Carry on and keep baking is my giddy aunt’s response to Covid. Her new pin up is the Reserve Bank Governor, Phillip Lowe – the quintessentially nice boy from next door. And he is, my aunt thinks, the perfect mandarin – measured in his comments. And the perfect afternoon tea guest. Who else could make economic contraction – recession – sound like an exciting new board game?
The RBA’s revised economic forecasts point to the biggest contraction in GDP growth since the 1930’s. With growth to fall by around 10%. But, in snakes and ladders, the Australian economy could rebound next year in a V shaped recovery. Restoring GDP growth to previous levels will take at least a couple of years. The IMF expects GDP forecast growth of around 6% for next year.
The biggest growth drag will be the unemployment rate. Initial Covid estimates had this at 15%, and legions of Australians painting kerbside rocks white – in Whitlamesque work for the dole schemes. But as restrictions begin to progressively loosen and are hopefully largely removed by year end, with the exception of international travel, Lowe thinks longer term unemployment will stabilise around 6%. Shorter term its much worse with the June figure expected to reach 10%.
A key determinant, however, is if small and medium businesses are able to retain their employees on shorter opening hours courtesy of the Federal Government’s 6-month income support.
Unemployment, or underemployment short term, may moderate as business gets back to normal. But it will still be ugly. And prompt possibly further business support measures from Government.
An economic inflation backflip, normally winning much applause, could be at least a couple of quarters of negative inflation rate. And for the first time since the 1960’s the RBA says the inflation index has fallen over a full year. Whether that means the things we don’t need get cheaper and things we do are priced checked in aisle 2, remains to be seen. Because despite this trend the bank says underlying inflation is expected to remain positive. The RBA is implying consumers cautiously return to spending later in the year.
All importantly, interest rates are not likely to move up anytime soon. The RBA is staggering its bond purchases three times a week, because of more settled financial conditions, and is buying less bonds.
Daily bond buybacks have scaled back to about $750 million. This suggests the RBA has more firepower to move if required because its total bond purchase program is smaller than projected.
For the equity market, post its recent two week rally, there is still as much uncertainty. The RBA’s best prognosis could be upset by external events such as falling commodity prices (think oil) producing unforeseen credit crunches. Thankfully for Federal Government revenues the iron ore price remains stubbornly high because of China’s demand.
But the index sitting around 5,300 points feels vulnerable. Much of the recent price action has been in a W shaped chart formation, which has got the index back at its early 2016 levels. And investors are nervous. Those that have needed to sell have been washed out of the market and others are sitting on cash waiting for the next leg down. It is very much a day by day proposition for the market. And sentiment is guided by which new capital raise is being put forward.
We are recommending a tread lightly strategy, looking for value in the major cap stocks when the market has its weaker days. The fact bank dividends are not off the cards, and subject to review by the individual bank boards, give us some hope there may be value start to emerge in this sector. But we are wary of a potential emerging bad debt cycle.
Our go to investment hymn is still the big three resource stocks, BHP, FMG and RIO, for exceptionally good dividend yields and potential capital growth.
And, as we bob about in the sea of uncertainty, I reckon we can take investment inspiration from Apple’s founder Steve Jobs, “You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something – your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.”