Macro Matters December 2021

(Source: Merlea Macro Matters)


The new variant has already been identified in Europe and Australia among others, and markets quickly priced in a potential “rerun of Delta.” The concern is that the new variant will not just spread quickly, but that the strain itself will overcome and prove resistant against vaccines.

The yield on 10-year and 30-year US Treasuries has fallen sharply by 16 bps to 1.47% and 8.75 bps to 1.82% respectively as the yield curve flattened and investors rushed for safe havens. As happened several times during the pandemic, the probability of another lockdown and associated economic pressures was priced in quickly. However, with each successive strain the markets are going to lose sensitivity. Covid is a fait accompli now and something the world will have to live with. And after two years of dealing with the pandemic, financial markets know what to expect now, despite the current volatility.

The global economic expansion is unevenly progressing. We see three headwinds going forward: a China slowdown, emerging market turbulence and the fear of global stagflation. Looking at the first risk, we see China growth will definitely slow due to three factors: government policy to emphasise quality growth over quantity growth, which implies continuous tightening regulation in key sectors such as real estate, e-commerce and fintech sectors; the energy crisis, which will continue into next year, though less intensified than this year; and a snowball effect due to the two previous factors, such as a consumption slowdown due to declining wealth as a result of real estate curbs, or production problems due to energy and supply chain problems.

Turning to the second and third risk factors, we see that because of the China slowdown, supply chain problems and the tightening cycle of leading central banks such as the Fed and the ECB, will create turbulence in capital flows, as well as an economic downturn, among emerging economies, especially those that have weak fundamentals, as well as those that have strong economic dependency on China.

The risk of inflation turning from “transitory” to “permanent” is real. Inflation has turned out to be less transitory than initially thought, but it could fall next year as supply constraints ease. That said, several countries might shift to a moderately higher inflation regime than before the pandemic due to factors including rising inflation expectations, housing booms, deglobalization, ‘greenflation’, and the increasing bargaining power of workers. Central banks, especially those in emerging markets, could face tough policy dilemmas around financial stability.

If that is the case, global central banks may need to raise interest rates higher and faster than the market expects, which may create a condition of persistent global stagflation. Given how these three headwinds are materialising, businesspeople, investors and policymakers had best beware.


Rising global bond yields and interest rate volatility have been dominant themes in fixed income markets so far this year. The steepening move in sovereign bond markets this year may have been rapid, but it probably has further to run. “It’s important to remember what’s coming over the next few quarters—potentially a strong acceleration in economic growth and an inflation pickup that major central banks, such as the Federal Reserve, are likely to look through. Based on an analysis of past yield curve steepening cycles, I believe that around half of the flattening retracement has taken place in this current rate rising episode, which suggests there is further to go.

It is also important to note that the current steepening trend is much more than just a U.S. phenomenon—other developed markets are also likely to participate. The UK government bond curve, for example, is likely to continue steepening because of its fast vaccination rollout and an ultra‑accommodative central bank.

Not all parts of bond curves have experienced the same degree of volatility, however. “Long maturity government bonds have seen the greatest degree of price fluctuation recently as investors attach a higher premium to that part of the curve due to inflation fears and supply risk concerns. Accommodative monetary policy has helped to keep volatility broadly in check at the short end of the curve, but that might not always be the case.” There’s a risk the Fed’s wait‑and‑see attitude backfires and the markets test its resolve, which could also lead to a temporary correction in short maturity bonds. Rising government bond yields are unlikely to concern central banks, but the speed and volatility of the rises will. Several banks have already expressed unease, and it is possible that some may follow in the footsteps of the Bank of Japan (BoJ) and the Reserve Bank of Australia by introducing yield curve controls to help smooth out fluctuations.

Listed Property

With the market expecting interest rates to rise from these historically low levels, we assess below the impact this would have on AREIT’s earnings and the flow-on effect on cost of capital and valuation.

From an earnings perspective, at first glance one can say that the impact of higher interest rates has minimal impact as the average gearing level for the sector is relatively low at 27%. However, with fierce competition for quality assets, many REITs (particularly the externally managed REITs) have utilised low floating rate debt to maximise the earnings accretion from acquisitions.  As a result, REITs’ earnings are now much more exposed to interest rate moves. Currently, the average debt cost for the AREIT sector is 3%, compared to 4% three years ago. The expected rise in rates would make it harder for externally managed REITs to grow through debt-funded acquisitions. The flow-on impact would be a slowing of fund manager’s AUM growth, and more importantly, it will highlight the REITs that are able to grow earnings through capital recycling and development compared to those purely relying on acquisitions.

On valuation, the AREIT sector has, for the past 10 years, benefited from falling interest rates supporting cap rate compressions. Going forward, as rates start to rise, we see a slowing in cap rate compressions and a catch-up in rental growth, particularly for favourable asset classes such as logistics. The average forecast distribution yield of the sector is currently 4%, providing a 195-basis point yield gap to 10-year bonds that should continue to provide support for the AREIT sector.

Australian Equities

Many listed companies have benefited from ultra-low interest rates. Not only does this bring down their borrowing costs, but it also makes ASX shares more attractive relative to low-yielding bonds or cash deposit accounts. Meaning more investors tend to put money into the share market. But with higher inflation now flashing red on investors’ radars, what’s the outlook for the year ahead? You’ve got much higher oil prices and commodity inflation, that’s obviously causing some issues. And it remains to be seen how long this will be an issue. But on the other side of the coin, you’ve got wage inflation. The wage inflation is becoming more of an issue, and we feel like that is going to be with us for some time.

One of the most common things we keep hearing from companies is that staff availability is a real problem. One of the side effects of COVID is that a lot of people simply don’t want to go back to work. They’re rethinking their lives and willingness to work. That’s causing some real labour constraints, across multiple jobs and multiple industries. With higher energy costs and potentially increased wage costs, some ASX shares are likely to do better than others. From a style perspective, quality companies that have pricing power can pass on those commodity price increases. Those are the ones that are going to benefit over and above the ones that can’t. Services businesses, like a software company or a consulting business, they don’t have any input price pressure. Those types of businesses, and the less capital-intensive businesses, tend to do better during inflationary periods.

Equity valuations already pricing in a lot

Equity markets have already rallied strongly, and while corporate earnings have also surged back in-line with growth, this has been needed to justify elevated valuations. Most developed equity markets are trading at the upper end of their 20-year trading band and the dispersion between value and growth valuations remains elevated. The ASX200 is currently trading on a PE f of 18.3x, which is 20% above the 20-year average. Across sectors, IT and media valuations are looking extreme, with the best value still in some cyclical sectors, although being supported by extreme commodity prices in many cases. I foresee a downturn, or mid-cycle slowdown, in the second half of 2022, with the key risk being the Fed forced to hike into a downturn.

Volatility tends to increase in a downturn, but this does not imply only negative returns. Downturns tend to be the best period of a cycle for defensives. While Fed hiking is a key risk, I note bond yields tend to fall in a downturn, which favours bond proxies such as REITs and infrastructure funds, as well as Growth stocks and gold.

Global equity markets

Global COVID-19 cases have been trending up slightly over recent weeks, but new cases are still running well below prior peaks (see chart below) and deaths are running well below prior waves. In Australia and the UK, deaths are running at less than 20% of the level suggested by the December/January wave, which are all signs that vaccines remain effective.

Most of the recent upswing in new cases has been from Europe particularly in Germany and the UK which is a risk going into the European winter and shows the requirement for booster shots, as Europe started vaccinating its population in early-mid 2021. Europe has given around 2.6% of its population booster shots, while the UK is at 12.6%.

Shares remain vulnerable to short-term volatility with possible triggers being coronavirus, global supply constraints & the inflation scare, less dovish central banks, US fiscal plans and the slowing Chinese economy. But we are now coming into a stronger period seasonally for shares and the combination of improving global growth and earnings, vaccines allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months.


U.S. equity markets are ahead of the fundamentals, but they can stay elevated in the near-term given incredibly strong flows from retail, systematic strategies, and buybacks. Furthermore, pressure to keep up with the benchmarks is curtailing willingness to de-risk early. While there are signs of deterioration under the surface with many individual companies suffering from inflation pressures, supply bottlenecks and even demand destruction in some cases, the S&P 500 earnings forecasts are still moving higher, albeit at a slower pace.

More specifically, we are witnessing weak breadth as the major averages make new highs. While many market commentators think 2022 will be more challenging than this year, most still expect US equity indices to deliver 5-10% returns over the next year, while my view leans flat to slightly down in returns as a base case. The primary difference of opinion is on valuation, which appears vulnerable, in my view, to tightening financial conditions and a more uncertain range of outcomes in the economy and earnings over the next 6 months, and that should lead to higher risk premiums or lower valuations. U.S. equity markets have delivered another stellar year of returns, which is typical in the second year of an economic recovery. However, given the speed of this recovery and record returns over the prior 18 months, it is prudent to reduce US equity exposure. While our timing on that risk reduction might be wrong, higher prices, driven mostly by higher valuations, only make the risk/reward for 2022 worse, not better. In short, stick with larger cap, higher quality stocks at reasonable valuations.


COVID-19 clearly remains an issue, with different effects in different geographies globally, with the Delta variant creating a lot of volatility in individual countries and regions. However, in general the economic recovery is still on track and the virus is more of a hindrance than an obstacle in the Western world.

The European and global economies are experiencing significant price increases across an array of commodities and input components. Particularly notable has been an enormous rise in natural gas prices which have been affected by many factors including most recently hurricanes disrupting the natural gas supply chain. This has the knock-on effect of significantly increasing the cost of electricity.

The rise in electricity prices will likely create a significant supply side shock to some companies and consumers. Some European governments have already begun to respond to the political pressure this is causing. Spain has effectively implemented a tax on the profits of utility operators to keep prices down. Italy, on the other hand has offered to subsidise electricity prices for consumers. There has been a significant level of disruption within the manufacturing supply chains for a raft of different reasons, relating transportation, lack of resources, and sometimes a lack of labour. Lack of chip supplies/production, a US hurricane, and a shortage of truckdrivers spanning several companies and countries have also impacted the distribution of everything from food to batteries.

This disruption and the consequences of it may increase as we progress through the fourth quarter. Companies who make things do not have all the components they need to make them, resulting in delays and/or price rises.

In Europe, the Stoxx 600 rallied to nearly a new record. The top sectors were linked to the reflation trade as the mood shifted away from the transitory to the persistent inflation camp. With Q3 results season now over half-way through, consumer discretionary and communications have been the clear losers. With the index near its highs, bears traders silent and some position covering, it appears less exciting to add risk now and there could be some softness ahead.


The structural transition to a green economy is likely to create a host of new investment opportunities. To meet targets from COP26 and beyond, substantial investments are needed in a range of areas and the UK is a leader in many clean technologies. There are several ways to gain exposure to climate initiatives, from larger established firms to growing and innovative smaller companies. Renewable energy including hydrogen, managing power grids, smart meters, battery storage, charging point infrastructure, and many electronic and software applications are areas that will need significant funding over the coming years.

The UK’s deep pool of talent across its universities and a strong entrepreneurial drive have delivered an enviable track record of commercialising new ideas. A relative weakness however, especially compared to the US, is the UK’s lack of start-ups transforming into global powerhouses. But industry and policymakers are increasingly aware of this problem and could provide support so that growing companies can thrive and remain based in the UK.


The au Jibun Bank Japan Services PMI hit a 26-month high of 52.1 in November from 50.7 in October. It was the second straight month of expansion in services activity, supported by loosening restrictions – the services sector is always hit harder by Covid-related restrictions. New orders returned to growth for the first time since January 2020.

On the cost side, input price inflation quickened for the third month running to reach its highest since August 2008, but selling prices dipped. Service providers were optimistic about the year ahead, believing they have turned the corner, as the domestic economy recovers. The composite PMI rose to 52.5 from 50.7 in October. It was the second straight month of growth in the private sector and the strongest pace since October 2018.

Growth in output quickened from October and was the quickest recorded since October 2018. By sector, service providers noted the sharpest rise in activity since September 2019, while manufacturers indicated the fastest rate of growth for six months. Firms across the Japanese private sector reported intensifying price pressures. Input prices across the private sector rose at the fastest pace for over 13 years with businesses attributing the rise to higher raw material, freight and staff costs amid shortages and deteriorating supplier performance. As vaccination rates rose and economic restrictions eased, Japanese private sector companies were strongly optimistic that business activity would rise in the year ahead. Positive sentiment was the strongest on record. Certain export-oriented segments of the market benefited from yen weakness versus the US dollar and higher commodity prices. Energy, materials and consumer discretionary recorded gains while utilities, health care and financials experienced the steepest declines.  Consumer sentiment remains firm, with mobility improving strongly following the end of the Covid State of Emergency. Retail sales also regained lost ground in September, indicating that shoppers are increasingly comfortable venturing out as infections fall.


China’s recent regulatory changes will set the tone for 2022, as the focus on sustainability becomes increasingly central to the Chinese economy. These actions have upturned sectors like education and online gaming and reined in the property sector — all aimed at addressing the main socioeconomic challenges facing Chinese society today. At the same time, China has announced measures to achieve its goal of peak carbon emissions by 2030, with implications for industrial energy use.

Navigating these changes may be the main challenge for investors in the short term against a global backdrop of rising inflation in the West and prevailing US-China tensions. That said, we continue to believe the long-term case for Chinese equities remain intact, particularly for investors with the patience and flexibility to position across the opportunity set. In China, 2022 is heralded as a pivotal year– bookended by the Winter Olympics in February and later by the Communist Party’s Congress, an important twice-per-decade political gathering.

All eyes will be on the latter for clues to Chinese leaders’ strategic direction. Chinese equities have staged a rebounded indicating that investors may have fully priced in greater regulatory uncertainty following several months of substantial underperformance. Beijing’s move to address the sharp rise in coal prices hurt energy names while real estate stocks remain under pressure as a planned pilot property tax scheme affected home buyer sentiment. A reescalation in US-China tensions hurt sentiment as the two countries clashed on multiple fronts including trade, human rights, Taiwan, and the pandemic.

Emerging markets

I believe economic activity will rebound to pre-pandemic levels in most emerging markets next year, however the pace of economic growth will be lower than that seen in 2021. Financial conditions will remain tight next year, and weaker corporate sector entities may face credit stress. External liquidity risks will also remain elevated for governments burdened with large foreign currency debt payments.

However, higher-rated issuers should be able to navigate 2022 fairly well despite higher debt levels, thanks to their strong economic or industry positions and good access to capital markets the rate of inflation is expected to slow in most economies, but the risks from high food and fuel prices will remain elevated. Higher commodity prices will support commodity-dependent countries and companies, however, emerging markets that depend on travel and tourism will take longer to restore revenues and profits.

Main reasons for a constructive view on EM:

  1. Vaccine rollout is progressing at an uneven pace, with some EM progress in steadily, while other are experiencing more difficulties.
  2. Following a robust economic recovery in the first half of 2021, DM growth momentum is expected to slow. As such, the DM-EM growth gap should narrow in favour of EM over the next few months, once the situation in China stabilizes.
  3. China’s regulation crackdown has hit some sectors, adding uncertainty to the economic outlook, possibly impairing a few EM. On the other hand, financial markets could shift from perceiving such slow down as a headwind for risky assets to viewing the possible easing as a tailwind.
  4. Inflation has been accelerating globally and some EM Central Banks have been hiking rates. Some EM are still normalising their monetary policy, while other Central Banks are closer to the end of their tightening cycles and we could see more supportive policy going forward.


High commodity prices, if sustained, could slow growth in energy importing countries and exacerbate food insecurity in low-income countries. Risks to the forecast include adverse weather, further supply constraints, and new outbreaks of COVID-19. The fluctuations in commodity prices this year highlight some of the challenges in transitioning to a zero-carbon economy.

The pattern of commodity demand will be affected by a continued increase in urbanization, with high-density cities having much lower energy use andCO2 emissions than low-density cities.


I’m very positive on the outlook for gold for next year and the reason is because of what’s going on with the macro environment, particularly inflation. Combine rate hike-resistant central banks with a supply chain crunch and inflation that may not be as transitory as expected. We have real inflationary pressures that, the longer they persist, the more of a problem that causes, and the more people will look for inflation hedges.

Recovering demand for gold jewellery could propel the price of gold even further. Consumer demand led by gold jewellery mostly going into the emerging markets has done very, very well in the first three quarters of this year. Jewellery accounts for 50% of global gold demand followed by central bank reserves at 25%, individuals at 15% and industrial uses at 10%, according to iShares.

The next six months tend to see the highest demand in India with festival and wedding season underway. We should be running into what is typically the strongest period for gold demand in terms of jewellery in the year for the next five to six months.


In terms of the strategic release from stock piles, the US is releasing 50 million barrels, while India, China, and the UK releasing between 1.5 and 7.4 million barrels. The intervention is the first I have seen of its kind. The Biden administration looks to be prepared to fight for the vote at the gas pump and take further unspecified steps if needed.

When asked about the potential for a US export ban in the future, the Biden administration continued to suggest that all options are on the table. I view the broader factors at play in the oil market of rising demand and muted supply responses (including muted strategic releases) that will continue to push crude prices higher.

This oil cycle is very different to anything I have seen before with a likely limited energy supply response colliding with world politics and the need for climate change. It is very unclear about exactly where new investment to expand production will come from, which may just well leave OPEC+ in the driving seat for the first time in decades.

Sector 12 Month Forecast Economic and Political Predictions
AUD 72c-80c Surge in Australian yields on the back of higher inflationary pressures is creating uncertainties over future policy actions from the Reserve Bank of Australia.
Gold Due to increased investment demand from ETFs and physical bullion buying, and despite increases in mine supply, we believe the price of gold will exceed $1,900 in the first quarter of 2022 and perhaps reach very close to $2,000 before pulling back for a bit. Gold could see some volatility (Fed policy normalisation) but is still a decent portfolio diversifier. So while rising interest rates may increase the U.S. dollar, pushing gold prices lower (because gold is denominated in U.S. dollars), factors such as equity prices and volatility coupled with general supply and demand are the real drivers of the price of gold.


Commodities Global decarbonisation is good news for the metals sector, Examples of metals that we like and are seeking exposure to in our investment strategy are copper, a universal beneficiary of electrification and select battery raw materials such as nickel and potentially lithium (where supply is more readily increased). While natural gas prices have increased due to demand/supply imbalances in Europe and Asia, they are not out of control.

In the long run, the world is expected to be in net surplus. OPEC should increase oil production to avoid a hit to global demand.



For listed property, as with equity markets more generally, the dividend yield of the S&P/ASX 200 A-REIT index, at 4.7%, remains attractive relative to the 10-year bond yield at 1.7% Although the longer-term impact of COVID-19, once populations are inoculated, remains subject to debate, the very low cost of capital is not. Offshore investors will continue to be attracted to Australian commercial property assets, given the attractive yields on offer.

Australian Equities

Value, cyclical orientation and financials exposure should benefit from unleashed pent-up demand, economic strength, higher rates, and infrastructure spending. Growth remains vulnerable to elevated valuations and higher interest rates. Australian equity valuations are not as favourable as they used to be. The impressive run in Australian shares over the past 12 months leaves little in the tank for the remainder of 2021, leading market strategists to predict a bumpy turn as the 2022 financial year begins.




Short duration

The Australia 10 Years Government Bond Yield is expected to be 2.372% by the end of March 2022.

The Australia Government Bond 10Y is expected to trade at 1.73 percent by the end of this quarter. Looking forward, estimate it to trade at 1.95 – 2.50 in 12 months’ time.

Cash Rates

The central bank has dumped one of its key stimulus measures, known as “yield curve control” — which was introduced in March 2020, shortly after the COVID-19 pandemic struck. Markets have interpreted this move as a concession from the RBA that borrowing costs may have to rise sooner than expected. I remain of the view that the conditions for rate hikes will be in place by late next year and see the first-rate hike being in November 2022.
Global Markets



Valuations are elevated amid post-peak growth and stimulus levels. Earnings strength has buoyed equities thus far but may face a more challenging environment amid decelerating economic growth.

Supply chain issues are weighing on economic growth.

Elevated stock and bond valuations.

Elevated corporate and government debt levels.

Fed accommodation has peaked.

Fiscal stimulus has peaked.




Elevated energy costs, low-rate environment and lack of long-term growth catalysts remain concerns. However, cyclical orientation, low valuations among financials and improving fiscal stimulus expectations provide near-term support.

Limited long‑term catalysts for growth.

Limited scope for the European Central Bank.

(ECB) to stimulate further.

Demand from China fading.

Elevated energy prices and supply chain issues are weighing on economic growth..



Slight over- weight

With vaccination rollout nearly complete, the domestic reopening is now underway.

Attractive valuations, strong global trade outlook and improving corporate governance also provide tailwinds

Supply chain disruptions in the auto sector, higher energy prices and Chinese economic slowdown are the key risks to watch.

Political concerns remain with the risk of surprising policies being released.

Stagnant productivity remains a structural issue for margins in the face of a tight labour market and inflationary pressures.



Emerging markets

Neutral to over- weight

Valuations are very attractive, and Chinese regulatory pressures may have peaked.

Global trade likely to improve as supply chain concerns ease and vaccine levels continue to improve.

Exposure to cyclical areas of economy should benefit from broad global recovery.

Accommodation from central banks is fading.

New coronavirus variants remain a threat.

Heightened political risk.




Regulatory overhand in China has likely peaked from here, with economic activity likely to increase in the next 12 months.

There are early signs from Chinese policymakers that easing may be possible for next year, with a focus to boost bank lending.

Chinese economic weakness is already broad-based, and sentiment remains fragile.

Fears of contagion from the property sector or a policy misstep remain tail risks.

The uncertain macro-outlook keeps us broadly neutral Chinese and China related assets in the short run.


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