Over the last month, as the coronavirus (COVID-19) began to affect society and investment markets, it became increasingly obvious that government directives would ‘make or break’ both business operations and the trading environment of many companies.
It’s fair to say for many businesses, the Government’s response was underwhelming. The most serious and obvious affects are for those small trading companies operating in hospitality, food and beverages. Small enterprises like cafes or restaurants that rely on tourism or people going to work are being crushed.
Consequently we are witnessing business closures (many before imminent collapse) and a sharp rising trend in the level of unemployment. To show how quickly the economic situation has deteriorated, on 25 March it was reported that over 200,000 people applied to Centrelink for unemployment benefits and assistance. Centrelink’s website crashed in response. Australia’s social security system is struggling to cope.
Clime predicts the economic consequences of the coronavirus will continue well into 2021 and require a significant Australian government response that will significantly grow its debt levels. The introduction of QE by the RBA was somewhat belated and it will now endure for many months if not years. We will return to these issues later.
Whilst many of the current Government directives are absolutely necessary, the consequence for important parts of the Australian economy are deeply concerning. Tourism, education, some aspects of healthcare, consumer related stocks, property funds (tenants and landlords) and any companies reliant on the movement of people are badly affected. Many other companies will suffer serious second-order affects.
When our various levels of Government introduced their health directives they did so without considering the economic consequences. The so-called “bridge to recovery” was declared but not planned, let alone constructed.
Companies with international operations have their own issues and are affected by similar overseas government directives to those seen in Australia. However, in many foreign jurisdictions governments have been quick to establish functioning ‘bridges’ that will allow businesses to reopen quickly
Understanding where we are at
Having noted the above it is important for all investors to understand that the current health crisis will subside and sooner than the “six months” flagged by government.
The problem is that the “six month” underlying forecast has been made by our Government due to the poor health safety net that it had in place. It is well reported that the Australian Health System was short of intensive care unit (ICU) beds given the risk of a pandemic occurring at anytime. Successive governments have under-invested in our health system safety net, which in light of the current crisis seems extraordinary given the wealth of our nation. The slowness to develop a focused virus testing and isolation regime such as that on display in more advanced Asian countries (Singapore, Korea and Taiwan), has resulted in a mass closure of Australian business.
Further, the social security system is totally unprepared for the significant lift in the level of unemployed citizens that is now occurring. The requirement that hard-working taxpayers, who have lost their jobs through no fault of their own, are required to line up (physically or online) to apply for social security is a national disgrace. In countries like the US and the UK the unemployed are being well looked after. Indeed payments are being made to employers to retain staff even though they can’t be utilised for the next few months. That is a true “bridge to recovery”.
The Government directives for the extensive “lockups” is both unfortunate and disturbing, but it is the situation we find ourselves in. The Australian Government, our bureaucracy and people will learn much from this.
Australia will be better prepared in the future but it is too late for the present crisis.
Whilst in the shorter term (say one to two months) the road to economic recovery is unclear, in the longer term there is no doubt that recovery will occur. Our view is that Australia’s recovery will be slower because of the damage done in not having a planned path to recovery.
Importantly, for investors the recovery of lost capital can only occur through a limited number of assets (mainly equities and property) because the so-called low risk yield or bond securities have been completely debased by central banks around the world.
In Australia cash rates are now 0.25% and the RBA is targeting a 0.25% yield for Government securities up to 3 years. Meanwhile, ten-year bonds have “weakened” recently to a 1% yield after touching 0.5% a few weeks ago. The yield curve, currently subject to manipulation, is forecasting a recovery but we predict it will be muted.
That is not to suggest that all equities (for instance) will recover strongly as the Australian and world economies recover. Clearly some companies have or will succumb and thus fail due to this particular economic downturn. This situation will be exacerbated by unique government direction.
However, high quality companies that can endure and self fund growth by generating free cash-flow will become highly valuable in a world of enduring low yield. This has become immediately on display in the US equity market which has responded quickly to a extraordinary “bridge to recovery plan”.
Similarly, high quality properties whom house good companies (tenants) will also be highly prized. The return on property equity (yield) will be enhanced by very low costs of leverage. Thus, while in the short term yields are expected to drop and / or go to zero, after a period (6 months to a year) yields on property securities will recover. Accordingly we believe this is not a time to sell property and is a time to buy if it were not that the market is frozen.
Investing requires a positive outlook tempered by reality. It is our view that there is indisputable evidence that a significant lock down will slow the progression of coronavirus. Further, the worldwide investigation and development anti viral drugs is showing preliminary positive results. That means that a possible return to a semblance of normal life is likely sooner than the government’s suggested six-month period. However, the destabilisation of the economic framework will have an enduring negative impact on many industries.
A return to normality will require significant ingenuity, assistance and market intervention by our Government, which at present is not on display.
It may be considered trite for a small fund manager to offer advice but everyone has a role to play in the recovery of the Australian way of life and our economy. In our view there is clearly a need for the Government to seek assistance from the broad range of capital available through the Future Fund, Industry Super Funds and major Retail Super Funds. Collectively these funds control towards $2 trillion in long term capital of which over 40% resides in offshore markets or economies. Is it not time for a portion of these funds to be mobilised for Australia’s immediate needs?
Meanwhile overseas we are witnessing the extreme mobilisation of seemingly “fictitious” capital through what the US Federal Reserve recently described as an “unlimited QE program”. This is a rerun of programs adopted across Europe and Japan that ultimately result in a ballooning of government debt that cannot be serviced without more QE designed to keep bond yields perpetually low.
In the worlds largest economy, the US, the Administration and Treasury, sanctioned by Congress and the Senate, has embarked on a US$3.4 trillion maintenance and recovery package. This package represents near 15% of US GDP and 2% of world GDP.
So how could it be funded given the US fiscal deficit was already $1 trillion? The answer is QE and the mass printing of money.
Whilst it appears to be “voodoo economics”, the reaction of equity markets in the US has been positive. QE leads to speculation in the value of risk assets and the greater the QE the greater the speculation.
Therefore, once the world endures the coronavirus crisis we believe it will enter a debt crisis that can only be resolved by a massive restructuring or forgiveness of government debt by central banks. The RBA is correct to commence a QE for it will also be restructuring or forgiving Australian Government debt at some point in the future. However, it needs to lift its QE program by a much larger amount because of the damage that has or will be done without it.
Ultimately the question for markets will be whether the world-wide debt renegotiations will be good or bad for equity and risk markets. Whatever the case the Australian Government funded by the RBA needs to be involved and not be a bystander.
Clime’s call on where to from here
The world will recover and growth will recommence at a solid rate in the major developing economies of China, India and across most of Asia. As for the developed western world, we perceive a sustained period of sub optimal growth checked by both excessive leverage and an ageing population.
In Australia, we perceive the possibility for a significant restructure of our economy that has largely been drifting since the GFC. The economic downturn is destructive but it gives our Government and its supporting bureaucracy a chance to reconfigure an economy that we contend has achieved well below its potential. Such an outcome would make Australia an exciting investment market once again.
Stay well everyone. The future is uncertain but recovery will occur.