This week, we review some charts and commentary that have caught my attention over recent weeks. We explain the importance and relevance of each, particularly what they may mean for markets and investment returns from 2022 and onwards.
The first chart compares inflation readings in the US against the cash rates settings of the Federal Reserve over the last 65 years. Today’s readings show that negative real cash rates have never been greater. Given current readings of inflation and market forecasts, it appears that “significant” negative real cash rates will endure for a sustained period and extend through 2022 and beyond.
This observation suggests that the upward pricing pressure on risk assets will persist - but with one proviso. The chart above measures “short duration” yields (i.e cash) and a significant pressure point for some parts of equity markets will be the move (higher) in yields for longer-dated bonds.
There seems no doubt that bond yields – from at least 3 years duration and further out – will continue to rise over 2022. An increase in bond yields will continue to put downward pressure on the PERs of the broader equity market and particularly on the market value of very high PER stocks and concept companies (those with no current earnings).
On the flip side, there is a range of established companies whose PER decline will be offset by earnings growth which (to some extent) is supported by inflation. It is our view that negative real cash rates (in particular) will maintain a steady tailwind for the equity market.
My next focus is on an observation reported in the AFR by Rod Simms, the retiring Head of the ACCC. It is an important observation because it succinctly describes both the inflationary and recurrent cost impost that Australia has created for itself. It is a remarkably candid statement from a senior bureaucrat that should have been aired years ago.
The privatisation of strategic public assets – for example, power, transportation hubs and roads – embeds increases the cost of doing business in Australia. Therefore, in an increasingly competitive world, we have created recurrent cost imposts that can only be offset by productivity improvements.
A focus on productivity improvements (for instance through targeted capital investment incentives) is not apparent, nor is there a sustained focus on education to both upskill and diversify the Australian workforce.
This impediment to Australia’s international competitiveness will not be corrected in the near future. To some extent, this explains the underperformance of Australian industrial companies compared to international companies – most notably found in the US - over the last two decades. This relative underperformance is likely to continue, therefore making a stock selection in Australia paramount.
However, private or listed assets, with inflation type hedged revenue streams, are becoming a focus and particularly for the burgeoning industry funds.
To this point, the next table can either be seen as a positive (growing the national savings pool and investment capital base) or a negative, which is best described as too much capital looking for a home. Indeed, the increasing flow of capital from industry funds into privatised assets (airports and toll roads) suggests that industry funds are entering a frantic period of securing “large” assets that are needed to deploy tens of billions of capital, ostensibly to meet the long term pension requirements of their members.
Asset allocation (dominated by Industry funds) are noted below. The carve-out to unlisted investments (privatisation of public companies) is developing. Noteworthy is the significant underweighting to property assets and this suggests that a period of privatisation by industry of large REITs may be about to occur.
The next chart reflects upon asset allocation, directed by members, in industry or retail funds. It focuses upon the switching between investment options and shows heightened activity in early 2020 as the COVID-19 pandemic commenced.
The chart suggests that “knee jerk” or “reactionary” switching between long term assets hardly improves the investment outcome. As has been widely reported, the financial advice industry is suffering a sharp decline in the level of participants, restricting the supply of advice and pushing up the cost of retail advice.
When the Government allowed withdrawals from superannuation funds in the middle of 2020, approximately $35 billion was accessed, mainly by retail members of large superannuation funds. In the main, these members received no advice. With over $3 trillion in superannuation assets in Australia, financial advice and education will become a critical issue for public policy in the next term of parliament.
Over the next 4 years, Governments (Commonwealth and State) will be burdened with a higher level of debt. Total combined gross government debt will exceed $1.2 trillion in 2022, with state government debt lifting from negligible levels to about $200 billion. The bulk of this debt has been accumulated in the eastern states (with Western Australia having benefited from a resources boom).