Macro Matters – July 2020

(Source: Merlea Macro Matters)


In a recent IMF report, pandemics lead to a sustained period of lower real borrowing costs, but higher wages. That is because pandemics often cause a shortage of labour relative to capital. Moreover, pandemics are often followed by an increase in private saving that leads to slower growth of demand. The good news is that, if pandemics cause a decline in borrowing costs and a rise in private saving, the recent and massive increase in government debt will be more easily serviced. The bad news is that, all other things being equal, it appears that pandemics are followed by slower economic growth, at least initially.

However, the IMF report had some caveats to their analysis. First, past pandemics created a labour shortage because of the death of working age people. But the current pandemic will most likely not lead to a shortage of labour. Indeed, because of modern medical care, the death rate in this pandemic is likely to be far lower than in the past. Second, governments have taken aggressive measures to offset the negative consequences, thereby potentially boding well for a more rapid return to normal growth. Finally, despite those caveats, the authors conclude that “we still expect a sustained period of low real interest rates (though attenuated by the factors we discussed). Low real rates should then provide welcome fiscal space for governments to aggressively mitigate the consequences of the pandemic. Their point is that we are likely to live with the economic consequences of this pandemic for a long time, although it is too early and too difficult to discern what those consequences will be.  Of course, this pandemic will be different from the others, not least because of the existence of medical technology and more sophisticated government policies. Still, we don’t know what we don’t know. For businesses, this is an especially difficult map to navigate.

The coronavirus shock is accelerating structural trends in inequality, globalisation, macro policy and sustainability. This is reshaping the investment landscape and will be key to investor outcomes. The most important action investors need to take today, in our view, is to review their strategic asset allocation to ensure portfolios are resilient to these accelerating trends. Normal business cycle dynamics do not apply, three areas of concern are:

  • how successful economies are at restarting activity while controlling the virus spread;
  • whether stimulus is still sufficient and reaching households and businesses;
  • and whether any signs of financial vulnerabilities or damage to productive capacity are emerging.

The strong recovery in risk assets is consistent with investors having essentially written off the first and second quarters.  While the recovery appears to be global—in large part due to the global nature of the virus that triggered the recession—there will still be winners and losers. The capacity to provide fiscal and monetary stimulus is likely to be a key determinant of the pace of recovery. So too will be choices around how to contain any future outbreaks of COVID-19, although we expect many countries will want to avoid a new round of lockdowns, preferring more targeted restrictions that minimise economic damage.


Government bonds are universally expensive. Low inflation and dovish central banks should limit the rise in bond yields during the recovery from lockdowns. Central banks buy government bonds at times of economic crisis to increase liquidity, reduce the cost of government borrowing, and stimulate growth, a process known as quantitative easing. As a bond investor this creates a problem when it comes to deciding whether to buy government bonds, as the market is distorted by central banks who will buy at any price, and so do not care about achieving an economic return. It is not just central banks that buy government bonds for reasons other than economic gain; commercial banks and insurance companies are compelled to buy them by regulators.

This is because most government bonds are classed as a “risk-free” asset, and banks and insurance companies are required to hold a portion of their capital in those.  Even in this very low rate environment, bonds remain a key part of a balanced portfolio. Perhaps the most important reason why many investors hold bonds in a portfolio is for their diversification and defensive benefits, to serve as a hedge against stock market selloffs, and this has not changed. Bonds are also likely to outperform cash: even though bond yields are low, they should remain attractive relative to cash and term deposits since cash rates are also likely to remain low.

Inflation has not been a significant concern for investors for some time, but looser monetary policy and an upturn in the economic cycle may mean this is about to change. As the chart below illustrates, looser financial conditions often lead to a rise in inflation expectations over time, and it is during these periods that government inflation-linked bonds generally outperform nominal (non-inflation-linked) government bonds.

In the corporate bond market, we still expect to see more credit rating downgrades to highly leveraged companies in the investment-grade market and a wave of defaults in the high-yield market. After the sharp rally, there is less compensation in the form of extra yield in the market for those risks than just a few weeks ago. We suggest investors avoid too much exposure to lower-rated corporate bonds and focus on issuers with stronger balance sheets that can weather the ups and downs of the recovery.

Listed Property

Nobody doubts retail landlords face severe economic, e-commerce and legal (rental contract) headwinds. The question is, how much of that is already priced into valuations?  Coronavirus health outcomes are far better than expected. Social-distancing restrictions continue to ease. Shopping-centre landlords report rising foot traffic and store reopening. Longer term, I am not convinced consumers will switch in masse to online shopping after COVID-19. Buying clothes and other high-involvement goods in-store is a hard habit to break.  For all the hype, traditional retail in physical stores still accounts for most sales. Yes, online sales are growing quickly and will grow even faster, off a low base. However, predictions that e-commerce will kill shopping centres are premature. Cash-strapped consumers might seek more “entertainment” at upmarket shopping malls as they cut back on movie tickets, dining out and other recreation.

Remote working is another opportunity. As more people work in the suburbs rather than in their usual CBD office , malls have an opportunity to develop co-working or other office facilities The office subsector continued to be affected by softer tenant demand which was expected to persist in a recessionary environment, the vacancies across the Sydney and Melbourne’s CBDs were still at low levels and the introduction of social distancing measures may further assist in pushing against the densification of workplaces. Overall, REITs are managing through a very challenging environment… they were at the front line of closing the economy but are poised to lead in the recovery. Additionally, AREITs benefitted from monetary policy and extensive fiscal stimulus measures announced by the Federal Government which also provided some support for the sector. As a result, Australia was ahead of expectations and opened the economy which had a positive impact on the REIT sector.

S&P/ASX 200 A-REIT Index

Retail REITs have bounced off their lows during the share market rally but remain a long way off their highs. The S&P/ASX 200 A-REIT index (which includes all A-REITs) has a negative total return of -17% over one year, despite outperforming this quarter. The ASX 200 index is down almost 6%.   Yet there is more life in select retail property trusts than the market realises – and an opportunity for patient investors with at least a three- to five-year horizon.

Australian Equities

We have been buying Australian equities since the beginning of April but still see upside. That said the next month or two may see some weakness, so those looking to add should still get the opportunity. Based on consensus expectations, financial year 2020 earnings are expected to decline by 20%, approximating what occurred during the GFC. A lot of bad news has been factored in. But like the GFC, earnings are expected to recover – by 8% in 2021 and 13% in 2022.

ASX 200 Earnings Index – Based on Consensus

Source: Credit Suisse, Data Stream

Not only are earnings expected to recover, but there is evidence that earnings upgrades are starting to filter through, as companies gain confidence in forecasting future earnings and economic data is not as bad as previously feared. The retail sector has been surprisingly strong as consumers spend superannuation withdrawals, receive government support, and buy the infrastructure to enable work from home.

The large miners are due upgrades based on spot iron ore prices. Energy producers should also see upgrades based on the current oil price. Even the banks appear to at least be meeting expectations as bad debts are contained so far. We believe economic and earnings data will continue to improve as the economy opens. Australia’s effort in controlling the virus, leverage to China which is essentially back to work, and massive fiscal and monetary support, should continue to see an improved earnings outlook. Australian equities have already recovered The ASX 200 has risen 31% since its March low. Capital gains have occurred against the backdrop of earnings per share (EPS) downgrades, such that the market’s price-to-earnings (PE) multiple on a 12-month forward consensus basis has risen disproportionately to almost 19x. Investors have now started to question whether the market has become too overbought, if not too expensive. To be sure the easy gains have been made, but the rise in PE is very similar to the GFC experience as the recovery got underway. PE’s early in an earnings recovery should be high. Admittedly the PE is higher than the recovery phase of the GFC, but very low interest rates do justify a higher PE going forward, as the discount rate applied to future profits is reduced. Historically, PE falls with earnings recovery rather than a decline in share prices. Apart from showing some absolute upside in the medium term, we also think Australian shares look attractive relative to international shares.

Global Markets

Markets are also a discounting mechanism and are looking forward to the anticipated powerful recovery in the global economy which will be fuelled by unprecedented liquidity in the system, near zero financing costs and pent up demand. As we have seen so many times in the past, it always feels very uncomfortable for many investors when markets “climb a wall of worry” and this time is unlikely to be any different.

Factors contributing to the rally.

With an unprecedented amount of cash in the system, equities and high yielding bonds are attracting a lot of interest from investors in the absence of acceptable yield from money markets and longer-term government bonds. That may continue to push risk assets higher, although valuations are approaching extreme levels. To keep this rally alive, we need more intervention from fiscal and monetary policymakers and for investors to believe that policies will be generous enough to provide further liquidity.

However, the more asset prices disconnect from their core fundamentals, the more likely we will see a sharp correction occurring in the future. The earnings season needs to provide some clarity after more than two thirds of companies failed to provide guidance in the first quarter. Without this, analysts’ expectations will diverge further leading to poor decision making from investors. Almost five months into the pandemic, companies should have some projections for revenues and profits. If investors have been forgiving in Q1, they will become more demanding going forward as they cannot remain in the dark for much longer.

There are plenty of reasons to be cautious, and we will almost certainly see bouts of volatility and market weakness along the way. It will also be interesting to learn more about the challenges that companies are facing when they report their second quarter results in the next few weeks and, in particular whether management have any more clarity on the future outlook. While there may be some link with reality and the value of stocks, a large proportion of what we’re seeing is a reaction to things seemingly not being as bad as first thought, and also a wilful desire to pretend things are not as bad as they are. For investors, it makes sense to retain sufficient hedges in place against some of the perceived risks including a weaker-than-expected growth environment or the emergence of rising inflation sooner.


The market rose about 45 percent in the 53 trading days from its March 23 low. This positive run has prompted predictions that the stock market is telling us that better days are near at hand, despite more than 132,000 deaths from the coronavirus pandemic, tens of millions of recently unemployed people, (even after last month’s reported, employment gains), civil unrest in cities and towns throughout America, and political and social divisiveness, which I suspect may be the  country’s biggest problem of all. The S&P 500 is back above 3,100 on July 3 and the Nasdaq hit a record high on June 10. Meanwhile, commentators have been lining up to claim that markets are detached from fundamentals.

For sure, markets seem to be priced for an optimistic outcome of no meaningful second wave of infections as lockdowns are lifted. But record levels of fiscal stimulus, sustained low interest rates and ongoing low inflation create a supportive environment for risk-asset outperformance.

The main risks come from a second wave of virus infections and the approaching U.S. federal elections in November. The U.S. federal elections are too close to call. They will become a bigger focus for markets if the Democrat nominee, Joe Biden, takes a decisive lead. Biden plans to at least partially reverse President Donald Trump’s 2017 corporate tax cuts. This could deliver a hit to earnings per share in 2021. One of the key watchpoints will be the election outcome of the Republican-led U.S. Senate. Democrat control of the White House, Senate and House of Representatives would make a corporate tax hike more likely. It would also create the risk of more corporate regulation.

The other election risk is a re-escalation of the U.S./China trade war. A recovery in the stock market and the economy provide President Trump with his best chance of re-election. We expect he will not endanger this by re-starting trade hostilities. This calculus could change if Trump’s poll ratings show him in a losing position a couple of months from the election. He may conclude that nationalism and China-bashing increase his chance for victory.


European economies are emerging from lockdown and, so far, there has been no evidence of a significant second wave of infections. Europe’s disadvantage heading into the COVID-19 crisis was its lack of policy ammunition. The European Central Bank (ECB) policy rate was already negative, there were strict rules around increasing fiscal deficits, and high-debt countries like Italy were at risk of a re-run of the 2012 debt crisis. The policy response has surprised to the upside. The ECB has increased its asset-purchase program by more than 12% of GDP. Rules on fiscal deficits have been temporarily relaxed, resulting in fiscal stimulus of around 3.5% of GDP across the region. The work subsidy schemes implemented in most countries have kept the Euro area’s unemployment rate near record lows. The most far-reaching policy response is the proposal by Germany and France for a €750 billion (6% of GDP) recovery fund that would be financed by the first-ever issuance of bonds jointly guaranteed by all 27 members of the European Union. This is still to be agreed upon but represents an historic step forward in European unity and stability. Europe’s exposure to financials and cyclically sensitive sectors such as industrials, materials and energy give it the potential to outperform in the second phase of the recovery, when economic activity picks up and yield curves steepen.

United Kingdom

The government will look to fast-track GBP 5 billion of spending on infrastructure works to help an economic recovery. More details are expected to be revealed later in July, when UK Chancellor of the Exchequer Rishi Sunak will unveil his plans for the economy, which reportedly include a temporary cut in the value-added tax. Latest economic data showed the UK economy was already two months into a recovery and rebounding faster than expected.


Having reopened its economy and done a comparatively good job containing the spread of COVID-19, we believe Japan has the potential for a V-shaped recovery. While the country still faces ongoing security issues with Huawei, a Chinese technology company, and obstacles to trade in the tech sector, the rest of the Japanese economy could see strong growth in the coming quarters. Purchasing Managers’ index releases have indicated a notable improvement in business confidence in China as it ramps up production, and stronger-than-anticipated demand there could benefit Japan.

Japanese corporations used the pandemic as an opportunity to put off forecasts for FY2020 earnings, and the first half of the fiscal year will likely be dreadful. However, the Japanese government’s fiscal stimulus package and a potential manufacturing rebound could lead to a fast recovery in consumer demand. I would expect to see a fair amount of upward earnings revisions relative to consensus expectations coming in the next few months. Japan stands out for its political stability, low valuations, and greater upside potential in the recovery, and yet its equity market performance still lags that of some developed market peers.


China’s economy is certainly improving but has not yet returned to pre-crisis levels. Proxy indicators like traffic congestion levels may suggest a recovery since they are higher than last year. However, these levels are higher because people are social distancing and avoiding public transport. The recovery in China has continued through the second quarter of 2020, with the services sector starting to catch up to the manufacturing sector. Construction activity has seen significant improvement in the last month, and there remains a large pipeline of infrastructure projects to be started.

With the combined turnover on the Shanghai and Shenzhen exchanges hitting a five-year high of 1.5 trillion yuan, (US$213.2 billion) China’s economy has been recovering from its first ever quarterly contraction and policymakers have been unleashing a record amount of liquidity to support growth. Adding to a slew of loosening monetary policies was the latest move by the central bank to cut the discount and re-lending rates for the first time in a decade, which investors have interpreted as a sign of further easing. Corporate profits are expected to post double-digit growth in the second half.

With major state media hyping up the market, traders see that as a sign of government support for further gains in stocks. A solid economic recovery and a spate of reform measures have laid the foundation for a bull market and China needs a rising market to fund its economic transformation and develop hi-tech industries.


The Chinese government has announced further stimulus measures, including coupons to households to encourage spending, and the People’s Bank of China is making monetary policy more accommodative. However, the stimulus does not match 2015/16 or the financial crisis of 2007-08, and the government appears worried about excessive debt levels. While geopolitical risks are rising, we think the rhetoric between the U.S. and China is at this stage unlikely to see the Phase One trade deal dissolved in the short term. China seems well positioned for a strong rebound through the second half of 2020 and into 2021 as stimulus kicks in and the global economy recovers.


In second quarter 2020 commodity prices rebounded as some optimism returned to the industrial commodity markets. Chinese demand began to rise, crude oil made a comeback, and base metals and other raw material prices rose. If the impact of central bank and government stimulus in the aftermath of the 2008 financial crisis is an example for industrial commodities, we could see prices move a lot higher over the coming months and years. The amount of stimulus in 2020 is far higher than in 2008. At the same time, the value of the US dollar index declined by 1.76% in Q2, which is also supportive of base metals, industrial raw materials, and other commodity prices. The bottom line is that the response of governments around the world supported the industrial sector of the commodities market in the second quarter. Coronavirus in Q1 caused the price of nickel to collapse, but the price held the $11,000 per ton level and moved higher over the second quarter.

When it comes to nickel, iron ore and steel demand are substantial factors for the price of the nonferrous metal. Nickel is highly sensitive to changes in global economic conditions, as we witnessed in Q1 and Q2. Nickel is a very volatile metal, and we could see a wide price range for the metal in Q3, but the bias is now to the upside as copper has led the sector higher. Stimulus and weakness in the US dollar underpin the price of nickel as we head into the second half of 2020. Expect lots of price volatility in the base metals and industrial commodity sector of the commodity market over the coming quarter and beyond. While economic contraction was bearish for prices earlier this year, inflationary policies to combat the financial symptoms of the pandemic and a significant decline in production could give way to lots of two-way price volatility.


Falling real yields, thanks to expansionary monetary policy, coupled with the global economic uncertainty brought about by the coronavirus pandemic, has provoked traders to diversify into precious metals Gold prices, having weathered the storm of improved risk appetite, appear to be gearing up for another move to fresh yearly highs, and their highest level since 2011. Gold prices have a relationship with volatility unlike other asset classes, even including precious metals like silver which have more significant economic uses. While other asset classes like bonds and stocks don’t like increased volatility – signalling greater uncertainty around cash flows, dividends, coupon payments, etc. – gold tends to benefit during periods of higher volatility. Heightened uncertainty in financial markets due to increasing macroeconomic tensions increases the safe – haven appeal of gold.

Now that there are plenty of signs that no V-shaped economic recovery will occur, and the Federal Reserve intent on keeping the liquidity spigot open for the foreseeable future, the winds of an inflationary US economic environment are blowing through financial markets. Gold prices are consolidating just below their yearly high set last week, continuing to follow gold futures higher, which have stretched their gains above 1800 to achieve their highest level since 2011. The developments remain in-line with our expectations. I would expect short term weakness until Q4.


The recovery in oil demand and the less-than-feared demand destruction earlier this year will support oil prices next year when producers will be playing catch up with demand, and Brent oil prices could rise to $66 a barrel. The worst of the demand destruction was 18 million barrels per day (bpd) during the April lockdowns, while expectations were for many more barrels lost, to the tune of 30 million bpd.

The Organization of the Petroleum Exporting Countries (OPEC), Russia and others, a group known as OPEC+, agreed to extend cuts of 9.7 million barrels per day (bpd) until the end of July. With the market almost back in balance in June and moving into deficit in July plus add that a fall in inventories could mean the OPEC+ pact to curb production may not last to the end of the year.

I believe oil demand and prices will be going up next year and the following two years, as global economies continue to recover, according to the oil price forecast seen by Bloomberg. Deloitte sees Brent Crude prices averaging $39 a barrel in 2020 but rising to average $46.50 next year and $64 per barrel in 2023.


Sector 12 Month Forecast Economic and political predictions 2020



AUD is forecast to average in the vicinity of 0.68 USD out to 2020-21, with an even more optimistic view out to 0.74 USD in 2024-25.


Investors have used the US jobs market as a gauge for economic resilience in the States ever since the virus took hold. The Federal Reserve (Fed) has been forced into making record breaking adjustments to their policy to help protect lending conditions and keep the opportunities for the US workforce to remain active. Further rises in jobless claims could force the Fed into further concessions which in turn might weaken the US dollar’s proposition on the international stage.





The $1800 level above should continue to be massive resistance, but if gold closes above that level, we could then start to see the market move to the upside, perhaps reaching towards the $2000 level over the longer term.


To the downside, I think that the $1765 level is significant support that extends down to the $1750 level.


Gold is a hedge against uncertainty. It is what is often called a “store of value.” Assets that qualify as a store of value include a few commodities and some currencies, particularly the USD. Store of value assets will rise in value as demand picks up during economic crises. That is the situation the world is dealing with right now.












Risk-averse investors might look to metals like copper, nickel, palladium and platinum for good gains later this year. Those who are willing to risk it should take a better look at oil instead.


Looking beyond the immediate picture to the medium–term, we see the need for additional supply, both new and replacement, to be induced across most of the sectors.


On the demand side, we continue to see emerging Asia as an opportunity rich region. China, India, ASEAN and the global impact of China’s Belt and Road initiative are all expected to provide additional demand.





REITs sold off heavily in March, with investors concerned about the implications of social distancing and online shopping for shopping malls and office buildings. Sentiment appears overly bearish, while value is very positive. By contrast, Global Listed Infrastructure is expensive, which leads us to prefer REITs to GLI.



Following the recent market crash, many REITs are priced at extraordinarily low valuations and offer generational buying opportunities for long term-oriented investors.


In many cases, REITs have dropped so much that they are now offered at up to 50% discounts to net asset value, which essentially means that you can buy real estate at 50 cents on the dollar.


At these prices, we are very confident that investors who buy today will earn very attractive returns in the long run.



Australian Equities



Short term pull-back expected.



Historic market cycles have displayed sharp bounces after large falls. Markets also typically run in response to large monetary and fiscal stimulus and we currently have quantities of both.


The Australian share market is currently on the highest two-year forward EPS multiple in fifteen years. Those forecasts incorporate a significant recovery from the current crisis and arguably do not fully account for some future disruption.


The P/E ratio for Australian markets is now at or nearing record highs. This is an extraordinary outcome whenever it transpires but especially when we are in a recession.





Long dated bonds 5-year duration preferred


Positive Inflation Linked Bonds


US Federal Reserve has broadened its reach into the purchase of corporate bonds (both investment grade and high yield) on the argument of ensuring availability of capital and liquidity to underlying corporates (irrespective of underlying corporate quality). This has buoyed investor confidence, and with exceptionally low yields accessible on cash and sovereign bonds (globally), investors have been happy to follow the Fed into corporate assets, suppressing corporate bond spreads and boosting equity prices.



Cash Rates


On hold at 0.25%


Governor Lowe has emphasised that the economic recovery depends on health outcomes and how quickly confidence is restored, where the recent COVID-19 outbreaks in Victoria have presented an additional downside risk.  Unwilling to consider negative interest rates, the RBA is essentially all out of tools to manipulate monetary policy and is now looking to the Government to provide support to the economy through fiscal measures.


Global Markets




Risk to US stocks include concerns about the pandemic, fading fiscal stimulus, volatility around the election and worsening relations with China.


We prefer non-U.S. equities to U.S. equities. This is partly driven by expensive relative valuation. It also reflects that the second stage of the post-coronavirus economic recovery will see corporate profits recover. This should favour cyclical and value stocks over defensive and growth stocks.


The rest of the world is overweight these stocks relative to the U.S.






Europe’s exposure to financials and cyclically sensitive sectors-such as industrials, materials and energy-gives it the potential to outperform in the second phase of the recovery, when economic activity picks up and yield curves steepen.


Europe’s disadvantage heading into the COVID-19 crisis was its lack of policy ammunition, but the region’s policy response has surprised to the upside.


The European Central Bank, for instance, has increased its asset-purchase program by over 12% of GDP.









Although a recovery is expected, it is expected to take at least two years to return to pre-infection profit levels.


Japan, fiscal policy has become supportive, with the government recently approving a second stimulus package worth close to 117 trillion yen ($1 trillion U.S. dollars). However, the country’s structural weaknesses in terms of monetary policy and persistent deflation mean it will likely remain an economic laggard relative to other developed economies.






Chinese stocks have rallied to a five-year high after a survey suggested the nation was recovering from the economic blow of coronavirus.


Rising tension between Beijing and Washington remains a source of concern for investors.


China’s recovery from the COVID-19 crisis has continued through the second quarter of 2020, with the services sector starting to catch up to the manufacturing sector. The Chinese government has also announced further stimulus measures, including coupons to households to encourage spending, while the People’s Bank of China is making monetary policy more accommodative.







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