Issue: 1st October 2021

What to expect next?

Earnings growth for companies has been strong, however, we cannot ignore the actions of Central Banks that continue to support valuations. Thankfully, Central Banks seem likely to ‘taper’ their support instead of a sudden withdrawal, reducing but not eliminating the probability of valuations decreasing sharply.

It is now widely accepted that the Fed, along with the Reserve Bank of Australia (RBA) will start to reduce monetary support over the next 2 years. The result of which will likely be a headwind to investment markets. Whether the return to ‘normal’ and pent-up demand/savings is enough to offset this will ultimately dictate the direction of market returns over the next 12-24 months.

Investment Implications

Investors should expect to see lower levels of equity returns relative to what has been experienced over the past 12 months. Changes in Central Bank support may be met with bouts of volatility, particularly when announcements differ to market expectations. While some sectors have provided handsome returns since the start of the crisis, others have some way to go in a relative sense. For these sectors the key consideration is whether the changes brought on by the crisis can be considered ‘temporary’ or structural and likely to persist post pandemic.

In the short-term, we expect to see more volatility over at least the next month or so: we’ve still got a way to run on the Evergrande troubles (more on this below); the US debt ceiling is far from resolved; tax hikes are likely on the way in the US; supply constraints are continuing to weigh on growth and contribute to inflation; and seasonal share market weakness usually runs into mid-October.

As we begin the lead up to the end of the year there is plenty keeping markets and investors on their toes.

We share again, the Guardian tracker on the roll-out across the nation, including estimates as to when we may reach the 70% and 80% milestones. For those of you interested in keeping track of the global vaccine roll-out, we again share the Financial Times rolling tracker.

Recently, we have had a number of calls from clients enquiring about the validity of their life insurance if vaccinated for COVID. The rumour mill strikes again!

Please rest assured that despite falsifications suggesting otherwise, taking a COVID-19 vaccine will not invalidate your life insurance policies. The false rumours predominantly circulating on social media incorrectly suggest the covid vaccine is an ‘experimental medical treatment’ and therefore having the vaccine is a ‘self-inflicted injury’ which could void life insurance policies.

As Financial Services Council (FSC) CEO Sally Loane stipulated in a recent media release, “To be clear – the COVID-19 vaccine is not an experimental treatment. Receiving approved treatment from a qualified medical professional at an approved medical facility is not a self-inflicted injury”.

“One of the main reasons why people hold life insurance protection is to provide peace of mind for themselves and their families. The FSC would like to reassure Australians that when they get vaccinated, their life insurance will be there for them, completely unaffected”.

As always, if you are at all concerned and would like to discuss this matter in more detail, please do not hesitate to contact us.

Global investors have been on tenterhooks in recent weeks ahead of Evergrande’s payment obligations over fears its difficulties could pose systemic risks to China’s financial system and possibly spill over to other markets.

It is a complex issue that has many interwoven elements. The big question is, is Evergrande too big to fail and will China bail it out?

Not in the Lehman league

Many have suggested that this is China’s Lehman Brothers moment. In our view, the challenges facing Chinese developers and their lenders is not likely a crisis of this magnitude, and there is a strong case for a Chinese government bail-out. Our thoughts following:

1. Social unrest and domestic support – The Chinese Communist Party (CCP) cannot afford to have hundreds of thousands of its people rioting on the streets. A significant layer of the Evergrande debt is funded by WPMs (Wealth Management Products), a high yield investment product widely used in the Chinese system. Realising what they hold is actually construction loans going bad, innocent ‘Mums and dads’ understandably want their money out.Not to mention the million-plus people that have put deposits and progress payments down on a unit that may never get built. It would seem there is too much at stake for the CCP not to provide domestic support.
2. China’s banking system – Unlike Lehman and the banking system in Australia in the late 90s, Evergrande’s debt is minuscule compared with the very profitable, well capitalised and flush (with cash) banking system in China. The impact of a bail-out on Chinese bad debt would be a mere blip on a blip.
3. The contagion effect – If Evergrande is left to default on one or more of its bond payments, broader access to foreign capital is likely to be curtailed for some time. This could escalate very quickly and is not something the banking system will want. The knock-on effects are simply too great.

Crucially, the CCP has no motive to undermine the housing market. The populace has most of its wealth invested in property and, it is its most significant driver of the economy. Hence, we expect the Government will pull levers necessary to stabilise the market.

What we are likely to witness over the coming months is an epic clash between a leader with supreme powers determined to change the course of his nation and the economic constraints imposed by the heavy debts of the companies driving it.

Indeed, policy tightening is a major contributing factor to the timing of Evergrande’s troubles, but principally because it was already in a self-inflicted precarious financial position, as the chart below illustrates.

Our chart of the week provides a rather frightening insight into the debt to equity levels of the world’s largest, publicly-listed residential property development companies.

Major trends such as the revival in travel demand, the growth of digital platforms and the acceleration of mobile technology (now accessible by the majority of demographics) are responsible for spurring the prospects of these economies.

According to fund manager Capital Group, these are the key themes behind the opportunities in emerging markets in the next 10 years.

1. Emerging market middle classes are driving growth in air travel.

• Pre-covid, it was estimated that 150 million people in Asia travelled for the first time each year.
• Fuelled by the rapidly rising middle-class population, over the next 20 years, the region is expected to account for around 50% of new air traffic.
• A revival in travel demand in Asia and other parts of the world will have a powerful ripple effect, creating the need for a range of goods and services and helping drive jobs growth across a variety of industries.

2. Emerging markets underpin long-term growth in luxury goods.

• The evolution of a wealthy class in China and other Asian economies over the past three decades has provided the industry with an underpinning of sustained and structural growth.
• As the ranks of this consumer class, expand and newcomers are attracted by the social cachet and aspirational value of luxury items (driven by their consumption of social media), demand for these goods is expected to escalate in coming years.

3. Emerging markets are driving the transformation to digital payments.

• The pandemic has expedited the trend from cash to electronic payments.
• The expanding middle class is rapidly adopting the internet, e-commerce and smartphones given a younger, more tech-savvy demographic; ease of use (versus cash) and greater access to financing; and changing regulations allowing unbundling from banks through fintech.

4. Mobile technology trends are accelerating as internet usage rises.

• Emerging-market companies within e-commerce, gaming and social media have developed and localised their technology, accelerating their growth in ways that differ from their peers in developed markets.
• In many emerging economies, it is often women, the poorest and those living in rural areas that have the least access to such things as the ‘knowledge economy’, financial and medical services. As mobile technology and internet access becomes mainstream and increasingly cost-effective, this divide narrows.

5. Innovation is a dominant force that will transform the health care industry in emerging markets.

• China is already the largest global supplier of active pharmaceutical ingredients and is steadily closing the gap between it and the US market.
• Telehealth is set to become a permanent fixture in the way health care is delivered going forward. Funding has been given to many companies offering online alternatives as a front door to a medical system or remote patient monitoring for things like blood glucose and blood pressure. This approach is greatly benefitting those living in remote and rural areas.

6. The US-China rivalry

• Geopolitics and trade disputes (the biggest economic storylines of the pre-covid era)
• Opportunities exist for companies that won’t be hurt by a trade war. For example, companies and industries that are aligned with the Chinese Government’s policy priorities as well as having attractive long-term fundamentals.

7. India’s equities

• India’s entrepreneurial culture and vast pool of technology talent has given rise to a host of domestic competitors, some with significant private equity funding.
• Key sectors to watch include e-commerce, banks and residential real estate.

8. Banks, insurers and financial exchanges: The rising trio of the financial sector sets the stage for long-term economic progression in emerging markets

• Insurance companies, for instance, have reported significant growth in business segments serving China’s growing middle class and high-net-worth individuals.
• On the banking front – Amid the digitalisation of India’s economy, larger private banks are leveraging technology to make faster lending decisions and reach customers in rural areas through mobile apps. Many of these banks are now well-positioned to scoop up some of the country’s weaker lenders.
• In Asia, exchanges are at the centre of public financial markets that are expanding, providing a tailwind of secular growth. Russia has also experienced similar growth in recent times as retail investors flock to stock trading platforms in search of higher returns.

9. The continued urbanisation in China and rising incomes

• In recent times, the equivalent of 1% of China’s population moved to the cities every year. That is 14 million people, and it is equivalent to two cities the size of London.

Whilst many argue that this rate of urbanisation is slowing and the housing boom in mainland China is largely over, construction remains the single greatest driver of Chinese growth.

We note in the wake of Evergrande that contingent to this construction will be the CCP’s efforts to balance the economy and wider contagion impacts.

• Let’s also not forget – existing homeowners also tend to upgrade their homes as their incomes rise. Emerging markets, such as Qatar, United Arab Emirates and of course China, have among the highest gross domestic savings rates in the world. High savings rates, coupled with low-interest rates, have been the key drivers propelling the global property market.

The full paper can be accessed here.

The impact of this opening day rally saw the three co-founders of the business join the billionaire club, with each owning shares worth over US$1 billion. Steve Fredette, Aman Narang and Jonathan Grimm are among a long and growing roster of tech founders who have joined the three-comma club in 2021. Some may argue this is an alarming sign of overexuberance and foolish behaviour akin to the dot-com bubble, which popped in early 2000. Others will counter that we are in an age of technology revolution. The original dot-com bubble was built almost entirely on speculation, where today’s leading technology behemoths have revenues and profits on an enviable scale.

The risk for investors is one of FOMO (Fear-Of-Missing-Out). While this revolution will crown many winners, it will also have more than its fair share of failures. More important than ever is the need for careful due diligence and prudence to make sure you are backing the next Amazon, not the next pets.com.

Almost 598,000 residential properties were sold in the year to August, which is the highest number of annual sales since 2004, according to CoreLogic.

The August result was 42% higher than the year before and 24% higher than the 20-year average.

Six states and territories recorded sales volumes above their 20-year average:

• QLD = up 28.9% on the 20-year average
• WA = up 28.6%
• NSW = up 25.3%
• ACT = up 24.8%
• SA = up 23.4%
• VIC = up 20.5%
• TAS = down 3.3%
• NT = down 12.0%

“Phil McCann”

Is the name of a BBC journo who has been covering Britain’s fuel shortage crisis. Clearly, he was born for the moment!

Stay safe and look after one another. As always, if you have any concerns or questions at any time, please reach out to your FinSec adviser.