Christmas Boom Time; Asset Pricing and Inflation Risk Post COVID
With the ever-evolving post-COVID landscape, some investors see risk and others see opportunity. Yet, the outlook remains layered and complex based on a range of factors most of us have never experienced in our lifetime.
Stimulus and boom-time spending
Governments pump liquidity into the economy to stimulate spending, creating bullish pockets for a number of markets. Yet the underlying question around asset values is one which is hotly contested.
Global low-interest rates and extreme levels of liquidity mean there is huge competition for quality assets and yield, so upwards pricing pressure on assets continues concurrently with the trend of sharpening of capitalisation rates.
Domestically in Australia, as we approach Christmas, it feels like a boom time, with retail expenditure up year on year due to unprecedented stimulus. The travel restrictions mean expenditure is focused Domestically as international travel budgets are re-allocated to home acquisitions, renovations and localised spending.
Australian COVID numbers are negligible, and a mini domestic boom-time ensues.
The Balance between printing money and immigration
Yet, one thing which is unanimously recognised is that Australia does not have the localised wherewithal to create organic economic growth, unprecedented immigration has been the key driver to economic growth for the years that have followed the GFC.
Whilst our immigration in-flows are stemmed by the pandemic, which continues to ravage health and economies outside of Australia, the domestic stimulus continues bringing us to the precipice of a budget deficit which is near trillion dollars.
Whilst the Government has done a sensational job of cushioning us from the pain of a pandemic induced economic crisis, the question goes to the longer-term viability of the stimulus and its effect on the value of our dollar.
Our modern-day Fiat currency isn't pegged to any underlying commodity like the Gold Standard was; meaning that in times of economic pressure, the Government can literally print more money, enabling better currency flow through the system during uncertain times.
Compare this with the behaviour of a more finite currency like the Gold Standard, which is anchored to a commodity: in times of financial stress, people tended to hoard their money, which only exacerbated pressure on the economy during a crisis, hence the current unprecedented stimulus being provided to buoy the economy now.
There is no doubting that moving to the Fiat currency helped to modernise our global markets, not to mention deliver unprecedented regulatory control. However, the issue with cash is that it is easy to create more supply.
We are seeing both the Australian and American governments printing huge amounts of money, both devaluing the dollar and generating huge once-in-a-generation budget deficits in the process.
A licence to print money
America and Australia are two very different markets, and this is primarily due to sheer size.
As an example, in Australia in 2019, there were $1.8 billion in total combined national hotel transactions across the entire country. Compare that to just one hotel transaction in Las Vegas, America, where Blackstone acquired the Cosmopolitan Hotel for $1.8 billion in 2014, and the sale value in 2019 was a notional $4 billion. This is an extreme case but gives an example of scale as a result of the sheer size of the USA's market, their population and the overall economy.
However, two things that remain similar are the transparency and high level of visibly of our Australian and American respective banking systems, comparative to other established nations.
The strength of the Aussie banks
Fortunately, Australian banks are in a robust position. APRA's requirement is that banks hold an 8% minimum reserve on balance sheet to protect against volatility and recessionary conditions. Also, most major banks have - in the last few months - undergone additional capital raising specifically to prepare for the uncertain road ahead.
Concerning the risk banks have on their residential mortgage books, in Australia in the March 2020 quarter, there were a total of 10.4 million residential dwellings, with an aggregate value of $7.2 trillion.
The banks' total residential mortgage debt exposure sits at around 1.8 trillion dollars, or a Loan to Value (LVR) ratio of (25%), with approximately $5.4 trillion of unleveraged equity.
However, this doesn't account for those 11% of all home loans in mortgage distress in May this year, falling to 9% in September according to APRA.
It is a similar case in America. The essential difference being, The Fed not only guarantees the assets of the banks but during this pandemic, it has waived any minimum reserve.
Essentially what this means is the bank can have zero assets, or negative assets and still be trading & lending money.
So American banks are trading at a negative cost of capital and the American Government, much like the Australian Government, is printing money to ensure businesses and the economy can stay afloat.
Banking on bricks and mortar
As a result of the negative global interest rates, high volatility of listed markets and printing of cash in Australia and America, most leading investment houses are weighting recommendations towards alternatives - like unlisted property - for wealth protection and stable yield cash flow.
Those assets uncorrelated to the listed markets experience less volatility than the listed equities market. High quality, high demand and high barriers to entry will protect against asset devaluation.
Global low or negative interest rates, the printing of money, global volatility in listed markets together with excessive liquidity create a layered and complicated post-COVID investment landscape. These conditions will likely create upward pricing pressure on assets offering stable cash flow yield that can safely warehouse capital and provide a moderate probability of outperformance.
Long term outlook
Longer-term it's likely that the Australian Government will move towards inflationary measures to reduce the real value of the burgeoning deficit, meaning longer-term pressure on corporate profits as costs rise also creating the potential for asset yields to soften.
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