The Big Picture
Whenever a new President of the United States is sworn in, there is a natural period of reflection on the policies that were promised, and a contrast with those that went before.
One expects even more introspection when there is a change in the governing party – as there was from Republican to Democratic on 20th January 2021. In addition, this inauguration focussed attention on the end of possibly the most divisive presidency in recent history.
It would be easy to be dismissive of Trump’s term – as many Democrats have been – though, even in losing the election, Trump garnered around 48% of the popular vote. A lot of people liked him and his policies! The Sydney Morning Herald reported a statistic at the end of January that one third of Americans still thought Trump had won!
If we turn the clock back by about four and a half years – to the referendum on Britain’s membership of the European Union (EU) – the two sides to that argument were also vociferous in putting their cases. The disbelief of the losing side-rallied people to predict disarray and worse. Some even demanded a fresh referendum (and so on until they won, we suspect).
As it turns out, Brexit at the end of 2020 went quite smoothly with Britain getting most of what it wanted. The finance industry has not migrated to Europe as many predicted. It seems to be a fact of our times – either through education and/or the internet – that people on both sides of most arguments are having their voices aired and magnified like never before.
President Biden had denounced Trump’s “Make America Great Again” slogan. Trump wanted to take on each nation separately in an attempt to get good deals for the US. Biden wants to go back to multilateral agreements. On day one, Biden signed executive orders to go back into the World Health Organisation (WHO) and the Paris Climate Accord.
As with many policies, there is no universally-best outcome; just one which suits the current mood and opinions of the people it represents. The riots in Washington, DC on January 6th 2021 made it clear that not everyone is happy with the new future under Biden. Trump was impeached in the House of Representatives for his role in those riots and Biden must handle the ‘trial’ in the Senate, along with all of his other pressing issues.
Thankfully, there has not been any recurrence of the violence from when the Capitol building was over-run. Biden has a big job on his hands to make both sides see reason. The solution seems a bit like holding a big dumbbell above one’s head but grasping the bar only in the middle. Every slight movement can generate a big, potentially dangerous, sway from one side to the other.
It is also important at this time to reflect on the new sizes of the majorities in both houses of Congress. Democrats have only a slim majority in the House of Representatives – but all Democrats are not ‘equal’ and neither are all Republicans. Deal-making will still have to be done within and across parties at a frenetic pace for Biden to get close to what he wants, particularly in his first 100 days.
The balance of power in the Senate is even more precarious. The Vice President, Kamala Harris, has the casting vote but the Senate works largely on a committee structure. Will each committee have to have a 50:50 balance? And then there is the filibuster rule that doesn’t seem to be going away. That rule requires a 60:40 majority vote to avoid them. In other words, bipartisan bills will still need to be crafted.
Nevertheless, Biden has moved swiftly to sign many executive orders. These orders require no vote but the bigger bills need to go to Congress. Biden has already ended building of ‘the wall’ and mandated the wearing of masks on Federal premises and certain air travel. He has provided some relief to those whose jobs were affected by the pandemic.
On another contentious issue, Biden has shut down work on the Keystone XL oil pipeline from Alberta, Canada to a US pipeline 1,200 miles south. There are obviously economic consequences for the shut down. The upside is the reduction in the environmental and indigenous population concerns. Most things come at a price.
When we turn to the bills which must be voted on in Congress, perhaps the most important, immediate issue is the $1.9 trn proposed coronavirus relief package. Much has been made of the wish to add $1,400 to the $600 cash payments to individuals that has already just been passed in the $900 billion relief package passed in December.
Some ‘progressives’ want this $2,000 payment to lower income earning individuals to become a recurrent benefit. Others will no doubt want to scale it back, even within the Democratic party. A CNBC TV guest estimated that the package might be scaled back to about $1 trn before it can be passed.
Naturally, the new administration has already claimed that the coronavirus situation is a lot worse than they had expected. It is not clear to what problems they are referring that were not in the news in recent weeks. But doesn’t every new government everywhere try to heap as much responsibility as possible on the previous government?
Biden stated, “It’s going to get worse before it gets better”. US COVID deaths are expected to reach 500,000 in February and he said, “deaths are expected to exceed 600,000 before we start to turn the corner”.
There have been important disruptions to the supply and distribution of vaccines in the US. Biden has stated they plan to oversee 100 million vaccinations in his first 100 days. Since two doses are required for each person (although the Financial Times reports some early results from Israel suggesting that the Pfizer vaccine is 90% effective with only one dose), that means only 50 million of the 323 million Americans can be expected to be vaccinated by the end of April – at best. Apparently, herd immunity can be achieved with around 70% to 80% of the community so vaccinated. That still leaves a long way to go but it’s a great start.
There are many unknowns in these vaccine roll-outs. Does the vaccine work as well with the new strains of the virus? Moderna has stated their vaccine is much less effective with some new strains but that they are developing a new ‘booster’ vaccine. Germany is reported to not giving the AstraZeneca vaccine to over 65s because it does not work well enough – but the EU approved it anyway!
Provisional results for Novavax suggest it is 89% effective against the original strain and 85% effective against the UK variant. It is reported to be much less effective against the South Africa variant.
Can immunised people still pass on the virus? For how long does immunisation last? None of these issues, and more, should stop us supporting the initiatives. What we wonder is when will the US and global economy be relatively safe from the effects of the virus?
Much of US economic activity depends on international travel and trade. Unless all other relevant nations’ populations are largely vaccinated, normality cannot return in full. The latest growth figures for the US shows that the stellar result for quarter 3 (Q3) has pulled back to 1% for the Q4 quarter – not bad in itself but GDP for 2020 is still 3.5% below 2019’s figure.
Both the US and Europe are very much engaged in tackling the virus. Poorer countries are at the back of the queue in being allocated sufficient vaccines to produce herd immunity. Even Australia – certainly not a poor country – is facing supply constraints; and now, the EU is placing export restrictions on exports if home demand is not supplied.
Our government pre-ordered some Pfizer and a lot of AstraZeneca, but no Moderna vaccine. It turns out the AstraZeneca vaccine is insufficiently effective to produce herd immunity and we cannot access any more of the Pfizer or Moderna drugs this year – at least.
Our government’s plan is to use the AstraZeneca vaccine, manufactured by CSL in Melbourne, as a stop-gap until better vaccines become available next year. New vaccines are expected from the US, India, China and Russia. We are not yet aware of their final trial results or their availability.
We surmise that the end is potentially in sight as, according to Johns Hopkins university COVID-19 tracking, the reported daily infection rate has been falling for the last month. But we still have a long way to go and there may be fresh outbreaks and shutdowns along the way. We feel that stock markets have priced in a best-case scenario so we would not be surprised to see more market volatility until it is clear that we are indeed defeating the virus and the world can focus beyond it.
Meanwhile the Chinese economy is going from strength to strength. China surprised on the upside with its economic growth figure of 6.5% in quarter 4, 2020 compared to its 6.3% expectation. Its industrial output and fixed asset investment both beat expectations but retail sales missed at 4.6% compared to an expected 5.5%. Exports grew a stellar 18.1% against an expected 15.1%.
China slapped sanctions on 28 people from the Trump administration. Its air force has also recently conducted 20 flights in Taiwan airspace over one weekend in what has been described in some media outlets as a direct challenge to Biden. It is yet to be seen if Biden can smooth things out but there has been no sign yet of him intending to repeal the massive Trump initiated tariffs placed on Chinese imports to the US. If they were as bad as many suggested, why not repeal Trump’s executive orders?
At home, there are still many unresolved issues in the China-Australia trade war. China has held up, or imposed significant tariffs on, a variety of imports from Australia such as coal, wine, barley, copper and timber. It is not clear what China’s end-game is but iron ore prices increased rapidly through 2020 and there seems no end in sight for China’s demand of that ore. Is China trying to craft a strategy to impact iron ore prices?
Our labour market data continued to improve but the consequences of changes in COVID-affected immigration pressures may not have yet fully worked themselves into our economy.
We feel that it is time to set an investment strategy that is looking through to 2022 and beyond – and be prepared to ride out any short-term volatility in the early part of this year.
We see Biden as being too tied up with impeachment proceedings, senate committee structures, coronavirus issues and healing the rift between the two extremes of the political divide in his first 100 days to even think about tax and other policies. He campaigned on raising taxes (income, corporate and capital gains) and no doubt he will eventually make some moves in that direction. In spite of all of the fiscal stimulus packages, he will have to move slowly so as not to rock the boat too much.
We also see Australia continuing to pursue stimulus top-ups as needed. So, as far as we are concerned, there is likely to be a big push of stimulus-induced growth here and in the US. As a result of fiscal stimulus and the Federal Reserve’s quantitative easing programme, we see continued weakness in the US dollar. Providing commodity prices hold, it is possible that the Australian dollar against the US dollar will strengthen. But, again, we emphasise possible stumbles in markets if the re-opening of economies is adversely affected by new COVID outbreaks.
The consensus 2021 forecast for the S&P 500 is for a capital gain of about 10.5% and for the ASX 200 the forecast is 9% but, of course, our dividend yield is usually about 2% points higher than in the US – and many of us also benefit from franking credits. Our in-house forecasts are slightly more optimistic than the consensus but we are not expecting markets to move in a straight line. There is little hope for interest rate increases in 2021; and in an uncharacteristically forthright announcement, the Reserve Bank of Australia, following its meeting on February 2, committed to holding cash rates and terms out to 3 years at record lows of circa 0.10% out to 2024; and increased their bond-buying program by $100 billion. These are appropriate but extremely accommodative policy settings designed to support the Australian economy through COVID-19.
The ASX 200 had a flat month in January but the Consumer Discretionary, Financials and Telcos sectors had strong gains. We have noted that the consensus forecast for capital gains is 9% (plus dividends and franking credits). While we have no material issue with the consensus forecast, we are concerned that the market is vulnerable, given its lofty valuations, to unexpected bad news most likely resulting from COVID-19 related events.
The S&P 500 gained strongly in January until the last three trading days when it gave away those gains – and then some. It would seem that some disappointing news on vaccines, retail traders taking on short-sellers and the Federal Reserve’s comments about headwinds were the main contributors to the retracement.
We expect the S&P 500 also to have a relatively good year – as does the consensus forecast of 10.5%, though the current high valuations present a risk. While accurate valuation of stocks is difficult at the best of times and markets are expensive now when assessed against historical multiples, in an environment of historically low interest rates higher multiples can be accommodated. Our assessment is that providing interest rates stay low and Governments maintain stimulatory policy settings the current regime could persist for some time. In this environment we remain vigilant but we are fully invested.
Bonds and Interest Rates
It is generally accepted that central banks have done just about all they can to stimulate the global economy. They still need to continue quantitative easing – or the process of buying and selling bonds and other assets to manipulate interest rates. Official rates, being zero or close to it, are unlikely to be cut further. It is all down to elected governments using fiscal policies, as appropriate, to stimulate their respective national economies.
Bond rates are very low by historical standards and they are likely to stay there. Denmark recently announced a 0% interest rate 20-year home loan! Given the fees and break costs in term deposits, together with inflation, this creates a challenging environment for term deposit and bond investors as returns are the lowest in living memory.
Unsurprisingly, in Australia under the current regime there has been an increasing demand for equities exposure to support income return via dividend payments. With the inclusion of franking credits, gross yield is at circa 4.0% – a very big difference to that available in traditional fixed interest investments. However over longer periods, such as 5 or 10 years, Australian equities have always done well – or not too badly. It’s a question of having sufficient cash or bonds to ride out the dips in order to avail oneself of the higher yields in equities – but, of course, with an appropriately diversified portfolio.
Bitcoin and other crypto-currencies have been in the news again. New highs were reached recently and some hopes were dashed. The story of one particular ‘investor’ accidentally throwing out his hard drive to the tip – only to then offer the council $50 million to dig it up (because it contained his Bitcoin ‘wallet’) tells it all. There was another story of an ‘investor’ having failed on his first eight of ten password attempts facing the prospect of losing the lot if his next two guesses also fail! There was also the Mt Gox exchange hack that cost investors dearly.
Obviously, profits can be made in any asset class such as art, vintage cars and the like. Though, for normal risk-averse investors, stocks, property, bonds and cash define the bulk of the universe for prudent capital allocation.
More traditional ‘other assets’ like iron ore, copper and gold had a flat to weak month but the price of oil rose by around 8%. Volatility on Wall Street was well down until it spiked during the end-of-month sell-off. Our dollar against the US dollar was stable over January.
Australia’s economy always has a ‘sleepy month’ in January. 2021 was no exception. The only important data to be released maintained the view that our labour market is doing quite well given the existence of the pandemic. The unemployment rate is down to 6.6% after peaking at 7.5% in July 2020. This rate was 5.1% in December 2019. The government is predicting that it will take four years for unemployment to get back to pre-COVID rates.
There were big concerns about fresh breakouts in COVID-19 following Christmas and New Year celebrations. There are restrictions of various types across the country but it seems there is a will to get back to normal quickly.
Australia is much better off than the US or UK in handling the virus. We ranked eighth in a study of 100 countries in how well we have dealt with, and are dealing with, the virus. New Zealand came first.
Arguably, our biggest problem is that we backed the wrong horse in the vaccination stakes. The Oxford University/AstraZeneca vaccine turned out to be an underperformer as we reported in these updates last year. Its ‘efficacy’, or the ability to immunise people from the virus is too low to prevent herd immunity. Herd immunity is the concept that the proportion of people in the community that are immune is so high as to make transmission rates to others to be very low and eventually fizzle out.
Our government tried to get more of the superior Pfizer and Moderna vaccines but that event is ‘sold out’. We will have to use a less-than-premium vaccine until we can secure supplies of something as good as the US is rolling out.
There is no question of safety. It is just that efficacy rates are about 60% compared to the 95% of the “mRNA” vaccines produced by Pfizer and Moderna. Unfortunately, it is a ‘watch this space’ for news on how we will cope with the medical side of the pandemic.
Naturally, our economy cannot get back to anything like normal while we are not safe from the virus. Between now and then we expect short periods of lockdowns and disruptions that will slow down economic growth. The same is true for other countries but we have a less than optimal vaccine solution which is likely to see greater focus on social measures such has lockdowns, social distancing etc.
China is angling for a new relationship with the US after the end of the ‘hard-ball’ Trump administration. They certainly have focused their ire on Australia for the last few months so it is a question of whether Biden marches arm-in-arm with Australia down Pennsylvania Avenue or whether he throws us under the bus.
We are yet to see where Australia-US relations will head. On our own, we may have problems dealing with China’s wrath on Australia because of our prior allegiances to the US and our comments on China’s role in starting the pandemic.
On the bright side, China’s economic data has looked pretty good. First in – first out of the pandemic has put China in good stead. Their economic growth just came in at 6.5% p.a. which would have been seen as a positive pre-COVID.
Exports recorded a growth of 18.1% against an expected 15% while imports came in at 6.5% against a 5% expectation.
The US economy is going through a massive transition as its economy deals with the consequences of COVID-19. Jobs and other economic data are worse than pre-COVID days but much better than at the height of the February 2020 to July 2020 part of the crisis.
The latest nonfarm payrolls data recorded a loss of 140,000 jobs when +50,000 new jobs were expected. The unemployment rate was 6.7% against an expected 6.8%.
Q4 GDP growth came in at 4% (annualised) or 1% quarter-on-quarter. Since the economy is still rebounding from the Q2 low, 1% is not great however, in an ordinary year it would have been. That growth in GDP in 2020 over 2019 was 3.5%, a lot more growth is needed to get back to previous highs.
The Case-Shiller house price index across 20 cities was up 9.5% over the 12 months to November – which is near record highs.
The big thing that we don’t know is how Americans will react to new rules and regulations over COVID. First amendment rights seemingly reign supreme in the US. Will they wear masks – especially after some have the comfort of having been vaccinated? Americans are very different people from Australians, British and Europeans.
We see that there is a clear light at the end of the tunnel. But it will not be an easy road to get there. Biden has promised much and hopefully he will achieve. But, what if he doesn’t? It is a country politically divided by so much.
A month after Brexit, there still seem to be no major fall outs after the exit. Of course, Britain is in a bit of a mess over their handling of COVID-19 but that has nothing to do with Europe and the Brexit negotiations.
The EU and UK economies are not doing well. But, in the short-term, it is more of what governments are prepared to borrow to stimulate economies rather than what economies can do for themselves.
Given that the EU is now restricting exports of vaccines if they need it first, there seems little chance that Australia will get its fair share – or even what it ordered – this year.
Rest of the World
While all of the vaccine roll-outs get underway, little seems to be written about when the rest-of-the-world can access the vaccine. One SBS News report did mention a full global roll-out might take until well into 2024. Israel and certain Arab Gulf states are well ahead in vaccinations. Israel has already vaccinated over 25% of its population.
Until all nations that interact with the developed world are largely vaccinated, there can be no complete herd immunity; and that brings us to: who will pay for those vaccinations?