December | Monthly View

What we liked

• Retail spending rose 4.9 per cent in October as COVID-19 restrictions eased across the country, this far exceeded expectations of a 2.5% rise. It was the strongest monthly rise since Victoria’s first lockdown bounce-back in November 2020, with retail turnover rising to its highest level since June.
• National Australia Bank’s business confidence index jumped 11 points to an index of 21 points. This exhibits improved business sentiment as NSW and Victorian economies re-opened.
• Payroll processor ADP released a report showing private sector employment in the U.S. increased by more than expected in the month of October. Economists had expected private sector employment to climb by 400,000 jobs with the reading coming in at 571,000 new jobs instead.
• U.S retail sales rose 1.7% in October to a record high. That beat the median forecast for a 1.1% jump from economists surveyed by Bloomberg. It also shows consumer spending picking up from September’s pace.
• US job openings fell to 10.4 million from 10.6 million in September. Despite the fall it came in above the median estimate of 10.3 million openings from economists surveyed by Bloomberg as job openings outweigh the number looking for work.
• China’s retail sales rose more than expected in October. Sales grew by 4.9% from a year ago, beating a Reuters’ poll forecasting 3.5% growth and indicating healthier domestic demand amongst Chinese consumers.

What we didn’t

• Increasing COVID cases in Europe and the potential for more draconian lockdown policies to re-emerge. Also, the concern over the new Omicron variant of COVID that may prove more resilient against vaccines bears watching.
• The annual rate of inflation in the United States hit 6.2% in October 2021, the highest in more than three decades, as measured by the Consumer Price Index (CPI). This places pressure on the U.S. Federal Reserve to withdraw monetary support to the economy.
• Consumer sentiment in the U.S. stayed at decade-low levels in November as surging inflation soured households’ views on both their own finances and the national economy. The final reading of the index of consumer sentiment came in at 67.4 in November, down from the 71.7 reading registered in October, showing a deterioration in consumer confidence over the month.
• Growth in the eurozone services sector slowed in October as the rebound from the summer reopening waned and renewed public health concerns weighed on demand. The final reading for the eurozone’s services PMI in October was 54.6, data from IHS Markit showed, although it is worth noting a read above 50 indicates continued expansion.
• Eurozone retail sales dropped unexpectedly in September as German shoppers stayed at home, preliminary Eurostat data showed. Most analysts had expected an increase of retail sales of around 0.3 percent from August.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.
70% Probability

A greater spread of vaccination rates outside of major developed economies along with newly developed treatments for COVID sufferers is expected to see a more synchronous economic growth story develop over the coming months. While the speed of the economic improvement is expected to be lumpy due to COVID cases increasing in the northern hemisphere along with continued supply chain disruptions, economic demand and activity is anticipated to remain at elevated levels.

Globally, central bankers will look to continue their accommodative policy stance, but markets will continue to question the sustainability of this level of support, as economies show growth and inflationary pressures build. This is likely to manifest itself with increased market volatility over the coming months. On the fiscal front governments have indicated they are willing and able to step up with spending to support their economies. Governments are expected to maintain stimulatory policies with an eye to sustain employment and wage growth, as well as supporting long-term social objectives such as carbon reduction and social inequality. Political wrangling over the size and make-up of such government spending, particularly in the U.S., is likely, and may create uncertainty and add to market volatility.

Risks remain. Those we view as most prominent include increased China and Australia/U.S. trade tensions, greater slowdown in the Chinese economy than is currently expected, faster than expected increases in government bond yields (due to inflationary pressures building), a further increase of COVID-cases across different regions pressuring health systems, continued high levels of supply chain disruptions and stimulus packages that underwhelm expectations.

This scenario is likely to see us maintain a constructive medium-term view on growth assets, using any volatility to increase exposure to growth assets. Capital preservation will be targeted through appropriate company and sector allocations. Overall asset allocation will retain a bias to growth assets.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.
15% Probability

Global consumer demand for goods and services falls further than expected as the expected pick up from pent up demand does not eventuate. Rather, the consumer remains apprehensive once the direct-to-consumer fiscal support from governments begin to wane. Additionally, supply chain issues remain as do inflationary pressures. There is also potential for new strains of the COVID virus to cause governments to increase lockdown measures, further supressing economic activity. In this environment we observe slowing growth while higher inflation levels place pressure on Central Banks to begin withdrawing monetary support.

This scenario may see central bank stimulus and fiscal support from governments as lacking the required potency to maintain economic support and provide further improvement in consumer confidence. Additionally, a premature withdrawal or reduction of central bank liquidity could derail financial markets which have become accustomed to liquidity support. Any failure of governments across the globe to extend or further stimulate their economies through fiscal spending would further erode confidence. This may cause consumer confidence and spending to fall as government support is not fully replaced with gainful employment income. Such a scenario would likely see a level of dislocation in financial markets across the spectrum.

An emerging risk is rising government bond yields. The disruption of supply chains and high input costs is expected to place upward pressure on bond yields, particularly if judged to be more sustainable. While considered unlikely, an unexpectedly swift acceleration of bond yields from current levels could see valuation compression in financial markets as well as adversely impacting economic activity. This would be more pronounced in high valuation stocks and company’s unable to exercise pricing power in such an environment.

Left-field events such as a rapid escalation in geo-political tensions (especially between the US and China) or a significant or systemic corporate default (especially due to over-indebtedness in an environment of rising bond yields) could see a liquidation of risk assets in a compressed period of time. This risk appears to be most acute in China following recent delays in scheduled bond payments from domestic property developers.

Above scenarios will see us take a more defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. The overall focus will remain on capital preservation.

Bull case

Our most optimistic view for markets over the coming months.

15% Probability

Economies across the developed world continue to exhibit strong economic growth. Substantial fiscal support from governments would combine with high cash levels on household and corporate balance sheets to sustain the speed of the global economic recovery. At the same time COVID case increases in the northern hemisphere fail to crimp the current upward trajectory of global economic growth as vaccination rates and medical therapeutic advancements limit the pressure on healthcare systems. In the event central banks maintain measures aimed at supressing interest rates, we would expect this to further fuel asset appreciation, while any extension of these accommodative policies would further accelerate the expected upward re-rating of asset values.

Such a market dynamic would see substantial improvement in economic activity globally, particularly in service-oriented businesses that will benefit from social re-opening. This would occur as pent-up demand from business and consumers combine with massive government and central bank stimulus measures to create a potent environment for risk assets. Sectors expected to benefit most in this environment are those leveraged most to economic activity, in many cases these are the same companies that were most adversely affected by the COVID-19 induced lock downs.

This scenario would be cheered by financial markets as the combination of monetary and fiscal stimulus act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by reducing our cash levels further and adding to the growth asset allocation at the expense of cash and other defensive assets.

Stock in Focus – Flight Centre

Investment Thesis

• Key reasons for the investment:
  • Re-opening beneficiary – Recent domestic government policy changes from a zero-case to vaccination target has provided a clearer window as to when travel domestically and internationally is likely to become more freely available. We view high pent up demand for business and leisure travel as strong tailwinds for FLT over the coming 12-24 months.
  • Strong balance sheet maintained – As at 30 June, 2021 FLT had total available liquidity of $941m and a net cash position of $440m. Despite an extremely challenging trading environment due to COVID restrictions the strength of the balance places FLT in good stead once restrictions ease.
  • Attractive competitive landscape – With COVID lockdowns decimating the travel industry we see a more consolidated industry once travel restrictions ease. This should allow FLT to take advantage of a lower competition environment and emerge with strong demand and higher margins. FLT has considerable brand strength in the domestic leisure travel market, extensive global growth opportunities across the corporate travel segment, strong cash generation, a strong balance sheet and historically attractive return on capital metrics

History

The Flight Centre Travel Group Limited (FLT) is one of the world’s largest travel groups with a vast leisure and corporate travel sales network that extends throughout four major regions:

1. Australia and New Zealand
2. The Americas, specifically the United States, Canada and Mexico
3. EMEA (the United Kingdom, South Africa, Ireland, the Netherlands, Germany, Denmark, Sweden, Norway, Finland and the United Arab Emirates); and
4. Asia (Greater China, India, Singapore and Malaysia)

Flight Centre’s journey began in the early 1970s when Graham ‘Skroo’ Turner and his friend Geoff ‘Spy’ Lomas created Top Deck from very basic building blocks – a sense of adventure, an eye on a growing business opportunity, and one double decker bus they called ‘Argus’.

The number of buses kept on increasing and by the early 80’s Skroo returned to Australia as the Top Deck Travel director. At the same time, the airlines were de-regulating and he saw the Australian travel market as “ripe for the picking”.

The first Flight Centre shop opened in Sydney in 1982 and the business rocketed in the mid-1990s, with Flight Centre listing on the Australian Securities Exchange in December 1995.

The float saw Flight Centre become the first travel agency group to list on the ASX. This bold move was hugely successful and saw the company’s share price close at $1.23 after the first day of trading.

By this stage, the cornerstones of the company’s future success were in place; a successful business model, ten core philosophies, and Flight Centre’s iconic branding have helped shape a global travel group that today is worth over $20 billion.

In addition to the flagship Flight Centre brand, FCTG’s other travel brands include:

• •  Student Flights
  • Travel Associates
  • Liberty Travel
  • Infinity Holidays
  • GOGO Vacations
  • FCM Travel Solutions
  • Corporate Traveller
  • Stage and Screen
  • cievents.

In addition, FLT’s global corporate travel management network, FCM Travel Solutions, extends to about 90 other countries through strategic licensing agreements with independent local operators.

The company has twice been judged Australia’s best employer, in addition to claiming a number of other employer and travel agency awards in Australia and overseas.