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 underinvested 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 focussed 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 cashflow 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 lockdown 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.
I don’t disagree with any of what you have written however I think they have taken the lockdowns too far. If this is a war against an invisible enemy as they all say you won’t win by having all your troops sitting in bunkers. Wars are won by calling for volunteers to achieve specific objectives. By all means ring fence the elderly. The 13 deaths here were people 70+ most with pre-existing conditions. The US in three months has lost 1400. 40,000 a year are lost to flu and God knows how many on the roads, to murders, drug overdoses, suicides etc and no one flinches. People recover from this virus and they will find a drug to block or slow it like the flu but never a complete answer. If the world doesn’t go back to work and soon there won’t be much to go back to. In war everyone knows there will be casualties but they go anyway. It’s radical but rather than dictate to the population governments should call for volunteers to go back to work and get the economy moving again. Start with those under 40. If that works move the age to 60 and stop the press and social media reporting every death as though it’s another JFK assassination. There will be plenty of volunteers because they have no alternative. Jack Roberts
I am an 89 year old recently retired GP who is greatly concerned about the general response to the recent Coronavirus problem, which is affecting the whole world. I believe our response has not been a correct one. We are in fact at war against the virus, demanding a war time response to deal with it. In war we mobilise our forces and go out to attack the enemy. Our work force should continue to operate normally. We do not stay at home and meekly put up our hands and surrender. Yes there will be more casualties with more deaths than we are presently experiencing, but that is something we will have to wear in war. It is in fact part of war. I realise that hospitals and doctors will find it difficult to cope with the extra cases they encounter, especially for the patients requiring ICU, but as we do in war, we will have to do the best we can with the available resources. I know there would be many retired doctors who would be willing to temporarily return to the work force to help. Obviously there will have to be extra precautions in place for the elderly, especially in nursing homes. Let’s keep the economy going. Dr Patrick Tomasiello
We need a test NOW to see who has HAD the virus not HAS the virus. We need these people back at work. There must be a thousand or more people out here who are now immune. Our Economy needs these people. Where is the test for people who have recovered from the virus without even knowing they have been infected or people (and there seem to many of them) who have been refused the test because they don’t meet the criteria for testing, which is coming back from overseas or being in contact with someone from overseas. Who would know if they have been in close contact with someone from overseas. Also I am hearing continuously over radio people wanting themselves tested or a relative tested who has been near people with the virus. Not enough test kits so not happening. Margaret Kirby
Good points again John. Thank you. It just shows how out of touch with reality our government has become. Stimulus packages announced, Centrelink under resourced and its online systems inadequate at best AND THE GOVT WAS SURPRISED THE QUEUES AT CENTRELINK WERE OUT THE DOORS AND ROUND THE BLOCK SEVERAL TIMES Announce a large recovery package but are they hoping no one lodges a claim? Where is our welfare system when the truely needy require funds now not April 13. Scomo’s marketing hype again and no practical use. Come on Australia let’s pull together and get well thought through properly targeted policies before it’s too late
Marvin - Do you seriously think ANY public service or private sector operation runs its business with over-capacity to adjust for a situation such as this ? Of course not - if you were in the public service you'd have people wandering around doing literally NOTHING, and if you were in the private sector you'd be out of business. The sad reality from recessions and downturns is that jobs disappear and don't come back; so the planning needs to also look 3-6 months out to get people back into work asap with a minimum of fuss (if they go back to the same employer who's hopefully still in business). Putting the economy to the sword depression-style is a recipe for a lot of pain when things get back to "normal". Nobody expects a "perfect" response from the Federal, States and National Cabinet, just support the decisions that get made.
John, can you make comment please on how and when QE will be reversed? In my experience all loans need to be repaid, can we assume same for our government?
Thank you for the comments so far and I expect many more in coming days, especially after the Governments announcement tonight (rents and the two person rule) and the coming announcements regarding the governments supplementing the salaries of displaced but retained workers - pity about the hundreds of thousands whom have lost their jobs already. There is a clear desire by many to have a plan to get the country back to work quicker than the 6 months that is proposed by the Prime Minister. If it is 6 months before the economy returns to work (young people only or the whole workforce) the cost of the Government support programs will be astronomical. It simply could not be funded outside a significant QE program unless the Superannuation Funds of Australia are accessed. There is no way that the massive fiscal deficit ( and resultant debt) will be left to taxpayers to repay. No government will promise massively higher taxes. It hasn’t happened overseas and since the GFC Government debts across the world have ballooned and with no repayment attempted through fiscal surpluses. Even Government debt to GDP has grown as developed world countries generally have grown debt faster than GDP. No more so than the US. So QE will continue on and won’t be reversed. It will become embedded in the bond market . The growing debt will be extended out the maturity curve (30 to 100 years) and debased by QE that holds bond yields near zero IE negative real yields. The debt may held on Central banks balance sheet as “zombie debt” and never to be called, or it may be written off in a world wide agreement to restructure government debt to reignite the bond market as a necessary mechanism to fund governments and support pension liabilities. I am speculating and I am always keen to hear from others as to how they think this ballooning government debt will be dealt with. Keep well everybody John Abernethy
One change I'd anticipate in corporate behaviour is reduction in dividend payouts and retention of a greater proportion of profit. Rather like my parent's generation edict that we should save for a rainy day. This isn't the only pathogen that will enter humanity. There are dangers from melting permafrost that has kept pathogens in a frozen and safe condition since the last ice age. The question of debt repayment is interesting. Once upon a time, printing money was thought to be a recipe for inflation. Not today, at least not yet. QE, easier access to credit and printing money to pay off debt that is caused by QE, easier access to credit and printing money shows just what a fragile house of cards the capitalist enterprise is. According to Germany's Kiel Institute China's lending to other countries surged 10-fold between 2000 and 2017. If China decides to require repayment, look out!!!
More stimulus packages/debts taken on by the Australian government. People still wouldn't go to the shopping malls and eat out knowing that successive wave is just around the corner. I know I won't. People need to know that they are safe before heading out again. I think a better way is to lock down for 18 days only. Nobody moves. Test everyone on the first day, the sixth day and the 18th day. This is based on the 5.8 day for the next infected person to show symptoms of Covid-19. Those tested positive will be isolated and treated for the appropriate amount of time. Then, release lock down, on the 19th day, everyone will be confident enough to head out. The series of three testings will be far cheaper that any stimulus package and loss of consumer confidence.
What I'm confused about is, if small business owners have had their revenue cut off and they are living on personal savings, while still paying fixed operating costs, how will the incentives to hold staff be of any help? If the businesses fail to survive, then the team members will be unemployed anyway. Any deferred costs simply become debt that will need to be paid down from future earnings. I personally, will need to liquidate at the end of this period. Simply because my accrued debts will make it pointless for me to remain self-employed. I consider lucky to at least have this option.
Excellent article. Thanks John.
Yes John, the RBA has realised QE,/bond buying, to support the now disorderly bond market and try to keep rates low, is equivalent to cancelling bonds, just as the Fed in the US has been doing since the GFC. All purchased Govt Bonds go into the top draw, while Govt Treasuries pay interest on those bonds to the RBA, which then distributes its profits back to the Federal Govt Treasury. In the Corporate world this is the equivalent to an unauthorised / illegal reduction of Share Capital , because creditors/lenders are prejudiced. More than that, the Fed and Bank of Japan have now furtively taken on the unconstitutional role of : "Buyer of Last Resort" , circumventing their mandated powers, through formation and funding of " Special Purpose Vehicles" to buy Stocks and so infect the Stock Market with the same virus they have planted in Bond markets. With Blackrock appointed to administer the SPV buying of illiquid ETF's , that might partly explain the recent bounce. One thing is certain - gravity can't be defied too long, particularly by Zombie businesses, on Govt sponsored ventilators.
So economic consequences should have greater priority than people's lives...... You need to go and live in America.
Hi John - Too much implied Modern Monetary Theory, and Debt Jubilee dreaming in your visions for what may happen next. Albeit reality far stranger than fiction right now. As you know, RBA doesn't fund the Australian Government, it facilitates debt issuance. RBA profits on its own balance sheet are a fraction of Aust govt revenue, that being directly RBA dividend funded. Talk of potential restructuring of our national debt obligations = incredibly destabilizing for the AUD (Australian Dollar) outlook and threatens our access to Debt Markets, financed 50-65% by Foreign capital!! We are a AAA rated sovereign credit. Talk/speculation about restructuring our national debt (in March 2020), right before we tap Debt markets throughout late 2020 and 2021 is both harmful and odd, but if it does go on to occur, we definitely heard it from you first! If you want to create an activist RBA to implement some of your ideas, you'd probably need parliament first to remove the currency stability mandate from the RBA's core duties. RBA makes it clear, "widespread funding in domestic currency is feasible, (if) several pre-conditions (are) met: investor willingness to hold assets domiciled in Australia investor willingness to hold assets denominated in Australian dollars" JOHN ABERNETHY - 28 March 2020 Livewire piece. "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."
Hi Matt The expectation for Australia’s fiscal deficits over the next two fiscal years is now towards $500 billion. As the Government undertakes its funding process the RBA has committed to keep 3 year bond yields at 0.25% and is providing unlimited funding to our banks at 0.25% for ( presumably ) at least a 3 year term. There may be a RBA rule book , similar to every other Central Bank rulebook. However, since the GFC the major Central Banks have made up their own rules in dealing with their Governments debt funding obligations. The debt was simply ( and is today) too large to fund through any normal Bond market that is not supported by QE. By the way I have been predicting for well over 6 years now that government debts around the world would balloon and eventually the debt held by Central Banks would be compromised by them in some way. I note ( and you would claim) that debt forgiveness or write off hasn’t happened - but we do observe that across the world ( outside Australia) 100 year bond issues have appeared and negative yielding 10 and 20 year bond yields exist. Are these examples of government debt being compromised or are they the result of the bond market operating efficiently and free of Central Banks direction because they ( the Central Banks) are bound by their own rulebooks? Cheers JA