. Buddha long ago observed that most human suffering comes from desire and this has to brought under control to achieve happiness. But seeking happiness and enlightenment is up to individuals, not the state. Maybe Thomas Jefferson was on to something when he wrote in the US Declaration of Independence that all people had the right to “Life, Liberty and the Pursuit of Happiness” with the implication that happiness is something we can only pursue.

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Source: AMP Capital April 2024

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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Israel/Iran fears and rate cut uncertainty

Posted On:Apr 17th, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
– shares are vulnerable to a bout of volatility but here’s five reasons why the trend will likely remain up

Introduction

From their lows last October, it has been relatively smooth sailing for shares – with US shares up 28%, global shares up 25% & Australian shares up 17% to recent highs. But the last few weeks have seen a rough patch

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– shares are vulnerable to a bout of volatility but here’s five reasons why the trend will likely remain up

Introduction

From their lows last October, it has been relatively smooth sailing for shares – with US shares up 28%, global shares up 25% & Australian shares up 17% to recent highs. But the last few weeks have seen a rough patch with renewed concerns about interest rates and fears of an escalation in the war around Israel to include Iran (after Iran fired missiles & launched drones at Israel in retaliation for an attack on its consulate in Syria). The obvious issue is how vulnerable are shares? Could the bull market that got under way from the inflation and interest rate lows of 2022 (that has seen global shares rise 42% and Australian shares rise 23%) be over?

The worry list for shares

The bull market since the 2022 lows has been driven by optimism that inflation is falling enabling central banks to lower interest rates at the same time that economic growth has held up better than feared resulting in a sort of Goldilocks – not too hot and not too cold – scenario. But after such strong gains there is now a significant worry list for shares.

  • First, share market valuations are stretched. The next chart shows that the risk premium offered by shares over bonds – proxied by the gap between forward earnings yields and 10-year bond yields – has fallen to its lowest since the early 2000s in the US. Australia is a bit more attractive, but the premium is still near the lowest since 2010.

Equity risk premium over bonds

Source: Bloomberg, AMP

  • Second, US investor sentiment is at levels that can warn of corrections (red arrows). It’s not a super reliable timing indicator but it is back to levels seen last July prior to the 10% fall in shares into October.

Composite Investor Sentiment vs US shares

Sentiment index based on a composite of surveys of investors and investment advisers and options positioning. Source: Bloomberg, AMP

  • Thirdly, after strong gains shares have become technically overbought, but it’s normal to have 5% plus pullbacks every so often.

Periodic share market pull backs are normal

Source: Bloomberg, AMP

  • Fourth, uncertainty over when the Fed will start to cut rates has been increased by three worse than expected monthly CPI inflation results in a row as a result of sticky services inflation. This has seen money market expectations for 0.25% rate cuts this year scaled back from 7 starting in March this year to now less than two starting in September. And in Australia they have been scaled back from nearly three starting in June to no rate cut until late this year/early next.

  • Fifth, Iran’s retaliatory attack on Israel risks an escalation depending on how Israel responds. This would threaten Iran’s 3% of world oil production and the flow of oil through the Strait of Hormuz (through which roughly 20 million barrels a day or 20% of world oil production flows mainly enroute to Asia). Another sharp spike in oil prices would be a threat to the economic outlook as it could boost inflation again and risk adding to inflation expectations potentially resulting in higher than otherwise interest rates and act as a tax hike on consumers leaving less to spend on other things. Australian petrol prices are already around record levels despite oil prices still being well below their 2022 highs because of the rise in oil prices this year and wider refinery margins. A spike in world oil prices from around $US85/barrel for West Texas to around $US100/barrel would add around $15cents/litre to average Australian petrol prices and push the weekly household petrol bill in Australia to a record $76 up $10 a week from where it was a year ago. This would mean more than $500 less a year for the average family available to spend on other things.

Australian petrol prices versus Tapis oil price

Source: Bloomberg, AMP

  • Sixth, the US presidential election threatens to cause volatility particularly if it looks like former President Trump will be returned. His policies to lower taxes would be taken positively by the US share market as they were in 2017, but his talk of raising tariffs (10% on all imports and 60% or more on Chinese imports) threatening higher inflation and an all out trade war would be negative. In his first term he went with tax cuts first (shares surged in 2017) then tariffs (shares slumped in 2018), but he may go with tariffs first if he wins this time.

  • Finally, while the global economy has held up well, the risk of recession remains high as the full impact of the monetary tightening since 2022 continues to feed through as things like savings buffers built up through the pandemic are run down. Chinese growth also remains at risk given the ongoing weakness in its property sector.

In short, the combination of stretched valuations, high levels of investor optimism and technically overbought conditions leave shares potentially vulnerable to a further pull back. Geopolitical risks including events in the Middle East, delays to rate cuts and recession risks could provide a trigger.

Five reasons for optimism

However, while shares may be vulnerable a pull back and a period of increased volatility, several considerations suggest that the bull market will remain intact and the trend in shares will remain up.

First, US, global shares and Australian shares are still tracing out a pattern of rising lows and highs from 2022, which is still consistent with a bull market. Similarly, we have yet to see the sort of churning and a declining trend in the proportion of stocks making new highs that normally comes at major share market tops. And while many worry about a new tech bubble (and have done for years) the tech and AI centric stocks of today make real profits so Nasdaq’s PE is around 35 times, not the 100 times plus it was at the tech bubble high in 2000.

Second, while there are areas of weakness, global and Australian economic conditions generally continue to hold up far better than feared. In fact, business conditions according to purchasing manager surveys (PMIs) have improved recently. Consistent with this, profits have generally held up better than expected – while down slightly in Australia they have increased more than expected in the US and March quarter earnings results are likely to show a continuation of this.

Global Composite PMI vs World GDP

Source: Bloomberg, AMP

Third, despite the relative resilience of economic activity inflation has fallen sharply globally (from highs around 8% to 11% to around 3%) and will likely keep falling allowing rate cuts. Although the US has proven a bit stickier in the last three months reflecting its stronger economy, inflation has continued to fall in other countries. And even in the US, cooling measures of labour market tightness are continuing to point to lower services inflation ahead. It’s a similar picture in Australia. So, while rate cuts have been delayed, they are still likely.

Fourth, while Chinese economic growth is not as strong as it used to be it seems to be hanging in there around 5% despite its property slump. While the iron ore price has recently fallen it remains in the same range it’s been in for the last two and a half years and well above many assumptions. Furthermore, the copper price appears to be breaking higher which is normally a sign of strength.

Finally, while geopolitical risks are high, they may not turn out the be as bad as feared – much as was the case last year:

  • While the risk of an escalation between Israel and Iran is high – Iran’s retaliation to the attack on its Syrian consulate was similar to its response when General Soleimani was killed by the US in in 2020. It was well flagged, measured and there was minimal damage and designed not to provoke a bigger Israeli counter-retaliation. The US is also pressuring Israel to hold back and of course is motivated by trying to keep oil prices down in an election year. So far so good so markets have not gone into free fall and the oil price has not surged. Hopefully that remains the case, but there is a way to go yet.

  • There is still a long way to go in the US election.

  • It’s worth bearing in mind the response of shares to past geopolitical events. An analysis by Ned Davis Research on a range of crisis events back to WW2 shows an initial average 6% fall in US shares, but with shares up an average 6%, 9% and 15% over the subsequent 3, 6 and 12 months. Of course, there is a huge range around that!

Implications for investors

We remain of the view that shares will do okay this year as central banks ease. But given the long worry list, global and Australian shares are vulnerable to a correction or at least a more volatile and constrained ride than seen so far this year. For most investors though the key is to recognise that share market pullbacks are healthy and normal, it is very hard to time market moves and the best way to grow wealth is to adopt an appropriate long term investment strategy and stick to it.

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Source: AMP Capital April 2024

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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Seven lasting impacts from the COVID pandemic

Posted On:Mar 26th, 2024     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

It’s four years since the COVID lockdowns started. The pandemic ended when it morphed into the less deadly Omicron variant in late 2021, but just as a sound can reverberate around a room the effects of the pandemic continue to reverberate in economies. Putting aside the long-term health impacts this note looks at 7 key lasting economic impacts.

#1 Bigger government

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Introduction

It’s four years since the COVID lockdowns started. The pandemic ended when it morphed into the less deadly Omicron variant in late 2021, but just as a sound can reverberate around a room the effects of the pandemic continue to reverberate in economies. Putting aside the long-term health impacts this note looks at 7 key lasting economic impacts.

#1 Bigger government and more public debt

The malaise of the 1970s ushered in “smaller” government in the 1980s in the Thatcher, Reagan, Hawke and Keating era. But the political pendulum started to swing back to “bigger” government after the GFC & COVID has given it another push. Memories of the problems of high government intervention in the 1970s have faded and there is rising support for the view that government is the solution to most problems – via regulation, taxes, spending or education campaigns. The pandemic added to support for “bigger” government: by showcasing the power of government to protect households and businesses from shocks; enhancing perceptions of inequality; and adding support to the view that governments should ensure supply chains by bringing production back home. It’s combining with a desire for governments to pick & subsidise clean energy “winners”.

Public spending as a share of GDP

Source: IMF, Australian Government, AMP

IMF projections for government spending in advanced countries show it settling nearly 2% of GDP higher than pre-COVID levels. The success of governments in protecting households from the worst of the pandemic has also reinforced expectations they would do the same in the next crisis. The pandemic ushered in even bigger public debt just as the GFC did. While high inflation helped lower debt to GDP ratios in 2022 it’s settling at higher levels than pre-pandemic.

Net public debt as a share of GDP

Source: IMF, AMP

Implications – While there may initially be a feel good factor, the long-term outcome of “bigger” government is likely to be less productive economies, lower than otherwise living standards and less personal freedom. It will take time before this becomes apparent though. Meanwhile, higher public debt means: less flexibility to respond with fiscal stimulus to a crisis; a greater incentive for politicians to inflate their way out; and interest payments being a high share of tax revenue.

#2 Tighter labour markets and faster wages growth

In the pre-pandemic years, wages growth was relatively low, & a key driver was high levels of underemployment, particularly evident in Australia. After the pandemic, labour markets have tightened reflecting the rebound in demand post pandemic, lower participation rates in some countries and a degree of labour hoarding as labour shortages made companies reluctant to let workers go. As a result, wages growth increased, possibly breaking the pre-pandemic malaise of weak wages growth.

Australia – unemployment & underutilisation

Source: ABS, AMP

Implications – Tighter labour markets run the risk that wages growth exceeds levels consistent with 2 to 3% inflation.

#3 Reduced globalisation/more geopolitical tensions

A backlash against globalisation became evident last decade in the rise of Trump, Brexit and populist leaders pushing a nationalist gender when the benefits of free trade were being questioned. Also, geopolitical tensions were on the rise with the relative decline of the US and faith in liberal democracies waning resulting in a shift from a unipolar world dominated by the US, to a multipolar world as regional powers (Russia, Iran, Saudi Arabia and notably China) flexed their muscles. The pandemic inflamed both: with supply side disruptions adding to pressure for the onshoring of production; conflict over the source of and management of coronavirus; it heightened tensions between the west and China; and it appears to have added to nationalism and populism. So, the days of global free trade agreements and falling defence spending seem long gone for now. Rather we are seeing more protectionism (eg with subsidies and regulation favouring local production) and increased defence spending.

Implications – Reduced globalisation risks leading to reduced potential economic growth for the emerging world and reduced productivity if supply chains are managed on other than economic grounds. And combined with increased geopolitical tensions resulting in more defence spending it could result in a more inflation prone world than was the case.

#4 Higher prices, inflation and interest rates

A big downside of the pandemic support programs was the surge in inflation. The combination of massive money printing along with a big increase in government payments to households (eg, Job Keeper) resulted in a massive boost to spending once lockdowns were lifted which combined with supply chain disruptions, also flowing from the pandemic, to cause a surge in inflation. Inflation is now starting to come under control as the monetary easing and spending boost has been reversed and supply has improved again but the pandemic has likely ushered in a more inflation prone world by: boosting “bigger” government; adding to a reversal in globalisation; and adding to geopolitical tensions. All of which combine with aging populations to potentially result in more inflation.

Implications – Higher inflation than seen pre-pandemic means higher than otherwise interest rates over the medium term which reduces the upside potential for growth assets like shares and property.

#5 Worse housing affordability

At the start of the pandemic, it was thought the economic downturn and higher unemployment and a freeze in immigration would cause a collapse in home prices and they did initially fall. But not by much as it was quickly turned around by policy measures to support household income, allow a pause in mortgage payments and slash interest rates and mortgage rates to record lows. What’s more the lockdowns and working from home drove increased demand for houses over units and interest in smaller cities and regional locations. As a result, Australian home prices surged to record levels. Meanwhile the impact of higher interest rates in the last two years on home prices was swamped by housing shortages as immigration surged in a catch up. The end result is now record low levels of housing affordability for buyers (who are hit by a double whammy of higher prices relative to incomes – see the next chart – and higher mortgages rates) and renters (who have seen surging rents).

Ratio of home prices to wags and incomes

Source: ABS, CoreLogic, AMP

Implications – Ever worse housing affordability means ongoing intergenerational inequality and even higher household debt.

#6 Working from home likely here to stay

While there has been a return to the office, for many its only two or three days a week. Basically, the lockdowns resulted in a step jump towards working from home (WFH). A UK study of over 2000 firms is indicative. It showed that while around 90.8% of employees were fully onsite in 2018, last year this had fallen to 62.3%, with 30.2% with hybrid (working in the office and at home) arrangements. Similarly, the ABS found 37% of employed people in Australia regularly worked from home. Of course, this masks a huge range with industries with a high proportion of computer-based workers having more hours working at home. And firms expect this to remain the case. There are huge benefits to physically working together around culture, collaboration, idea generation and learning but there are also benefits to working from home with no commute time, greater focus, less damage to the environment, better life balance and for companies – lower costs, more diverse workforces and happier staff. So the ideal is probably a hybrid model. The proportion of workers in a hybrid model may even rise as new firms are quicker to embrace WFH.

Working arrangements for UK employees

Source: K Shah, and others, Managers say working from home here to stay, CEPR

Implications – Less office space demand as leases expire resulting in higher vacancy rates/lower rents, more people living in cities as vacated office space is converted and reinvigorated life in suburbs and regions.

#7 Faster embrace of technology

Lockdowns dramatically accelerated the move to a digital world. Everyone was forced to embrace new online ways of doing things. Many have now embraced online retail, working from home and virtual meetings. It may be argued that this fuller embrace of technology will enable the full productivity enhancing potential of technology to be unleased. The rapid adoption of AI will likely help.

Implications – This has meant a faster embrace of online retailing (up from 7% of retailing pre-pandemic to around 11%) at the expense of traditional retailing, virtual meeting attendance becoming the norm for many (even in the office) and business travel settling at a lower level.

Concluding comments

Perhaps the biggest impact is that the pandemic related stimulus broke the back of the ultra-low inflation seen pre-pandemic. Together with bigger government and reduced globalisation, this means a more inflation-prone world. So, a return to pre-pandemic ultra-low inflation and interest rates looks unlikely. It’s not all negative though – apart from the faster technology uptake, the global and Australian economies have come through the last four years in far better shape than might have been imagined at the start of the lockdowns!

Dr Shane OliverHead of Investment Strategy and Chief Economist, AMP

Source: AMP Capital March 2024

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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