Economic update - July 2021

Key points

• More vaccination confusion leading to increased political tension between the states and Canberra
• Bumper Australian jobs data showing the economy, as a whole, is travelling well
• The recent rise in US inflation is temporary, and driven by increased demand on COVID impacted supply chains

The Big Picture

During June, the COVID vaccine saga lurched deeper into confusion. Initially, it looked like the older residents in the 1a (frontline health and aged care workers) and 1b (the elderly, those with medical conditions and emergency services workers) groups would get the Pfizer vaccine and younger groups would receive AstraZeneca (AZ). Indeed, the government had put nearly all of its eggs in the AZ basket.

There were major delays in supply of both vaccines so our vaccination rate was very low. Then came news about AZ and blood clots. Different countries took different stances on AZ. We went for Pfizer for the under 50s. AZ was ‘recommended’ for the over 50s. Of course, AZ was not really ‘recommended’ but it was the only vaccine left over for the oldies. There was no choice for anyone.

Then there was more bad news on blood clots. AZ was bumped up to over 60s with Pfizer now also given for the 50-60 age group. The disarray surged as the Sydney June breakout took hold and the city went into lock-down. Presumably because the fully vaccinated locals then amounted to only 2.5% and 23% for one shot, the government said at the end of June, young folk could request AZ if they wanted! Initially we were told people could not choose their vaccine but that was a few months ago. The young can choose but the old cannot!

There are countless stories going around the traps that young people cannot even get an appointment for a Pfizer jab. The NSW premier is pleading for a better rollout of Pfizer.

The Australian Medical Association (AMA) then advised young folk to wait for Pfizer rather than head off for an AZ jab and the NSW health minister will not allow AZ in clinics for young people!

Confused? You are not alone. We have been told that lots of Pfizer should be making its way to our shores from October. Three capital cities went into prolonged lockdowns but the rate of infection is still low by international standards.

The situation has been worsened by the prevalence of the ‘Delta’ variant and now the Delta plus. Delta is now said to be able to transmit from one person to another simply by them walking past each other – based on a CCTV image from the Bondi Junction (Sydney) shopping centre. If that were true, how come only one person became so infected despite the ‘carrier’ wandering round the crowded shopping centre and elsewhere? Looks like someone doesn't like the Roosters.

Since the UK’s vaccination programme is largely based on AZ, we can use that country’s experience for some additional indicators as to how things might pan out here. They have about 60% with at least one dose and not far off half the population is fully vaccinated.

The UK became the poster child for controlling one of the worst outbreaks – by a combination of a strict lockdown and a good vaccination program. However, now that football matches are going ahead with reasonable crowds and dining out and drinking in Pubs are again commonplace, the infection rate has jumped back up to the December level – before the vaccinations programme took off. "It's coming home" more like it's coming to Rome.

It has been reported that of those recently infected, 83% were not vaccinated – therefore 17% had one or more doses. Apparently 3.7% were fully vaccinated but still succumbed to COVID. It is no trivial matter for even experts to interpret fully these statistics. The major question to be asked is whether the vaccinated and the unvaccinated behave differently when it comes to social distancing, masks and the rest.

New Zealand burst the travel bubble with Australia, and Singapore is looking to go the same way. Hong Kong is no longer accepting visitors from the UK.

We are not experts in vaccinations and epidemiology but we can read the official statements and observe what is being reported. Our reason for going so deeply into this public health issue is to estimate how quickly the global economy may open up and how markets will react.

The Delta variant is dominant in many major countries and even the US and UK are having trouble getting everyone vaccinated. As we wrote when the first vaccine trials were reported, it is great news but there will be problems along the way. Last year, many expected a reasonably open economy by now – that’s been pushed back to mid-2022. We think that, too, is optimistic. It is important to get vaccinated and to continue safe practices.

Unsurprisingly, the Reserve Bank of Australia (RBA) did not change its policy stance at the June meeting. It did note the rapid rise in house prices but argued that there are better measures than rate hikes to tackle that problem. House prices rose 5.4% in the first quarter (Q1) of 2021 and 7.5% over the year.

Q1 GDP growth in Australia was very strong at 1.8% and that takes the latest level of GDP above where it was at the end of 2019. However, such was the impact of the lock-down, about 5% of GDP was ‘lost’ against trend during 2020 which we think needs to be regained – and more – before we see any inflation pressures start to emerge.

The National Accounts also showed that the household savings ratio fell to 11.6% from a peak in the lock-down of 20%. The ratio was 5.4% in Q4, 2019.

Presumably households are saving on international holidays and, to some extent, the reduced opportunities for entertainment in Australia. It is also reasonable to think that part of the elevated savings is due to the building of nest eggs in case things get worse. We see this falling savings ratio as a good sign that people are gliding back toward their pre-pandemic lifestyles.

Our unemployment rate fell to 5.1% when 5.5% had been expected by the market. 5.1% is the best rate we experienced before the onset of the pandemic. There were 115,200 new jobs created against an expectation of 30,000.

We see the Australian economy moving along nicely but problems may emerge because of a lack of migration intake for the labour force and international travel in general.

Much of the market volatility on Wall Street in June can be attributed to the interpretation of recent US inflation data and the likely course of action by the US Federal Reserve (the “Fed”). Inflation data were elevated in May because of the impact of the lock-down 12 months prior. Fed chair, Jerome Powell, pronounced that this blip would be transitory and he had no inclination to act on expectations data.

The annual US CPI came in at 5.0% for May (reported in June) which is well above the 2% Fed target. Core inflation that strips out volatile elements such as energy and food was a more modest, but still relatively high, 3.8%. The Fed’s preferred PCE (personal consumption expenditure) inflation measure came in on expectations at 3.4%.

The markets seemed to have digested all of this data and come to the view that the inflation blip is indeed transitory. The US 10-year bond yield fell below that of the 5-year bond, supporting that view.

In the US, the nonfarm payrolls data reported that 559,000 jobs were created in May which is a substantial figure but there are still around seven million jobs that were lost in the shut-down that are yet to be re-filled. However, some are arguing that many of these displaced employees will not attempt to return to the workforce. Some may retire early and others might find issues such as childcare in the new pandemic order to make work too problematical. The unemployment rate fell to 5.8% from 6.1% beating the expected 5.9%.

There are reported bottle-necks in US labour supply. Construction workers in particular are reportedly hard to find which does not bode well for Biden’s infrastructure package which continues to struggle to navigate its way through Congress.

Biden has negotiated around a one trillion-dollar infrastructure package about half of which is new expenditure with the rest having been flagged in previous bills. Biden says that he will now not reverse the Trump tax cuts nor place new taxes on electric vehicles or gas.

We think the US economy is far from becoming overheated and so we believe interest rates will indeed stay lower for longer. Talk of tapering the Fed’s bond buying program might start sooner than later but the “taper tantrums” of 2013 are unlikely to recur. The Fed has learnt how to deal with the market.

China’s monthly data download of retail sales, industrial output and fixed asset investment slightly missed expectations but they were all strong figures. Producer price inflation (PPI) came in at a 13-year high of 9% but CPI inflation came in at an annual 1.3% or a month-on-month change of  0.2%.

China has been faced with high commodity prices – especially from Australian iron ore – and is looking to change the outlook. China has considerable reserves of major commodities and it is looking to influence prices by switching between imports and stock-piles. That could be bad news for Australia but, so far, there has been no deleterious impact.

While the UK government has been hands-on with COVID-related policies, it has not taken its eyes off negotiating new trade deals to replace the former relationship with Europe.

Russia, unlike most other major countries, has been hiking interest rates. It just hiked for the second time this year to take the base rate to 5%.

The Tokyo Olympics are very close now and problems with COVID abound. Apparently, the IOC, and not the host nation, is the body whose decision it is to cancel the games or not. It seems there is little appetite in Japan to continue with the games. Japan did just break one record; it recorded its first positive monthly inflation read in over a year – at +0.1!

With the 2020/21 financial year (FY21) having just concluded, investors who stuck with long-haul plans in equities would have done very well. With central banks likely to hold interest rates steady and vaccination programs continuing, we see no reason at this point to make major changes to asset allocations for FY22.

Asset Classes

Australian Equities

‍June recorded the ninth consecutive monthly gain on the ASX 200 making for a total gain of 24.0% over FY21. The 2.1% gains for June would have been much larger had the Financials sector not gone backwards. At one point the index broke through 7,400.

Utilities stocks lost around 22.9% over FY21 but all other sectors made solid ground. Consumer Discretionary, IT, Property and Financials were the best performing sectors during FY21.

International Equities

‍The S&P 500 was the best performing of the major indexes we follow. Over FY21, the S&P recorded gains of 38.6% in line with the world index and just ahead of emerging markets.

The S&P 500 posted several all-time highs during June but we see gains continuing into FY22 including ending the month with five straight record closing highs!

Emerging markets (+33.6%) also out-performed the ASX 200. Hope you had your allocation to emerging markets.

Bonds and Interest Rates

The US yield curve steepened sharply from late last year until recently. Indeed, the long rates have come back a fraction to the extent that the 10-year bond yield fell below that of the 5-year yield, indicating an expected reduction in inflation.

At the last Fed meeting, Powell was quick to dispel rumours about rate hikes. However, the dot plots that display each committee member’s private forecasts over time revealed the committee now predicts two rate hikes for 2023. Since not all members vote, it is not yet clear what pressures are emerging, if any, against Powell’s stance.

The Fed’s forecasts for PCE inflation in the current and following two years are 3.0%, 2.1% and 2.0%. The corresponding GDP growth forecasts are 7.0%, 3.3% and 2.4%. If these forecasts come to pass, we see no problems for rates or equity markets any time soon. We think the Fed will start “talking about talking about tapering”, the Fed’s bond buy-back programme, this year.

Other Assets

‍The prices of iron ore and oil rose sharply over June while the prices of gold and copper fell. Our dollar slipped -2.7% against the US dollar.

Over FY21 the price of gold was fairly flat but the price of iron ore more than doubled. The price of oil nearly doubled over FY21 but the price of copper ‘only’ rose by just over 50%.

Regional Review

Australia

The labour market now looks healthier than it did just before the pandemic was called. There are more people now employed and the unemployment rate is back to 5.1%.

Apart from the impact of the current, hopefully brief, lock-downs there are plenty of businesses not back to where they were – especially in tourism and hospitality. It looks likely that we are well over a year away from a return to ‘normality’ but we are at least getting closer.

If the government comes good with its promise to start taking delivery of large consignments of Pfizer vaccine from October that puts us only about 8 months behind what we might have expected at the beginning of 2021. Of course, we don’t know how much damage has been done to residents’ perceptions about being vaccinated and living in a safe way after having received both doses. The vaccine communiques and policy shifts have been disturbing.

The Novovax vaccine, which Australia also ordered earlier in the year, has reported that its efficacy in the recently completed trial was an impressive 90% given the new, more virulent, strains that have emerged. They are hoping for FDA approval in the US in Q3. Hopefully, we can get supplies shortly after.

Economic growth has also made great inroads into a return to normal. However, we see the delays in vaccine rollouts and hesitancy of some residents to be vaccinated preventing any reasonable fear of our economy over-heating in the near future.

Whilst it is very inconvenient – and in some cases worse – to live through these stages of pandemic recovery, our residents have not been subjected to the health issues found in comparable countries. In that sense we are doing quite well  but it will take continued co-operation of our fellow residents to get back to normal.

China

China’s 100th anniversary of its Communist Party has just taken place. The China economy has come a long way in that time but it is now facing strong reaction from major powers over how it conducts its business and political policies.

July 1st also marked the 24th anniversary of the handover of Hong Kong, by the U.K., back to China.
The China economy is doing very well and, through the ‘Belt and Road Initiative’ and others, the economy may well boom for many years to come.
While many deplored Trump’s China stance and his imposition of tariffs, Biden is not seemingly moving to reverse the tariffs.

US

The US economy is performing very well – particularly when compared to what analysts were expecting over a year ago.

The ISM is an index, like the PMI, that measures expectations of businesses about future growth. A figure above 50 indicates that expectations about growth are improving. The latest read for the US was 64.0 against an expected 62.5. This result is particularly strong.

As with Australia, we see growth, vaccinations and lax monetary policy underpinning growth in the stock market while likely new COVID variants and reticence to get vaccinated by a sizeable number of people will prevent overheating and inflation.

Europe

Europe and the UK are still squabbling about the parting of their ways. Since Northern Ireland (part of the UK) has remained inside the EU for now, some trade issues remain. The latest stoush is over the export of chilled meats – in particular, sausages from Britain to Northern Ireland. England is having more success negotiating new trade policies with the US and Australia, among others.

England just knocked Germany out of an international Soccer tournament for the first time in 55 years! 40,000 fans watched at Wembley including The Duke and Duchess of Cambridge. Few masks, if any, were spotted.

The recent uptick in infections in the UK and the expected roll back of all COVID restrictions from July 19 will be watched closely as people continue mingle in large numbers in sporting and entertainment venues.

Rest of the World

COVID rages around the world but Biden has offered 500 million doses of vaccine for poorer nations to match the rest-of-the world contribution. As welcome as these donations will be, another 10 to 12 billion doses are needed to control the pandemic to achieve herd immunity! The end of COVID is not in sight.

‍