Market Risks and the Government Response
The State of the Economy
The corona virus continues to spread, leading to uncertainty and volatility in the global markets. At the time of writing there had been 95,180 cases globally, with 3,254 deaths. Australia has had a total of 50 cases with 2 deaths. To stem the spread of the virus, travel restrictions have been put in place by many governments, and supply chains have been closed by both trade route restrictions, and factory closures and production slowdowns with lower staff levels.
As we noted in our January investor report, domestically, we expected significant ramifications to the tourism and education sectors as a result of these measures. This was confirmed this week by governor Lowe, with the RBA cutting interest rates to 0.5% citing weakness in each of those sectors. We are of the view that the secondary impacts from supply chain restrictions will start to have a real impact on the economy. Examples include wholesalers and retailers not having inventory to sell to customers, and manufacturers not having components to complete their production process.
Government estimates are of a 0.2% reduction in GDP off the back of the reduced tourism flow. With the December 2019 quarter GDP coming in at +0.5%, there is not a lot of room for error for a flat or negative quarter of GDP Growth in March 2020. It should be noted that the March quarter will include some impact from both the summer bushfires and the Coronavirus. We will see the March quarter GDP figures released on June 3. We anticipate a flat to negative March Quarter with respect to GDP growth. To avoid a technical recession (two consecutive quarters of negative economic growth) which Australia has not had in 29 years, a boost will be required in the June 2020 quarter. The government have two tools to influence this outcome, monetary policy, changing the underlying cash rate, or fiscal policy, government income (via tax) and expenditure.
The Initial Response
The monetary response that occurred on Tuesday will have some impact in the economy, with the full 25bp cut passed through from all 4 major banks, and most other residential mortgage lenders. We are of the view that the main impact of the rate cut will be a reduction of household debt as borrowers retain repayment levels on their mortgages. With confidence levels low, we do not expect a significant increase in home buying activity. The negative impact of the rate cut will be further erosion of retiree’s income.
Our View on What is Required
What is really needed at this point is support to Australian businesses to keep people employed and spending. This action is required quickly and efficiently to ensure the impact arrives in the June 2020 quarter.
From a business perspective, cashflow is the key concern at this point. Tax breaks on asset purchases, and potential tax cuts have been mooted in the market. The cashflow impact will not be felt by the business until the business lodges it’s 2020 income tax return, which will be after June.
The government set up the $2bn Australian Business Securitisation Fund (ABSF) to assist in the supply of credit to Australian SME’s. An initial tranche of $500m has been approved. Deployment of this capital could be increased and fast-tracked, with an increase in the total facility size. This program has been established and vetted, removing some of the red tape of government funding programs.
From a consumption perspective, the confidence of the consumer has been hit with fears of the virus. People are being encouraged to limit exposure to large groups, and generally limit movement. ABS retail sales data for January showed a nominal -0.3% month on month move, with a revision to the December decline of -0.7%. We anticipate this is the bushfire impact. To gain an immediate response on this a direct cash injection is needed for consumers. This was done in 2009 by the Rudd government with up to $900 being paid to those earning up to $80,000 and sliding to $250 for taxpayers earning up to $100,000.
To create longer term stimulus the government should take advantage of the low government bond rates. The current 10-year government bond rate stands at 0.67%, an all time low. The government should take advantage of these low rates and embark on additional infrastructure initiatives that will provide a long-term structural value add to the nation.
What We Are Watching
As a capital provider to Australian SME lenders, we are very focused on the underlying loan quality of the pool. The leading indicator of 30 day plus arrears is key at this point, with all loans in arrears being discussed with the relevant lender at multiple points during the month. We are maintaining short duration within the portfolio to remain nimble with allocations. Over 2019, we had consciously increased the underlying security within the pool at a borrower level.
The lenders we are funding are all adjusting to the conditions, adjusting their risk appetites, and tightening lending criteria. This is the reaction we expect from the responsible lenders we support.
It is at these points in the market where the two pillars of our investment philosophy, careful initial selection of assets, and diversification pay off.
This report is provided to you for information purposes only by Aura Funds Management Pty Ltd (Aura) (ACN 607 158 814, Authorised Representative 1233893 of Aura Capital Pty Ltd AFSL 366 230). Aura Funds Management Pty Ltd is the Trustee of the Fund and a subsidiary of Aura Group Pty Ltd.
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Brett is responsible for portfolio management and asset origination for the Aura High Yield SME Fund. He has over 15 years’ experience in sales, origination and analysis of debt finance. More on the Fund https://bit.ly/AuraFunds