Our diversified models continue to perform well compared to their peers, benchmarks and objectives. When markets rally strongly, as they have, our quarterly rebalancing allows for profits to be taken and underperforming assets to be topped up. This disciplined approach to asset allocation remains a key part of our investment philosophy.
Over the last 40 years interest rates have largely been on a downward trajectory as governments separated central banks from political influence, and refocused them on broader objectives linked to employment, inflation, and currency stability.
Central banks have navigated numerous crises with varying success, and worked within their mandate using monetary policy to help all of us have some greater certainty on the cost of living, jobs, and other aspirations. The charts below show a helicopter view of how some of this policy has seen interest rates fall over this period, and in turn support confidence, economic activity, and (very simplistically) lift asset prices.
We point you to these charts, as over the decades there has been a lot of noise. This has included (but not limited to) oil shocks, Japanese asset bubbles, savings and loan crises, an Asian Financial Crisis, the blow up of hedge fund LTCM, Tech bubbles/busts, the Global Financial Crisis, the European Sovereign Debt Crisis, and the Covid-19 recession to name just a few. Each time an issue arises, we are told this time it is different.
But is it?
Central banks respond, governments respond… and sometimes this is very well co-ordinated, meanwhile we get some blips on the right hand side chart, but largely the green line holds. Irrespective of the blips, what we learn is the importance of having an investment strategy and following a disciplined process.
While the ASX has printed 11 months of straight gains to September, we tune out the noise of US debt ceilings, Evergrande’s impending collapse, inflationary concerns, energy shocks, the spread of Delta, and other events of this quarter. Instead, we continue to follow our strategy which saw us reduce risk over this period by banking profits, and reinvesting in cheaper assets. This has helped to deliver consistent and strong performance for your investment above benchmarks.
We summarise below the other important factors this quarter and how they influenced your investments below.
Quarterly market overview
The quarter had most markets exhibit positive returns, albeit a number of events toward the end of September saw equity markets decline in a “risk off” sentiment, and bond yields rise on inflation and tapering concerns. The net effect delivered both bond and equity market losses for the month of September..
The Australian economy was largely locked down over the period with some of the largest states and regions losing control over the Delta variant. South East Queensland LGAs managed to go in and out of lockdowns, but NSW and Victoria were not so fortunate. Victoria’s capital Melbourne surpassed Buenos Aires’s unenviable 234 day record for the longest cumulative lockdown for any city in the world.
The Australian economy also weathered a collapse in the price of Iron Ore (its largest export) from around $230/t US in July to a low of $103/t US in September. This was on concerns around China’s second largest real estate developer collapsing, as well as Chinese regulators applying a decarbonisation policy reducing steel manufacturing. Thermal coal prices went the other way, spiking higher despite a ban on Australian coal. The combination of strong demand, regulatory issues with Chinese officials checking on the safety of mines, and decarbonisation supported the move. Broader demand for energy around the world saw the oil price rise $6bbl.
Australian unemployment surprised most with a lower than expected print of 4.5%, which on the face of it suggests a booming economy. However with significant lockdowns, the detail revealed a spike in underemployment (which includes underutilisation), and job losses in NSW of 210,000 (chart above).
To date, policy measures (both monetary and fiscal) have supported households and businesses, however it is those in highly impacted industries and based in areas under stringent lockdowns which are most at risk. Housing continues to be resilient with prices in August rising 1.8% for the month or 18.3% yoy. This is the fastest pace since 1989 (see chart to the right).
The global economy pushed forward over the period with the US (the world’s largest economy) growing 6.5% in 12 months. The strong growth was matched by even stronger Non-Farm Payrolls (NFP) data released in August which showed 943,000 new jobs added in a single month. All eyes now turned to the US central bank, and whether there’d be an easing of the incredible stimulus. A further NFP data release before the meeting provided some bad news with the jobs market weakening with only 235,000 new jobs added. Ironically the bad news pushed stock markets to new all-time highs, as it was likely the easy monetary conditions would continue. The US central bank Chairman Powell spoke at Jackson Hole saying the circa 5% inflation rate was still transitory, and that it might be appropriate to taper some of the $120b/month in bond buying before the year’s end as forward looking manufacturing data was extremely strong. This spooked bond markets and pushed yields higher.
The European Central Bank (ECB) announced a reduction in the pace of its asset purchases, but in contrast to the US central bank, it was keen to stress that this was not the beginning of a process of tapering purchases down to zero. As the US & UK central banks set out on a path towards higher interest rates, the ECB looks likely to be left behind.
Markets also had to weather the potential of defaults in debt markets with China’s second largest property developer struggling with $300b US of debt, and the US Government shutting down as its levels approached their ceiling/limit. In a Senate hearing, both the current US central bank Chair Jay Powell and former Chair (and now Treasury Secretary) Janet Yellen both warned a default (because of a failure to raise the debt ceiling) would have catastrophic consequences. This helped spur the US Senate to pass a “stop gap” bill to avoid the government shutting down.
Outlook
After being extraordinarily strong in the second half of 2021, global economic growth has likely peaked, and expectations are continuing to be revised down on the spread of the delta variant (especially in the US and UK).
In the short term, the recovery in the services sector has been restrained by the spread of the delta variant and the manufacturing sector continues to be affected by supply chain disruptions caused by the pandemic.
In the medium term, the re-opening trade will likely fade and fiscal policy will become progressively less stimulative. Inflation is expected to moderate as high inflation prints in the US over recent months have been largely attributed to supply chain disruptions and believed to be ‘transitory’.
Economies will now be defined by their levels of vaccinations and/or natural immunity. The UK and Europe (and to a lesser extent the US) have managed to break the link between infections and hospitalisations through high rates of vaccination. With the benefits of reopening still to be fully realised, Europe and the UK are the regions with the most promising growth outlook.
The outlook for Australia is delicately poised given the combination of a highly contagious variant and low (but rapidly increasing) levels of vaccination. The National Accounts show the economy was slowing before the full impact of the lockdowns, and a substantial fall in activity in the September quarter is inevitable.
More recently, the “Covid zero strategy” has been abandoned by NSW and Victoria. As a result, this re-opening is going to be very different to what happened in the second half of last year. Added to that commodity prices, including iron ore, are now falling (from extraordinarily high levels) due to the slowdown in demand from China.
As a result, ongoing fiscal support in Australia will be crucial to the path of recovery. In the lead up to next year’s Federal election it’s likely further stimulus will come and underpin a robust recovery. There remains however, an unusual amount of uncertainty about the outlook.
Regards
AAN Investment Committee
