Tony Alexander update September 2020

The past month has certainly been an interesting one, with Auckland going back into a mild form of lockdown and the rest of the country watching anxiously to see if the cluster would spread beyond Tokoroa. Thankfully, at the time of writing on the day when Auckland’s alert level dropped from 3 to 2.5, no spread had occurred.

When the entire country went into near complete lockdown earlier this year there was a temporarily devastating impact on the economy and some fairly clear effects in asset markets. Share prices fell sharply, housing turnover almost disappeared, and house prices pulled back.

These moves reflected the fact that we had no experience of what happens during and after a lockdown associated with a global pandemic. Now we do, and for that reason, while there have been some definite changes in sentiment attached to this latest smaller lockdown, the sense of impending doom back then has not been repeated.

One thing we have learnt here and overseas is that with time on their hands, spare cash building up, and technology at their fingertips, young people dive into the sharemarket. Major share indices offshore have reached record levels and the initial 35% or so falls of earlier this year were all but erased very quickly.

The new dominance of retail investors may suggest some fragility to the surge in share prices. But there is more than just a rush of fresh money involved. Our world is changing at an accelerated pace and people with knowledge of the technology sphere say that the changes they expected to see over ten years are now happening in the space of perhaps one year.

This has been exceedingly positive for a wide range of businesses stretching from the technology sphere into online delivery operators and home furnishing suppliers. Investors have flocked to these businesses, pushing share prices much higher.

But prices for other assets have also soared, most notably precious metals such as gold. Gold prices have been boosted by concerns over the trade dispute between China and the United States, geo-political concerns, and the cementing in of low interest rates for a long period of time reducing the opportunity cost of keeping one’s cash in gold.

The dominance of low interest rates brings us to another thing we now know happens when lockdowns end. People dive back into the housing market. First home buyers are attracted by low interest rates and the removal of Loan to Value Ratios bringing hopes of making a purchase with little deposit.

So far, most of those young buyers have been disappointed because banks are extremely busy, staff don’t have sales targets any longer, and the economic outlook remains uncertain. Therefore, as yet, only slight reductions have been made to minimum deposit requirements. But still the young buyer’s queue, and an interesting aspect of this latest lockdown is that although mortgage advisors in my monthly survey reported a pullback in most activity measures, the pullback was for all the country and not just Auckland.

Given that the Reserve Bank has recently openly talked about the possibility of a negative official interest rate next year, there is near universal expectation that mortgage rates will decline from current levels and stay low for many years. Thus, as Auckland slowly opens again, we can expect to see the surge in housing activity which happened after Lockdown 1 ended replicated to a lesser degree as we now pass through Spring into Summer.

We have also learnt over the past four months that it is not just first home buyers who dive into the housing market. So too do investors. Term deposit rates are low and set to go lower, to the point where inflation adjusted after-tax returns for average term deposit investors in the coming year will be negative – and then even more negative in the following year.

Around the world, investors are moving more into property assets – most notably residential. However, outside of central city offices and perhaps retail stores, there is strong investor demand for industrial and logistics stock. Some, with an eye toward a future where borders are open once again, will also be seeking assets in the tourism and accommodation sectors.

With interest rates staying low and central banks purchasing bonds held in the private sector and temporarily injecting extra liquidity into their economies, experience and logic tells us this will push asset prices higher. We cannot possibly predict with any reliability the extent to which particular asset prices will change in the next 1-5 years – especially not given the evidence of very poor forecasting performance from six months ago.

However, with economies slowly opening up, central banks determined to foster as much growth as they possibly can, and many people probably still straining at the leash to get back to their old lives, vaccine timing has become potentially the biggest new factor now in play. On the basis of comments by the science experts, it looks like viable vaccines will be developed, and that they will allow the return of our old lives.

As soon as we see a full vaccination timetable set, we will set timings for the return of economic normality, but with the knowledge that central banks will keep the ball of economic momentum rolling strongly – especially as their biggest concern has switched from inflation to deflation.

The Federal Reserve just days ago indicated that with inflation having averaged too low a level in the past decade, they want to run a number of years with inflation above their 2% target in order to get inflation expectations up and average inflation over the long-term back where they want it to be. The Fed. is virtually promising to run a low interest rates policy for many, many years.

Low interest rates coupled with rising economic optimism as we set a timing for vaccination as soon as we possibly can, means it is hard in the near future to imagine an economic environment which will cause any substantial interruption to the asset price movements which we have seen over the past 4-5 months.

But that is not to say things will move in a straight line. The situation involving China’s expansionism in the South China Sea and pushback by a growing number of countries, is raising the risk of some sort of military “accident”. China is also increasingly using threats of reduced trade access as a means of influencing policy-settings in other countries (as the United States and United Nations also do in more formalised manner.) Countries are responding by increasing locking Chinese investment out of their countries (Australia in particular in this regard), and “evicting” from their shores China-related institutions and relationships.

For New Zealand, so far, blowback from this growing source of global friction and uncertainty has been minor. However, interruption to confidence and our economic track from the developing situation involving China and the United States in particular, cannot be ignored. This is a good reason for not blindly extrapolating recent upward movements in prices for an exceedingly wide range of investments and taking on misplaced risk.

Momentum does not remove the need for diversification.

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By Tony Alexander

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