COVID-19 is boring but …

Monthly Market and Economic Update – January 2021

Peter Flannery CFP AFA

 

 

“If you have one economist on your team,
it’s likely that you have one more than you’ll need.” 

Warren Buffett

MARKETS

What pandemic?

Trading prices have pushed onto new highs, regardless of the ongoing spread of the Coronavirus and the more troubling mutations that make the containment of Covid-19 already tricky, even more difficult.

 

The chart on the left shows the US share market (the Dow Jones) over the last six months.  The chart on the right shows the US share market (the Dow Jones) over the last year. The US markets, as measured by the Dow Jones continues to rise to new all-time highs and the Nasdaq representing the tech sector even faster still. 

 

Key Points: 

  • Coronavirus impact 2020.

  • How are we looking in 2021, are we there yet!?

  • NZ residential property = BOOM!

  • How do those property numbers look in your region?

 

The market rise is despite the fact that the spread of the Coronavirus remains unabated and more troubling, as the mutation of the virus that we know has occurred in South Africa and the UK. 

So, if the spread of the Coronavirus is that bad, why are markets so happy? 

The simple answer is, it comes down to Central Bank stimulus and more recently, the inevitable removal of Donald Trump. 

More specifically, Joe Biden is on record as saying that he will focus on the containment of Covid-19.  He recently announced a stimulus package amounting to $1.9 trillion with approximately $415 billion allocated to bolstering the response to the virus and the rollout of Covid-19 vaccines; around $1 trillion into work relief to households which will likely be by way of cheque and approximately $440 billion for small businesses as well as communities that are particularly hard-hit by the pandemic.

On another note, 12 months ago Donald Trump was pushing back hard at the Chinese with trade tariffs and China responding in a measured way, taking the long view.  Although Biden has made no mention of undoing the tariffs, for now anyway the activity in this area has diminished and I imagine the focus will be on containing the Coronavirus initially. 

Interestingly, Chinese Premier Xi Jinping has written to Howard Schultz (the ex-CEO of Starbucks) asking the American billionaire and the global coffee giant Starbucks that he ran for many years, to help improve economic ties between China and the US.  Does Xi Jinping really desire a better relationship with America or is this more of a window dressing exercise to curry favour with America and the rest of the world?

And then there is interest rates.  We all know that rising interest rates mean declining asset prices generally.  Although I am early in mentioning this item, it nonetheless does represent a potentially significant pricing risk for markets in the future.  I remember back in 1994 when the US Fed raised interest rates several times over a period of 9 months.  Over that period market prices continued to decline.  I remember one of my clients at the time remarking that he wondered if his portfolio was going to continue to decline all the way down to $0.00!

Of course it did not.  And of course, we took advantage of lower prices etc, etc, etc, you know how it goes…

The above diagram shows the movement in the S&P 500 Index over 2020.

As usual, markets continue to rise, looking ahead, beyond the current play.  To pursue this analogy further, any game of sport involving a ball requires the players to be very focussed on the ball every split second of the game.  Playing the ball therefore is an important tactic to support the ultimate win. 

In addition to that, successful participants will also have an overarching framework or strategy along with specific methodology and “how to” when it comes to dealing with the other team and playing the game.  The point here is that just focussing on the ball and not having either an overarching strategy or finely tuned methodology around which discipline is applied would represent a significant handicap.

So too is the case for investors.  Markets generally tend to be a leading indicator and at times can be overly focussed on the current event (playing the ball) and at other times tends to look through the current events to future prospects.  That is why sometimes market prices suddenly spike up or sharply decline unexpectedly as the market catches itself out and quickly adjusts to reflect some recent bit of ‘news’.

Leveraged markets ( e.g. monetary and fiscal stimulus, low interest rates) can fall further when sentiment becomes fragile.  Not a problem now.  Rising interest rates will be worth watching.

 

The Global Economy

Mixed – recovering

The above graph tracks the decline in economic activity, comparing the global financial crisis with Covid-19.

The global economy according to the International Monetary Fund could shrink by around 4.4% over 2020 before bouncing back to 5.2% growth over 2021.  Obviously 5.2% growth is great but on the back of 4.4% decline in activity, a different story emerges.

As I have shown previously elsewhere, the impact of Covid-19 is unevenly spread throughout the global economy with generally those at the lower end of the socioeconomic scale being hit the hardest. 

For example we have all seen how those in hospitality and tourism have been severely impacted, as many business owners struggled to stay in business.  Their staff of course have lived through a high degree of uncertainty which can be stressful, not knowing whether they have jobs tomorrow or not.  We also know that many people regardless of where they sit on the socioeconomic ladder, have only a few weeks or even days of reserves in the event of a serious event like the Coronavirus.  Travel restrictions have been a key aspect of Coronavirus lockdowns.

The above chart shows the degree of lockdown in a variety of countries around the world.  Note New Zealand is shown as complete closure of borders which could be wishful thinking!

One feature of the Coronavirus lockdowns is the partial or total closure of borders which of course is interesting when you consider that the global economy was continuing to grow and progress on the basis of an ever more closely knit and more interactive global population. 

However, as of November last year, around 150 countries and territories had eased Covid related travel restrictions according to the United Nations World Tourism Organisation. 

This has proved tricky though and Britain is a good example of arguably insufficient action and having to step backwards by having further lockdowns in order to attempt to contain the Coronavirus.  It is not helped either by the emergence of a new strain of the virus making a tricky virus more tricky to contain. 

The problem of course is that this new strain of the virus is still under investigation but appears to be much more contagious than the original version – not ideal.

I notice in the US recently, Dr Fauci warns the Covid variant found in South Africa could pose a threat to antibody drugs.  Although it is possible, it is too early to tell yet but a disturbing possibility.

This highlights what I refer to as “the sting in the tail”.  It is not the body of the pandemic that creates the most damage but the latter part of it where, for those who are compromised financially and mentally, their financial and mental reserves become exhausted as they enter crisis mode.  A dangerous time for them and for people around them also.  For some, the worst is yet to come.  For them, the containment of the virus cannot come soon enough.

The above graph shows the level of unemployment from 2007 through 2020.

The loss of jobs has been significant, no less so for the US economy as the chart above highlights.  Unfortunately vulnerable workers appear to be bearing the brunt of this pandemic.

For most however throughout the global economy, our lives have continued on, affected in some way to a greater or lesser extent by the Coronavirus but more of an inconvenience by comparison to others less fortunate.  That is partly thanks to the support from Central Banks around the world including our very own New Zealand Reserve Bank.  In short, they have stepped up and provided support and stimulus to help reduce the economic impact of the spread of the Coronavirus.

The above graph tracks the ongoing increase in public debt from 2007 up to now and projecting up until 2025.

According to the International Monetary Fund (the IMF), governments have increased spending to protect jobs and support workers.  Globally these government measures to help cushion the pandemic’s economic impact amounted to around $12 trillion.  Although some argue this amount of support is basically getting carried away and too much because it needs to be repaid at some point, on the other hand I wonder what they think about the alternative implications of not having the support in place?

Already high levels of debt continue to grow thanks to the pandemic.  Nonetheless the global economy continues to function reasonably well despite the challenges that have emerged out of the Coronavirus pandemic. 

At the same time, without going into the details, there has been a significant amount of innovation.  The fast tracking of vaccines is one example.  The ongoing development of technology (e.g. Zoom) another – there are many, many other examples.  Necessity must be the mother of invention!

 

New Zealand

The above chart shows the increase in the medium property price in all regions across New Zealand.

On the back of ever reducing interest rates, demand in some areas and New Zealand Reserve Bank stimulus, residential property prices are booming.  This is interesting when you consider that immigration has slowed, apart from New Zealand expats returning home.  Not only has low interest rates helped fuel rising residential property prices, also the shortage of stock has ramped up demand which again is fanning the flames of rising residential property prices.  Even Canterbury residential property prices are on the move!

 

The above charts demonstrate declining property stock across New Zealand.

So, we have the combination of easy money conditions up until the last 6 months or so, limited regulatory headwinds up until the last 12 months or so, ever reducing interest rates, a shortage of housing stock and of course the residential property gene that makes up the DNA of many kiwis.  Good times!

On the other hand though, affordability reduces and those looking to get on the so-called property ladder are confronted by an even bigger deposit required.

Of course, back in the day (the 1980s and 1990s) those looking to get into a property did not need the same deposit to get started.  However, they were confronted with high interest rates and a much greater debt servicing burden compared to those today with low interest rates although that of course is offset because property prices with reducing interest rates have increased, making the debt servicing also difficult for those looking to get on the property ladder today. 

It is not impossible.  It requires some commitment around saving and a focus on the goal of owning a property.  We all started somewhere.  Hopefully that kiwi property gene will kick in and provide the drive necessary to see the job through.

On another note, whilst some international organisations see the New Zealand border as completely closed, you and I know that this is not the case. 

With new strains of the virus having emerged in South Africa and Britain (I don’t believe the two are connected?) we now have the prospect of mutation that is real and happening.  I mentioned this as a threat in the early part of the Coronavirus, not as a prediction (I am not that good!) but as a potential threat that could be a game changer.  Right now we will have to wait and see.

 

To Summarise …

The global economy continues to limp along but all things considered it is functioning reasonably well.  Central Banks around the world including the New Zealand Reserve Bank have provided support and reduced the economic impact of the Coronavirus, particularly on many who are more vulnerable.  The personal hardship would otherwise have been more widespread and more difficult – possibly by a LOT.

As the resources of those less prepared for such an event become exhausted we have ‘the sting in the tail’, potentially made worse by at least two cases of a mutating Covid-19 virus.

All of this sounds a bit negative however I remain confident that the efforts to contain the current virus are on track and we will cope with new strains of the virus in the future. 

Those with a solid financial plan are arguably better placed for such an event and will be more resilient as the Coronavirus continues to spread around the world. 

In New Zealand it is almost as though the Coronavirus does not even exist.  I say that because I think about how often I use the app on my phone as I enter shops which I would say at this stage is somewhere around 30% – 50%.  From recent anecdotal reports in the newspaper and across the media it would appear that the New Zealand population is using the app at an even lower level.

As the old saying goes, it will not matter until it does. 

If there is an outbreak in New Zealand because of poor border control (regardless of the real risk) then that app will be critical to helping control any outbreak in New Zealand.  Interestingly, whilst it is slightly inconvenient to use the app, it is a minor inconvenience compared to lockdowns and the worry of vulnerable family members actually contracting the Coronavirus and what they go through to survive.

By the way, I am currently on a MESS Day at the Bach.  There are no signs of any virus here in the McKenzie country.  Still, I am pleased that any shops that I enter all have that sign up on their window or their front door for me to flash my iPhone to record my travel.

So far, how lucky are we!?

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