Monthly Market and Economic Update – June 2021

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

Warren Buffett

Key Points: 

• We have seen an inflation spike, why is that a worry?
• Is inflation transitory / temporary or coming at us strongly?
• Is COVID-19 still a problem?
• What is the inconvenient truth about the NZ economy?

THE MARKETS

Where is all the hot money?

The above graph compares the level of investment in April 2021 with May 2021.

It’s all about bitcoin and cryptocurrencies.  When you look at the unbelievable meteoric returns that have been achieved over the last few years, it might be difficult not to feel some FOMO.

As you can see from the graph above, bitcoin remains the overall winner with large tech companies that you know and love coming in second and not far behind, sustainable investments.

The reality is though that very few people are making money from cryptocurrencies.  Sure, those that were in early and took the chance have made a fortune.  Those who entered more recently will be struggling to make money at this point.

If you haven’t watched crypto-currencies, then it’s just words that you hear from time to time.  If you have followed cryptocurrencies, then have you felt FOMO?  One thing we know is that when the weight of money is significant and demand is strong, prices rise, whatever the underlying asset or commodity.

Bitcoin may still be around in 10 years and considered by those that invest in it to be a store of long-term wealth. It’s also just as possible that another cryptocurrency among more modern versions could pull the rug from bitcoin. That of course won’t happen whilst the weight of money in bitcoin remains strong, underpinned by those who ‘believe’.

We can use all kinds of words to describe the markets. Reliable and predictable are two words that we cannot use.

What about the inflation risk to trading prices?

The above graph tracks core services year over year against core goods consumed year over year. Note the spike in core goods (the solid grey line).

You may have noticed market volatility over the last 2 or 3 weeks. It wasn’t huge but significant enough to rattle the markets, creating uncertainty.  It was of course caused mostly by a spike in commodity prices and a realization by the market that long-term interest rates have actually been tracking up over the last 6 months or so (even if interest rates at the short end remain flat or are still declining).

I and others have written quite a bit about inflation, rising interest rates, and the possible outcome on trading prices over the last few months.  It’s nothing new.

The real question is whether or not the inflation we’re seeing is the lead up to a greater, more sustained and more damaging level of inflation and therefore ongoing rising interest rates in the future?

So what’s the answer?

Well, the US Federal Reserve along with other central bankers are saying that they believe it is “transitory”. In other words, it’s temporary.

Other commentators believe that because of all the fiscal and monetary stimulus that the so-called chickens are coming home to roost as it were. I’m not convinced about that though.

Whilst markets are dynamic and there are a number of variables across markets and the economic landscape that can change overnight, there is some evidence that suggests that the current level of inflation we’re seeing is indeed temporary and won’t be sustainable at high levels in the short to medium term.

Longer term it’s more difficult to gauge.

Although I am oversimplifying it all, there is still a significant deflationary impact at play with disrupted technologies emerging around the world. Greater efficiencies keeping levels of wages in check and reducing manufacturing costs, for example, are deflationary but in a good way.  That’s because it is positive for proactivity.  Innovation and leverage through technology can create significant efficiency and improved productivity.

Innovation and technology are helping to drive real change in some areas.  Zoom is a good example of how communications are changing, whilst not totally and irrevocably, but change is underway in that area and it is permanent.

Zoom as an example, is considered to be a disruptor for the traditional postal service, to some degree airlines, and hotels.  This is not to say that the game is over for airlines or hotels but rather that the game is shifting.  This is what is known as bad inflation because some of those industries that have been around for some time are being disrupted and will see their sales decline along with their profitability.

Without getting into too much detail, it has been pointed out by some commentators, that when we look at where the recent inflation comes from, quite a bit of it is coming from “goods inflation” as the chart above shows.

That’s the point.

In due course, as individuals slow down their spending that was due to pent up demand ( COVID-19, cabin fever and all that ) and companies satisfy their lack of inventory or indeed find themselves with a glut of inventory, this suggests that what we are seeing now could be a temporary bout of inflation that may ease back in due course.

I’m not pretending that I can predict the future or that I have secret intelligence.  Rather I am simply applying some thought and logic to market intel I have and to the situation.  I’m listening to what the market is telling me and making up my own mind about it.

So, we’ll see in the future whether I’m right or not.

By the way, I talked about inflation under the market section of this newsletter because we are interested as investors, not as economists or academics.  We want to know how it will impact our investing efforts in the future.

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.

Markets around the world recently became volatile and uncertain because inflation appeared to emerge much stronger and more suddenly than was anticipated. The volatility extended for the best part of two weeks which is always intriguing to watch.

When it’s a short blip for a few hours or a day or two, the market quickly recovers and moves on. When it continues on over a period of weeks, the market suddenly pays attention, starts listening to what everyone else is saying, watching what they are doing, and wondering if they should follow – the finger is on the panic button.

So, with markets having recovered from COVID-19, even though economically this story is still playing out and infections in some countries continue to rise, the markets moved on some time ago, but we then saw that volatility, which did begin to worry the markets for a time.  

By some measures, the global infection rate from the coronavirus continue to rise to all-time highs even though the likes of the UK, Europe, and the US appear to have much lower transmission rates now  ( as though they have it under control ).   

As we know it’s a tricky little virus and it may well be under control but only providing the roll out of vaccines continues apace.  Further, it will be essential that those third-world economies currently struggling with the virus are also able to roll-out sufficient vaccines in order to begin to control the spread of the virus.

The above graph tracks the production of oil from 1992 through 2020.

The above chart is about the production of oil. I raise it here because of course, we’re investors not economists or academics. There is a growing swell of opposition to fossil fuel industries with the world looking for sustainable investments and energy from renewable sources such as the wind and water.

Future exploration is frowned upon and being curtailed.  Oil inventories are running down and yet as the global economy removes itself from the clutches of the coronavirus, the consumption of oil will increase.

Inevitably that suggests that somewhere there could be a shortage of oil and what happens to oil prices then? That’s right, they will likely rise.  That of course could underpin inflation.  

Another possibility (admittedly I am speculating) is where there is a ransom demand on one or more major oil companies who are forced to shut down, creating a sudden and critical shortage of oil.  

Watch share markets prices drop like a rock in that situation!

I’m not predicting this type of event but pondering the impact on our investments in this type of scenario.  In short, we know that the global economy will slow down quickly and come close to grinding to an absolute halt without oil and fuel to help lubricate the wheels of manufacturing, productivity, and simple things like global trade.

Funny how in the midst of the coronavirus, all we could think about was the impact of it and the seeming never-ending spread.  

We weren’t thinking about the event I just mentioned or a number of other events which were just as likely over the last 12 months, even if we weren’t thinking about them ( but will probably never happen – right?! ).

The above chart tracks the movement in residential property prices comparing the asking price in April 2021 with the asking price in May 2021. Please be aware that asking prices are a simplistic measure.

While some areas show ongoing residential property price increases, others appear to be slowing down.   At least that’s the case over the last month. Does this mean that these recent initiatives from the Labour party (e.g., the healthy homes initiative, removal of tax deductibility for interest costs for existing houses) are starting to impact?

It certainly did make some people in the property market think twice about whether or not to go for the next property.  The removal of the tax deductibility of the interest rates does seem like a strange move when other business owners can deduct interest expenses.  However it does actually have some merit if their plan is to encourage investors to build new properties (for them the tax deductibility of interest costs remains in place).

On another note, Jacinda Arden and the Labour party appear to be walking a very fine line by appearing to side with Australia and receiving a stiff rebuke from China recently.  In short, whilst China’s sharp response to recent comments by Jacinda Arden and other members of the Labour party about human rights abuses in China would appear to be antagonistic they could also be regarded as fair enough.

However, if you’re a dairy farmer or some other manufacturer exporting to China, the meaning of the word “fair” may start to take on a different meaning.  It’s all very well to make comments when you’re not directly affected.  It sounds so valid and right to stand up for what one believes in, free speech and all that.  Where is it though that the unintended consequences are considered for those who have no say in those types of discussions who are adversely affected?

The Global Economy

The above table highlights the largest countries globally ranked by economic output (GDP) and highlights their state of health – see the indicators outlined at the top of the table.

The global economy is getting there, but COVID-19 is far from over.  We have many third-world countries still struggling as they suffer the coronavirus pandemic recession, whereas other countries such as China are leading the way as well as perhaps the US and Europe and Australasia making better progress at the moment.

Britain is in the process of deciding whether or not to release some of the lockdown restrictions that have been in place for many months towards the end of June.  It is a tricky decision.

Among other countries, Singapore and close to home Australia has seen the spread of the coronavirus flare up again unexpectedly.

The above dashboard provides a variety of data around the spread of coronavirus.

The global economy continues to struggle along as it emerges from the grip of the coronavirus pandemic recession.  It has quite a long way to go yet because, whilst a number of developed economies such as China, the US, Europe and Australasia appear to have made good progress with regard to containing the spread of the virus, as Australia has recently discovered, it’s not as easy as it seems.

Looking at the map on the diagram above you can see that third world countries have a long way to go with their rollout of vaccines ( the green dots ), which of course can’t even begin in earnest until they have received the proper level of supply in the first place.

In short, the spread of the coronavirus is not over, and the global economy continues to struggle along as it emerges from the clutches of the coronavirus pandemic recession.

Global vaccination rates

Both of the above charts show the progress with regard to the vaccine rollout.

Thanks to medical science we have vaccines in the first place that can be rolled out.

Now the challenge is to roll out those vaccines at pace which is underway in the likes of the UK, Europe, and America.

Critically though as I’ve mentioned elsewhere, it is vital that third-world countries are given supply and assisted with the distribution of the vaccine and inoculation of the population.

By the way, I have no personal view as to the ethics behind vaccinations.  I take a pragmatic view and with regard to this economic update.  I am simply reporting the facts and my views around those facts as I see them.  There are a couple of questions that some ask.

Should the drug companies be making money out of other people’s misfortunes? On the other hand if they don’t develop these vaccines and get paid for it, would governments be able to achieve the same outcome as quickly?  If not, what is the impact of the lives and health of people all around the world? I’m happy for you to answer those questions as you think fit.

The United States of America

Inflation – USA

The above bar graph tracks inflation in America.

If you compare last month’s inflation chart with this month, you can see on the chart above the significant increase in the rate of inflation.  

Inflation for March came in at 2.6% annualized whereas the April number came in at 4.2%, a significant increase and of course the reason why there has been a flurry of discussion and in some areas, worry about what’s coming next.

Looking ahead, the evidence suggests that inflation is increasing, however my opinion at the moment is that, the weight of evidence suggests a transitory/temporary spike in inflation rather than a starting point for rampant inflation.  No guarantees of course because there are a number of variables that could change that view after midnight tonight.  Currently though, that’s the way it looks to me.

No need to show you the graph of interest rates because they remain on hold – no change from my report last month.

As the concern over the spread of the coronavirus diminishes ( let’s be careful though, we’re not out of the woods yet! ) the emerging worry is the shortage of labour.  In some states in America, this is now the top concern, ahead of COVID-19 worries.

At the same time, the US government continues to negotiate on their infrastructure package. We’ll be soon hearing more about their proposed US$6 trillion budget (!). That is a meaningful amount of money and will help to underpin a positive economic environment moving forward.

Forecasts for the US economy look good with some of the recent estimates coming in at the fastest pace in over 35 years.  When we look more closely, we can see that this optimism is supported by some indicators such as for example PMI manufacturing report which came in at 62.1 versus last month’s 60.5.

Manufacturing PMI – USA

The above bar graph tracks the US manufacturing Purchasing Manager’s Index (PMI).

Other indicators also look positive in America which supports my theme of economic optimism and growth as America continues to emerge from the coronavirus pandemic recession.

Britain

The graph to the right shows projected economic growth. The bar graph to the left shows the projected improvement in the public deficit.

Recent economic growth revisions show an improvement in economic growth over 2021 and 2022 as Britain’s services sector rebounds strongly as pubs, restaurants and retail outlets reopen. 

From a  COVID-19 perspective, the situation in Britain is challenging because of the different variant strains of the virus in Britain and the risk of instant spread at any moment.

Therefore, a relaxation of the current controls is considered by many to be too soon. On the other hand, we have the politics surrounding the decision and then of course there is also the will of the people.  Simplistically, some people want the freedom and are not worried about the consequences until they are confronted by the outcomes of their decisions.

This is where the role of the government is critical. That is, in simple terms to be strategic and make the decision that is best for everyone in the long run rather than just what makes them look good now.

On the other hand, the National Institute of Economic and Social Research (NIESR) has revised its forecast for UK’s economic growth over 2021 up to 5.7% up from its previous 3.4% earlier this year.

They also forecast economic growth at 4.5% over 2022.

Not a bad outlook all things considered, even if it is catching up on lost ground over 2020.

Inflation has been a topic of much discussion around the world lately.

NIESR are forecasting CPI inflation to reach 1.8% in the final quarter of 2021 and then declining to 1.5% by the end of 2022. This means that inflation in Britain could settle just below the 2% target between 2023 and 2025. 

If correct, this would appear to confirm the UK Central Bank view that current inflation is transitory and not ramping up to levels seen back in the 1970s, 1980s, and 1990s. Time will tell…

New Zealand

Economic Indicators

The table above provides a variety of economic indicators across the New Zealand Economy.

Limited economic information in the above image I agree.

Are we messing in our own nest and screwing the scrum for future generations? What I mean is, with our blind devotion to residential property as a way to get ahead, are we making it unnecessarily difficult for our children and their children in the future?  How will they pay for health care, education and a growing infrastructure problem?

Arguably, homes whether they be owner-occupied, or investments rented out to others to rent, form part of economic output and growth for the New Zealand economy. It’s not all bad. After all, we live in houses not caves.

The solid question raised by David Hargreaves in an article that he published recently is “Are our banks just putting proportionately too much money into our housing market?”

The Reserve Bank mandates that mainstream banks and other lenders do so using residential property as their preferred security. Simply, lending against residential property is hardwired into the system.

Ask any business owner with or without a property how things go at the bank when they want to borrow money for expansion or to cover a cashflow timing issue because of unexpected market events.

It’s the same old story.

If you’ve got residential property against which you can borrow then no problem ( assuming the servicing of the new debt is OK ).  If not, then the Bank may tell you it’s too risky and they are not able to help.

Okay, this is not to say they won’t lend for business owners at all.   However how easy it is for everyday business owners to get a loan from any bank without residential property as security?

In short, the New Zealand economy to some degree relies on property.  That’s the inescapable and inconvenient truth of it.  I know, there are other contributors to economic growth such as for example agriculture. There is a small but  growing tech industry that would benefit very much from greater support from banks and the government.  Tourism used to be right up there too, but of course the coronavirus pandemic has changed that, at least for now.

Interestingly, COVID-19 does give New Zealand an opportunity to build enough houses so that we can possibly catch up on that ever-elusive housing deficit.

But – small business owners who are plumbers, electricians, and builders are battling with a pricing mentality driven partly by government organizations which means that they accept the lowest tender, cutting margins and profits to the bone.

Add to that, we have a looming shortage of apprentices and little assistance from the government to help business owners and apprentices to get on board to help support the building industry in the future.  If you go to build a new house now, I wonder how long it would take to actually achieve a completion date?

Looking after those less fortunate with limited resources I believe is a must do.

There have been studies showing, that when they’re looked after, everyone else is better off anyway.

At the same time though, thinking beyond this week, this month, and this parliamentary term, where is the support for small business and mainstream New Zealand?

Do I hear crickets?

This is easily overlooked for one month, for one year to the next …. but for decades?  

It seems out of step with reality, to simply continue to perpetuate this blind devotion to supporting housing and spending borrowed money as though they are both the long-term solution to everything – what do you think?

When can we stop with this short-term myopic approach to our economy and get on with a more balanced and effective long-term strategy that ensures everybody has work, makes a good income, lives in a comfortable house that they don’t pay too much for and can also develop real financial independence, without relying on a unique set of conditions to all line up together so that the value of our house goes up?

That won’t last forever.   

Property is hardwired into the genetic code of everyday Kiwis and so I don’t expect a house price correction anytime soon either.

Investing in residential property and supporting housing is not in of itself necessarily the wrong thing.  However, it’s also far from the best plan. 

It is a narrow, transactional approach to economic stability and “growth” as distinct from a more strategic and therefore transformational way of delivering a better economy and a better life for everyone.

On another note, the recent surprise outbreaks of the coronavirus in Australia are a good reminder of why we’re not out of the clutches of the coronavirus quite yet. Complacency comes with a price to be paid – ask the Aussies or any Kiwis who have been caught up in it.

The New Zealand economy appears to be tracking along okay and yet the sad truth about the New Zealand economy is that the amount of support by way of lending for the property sector dwarfs that of the productive business sector – big mistake.

Building new houses does create economic activity. Buying and selling existing houses not so much.

Hardworking industrious business owners looking to expand and hire more and more people is a clear winner when it comes to improving the economic fortunes of an economy, particularly in the long run.

Borrowing money to buy properties is highly questionable as a way to generate productive economic growth and yet New Zealand behaves as though residential property and the weight of money directed to this sector is a rite of passage and the holy grail when it comes to economic success – it is not.

And so we get by, indeed we look like we are doing well when we think about our freedoms compared to other countries around the world with our control over coronavirus and our comparatively low level of debt.  That said though, our level of debt is not good compared to other countries, just less bad.

For a more in-depth review of the global economy, click here to view the Market and Economic Update published in May which takes a closer look around the world of what’s going on and where we’re heading.

”What is cryptocurrency? Everything you don’t understand about money combined with everything you don’t understand about computers.”

– John Oliver (British/American Talk Show Host)