The Big Picture
The US Federal Reserve (the “Fed”) has maintained an accommodative monetary policy stance – to a greater or lesser extent – since the onset on the GFC in 2008. On a couple of occasions, the Fed caused a stir with consequent falls in share prices. The first resulted in the so-called ‘taper tantrums’; the Fed was talking about reducing its bond purchases that were aimed at keeping longer term interest rates low. More recently, the second followed Fed chair, Jay Powell, talking about raising rates at the beginning of his term in office.
Since the onset of the pandemic, the Fed has maintained an all but zero Fed funds rate. We all know the party will end one day; nobody knows quite when.
The Fed recently changed its policy to wait for actual increases in inflation before it moves – rather than basing its policy decisions on expected inflation. It has also stated that it is prepared to live with inflation above its 2% target for ‘some time’ before it acts.
Because prices of some goods and services fell sharply at the onset of the COVID 19 pandemic (March – May, 2020) as a result of the original lockdowns early last year, the annual inflation rate was destined to jump up 12 months later. Fed Chair, Powell, warned us of this well in advance but the markets got the jitters at the start of May when the CPI came in at 4.2% for the year against an expected 3.6%. Matters were not helped when Powell’s predecessor, Janet Yellen – now Secretary of the Treasury – made a public statement to the effect that rates would have to go up sooner than previously expected. She knows that the Fed is meant to be independent of government – as is our Reserve Bank (RBA) – and she even said as much. Yellen’s expressed opinion was unhelpful.
The 4.2% inflation level was high because of two major factors. The first was due the price falls at the beginning of 2020. The second was, by chance, that the US economy was opening up 12 months later. Big discounts on hotels, air fares and second-hand cars were being removed. These categories jumped about 10%. The combination of these two factors creating a double whammy and inflation prints 4.2% which will almost certainly be transitory. However, the next month might also be a bit high for similar reasons – and then likely to fall back under 2% again is both our current view and the Fed’s.
The 10-year bond yield jumped on the inflation fears so share prices fell as their yields were less competitive against a higher bond yield. However, this effect was short lived and it didn’t take long for the markets to recover the losses. The S&P 500 got back to well within 1% of its all-time high and the ASX 200 actually made a new all-time high at the end of May.
The Fed’s preferred inflation measure – the so-called core Personal Consumption Expenditure (PCE) inflation – strips out volatile energy and food price variations. The PCE measure, at the end of May, came in at a more modest 3.1% and the market barely reacted to that data point.
With U.S. President Biden handing down his first budget on the same day as core PCE was published, the ‘punch bowl’ is still overflowing and we currently have little fear of any substantive change in policy this year.
And it’s much the same in Australia except for our latest inflation read of 1.1% being adversely impacted by lockdowns. The RBA has revised its forecast of GDP growth for 2021 to 4.75% from 3.5% with a fall in the unemployment rate at the end of the year to 5.0% from 6.0%. Given that the latest read on unemployment was only 5.5%, the RBA couldn’t have waited much longer to play catch up!
At 5.5%, our unemployment rate is barely above the rate that existed just prior to the pandemic. The same cannot be said of the US. It’s rate up is 6.1% against an expected 5.8% and its pre-pandemic rate was 3.5%. This month’s US jobless data showed 266,000 jobs were created against the one million expected. They still have about eight million jobs that were lost in the pandemic but not yet re-filled.
There have been massively different responses to the pandemic in the US and Australia – both in vaccination take up and lock downs. Around 60% of Americans have been vaccinated at least once (40% have had both shots) whereas many are reluctant to get vaccinated in Australia most probably because of the bungled messaging from both the government and the drug companies. Only about 1% of NSW and Victorian resident are fully vaccinated.
We obviously feel like a ‘lucky country’! The NAB business conditions and confidence surveys produced the best ever response in their 24-year histories. The Westpac consumer sentiment index was not at its highest level but it was not far off it.
Australia has taken a strong approach against allowing people in and out of the country. With over 7 billion people in the world nowhere near getting vaccinated yet, we’ll be in near isolation for a long time unless vaccination rates improve.
But vaccination rates at home alone don’t solve the world’s problems. Singapore had 25% of its population fully vaccinated and another 8% on one shot but they just experienced an outbreak that closed the schools again.
The Tokyo Olympics are still hanging on to a slight hope of going ahead. However, the European Cycling Union just cancelled its European Track Championships to have been held in Minsk, Belarus. This cancellation was not, however, because of COVID, but allegedly because the Belarus government forced a Ryan Air jet to land (assisted by a Mig fighter jet!) on its way to Lithuania from Greece so that Belarus could detain a journalist who is an alleged ‘dissident’!
On another bellicose front, Britain, now free from EU policies, sent out warships to help guard Jersey’s (one of the Channel Islands) fishing grounds. France retaliated by threatening to stop its electricity supply to Jersey (the island is only a few miles off the France coastline but it is a member of the UK). Was it a coincidence that the UK entrant in the Eurovision Song Contest this month scored zero points from the member states and zero points from viewers? They had never scored zero before!
On the UK economic front, the struggling economy is now forecast by the Bank of England to grow by 7.25% this year. That might not be far off the mark as the UK retail sales jumped +42.4% in the latest month. Brits have just been let out after a very long shutdown – and they’re very happy about it.
UK prime minister, Boris Johnson, married Carrie in Westminster Abbey at the end of May. Carrie attracted extra attention because her wedding dress was reportedly rented for the day at about $100 and she walked shoeless in the garden party.
Even without all of the global monetary and fiscal stimuli, major economies are expected to do well for the remainder of 2021. Savings ratios went up sharply in most relevant countries from mid-2020. Limited travelling to work; many shops, bars and eateries closed; and simply the fear of the future, aided hoarding. Now it is time resume a more normal existence. Yes, there will be occasional lockdowns for quite some time but we’re all starting to get back to normal – and markets like that.
The US celebrated its Memorial-Day weekend (1 June) with pandemic record air travel and 135,000 spectators half filling the grandstands at the Indianapolis 500 (car race). If there is no spike in infections following that weekend, the end may seem to be in sight.
Asset Classes
Australian Equities
Although the price of iron ore retreated from its all-time high of $233 per tonne, resources stocks remained strong and the ASX 200 reached an all-time high on May 31st with gains of (+1.9%). That is eight months in a row that the index has posted positive capital gains
The Financials sector had a particularly strong month at +4.4%. The consumer discretionary and health sectors posted 3.5% capital gains over May.
However, we do not estimate that the index is significantly over-priced and market volatility has fallen almost back to average levels.
International Equities
The S&P 500 experienced a short-lived pull back in May but returned to within a whisker of the all-time high. Gains in May were +0.5%.
Emerging markets were all but flat on the month. However, the German DAX posted a healthy gain of +1.9%. The Shanghai composite did even better at +4.9%.
Bonds and Interest Rates
The steepening of the US yield curve was halted in May and, indeed, 10-year treasury yields retreated a little towards the end of May.
The market chatter about the Fed moving to taper its bond buying program and short-term rate hikes had all but vanished towards the end of the month. Markets seem settled that ‘lower for longer’ remains the Fed’s view and most probably reality.
The RBA also kept rates on hold in May but upgraded its economic forecasts for the country. We think that the bank was just a tad slow to catch up with market views.
Other Assets
Bitcoin and other cryptos made repeated headlines throughout May but for all of the wrong reasons. Elon Musk, the CEO of Tesla and SpaceX, seems to playing to the crowd as he moved prices up and down by over 20% on single tweets. We find it hard to take cryptos seriously as a viable asset or currency. And the complex tax implications may come back to bite some ‘investors’ though we think ‘speculators’ is a more appropriate description.
The answer to the question, “How much of my portfolio should I allocate to cryptos?” perhaps should be, “About the same as your allocation to lottery tickets. Prudent investors should aim for modest, consistent returns!
Gold prices rose by 7.7% over May with iron ore, copper and oil prices following closely behind. Iron ore did retreat from $US 233 per tonne during May to just over $US 200 at the end of the month.
Our dollar, against the $US, lost a little ground. There is speculation that China may ‘do something’ about the price of iron after it reached $233 a tonne. It was less than half of that just a year ago. Since the $A is widely thought to be a commodity currency, its plight might worsen if, indeed, commodity prices push back. However, in the opposite direction, lax monetary policy in the US might send our dollar higher. Currency forecasting is very difficult at best – and even harder right now.
Regional Review
Australia
The unemployment rate fell again for April (the latest data) to 5.5% but 30,600 jobs were lost when +15,000 were expected. The numbers do bounce around quite a lot so we are not immediately perturbed by this outcome.
The Westpac and NAB confidence indexes all performed well indicating that the nation is quite comfortable with the way the pandemic and the economy are being managed.
The vaccination rate is certainly too low but there is currently little danger to our population as there is limited opportunity for locals to be infected from outside the country.
Morrison has ordered 25 million Moderna shots (which is based on the same technology as the Pfizer vaccine). He has also said that the over 50s who are hesitant about getting the AstraZeneca shot will be able to get Pfizer from October.
The fresh outbreak in Melbourne was met with a swift seven-day lockdown. This outcome might be frustrating for many but the alternative seems a lot worse. We suspect there will be occasional such responses around the country over at least the remained of 2021. Regular international travel seems unlikely before the middle of next year.
China
China’s retail sales missed expectations at 17.7% (24% was expected) but when big numbers are expected – because of the influence of lock-downs a year ago – the margin of error has to be given more latitude. The industrial output and fixed asset investment accorded with expectations at about 10%.
The China manufacturing PMI came in at 51.0 against an expected 51.1; the services index variant came in at 55.2 against an expected 54.9. Both statistics confirm that the Chinese economy continues to flourish.
US
President Biden seems to be in control of the vaccination programme and he is certainly pushing hard for fiscal stimulus. There is some concern that he is pushing too hard on that front and problems may occur further down the line. Wanting to run the budget deficit at one trillion dollars a year for the next decade does seem a little excessive.
The $6 trillion budget he handed down at the end of May actually included the previously announced American Jobs Plan and the American Families plan (totalling about $4 trillion but is still under negotiation). Only $300 billion of the new part of the $6 trillion is proposed to be spent this year!
The jobs data, which were a big miss for April were even worse than the headline when the revision to the previous month is taken into account. The March data were revised down from 916,000 to 770,000 while the latest month was a mere 266,000 – a number that would not have been unreasonable in a pre-COVID month.
There are many reports of certain types of workers being hard to find and/or attract. Childcare problems and possible exposure to COVID in customer-facing jobs might be worrying some potential workers from returning to jobs.
While these job-matching problems might have caused – or be causing – localised wage hikes, we do not think the effect will be strong enough to pass through into significant consumer price hikes – hence inflation and rate hikes may be avoided.
Europe
Europe continues to struggle with the economy and the pandemic. Internal politics in Britain are undermining Boris Johnson’s handling of the pandemic at its start. Whether he is guilty of ineptitude or incompetence or not, decent sized crowds were allowed back into English Premier League football matches and other big sporting events. They even staged a ‘rave’ for 3,000 kids in Liverpool under strict controls but so far there is no reported major downside from these crowds.
Rest of the World
India continues to struggle with COVID, though its daily infection rate had declined from recent record highs, but major nations are offering help in medical supplies and vaccine supplies.
Japan is running down to the wire over the Olympics. There are still lock-downs in the country and the majority of the residents do not want the games to go ahead.
