Some questions answered

John Abernethy
John Abernethy
Director
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This edition of The View has questions posed by Paul Zwi (PZ) Clime Portfolio Strategist for John Abernethy.

PZ - John, everyone is feeling unsettled by the COVID-19 pandemic. When do you think we’ll get back to “normal”? How does the economy recover from this?

Normality (or a return to a period reminiscent of the comfortable past) is at least a year away and even that is not certain. The opening of our international borders, the resumption of travel and thus the return of an important part of Australia’s services sectors (tourism and education-related) is highly dependent upon a COVID vaccine being developed. Further, the vaccine must be widely available across the world.

Presumably, it will be easier for Australia to vaccinate its population than for many of our neighbours. We enjoy a highly developed health system and a largely urbanised population but think of Indonesia, the Philippines, PNG, Fiji, etc. So the full opening of borders may be years away.

In previous editions of The View, we suggested that the full recovery of the Australian economy – back to its level achieved in calendar 2019, may not occur until 2023. There is no reason at this point to change this forecast given the predicament in Victoria and the risk of sporadic outbreaks across Australia. Indeed it may be slightly optimistic.

In describing the journey back through recovery (in Australia), we can say that it has commenced. The economic (or GDP) collapse in the June quarter should be the low point. We must be careful not to get confused when looking at GDP comparisons. For instance, there will still be very negative GDP numbers produced on a rolling year or “previous corresponding period” basis. However, it will be more informative to compare September-quarter GDP to June-quarter GDP to see the trend lines.

Further, actual economic analysis over the shorter term is difficult to calculate and will be subject to many revisions, more so because of the unprecedented government assistance programs.

So to specifically answer your question – which is a difficult one – I will make the following observations:

A. Government assistance (JobKeeper, JobSeeker and business cash flow support) will continue but will be better targeted from the December quarter to support sectors most clearly in need;

B. The internal economy will still be operating at say, 80% capacity throughout most of 2021 but unless you are unlucky enough to be in one of those sectors directly affected, this will not be apparent or felt because of government assistance programs;

C. The fiscal support will continue for as long as necessary with targeted or fast-tracked infrastructure investment undertaken to ensure that there is no slack in the construction sector; and

D. The services sector will be sustained by Government assistance that will only diminish when internal borders (interstate) are totally opened – presumably in early 2021.

PZ - Drilling down into the Australian economy for a moment, which sectors are the winners and the losers?

The winners (or beneficiaries) of government support initiatives are clear to see through the current ASX reporting season. However, some of the beneficiaries may only be early-stage beneficiaries and the tailwinds that are helping them may soon begin to decline.

The government support packages noted above plus the rental directives, bank forbearance on debt servicing and the early access to super, have all given tremendous support or stimulation to non-discretionary household expenditure and to the direct suppliers (manufacturers or importers) to this demand.
 
The numbers are truly huge (collectively hundreds of billions of dollars) and the support mechanisms have been utilised in quick order. Obviously, some will finish quickly (super access) whilst others will dissipate over the next 6 months (rental agreements, JobKeeper and bank support). Also, as noted above, the government support packages will be fine-tuned to target those sectors in greatest need and to stimulate real activity.

In the category of short term winners are clearly the discretionary retailers (think of the “Netflix effect”, home comforts, IT spend as people upgrade their TVs, etc) that benefited from the consumption “sugar hit” of income support and early access to super. Notably, the bulk of households have also benefited from a lowering in the cost of living because travel (including to work) has been curtailed so everyday non-discretionary costs have declined. Households (in the main) have benefited from a real increase in net disposable income and this has occurred as a recession enveloped the economy. This dual occurrence is quite unprecedented.

Retailers that had a secure and efficient online offering benefited from the surge in demand. Some retailers closed stores (physical sites) and created a short term trading downturn that helped them qualify fully for government and rental assistance before it was clear that they would actually benefit from an online trading surge.

Some suppliers to the discretionary market – notably home renovations – have seen a pick-up in trade although this type of activity is challenged by level 4 COVID restrictions.

The increased activity online (consuming and business) has benefited IT service companies operating in that space. Some IT companies will report a surge in demand for their online services and benefit the longer this crisis continues. Further, the suppliers of online offerings that ensure secure communication and the access to (at home) entertainment are clear winners.

On the flip side is the longer list of losers that have weathered the worst of the initial storm through government assistance or by astutely accessing capital markets through equity raisings that ensured their survival. Of course, small and medium-sized businesses have been worst affected as they do not have scale benefits.

Travel related stocks have raised billions in capital and the subscribers to those raising (and their shareholders at large) will be confronted with no income (dividend) return for years. Their stock prices will trade like zero-coupon bonds that ebb and flow with market sentiment. In some cases, the capital providers have not appropriately priced the massive dilutionary effects of the increased capital.

Over time some winners will wane, and some losers will recover but the certainty of this is in question on many fronts. Will borders open quickly enough for foreign students to return? Will isolation regimes stifle the education sector for years? The COVID crisis has exposed severe regulatory and operational weaknesses in aged care and this growth sector (which seemed secure) is now seriously challenged. The sharp drop in immigration will affect a whole range of businesses (over the medium term) that would previously have expected and planned for consistent demand growth (eg housing). The major banks have been directed to provide support and not foreclose on borrowers unable to service loans because of the pandemic. This naturally leads to a compression on bank margins and therefore profits.

Standing back and reviewing the storm, I believe that there are many more losers than winners and that many winners are actually not represented on the ASX. Similarly, most losers are not represented on the ASX as they are mainstream small business operators whose survival is really in government hands.

Finally, it is the speculative gold miners and explorers that are clear beneficiaries of both the financial mayhem and the central bank largesse across the world. The clouds have certainly parted for this sector and there is no shortage of speculative capital available for them to tap.

PZ- We’ve all heard about “work from home”. Is this the end of the office market? Can you comment about how you see the other property sectors such as retail shopping centres and industrial or warehouse assets?

Change is a constant in human life and most change is usually for the better. However, one aspect that will not change (because we are human) is the need for interaction. That is certainly true in our domestic or family life and it is certainly required in business.

Of course, some aspects of business have or will migrate to remote/home office settings, but they were probably going that way pre COVID. The crisis has hastened this transition. War (and pandemics) is the great accelerator, as the economic historians like to say.

However, some businesses operating remotely have become challenged. For instance, have you spoken to a banker working from home lately who is trying to access your personal information?

In terms of offices, there may well be changes that actually grow parts of this sector. Offshore call centres may return to Australia because the business risk due to third world health standards have been clearly exposed.

It is not the end of the office market but the potential for growth (and thus owner returns) will be challenged because the normal rates of recovery by which vacancies are filled will be a slow process as Australia’s growth rates are diminished. If it takes 3 years to return to 2019 GDP levels, it will certainly take longer for commercial property to fully recover given that in the meantime office supply will actually expand.

Other sectors are mixed but generally have better recovery and growth prospects than prime commercial. The industrial property sector has generally not missed a beat (except now for Victoria). Well-positioned warehousing facilities were at a premium before the downturn and the consumer influences noted in earlier answers have been very positive for this property sector.

Suburban retail centres anchored by a major food retailer have held up well and suffered only mildly from the pressure upon smaller discretionary retailers and cafes and restaurants.

Destination big box outlets have had a challenging period with more discretionary expenditure moving online. Major shopping centres have a range of troubles in dealing with small retailers suffering as consumers avoided congregating, and we are seeing valuation declines in this space of between 10% and 15%.

PZ - Emergency access to super in Australia has been drawn upon more than expected, and seems to be driving a spending boom. Where do you stand on this political hot potato?

I have written in the past that Australia’s superannuation system is not it for purpose - at least for the purpose that I have defined for it. My definition of that purpose is to ensure that the overwhelming majority of retiring Australians have a pension entitlement that ensures that they can maintain a reasonable basic living standard in retirement. In particular, one that is free of financial stress either in or approaching retirement. That would be best achieved by a national contributory pension scheme at its core and an account-based scheme as a supplement.

Today and even before COVID, 75% of retirees required access to a full or part pension. Even with another 20 years, the forecast by 2040 was that the majority of retirees would still need this support.

Source: Livewire


COVID has exposed a few unsavoury truths about our superannuation system and indeed the makeup of our workforce and society.

The first truth is that younger people simply do not trust a scheme that is supposed to look after them when they are 70 years old. The constant tinkering, the inherent unfairness in its structure and the reliance on the integrity of politicians (over many decades) leaves younger generations suspicious and unexcited. Thus, when the option is given to access funds early in their working life they take it with open arms.

Second, the COVID crisis has put into critical focus the under payment (indeed under-resourced) parts of the healthcare and aged care workforce. These crucial workers will never have sufficient accumulated pension funds at their retirement. It is simply impossible, and one wonders why our national superannuation scheme operates under this delusion.

Third, our current unfunded commonwealth pension scheme, paid from consolidated revenue, is better accessed by retirees who have little or no personal super. There are clear holes in the interplay between a personal pension balance and an entitlement to a full pension. So many people came to the decision, when offered the chance, to access their super earlier. Also in most cases they accessed their super without appropriate inancial advice because they could not afford it.

My conclusion is that early access to superannuation has been a large support mechanism for the Australian economy during a time of crisis. However, that was not the purpose for which super was set up. The fact that super was made accessible shows that there is no over-riding “purpose” or strategy that dictates superannuation policy. Now is a good time to reset the principles and the purpose of superannuation. Unfortunately, the conflicted interests and powers that control super will not allow that to happen.

PZ - Turning to the international scene, Joe Biden has picked Kamala Harris as his running mate. Will the US presidential elections cause market ructions? How do you see this playing out?

Very difficult to predict this one. The reason is that markets are currently been driven by monetary policy that includes un-constrained QE and zero-bound interest rates.

The illusion, promulgated by President Trump, that he is responsible for the record index level of the S&P 500 must be dismissed and therefore the fear that a Biden Presidency will overwhelm the market should also be restrained.

It will probably not matter that much to financial markets who is the next US President. Either President will have the unconstrained support of the Federal Reserve to keep interest rates low, and they will do whatever is necessary to maintain the US economy and the funding of the US Administration.

Of course, that won’t stop the traders and hedge funds from attempting to upset market sentiment by creating false narratives or commentaries. We should remember that when President Trump won the US election in November 2016, whilst the Australian market was open, it dived hard in response to US equity futures. Trump was not expected to win by markets, so traders of futures concluded that it was bad news. The next day when US markets opened, logic set in after a good sleep and markets were significantly higher and the fall in the Australian market was totally reversed.

The irony is that if there is a change in Administration, Joe Biden’s plan contains key elements of what Trump promised but never delivered. Biden has promised to modernise American infrastructure and protect “forgotten Americans”. The logic of Bidenomics is obvious: borrowing costs are extremely cheap, the US is in the midst of a deep recession, unemployment is at a generational high, and the country’s infrastructure is old and outdated. It seems like the time is right for “the largest mobilisation of public investments” since the Second World War.

PZ- You’ve written about how the Big Tech stocks are beneficiaries of the changes the pandemic has wrought. Can you talk to us about TikTok and why Trump seems to be going after it? Is this the sharp end of the new Cold War?

The political agenda of Donald Trump (at this point) is all to do with his attempt to secure his re-election. US foreign policy has become increasingly chaotic as the US ostensibly withdraws from world leadership. The rest of the world (more so than China) is sitting back and waiting to see how the US votes before making fundamental adjustments to relationships with the US.

The international governance and security arrangements are suffering due to COVID. The G20 is not engaging and the proper forums for checking both Chinese and US excesses are simply not available.
 
So China is seemingly pushing boundaries (see the Indian border clashes and Hong Kong repression) and the US response is targeted to suppress the unrelenting push forward of Chinese technology.

As far as the TikTok issue is concerned, I would suggest that a Trump administration decision to ban WeChat in the US would be of more significance to Australia if we are obliged to follow the US decision. That is because Chinese tourists (including students and business people) will most certainly use WeChat. One billion Chinese already do, and they will certainly be reticent to travel to places where their normal communication is constrained.

President Trump seems prepared to forgo Chinese tourism and trade as recovery occurs. However, that is pre-election. Having witnessed Trump’s behaviour in the past, it would not surprise if he reversed these decisions on his reappointment – if it happens. Consequently, Australia should be very careful not to create collateral damage for ourselves.

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