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Macroeconomic Update - September Quarter

26 November 2020

Over the past few months, news headlines have been dominated by daily pandemic updates, political scandals and the US presidential election. Uncertainty remains, as investors continue to sit on a seesaw of positive and negative updates.

In the current low yield environment, interest from term deposits, distributions from managed funds and dividends from equities have been significantly reduced, and are likely to remain so for the foreseeable future. Investors are faced with the conundrum of increasing their exposure to growth investments or potentially have negative real rates returns on their defensive investments, with term deposit rates now well below 1.00%.

There is a large range of possible outcomes. Investors need to remain cognisant that there are risks in the market and diversification is the key to providing protection throughout periods of heightened uncertainty

Reasons for Caution

  • New coronavirus cases continue to rise across Europe, prompting countries to implement new restrictions. The UK increased the number of cities under the highest tier restrictions, while Germany and France announced heightened restrictions to prevent an uncontrolled outbreak.
  • The absence of an available vaccine and closed international borders is preventing any substantial increase in business or consumer confidence.
  • Although the European economy expanded by a record 12.7% in the September quarter (following the 9.4% contraction in the June quarter) the economic data showed signs of softening in September.
  • US uncertainty remains with the presidential election still subject to legal challenges and concerns about the smooth transition of power, although there has been some progress on this in Washington this week.
  • We have witnessed glimpses of escalation in US - China tensions. 
  • Australia entered recession for the first time in 29 years. Gross domestic product for the three months ended 30 June was at -7.0%.
  • Australia-China relations, which were already fraying, deteriorated further in November when Chinese authorities ordered traders to stop purchasing certain Australian commodities.

Reasons for Optimism

  • Global share markets were higher in the September quarter, with expectations that supportive government and central bank policy will drive the global recovery. This has continued into November, with the likelihood of a record monthly return for the ASX being achieved.
  • The US Federal Reserve adopted a flexible inflation target, aiming to achieve an average 2.0% inflation over time. 
  • US GDP expanded 33.1% in the September quarter however, more importantly, the economy is still 3.5% smaller than it was in December 2019.
  • There is growing evidence the post-coronavirus recovery in China is gathering momentum. August saw Chinese factory output expand at its fastest pace in almost a decade. The Chinese economy expanded 3.2% in the 12 months to 30 June.
  • The Reserve Bank of Australia continued its accommodative policy by expanding its Term Funding Facility for banks from $90 billion to $200 billion and extended the facility’s availability to the end of June 2021. This will encourage banks to lend to small and medium sized businesses.
  • Australian shares benefitted from a series of better than expected earnings results and an unexpected drop in the unemployment rate from 7.5% in July to 6.8% in August.
  • With a string of zero daily cases, the Victorian Premier Daniel Andrews announced an easing of restrictions, including the removal of the 25km ‘ring of steel’ around Melbourne and a further relaxing of rules around social gatherings and businesses.

Going Forward

Although the final result of the US presidential election is still not confirmed, it is increasingly probable that the outcome will be a Biden presidency with Republicans maintaining control of the Senate. From early indications, markets appear to be celebrating the potential for a divided government, tempering the chances for more aggressive policies by either party which hopefully leads to an environment of more compromise.

The absence of a readily available vaccine coupled with the onset of winter in the northern hemisphere could heighten the effects of a second wave of coronavirus infections. There have been some recent vaccine developments which look to be very encouraging.

The Australian economic recovery is likely to be uneven and continues to suffer from the drag of the international border closures. The potential loosening of coronavirus containment measures and extensive ongoing fiscal and monetary policy support, places Australia in a strong position relative to other countries.

Markets are unpredictable, but having the right strategy that takes into consideration a range of possible scenarios will assist in generating more consistent outcomes for portfolios over the long term

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