March 2022 | Monthly View

What we liked

• Australian month-on-month retail sales rose by 1.8% for January, against 0.3% expected. This strong rebound is encouraging following a weaker than expected December, which was impacted by the spread of Omicron.
• Australian economy added 12,900 workers and the participation rate edged 0.1% higher to 66.2%. This positive read occurred despite an Omicron effected economy. This exhibits a strong underlying economy.
• The National Australia Bank business survey for January showed confidence rebounded 15 points to an index of plus three. Encouraging following a big drop in December when Omicron impacts where at their peak.
• America’s jobs recovery got an unexpected boost in January despite the Omicron variant spreading rapidly throughout the country. The economy added 467,000 jobs in January, significantly more than the 150,000 jobs expected. More encouragement came from the steep reduction in long-term unemployed, which fell by 317,000 from December.
• Economic activity in the U.S. services sector grew in January for the 20th month in a row, with the Services PMI registering a read of 59.9 (above 50 is expansionary). Services demand has been strong as mobility improves and COVID restrictions ease.
• US retail sales surged 3.8% to record highs in January as the Omicron wave peaked. The reading beat economist’s expectations of a 2%, showing the U.S. consumer remains resilient.
• In the euro area, the unemployment rate also declined for the eighth month in a row in December (to 7.0%, from 7.1% in November).
• Britain’s economy grew by 7.5% last year in the fastest annual growth rate since the second world war, despite falling back in December as the Omicron variant dented consumer spending, a stronger performance than the 0.6% expected.
• China’s consumer price index, measuring inflation, inched up 0.9% in January from a year earlier. Economists had expected a 1% rise following a 1.5% uptick in December. This is positive as it leaves room for further stimulatory monetary policy easing in.

What we didn’t

• Threats turn into a physical invasion of Ukraine by Russian military forces. Involvement of a military powerhouse in a region where many resources such as oil, gas, grains, and base metals are produced is expected to place further strain on an already stretched global supply chain.
• Potential for negative knock-on effects in Yemen (proxy war between Saudi Arabia and Iran) and China/Taiwan geo-political tensions from the current incursion into the Ukraine by Russia.
• The Westpac-Melbourne Institute Index of Consumer Sentiment falls by 1.3 per cent in February to 100.8 compared to 102.2 in January. Higher costs of staples like petrol and rent are largely responsible for the decrease, which occurred despite Omicron economic disruptions beginning to ease.
• Inflation in the US climbed to its highest level in 40 years in January, with prices rising by 7.5% from a year ago. While measurement of the rate of change in prices may be close to peaking in the short-term, it adds pressure on central banks to reduce monetary stimulus and begin raising rates.
• U.S. Federal Reserve officials set plans into motion at their February meeting to begin raising interest rates and shed the trillions of dollars in bonds on the central bank balance sheet. Concerns over the reduction in liquidity within the financial system are expected to increase volatility in parts of the financial markets.

Base Case

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

71% Probability

The speed of the economic activity improvement is expected to moderate from 2021’s stellar growth rate. Despite this global economic activity is expected to remain above average although lumpy as COVID along with continued supply chain disruptions.

Central banks in developed economies are expected to diminish their ultra-accommodative policy stance as economies improve and inflationary pressures build. This is likely to manifest itself with increased market volatility over the coming months. The exception to this appears to be China, who is expected to begin a more accommodative monetary policy stance to promote growth within their economy. 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.

Risks remain. Those we view as most prominent include increased Geopolitical tensions (U.S./China, Aust/China, Russia/Ukraine, China/Taiwan), greater slowdown in the global 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. Capital preservation will be targeted through appropriate company and sector allocations that benefit from the maturing of this business cycle. 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.

14% 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 and central banks begins to wane. Additionally, supply chain issues remain as do inflationary pressures. Geopolitical tensions could act to further increase commodity prices, further exacerbating inflationary pressures. This could leave central banks with conflicting signals. Essentially this means financial conditions are tightening while inflationary pressures remain elevated. This could see Central Banks beginning to withdraw monetary support at a time when the real economy cannot handle further tightening without crimping demand and economic activity.

An untimely 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.

Tightening financial conditions added to supply chains issues and high input costs would be expected to place upward pressure on bond yields, particularly if judged to be more sustainable. An acceleration of bond yields from current levels could see valuation compression in financial markets continue, 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.

Rapid escalation in geo-political tensions 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 within a compressed period.

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 with a reacceleration of economic activity. This would lead to a synchronous global growth environment, where economies that have lagged see accelerated 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 becomes endemic, resulting in mobility improvements and increased economic activity. 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 provide support for 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 improving financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels.

Stock in Focus – Macquarie Bank

Investment Thesis

• Key reasons for the purchase:
  • Value emerges – Recent earning upgrades for the company combined with its recent ~15% share price fall has seen valuations return to attractive levels.
  • Leveraged to Structural Tailwinds – MQG provides unique capabilities and track record in renewable energy advisory, development and management. Additionally, it provides access to private markets and alternative asset management, an area we expect to see continued strong growth in.
  • Strong Balance Sheet – MQG recently raised ~$1.5B at price levels close to their all-time high. This was well timed and provides the company with a high level of balance sheet flexibility, allowing them to make strategic acquisitions to add long-term value.

On 10 December 1969, Macquarie’s predecessor organisation, Hill Samuel Australia, opened its doors with three staff and an ambition to provide advisory and investment banking services of an international standard to the Australian market.

Today they are a global business operating in over 33 markets and with specialist expertise in areas such as resources, agriculture and commodities, energy, and infrastructure, with a particular knowledge of the Asia-Pacific region, with a market capitalisation close to $70 Billion.

The company operates through four segments: Macquarie Asset Management (MAM), Banking and Financial Services (BFS), Commodities and Global Markets (CGM), and Macquarie Capital.
The MAM segment provides investment solutions to clients across various capabilities, including infrastructure and renewables, real estate, agriculture, transportation finance, private credit, equities, fixed income, and multi-asset solutions.

The BFS segment offers personal banking products comprising home loans, credit cards, transaction and savings accounts, and vehicle finance; and wrap platform and cash management, financial advisory, private banking, and stockbroking services, as well as investment and superannuation products. It also provides deposit, lending, and payment solutions and services to business clients, such as sole practitioners to corporate professional firms.
The CGM segment offers products in the areas of equities, fixed income, foreign exchange, commodities and technology, media, and telecoms; risk and capital solutions; and specialized asset finance solutions.

The Macquarie Capital segment provides advisory and capital raising services. It is also involved in facilitation, and principal lending and investments; and trading of fixed income, equities, foreign exchange, and commodities, as well as provides broking services, corporate and structured finance, leasing services, capital raising and advisory services, and underwriting services; Further, the company engages in the distribution and management of funds and wealth management products.