APRIL ECONOMIC UPDATE

Outlook for Investment Markets

While equity markets have generally recovered from their coronavirus-affected lows in late March, the prognosis for the world economy remains uncertain. While forecasters are typically running with a range of scenarios, most agree that their baseline or best-guess scenario is for a serious setback to world trade and gross domestic product this year followed by a recovery next year. The shape and speed of the recovery remains very uncertain, however, with fund managers inclined to believe it may be a more gradual affair rather than a rapid return to normality. In the interim, equity markets will continue to be confronted by generally downbeat economic and financial news, even as more countries succeed in bending the curve of new infections. On the plus side, bonds have preserved capital and prices are likely to be supported by ongoing central bank buying. In Australia, the decline in new cases is good news, but there is still a long way to go before the full extent of COVID-19’s impact becomes apparent.


Australian Cash and Fixed Interest — Review

Like everywhere else, monetary policy has been used vigorously to help offset the impact of COVID-19. The cash rate is 0.25%, 90-day bank bills are yielding only 0.15%, and the 10-year commonwealth-bond yield is only 0.862%. A lower exchange rate has also helped the overall easing in monetary conditions. The Australian dollar is down 6.6% in overall value since the start of the year, with especially large falls against the two main currencies regarded as relative safe havens--it is down 10.0% against the yen and down 9.2% against the U.S. dollar.

Australian Cash and Fixed Interest — Outlook

Currently there is a very strong consensus that the target cash rate will be kept at 0.25% over the next year. The Reserve Bank has committed to it and has said that the target will not be raised “until progress is being made towards full employment,” and inflation gets back up to 2% to 3%, which is likely some time away. This is also the view of both the futures market and the economic forecasters. Apart from providing ongoing support to the post-COVID-19 economy, the cash rate would need to be kept very low as inflation looks very likely to be well below what the Reserve Bank would like.

Long-term interest rates are also likely to remain unusually low for an extended period. As part of its quantitative easing programme, the Reserve Bank has committed to keeping the yield on three-year commonwealth bonds at 0.25% (as long as is necessary to get unemployment down and inflation up). And with over AUD $46 billion of bonds purchased already, it is very likely to be able to do so (currently the rate is indeed very close to 0.25%). At some point, the huge supply of new government bonds (as part of anti-COVID-19 fiscal policy support) may require higher yields to find homes with buyers, but that still looks to be a long way away.

The outlook for the currency remains, even more than usual, hostage to the global unfolding of the COVID-19 outbreak. Currently investors are in a strongly risk-averse mood and currencies like the Australian dollar have had little appeal to global investors who have preferred to stay closer to home. As the outbreak is better contained, it may be that peak pessimism diminishes and appetite for risk picks up. The low point for the Australian dollar could be behind us. There is still a very wide range of views, but the average pick in the latest (early April) Reuters’ survey of foreign-exchange forecasters is that the Australian dollar will stabilise around U.S. $0.63 over the next six months and pick up to $0.66 in a year.

Australian and International Property — Review

Listed Australian property has had a difficult time through the COVID-19 period. The A-REITs have significantly underperformed the wider market, with the S&P/ASX 200 A-REITs Index suffering a capital loss of 25.2% compared with the S&P/ASX 200 Index’s 17.9%.

Global property has also been out of favour. The FTSE EPRA/NAREIT Global Index in U.S. dollars has lost 25.6% in capital value, worse than the 14.5% capital loss for the MSCI World Index. Losses were similar across most of the main regions, ranging from the Asia Pacific’s 22.2% loss through to the U.K.’s 29.2% loss.


Australian and International Property — Outlook

Operating conditions have become very difficult for property owners. The latest (June quarter) ANZ/Property Council of Australia survey, which added some special questions about COVID-19, found that it was already having a serious impact on 35% of property businesses. Over the next three months it is expected to have a serious impact on 52% of them. The impact was expected to be particularly severe for hotel, tourism, and leisure properties, but all sectors reported sharply lower expectations for capital growth, with hotels and an already pessimistic retail sector in the worst shape. Even the relatively resilient industrial sector turned pessimistic about capital values. Respondents expected cap rates to increase, again depressing valuations, and, realistically, given the sector’s various issues, also expected debt availability to worsen over the coming year. As the Reserve Bank of Australia said in its April Financial Stability Review, “In the period ahead, declines in both sales volumes and valuations are likely, reflecting the weakness in the rental market and a repricing of risk by institutional investors.” And it looks likely that the REIT sector will remain weak until all the ramifications of COVID-19 have played out.

Global listed property faces all the same challenges. The retail sector has been hit by a double whammy. Its own businesses have faced reduced revenues as shoppers have been in lockdown and tenants have been unable to pay rents. A survey by the U.S. trade body NAREIT found that U.S. shopping centres collected only 46% of their normal rent in April, while its existential threat from e- commerce has surged as people, perforce, have turned to online retail channels. The impact on the retail REIT subsector has been dramatic. In the U.S. the prices of shopping centre REITs have effectively halved (down 49.6% year to date) and regional shopping malls have fared even worse (down 59.3%). Offices, while not as badly shaken (down 23.2% in the U.S.), also face the prospect that enforced remote working through COVID-19 lockdowns may permanently impact the demand for office space. Industrial property everywhere has been a beneficiary of the e-commerce demand for warehouses and logistics. The U.S. industrial REITs are down only 2.1%--and there are other pockets of good performance (big data has led to strong performance by data centres)-- but the few bright spots are unlikely to coun-terbalance the bigger picture in coming months.


Australasian Equities — Review

Australian shares have followed the global COVID-19 pattern, dropping sharply from mid-February to late March, before staging a partial recovery in more recent weeks. Year to date the S&P/ASX 200 Index is down 17.9% in capital value and down 16.9% in total returns. The financials, which will be exposed to business defaults and the costs of debt relief, have been particularly weak, and are down 28.0%. But weakness is pervasive across most subsectors, with the industrials down 20.6% and

the miners down 13.0%. Consumer staples are the only resilient sector, with prices up slightly by 2.3%.

Australian Equities — Outlook

The latest state of business sentiment, which now reflects the full impact of COVID-19 and the lockdowns, is, unsurprisingly, dire. The latest (March) business survey run by National Australia Bank, for example, found that: “Business confidence saw its largest decline on record and is now at its weakest level in the history of the NAB business survey ... the decline in forward orders and business conditions imply a large fall in GDP in the next 6 months ... The timing of a recovery is extremely uncertain at this point ... For now, more businesses expect it to get worse before it gets better. It could well be that conditions fall to the lowest level since the 1990s rece