The 2020 recession, why this time is different.

The 2020 recession, why this time is different.

There are number of things that make the global economic recession of 2020 different to any other we’ve seen, and while you’d never wish to go through an experience like it, there are definitely some silver linings.

The government forced the economy into recession

This was the first time in living memory that governments deliberately threw economies into recession. If you close down all but a few sectors and tell workers to stay home, obviously economic activity is going to crash.

Previous recessions have been attributable to the business cycle: typically there is a speculative build up which causes an imbalance that eventually tips over, and the worst recessions are those fueled by debt.

The standout example of this is, of course, the GFC. Building activity reached frenziewd levels in the US because buyers were able to access debt way too easily. The adjustment process was long and painful because credit, which is the lifeblood of a modern economy, all but seized up.

This time there were no baddies

When a recession is caused by excess building in some part of the economy, there is normally going to be a culprit you can point to. It might be banks, or it might be investors, but there’s a group that cops the blame and derision for crashing the economy.

That’s when the philosophy of ‘moral hazard’ argues if the culprits just get bailed out there’s no lessons learned to stop the same thing from happening again. Politicians and the media will often argue the responsible group should somehow be punished, perhaps with tighter regulations or even criminal charges.

This time (ignoring arguments about how COVID started and who or what is responsible), there is no real culprit to punish.

No holds barred support program

Because the government was responsible for switching off the economy and there was no concern about moral hazard, both they and central banks were able to throw the proverbial kitchen sink at supporting the economy.

Central bankers learned valuable lessons from the GFC that they had to make sure credit could continue to flow. The range of measures undertaken was unlike anything we’d seen before, and while things were ugly for a short time, markets were once again reminded how powerful central banks can be.

Remarkably, US financial markets have clearly recovered strongly despite the Federal Reserve barely tapping a range of the programs they announced – see chart 1 below.


Chart 1: US financial markets have recovered despite many of the Fed’s announced measures barely being utilized
Chart 1

The Bazooka

By far the most important support measures were from governments. One after another, governments wre throwing massive amounts of newly created money into their economies. Programs like JobKeeper in Australia and its equivalents overseas were critical in supporting families that otherwise would have been in dire financial circumstances.

The critical part is that it was newly created money, which governments can do directly, but central banks can’t. The central bank programs can help create new money by encouraging people to borrow (loans also create money) but that was going to be tough when the media was full of stories about the global economy crashing.

This is the opposite to what happened after the GFC, where, especially in Europe, governments preached from the gospel of austerity. Spending cutbacks sucked money out of economies and saw them slow to a grinding crawl.

Economies are on fire

Some of the data showing how sharply economies are bouncing back is remarkable. Here in Australia, we’re seeing restaurant bookings up to 50-80% compared with the same time last year, new car sales leaped 12% from last year and Commonwealth Bank credit card sales were up 11%. They are huge numbers and it’s not just because lockdown restrictions were eased.

The Australian government’s COVID support programs amounted to 13% of GDP. It’s hard to overstate how massive that is. In the wake of the GFC, the Chinese government ‘rescued’ much of the developed world by announcing a spending package equivalent to 12% GDP (clearly the absolute amounts are hugely different, it’s the proportion that’s significant). The early withdrawal of superannuation adds anotehr 2% to that. The household savings ratio hit almost 20% in the June quarter, only a fraction less than the highest it’s been in the past 60 years.

That’s an awful lot of pent-up spending power.

The silver lining

Ever since the end of the GFC, central banks have pleaded with governments to raise fiscal spending to help increase economic growth. But most governments, including Australia’s, were obsessive about balancing budgets and instead were more intent on reducing spending (the obvious exception to that was $1.2 trillion Trump tax cuts, which helps explain why the US economy was doing so much better than most others).

It’s taken the unique circumstances of the pandemic to show the power of fiscal spending to drive economic activity: low income families suddenly had enough money to go to the dentist and get the car fixed, and the money they spent doing that got spent again and again.

If governments take the lessons on board, it’s possible it could be the first step toward abandoning the flawed dictums of neoliberalism and addressing the massive wealth inequalities that lie at the heart of so many other problems we face. That would be a great silver lining.

Want to take advantage of the expected economic growth?

Call Steward Wealth today on (03) 9975 7070 to learn how.

What are the prospects of a post-COVID boom?

What are the prospects of a post-COVID boom?

This article appeared in the Australian Financial Review.

After news of a promising COVID vaccine hit financial markets on 9 November, those sectors that had been shunned like last week’s fish dinner while economies were at risk of ongoing lockdowns suddenly became flavour of the month.

Investors pounced on the stocks that should benefit from people returning to ‘normal’, which saw sectors like energy, banks, retail property trusts, hospitality and travel shoot up. At the same time, the companies that had starred during lockdown, that benefited from people shopping, working and exercising from home, surrendered some of their astonishing gains.

This has left smart investors facing the usual challenging questions: has the market already priced in the return to normal? Should you be erring on the side of caution and selling into these strong markets?

We continue to advise clients to remain fully invested in the allocation to growth stocks their risk profile allows.

Strong outlook for the economy

There are several indicators pointing to the possibility of a strong economic environment in the year ahead. First, the Australian government injected stimulus equivalent to 13% of GDP in the form of JobKeeper, JobSeeker and other direct payments. The $34 billion worth of early super withdrawals added another 2.5% to that.

A lot of that stimulus has already been spent, which was the whole idea, but much of it has been saved, with Australia’s household savings ratio hitting 19.8% in the June quarter, almost eight times higher than a year ago and only 0.5% below its peak of the last 60 years. That’s a serious amount of spending power.

And spending is exactly what it looks like Australian consumers are doing after confidence levels jumped to 10-year highs. The Commonwealth Bank reports its credit card data showed spending in the week to 13 November was up 11% compared to last year. Restaurants in New South Wales enjoyed seated dining numbers 55% higher than a year ago, while Queensland was a whopping 79% and even shellshocked Victoria was up 54%.

Retailers will be eyeing off that pool of savings in anticipation of a bumper Christmas and companies in general should expect a lot of that money to work its way around the economy for a while yet.

The US is in a similar position, with a 13% stimulus package pushing the personal savings rate to almost double what it was at the start of the year. Although a fresh stimulus package has been trapped in a political standoff for the time being, it is expected the new Biden administration will make it a priority. Meanwhile, record low interest rates have ignited the housing market, with home values at record highs, homeowners’ equity at record levels and monthly new home starts challenging their all-time highs.

If the new vaccines are as effective as they appear, the Chinese economy has shown how quickly things can bounce back. China’s manufacturing and services sectors have rebounded strongly, pushing annualised GDP growth to 5% and retail sales are almost 5% higher than a year ago.

What about the markets?

Whoever would have thought the US share market would already be at a record high the day a COVID vaccine was announced? Let alone that it would hit that high amidst COVID cases being reported at record rates across the globe. And that strength is being seen in stock markets around the world, with 52-week highs in China, Europe, the emerging markets and even Japan is at 30-year highs.

2020 has been a great reminder that share markets do not necessarily follow economies, so it’s entirely possible we will see an economic rebound and poor markets. And there are plenty of sceptics ready to point to elevated valuations as a warning signal.

So how do those valuations stack up? Australia’s ‘forward PE (price to earnings) ratio’, so based on earnings forecasts for next year, is at 19 times compared to a 32-year average of 14, and the MSCI World Index is at 21 times compared to 16.

On the face of it, that makes shares look pretty expensive. However, I’ve argued for a long time that low inflation supports higher PE ratios. 30 years ago, Australia’s inflation rate wasn’t far off 10% and it’s been trending downwards ever since. So, with inflation currently below 1%, it makes perfect sense that the PE ratio would be higher. In fact, comparing today’s PE ratio to any period as far back as 40 years ago, when inflation peaked at close to 18%, is like comparing the proverbial apples and oranges.

Further, high growth companies such as the tech sector have defied any gravitational pull of lower PE ratios. I’ve argued before that it makes little sense to value a software company whose earnings can grow exponentially without requiring any further capital outlay the same way you’d value a company whose earnings can only grow in proportion to how much they spend on building new factories.

Bond yields have also been steadily declining and, likewise, it’s well established that falling bond yields underwrite higher equity valuations. The typical way to value a share is by working out what a company’s future cash flows are worth today by applying a ‘discount rate’, which is normally based on the 10-year bond yield. The closer bond yields get to zero, the more valuable are those future cash flows in today’s money.

With interest rates at levels designed to punish savers and prospects of a vaccine unleashing a post-COVID spending spree, it’s little wonder global equities just saw the biggest week of inflows ever. Now is not the time to be sitting on cash.

Want some help with your investments?

To discuss how we can help call Steward Wealth today on (03) 9975 7070.

Addressing inequality would be good for the whole economy

Addressing inequality would be good for the whole economy

Inequality of incomes and wealth continues to be a well-deserved point of focus across the developed world. The US produces the best data, and by 2016 the top 1% of households held 29% of the country’s wealth, while the entire middle class owned 21% and real median income has fallen over the past 40 years. This inequality of wealth and income is actually reducing growth for the overall economy.

The chart below uses a simple, but insightful, method to argue inequality really took root under the ‘neo-liberal’ economic era. If it’s correct, that premise throws up some suggestions as to how it can be addressed.

First, what is the chart telling us? It effectively traces the relative strength of labour versus capital. When the line is trending upwards, share prices, as measured by the US’s S&P 500, are rising faster than the average wage. That means there is a greater share of the economic pie going to the owners of capital than to labour.

After WW2 the US became the world’s factory and there was a relative scarcity of workers, so wages were strong. The next bottom in the chart, around the 1970s, was when unions were throwing their weight around and the US and UK lost a record number of days to strikes. Wages were commonly indexed to inflation, which created the classic wage-price spiral: as wages rose, so did prices, which again caused wages to rise, and so on.

Then came the era of Thatcher and Reagan, and the wholehearted embrace of neo-liberalism. This philosophy, which was largely founded on the work of Milton Friedman, argued markets are best at determining the allocation of resources so the best thing governments can do is get out of their way. It coincided with the crushing of unions, and the highest interest rates ever recorded as central banks around the world followed the US Fed Chairman, Paul Volcker, in his efforts to stomp out inflation.

Neo-liberalism is also called ‘supply side economics’, the premise of which is that reducing regulation and government interference would enable markets to flourish and encourage economic growth, and the benefits of all that growth would trickle down and be shared broadly. Indeed, Paul Volcker predicted that “wages for all Americans will improve as we achieve greater productivity and moderation in the demand for nominal wage increases.”

Well, that hasn’t happened. In his terrific book, The Economists’ Hour, Binymain Applebaum writes that “the median income of a full-time male worker in 1978, adjusted for inflation, was $54,392. That number was not matched or exceeded at any point in the next four decades. As of 2017, the most recent available data, the median income of a full-time male worker was $52,146. Yet, over those same four decades, the nation’s annual economic output, adjusted for inflation, roughly tripled.”

Likewise, economist Thomas Piketty argues that, in fact, the whole of the US is worse off under the neo-liberal model: between 1910-1950 national income per capita grew at 2.1% per year, from 1950-1990 it was 2.2%, and 1990-2020 only 1.1%.

In other words, as income and wealth inequality has worsened, so too has overall economic prosperity.

The solution? On the face of it, economies would be collectively better off if there was some equalisation of power between labour and capital. It also suggests there is indeed a role for government in areas like regulating labour markets and controlling corporate power.