This article is a transcript of a webinar held by Cameron Harrison on 18th August 2021
View the presentation here.
The proposition is that without a return to a significant degree of social interaction and movement of people, economies cannot harness their fall and optimal capacity to produce goods and services and in turn, the equity markets abundant enthusiasm will have been misplaced To be sure, I think this is less of an issue for Europe, the UK and US, but for Australia, we see real risks that the governments have failed to grasp and comprehend how to normalise movements between significant vaccination with commensurate adverse economic impacts, which both Gerard and I will touch on. We view the prospects for social interaction normalisation is significantly diverged between Australia and the increasingly vaccinated regions such as Europe, the UK and US.
As matters stand, the UK provides the most optimistic path for developed economies and Australia, but we would be first to admit that the UK’s path for getting to this point was horrible and littered with policy blunders. In the UK, the adult population is now approximately 90% first dose vaccinated and 77% double dosed and 1-in-5 of the population estimated to have contracted COVID. Whilst herd immunity may no longer be possible nor the objective, such levels of vaccination and antibody, based on the available data, provides the necessary combination of immunity and protection from serious illness and hospitalisation. This confronts the reality that once vaccination rates reach > 70%, the policy objective could move to substantially protecting the community. Vaccines are of course not complete protection from hospitalization, delivering a 90% to 93% efficacy rate. In the UK, that would leave 4 million double vaccinated adults susceptible out of 41 million, but sensible mitigation such as booster shots, social distancing and masks substantially reduces this further. The difference in policy objectives of protection of community versus suppression to zero is stark. The economic outcomes even starker. Regions such as Europe, the UK and US have largely crossed the Rubicon into protection through vaccination. Australia is still firmly in the very small camp with New Zealand of suppression to zero.
Our concern for Australia is that it diverges significantly from this credible opening path provided by the UK experience and data. We haven’t arrived at that point yet, and hope we don’t but like the RBA, agree that the downside risks are building, and the downside scenario here clearly demonstrates a growth trajectory that would be lower than pre COVID levels and a poor outcome given where we were earlier in the year and the level and vast cost of stimulus to this point. Other than the policy question of our normalization of social interaction and movements, we remain cautiously optimistic with the core foundations for rebounding growth still in place through:
Stimulatory monetary policy (retained QE + probable delay in increased cash rates)
Developed economy enthusiasm for abundant government support (fiscal)
The market rebound over the last 15 months is one that any Olympic gymnast would be proud of. Over the last 12 months Cameron Harrison increased exposure to market risk across domestic and global equities and industrial property. We retain this stance at present, which reflects our cautious optimism for market risk over the outlook period but is highly selective and focused to dynamically conducted industrial and service firms. New capital is being cautiously deployed through staggered investment.
In terms of accounting for our strategy performance, Cameron Harrison have performed very well over the full spectrum of time periods from 1, 3, 5 and 10 years.
As private investment managers, we have navigated many cycles and market disruptions from the 1990 recession, the dot com era, GFC, COVID and now post COVID navigation.
Core to this sustainable success is that we operate our investment strategy with consistency and conviction and dispassionate analysis, often when it is unpopular or contrary to the prevailing momentum trade or fad.
As for the period ahead, this heat map shows our stance on relative asset class positions. We are moderately pro-risk with our asset allocation, with allocation to Equities & Listed Property retained at the expense of Bonds, due to reasonable yields for market risk and our bearish view on bonds over the medium and long term. We retain a pessimistic view beyond 2022 on commodities and particularly China demand and Brazil supply normalisation for iron ore. Also, with inflation a particular watchpoint, large, latent cash allocations should be protected for purchasing power.
We have a cautious but positive view of investment and economic conditions for the year ahead, but no forecast is without risks and our balance of risks are mindful that we have finished the last chapter which has run some 25 years, and we are now in a completely new chapter for which many of the old assumptions and conditions just don’t apply.
For the 6 to 12 month outlook period, we would highlight 4 + 1 key watchpoints for 2022:
Services are central to a modern economy, and it is the potential for services inflation feeding wages inflation which we carefully watch through 2022. On balance, we expect rising bond rates, which will adversely impact bond markets but also some elements of market risk markets, reversing a 25-year golden era for markets.
Delta strain has reminded Australians of the economic risk of lockdowns but timid political leadership in Australia, even at >70% vaccination rates, risks growth rates being lower than our mid-case.
We feel the taper can be managed as can some normalisation in interest rates… but the major risk is that inflation is allowed to overshoot for too long and the Federal Reserve acts late and too hard
Japan’s experience has shown a tendency to withdraw fiscal stimulus too soon rather than too late. This risk seems to be minimising both here and in the US.
— Recent crackdowns on technology and education companies signal a retreat from free market principles toward central control. The move will impact capital flows into China – CCP sovereign risk is a big deal and to be avoided.
— Risk of decoupling of supply chains between China and the West grows. The new US administration’s approach will be less volatile, but an anti-China stance will remain. The alternatives of Vietnam, India, Malaysia have serious COVID issues.
— Geopolitical tension concerning Taiwan truly elicits the hegemony aspirations of China.
If we see no more major COVID surprises overseas 2022 is looking to be a great year for global growth. It will be a different recovery from the post-GFC, as this one will be lead by developed markets instead of emerging markets. The below graph illustrates the additional discretionary fiscal spending by global economies in response to COVID-19 – in particular, the aggressive charge by developed economies such as the US, with approximately an additional 25% of their respective GDP deployed in fiscal response.
Ultimately, long rates are going to have to start to rise, with the recent declines to be only temporary. The world's most important central bank, the U.S. Federal Reserve, will need to tighten monetary policy in either late 2022 or 2023. Already, bond yields are looking anomalous compared to the strength of the cycle. The following chart shows the US 10-year treasury yield compared to the global manufacturing purchasing managers index, which is a measure of the global cycle. This suggests that yields should be a lot higher than they are at the moment. We are likely to see either by late next year or certainly in 2023, the Fed starting to tighten and we will see through the course of next year bond yields trending up towards 3%.
By reflation, we mean the improved earnings prospects for businesses that benefit when the broad economic growth aggregates move upwards. The outlook for equities over the next 12 months always carries the prospect of a correction. Equities are ahead of themselves in regards to vast valuations, however, the much bigger story is the potential rotation within the equity market. Essentially, the reflation trade lives -many of the ‘winners’ of the post GFC cycle which was your highly valued Tech stocks and bond proxies will start to ‘lose’ out relative to the losers to the post-GFC cycle, which were financials, cyclical’s and resource companies. Below shows the MSCI Growth and Value Price-Earnings, which highlights the unusual rerating of growth stocks over the past two years with lower rates, however have seen derating over the second half of 2021 as bond yields increased.
Within Australia, we do have positive fundamentals, however, they are overshadowed and complicated by policy uncertainties, relating to the COVID situation recovery. The below table exemplifies the Doherty Institutes modelling results of community transmission under vaccination coverage scenarios. Even after 6 months at 80% vaccination coverage, deaths are estimated to be approximately 1,281. This poses a significant question – will the Australian premiers find this acceptable? If not, this could cause ongoing restrictions between states as individual states try to achieve better outcomes than this modelling suggests.
Finally, in a domestic equity context, we should see Australia follow the trends set by the US, reflecting the rising bond yields and rotation within the equity markets. If we are to see rising bond yields as predicted, the growth stocks of the equity markets will be vulnerable to further rerating, as we’ve already seen over the past 6 months.
Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.
For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.
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