Shane Oliver

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<p>EXPERT OBSERVER</p>

<p>After a 2.8% dip around mid-last year in response to the pandemic, average capital city home prices are rising again.</p>

<p><img alt="" height="649" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_1.jpg" width="1200"></p>

<p>Put simply - record low mortgage rates, multiple government home buyer incentives, government income support measures, pent up demand from the lockdowns, bank mortgage payment holidays, activity associated with a desire to “escape from the city” and an emerging element of FOMO (fear of missing out) have swamped the negative impact of higher unemployment, a collapse in immigration and weak rental markets in Sydney and Melbourne.</p>

<p>So, we are in yet another cyclical upswing in property prices. So, where to from here? But first to provide some perspective, there are seven key things worth bearing in mind regarding the Australian property market.</p>

<h2>First – it remains expensive</h2>

<p>According to the 2020 Demographia Housing Affordability Survey, the median multiple of house prices to income is 5.9 times in Australia versus 3.6 in the US and 4.5 in the UK. In Sydney, it’s 11 times and Melbourne is 9.5 times.</p>

<p>The ratios of house prices to incomes and rents versus their long-term averages are at the high end of OECD countries – all of which have low interest rates too! See the next chart.</p>

<p>The surge in prices relative to incomes has seen the ratio of household debt to income rise 5-fold over the last 30 years, taking it from the low end of OECD countries to the high end.</p>

<p><img alt="" height="748" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_2.jpg" width="1200"></p>

<h2>Second – house prices go up and down</h2>

<p>A common property myth is that prices only ever go up. But this is not so. Real Sydney house prices (ie, after inflation) fell 36% in 1934-35, 32% in 1937-41, 41% in 1942-43, 12% in 1947-48, 14% in 1951-53, 12% in 1961-62 and 22% in 1974-77. In nominal terms based on CoreLogic data, Sydney dwelling prices fell 25% in 1980-83, 10% in 1989-91, 8% in 2004-06, 7% in 2008-09, 3% in 2011-12, 3% in 2015-16 and 15% in 2017-19.</p>

<h2>Third – talk of mortgage stress remains overstated</h2>

<p>There is no denying housing affordability is poor, debt is high and some households are suffering significant mortgage stress. But most borrowers appear to be able to service their mortgages. The share by value of housing loans on bank payment holidays has collapsed from 11% in May to just 2.4% in December. And the collapse in mortgage rates – that has seen household interest payments as a share of income fall to their lowest since the mid-1980s – has helped.</p>

<p><img alt="" height="762" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_3.jpg" width="1200"></p>

<p>In the absence of an unexpected renewed economic downturn, it’s hard to see much rise in distressed sales. It’s also easy to see from this chart, when combined with home buyer incentives, why home borrowing and buying is surging again.</p>

<h2>Fourth – the Australian property market has been in a long-term bull market since the mid-1990s</h2>

<p>Looking back over the last 100 years, the first long term boom was in the 1920s and ended with the Depression and WW2. This was followed by the post war immigration boom that ended with high rates in the 1970s. The latest long-term boom started in the mid- 1990s. The key drivers of this boom have been easier access to debt and the shift from high to low interest rates (with mortgage rates dropping from around 17% in the late 1980s to around 2-4% now) which allowed Australians to pay each other more for property and from about 15 years ago a chronic undersupply of property. The latter can be seen in the next chart.</p>

<p><img alt="" height="701" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_4.jpg" width="1200"></p>

<p>Annual population growth surged from around 2005 but the supply of dwellings did not start to catch up until around 2015, which led to a chronic undersupply of housing. This combined with low interest rates and easier access to debt explains why Australian housing went from cheap to expensive and stayed there over the last 25 years. Other countries have had low rates and tax breaks for property but far cheaper property because it’s been better supplied.</p>

<h2>Fifth – we may be getter closer to the end of the long- term bull market in property</h2>

<p>It may still have a way to go, but the two key drivers of the long- term property boom may be getting close to the end. First, interest rates are at or close to the bottom with the RBA now resorting to extreme measures to get inflation back up – which should ultimately mean higher interest rates. Second, the chronic under supply of property may be starting to fade thanks to the unit building boom since 2015, the hit to immigration and home building incentives which are likely to keep home building high for the next 12 months. As evident in the last chart, supply is likely to remain strong this year and next, but population growth has collapsed &amp; could take years to recover. This may take some pressure off house prices on a 3-5 year view.</p>

<h2>Sixth – “escape from the city” will have a big impact</h2>

<p>The pandemic has seen a profound shift in how office workers do work. In particular, the work from home phenomenon is likely to remain, albeit not five days a week for all. This means less need to live close to work and a greater focus on lifestyle, which means greater demand for houses relative to units and in outer suburbs, smaller cities and regional areas.</p>

<h2>Finally – the national property market is highly diverse</h2>

<p>While it’s common to refer to “the Australian property market,” in reality there is significant divergence between cities. This was clearly evident over the last decade with Sydney and Melbourne booming up until 2017, Perth and Darwin falling sharply after the mining boom and the other capital cities and regional property generally seeing modest gains. See the next chart. Right now, Perth and Darwin are only just starting to recover and there is potential for Brisbane, Adelaide, Hobart, Canberra and regional dwelling prices to play catch up to Sydney and Melbourne. The surge in immigration played a big role in the outperformance of Sydney and Melbourne into 2017 and this is now going into reverse as other cities and regional centres are benefitting from the “escape from the city” phenomenon.</p>

<p><img alt="" height="636" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_5.jpg" width="1200"></p>

<p>The divergence is also evident in residential vacancy rates that have been rising in Sydney and Melbourne, reflecting increased unit supply and the collapse in immigration, but falling in other cities. This in turn points to upwards pressure on rents and property values in other cities relative to Sydney &amp; Melbourne.</p>

<p><img alt="" height="714" src="https://s3-ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/pictures/article-images/shane_oliver_chart_6.jpg" width="1200"></p>

<h2>So where to now for residential property prices?</h2>

<p>Australian home prices are likely to continue rising over the next two years thanks to record low mortgage rates and the recovery in the economy, with the latter offsetting the phasing down of income support measures and bank payment holidays. Housing finance is running around record levels and auction clearance rates are at levels consistent with strong price gains.</p>

<p>As a result, average capital city home prices are expected to rise by 5-10% this year and next. While first home buyer incentives are likely to be reduced, investor interest is expected to pick up and fill the gap.</p>

<p>However, the outlook is divergent. The hit to immigration is likely to constrain inner city Sydney and Melbourne as well as unit demand but outer suburban areas, houses, the smaller cities and regional property are all likely to see strong price gains helped along by the “escape from the city” phenomenon and less exposure to immigration. Expect average price gains of around 10% in Adelaide, Brisbane, Perth, Hobart, Canberra and Darwin in addition to regional areas.</p>

<p>The broader economy is unlikely to justify rate hikes until around 2023, but if the property market continues to hot up as expected, causing financial stability concerns for the RBA, a tightening in lending standards is likely next year which should start to slow things down and eventually the bottoming of the long-term interest rate cycle and the shift to oversupply may take pressure off prices, but that’s a while off yet.</p>

<p>Dr Shane Oliver<br>
Head of Investment Strategy and Chief Economist AMP Capital</p>

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After a 2.8% dip around mid-last year in response to the pandemic, average capital city home prices are rising again.

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Seven things to bear in mind about the Australian property market as prices swing upwards: Dr Shane Oliver

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<p>EXPERT INSIGHT</p>

<p>With the deepest recession since the end of World War 2, a sharp collapse in employment in April and May and a halving in underlying population based demand for housing (as a result of the hit to immigration) it might have been expected that 2020 would have been a pretty bad year for house prices. As its turned out though the property market held up pretty well and in recent months has started to accelerate again. It certainly turned out a lot stronger than I anticipated 6-9 months ago.</p>

<p align="left">Basically, the combination of reopening unleashing pent up demand, an avalanche of government incentives (including stamp duty concessions, various state support measures, HomeBuilder which has now been extended to March albeit at a reduced payment and an expansion of the First Home Loan Deposit Scheme), a further easing in lending standards on the way for early this year (with the removal of responsible lending obligations), record low mortgage rates, the desire to "escape from the city" helped along by ongoing bank payment holidays and Government income support measures averted a sharp fall in prices that would otherwise have followed from higher unemployment and underemployment, weak inner city rental markets and the hit to immigration and brought forward demand from first home buyers and owner occupiers. As a result property prices turned up far earlier than I had been expecting and there appears to be a bit of FOMO (or the “fear of missing out”) creeping into some markets – particularly outside of Melbourne and Sydney.</p>

<p align="left">At the current rate of increase average capital city dwelling prices will surpass their September 2017 record high by March, although this masks a wide divergence with: record highs already in Brisbane, Adelaide, Hobart and Canberra and in average regional home prices; Perth and Darwin remaining well down on their 2014 highs; and Sydney and Melbourne prices having been range bound since 2017.  </p>

<p align="left"><strong>Outlook</strong></p>

<p>Australian home prices are likely to continue to be boosted through 2021 by record low mortgage rates, government home buyer incentives, with the recovery in the economy expected to offset the phasing down of income support measures and bank payment holidays. As a result average home prices are expected to rise by around 5% through the year.</p>

<p align="left">However, the outlook is widely divergent across cities, within cities and across units versus houses.</p>

<p>The risks relate to: renewed coronavirus related lockdowns although so far new case numbers seem to be getting kept down and vaccines should help head off this risk entirely later in the year; higher unemployment and underemployment and distressed sales as government income and bank support measures wind down although the risk on this front are rapidly diminishing; falling rents and high vacancy rates in inner city Melbourne and Sydney weighing on investors; a 100,000 per annum reduction in underlying dwelling demand flowing from the hit to immigration; and a pandemic/work from home driven “escape to the suburbs and regions” that is weighing on inner city/unit prices but pushing up outer suburban/house and regional prices.</p>

<p>It remains hard to see that the reversal in net immigration from around 240,000 people per annum to an expected net outflow of people this financial year (of -70,000) and next (of -20,000) won’t have a significant impact. The surge in population growth of around 150,000 people per annum taking it to around 375,000 people per annum due to higher immigration from the middle of the 2000s was the main factor explaining very expensive Australian housing over the last 15 years as the property market became chronically undersupplied. The collapse in population growth which is likely to result in a halving in underlying demand for housing this financial year and next at the same time that governments are intent on supporting housing construction via various initiatives including HomeBuilder is likely to weigh on prices at some point as chronic undersupply gives way to oversupply in some areas. Particularly with rate cuts and incentives pulling demand forward and mortgage rate reductions reaching the end of the road. This is particularly likely to weigh on unit rents and prices along with investor demand in Sydney and Melbourne.</p>

<p><img alt="image008.png@01D6B106.AC24C7A0" data-image-whitelisted="" height="376" id="m_-6478027253593781169m_-4542295210685584014_x0000_i1028" src="https://mail.google.com/mail/u/0?ui=2&amp;ik=134db8e8c7&amp;attid=0.7&amp;permmsgid=msg-f:1687916156705272432&amp;th=176caecd330f7270&amp;view=fimg&amp;sz=s0-l75-ft&amp;attbid=ANGjdJ9FtgYIq5JXDH2F_FyDfWWj9C1o7lbrwJ0rLtJRxkUsCjYI8qllivVKe1pXjUSJNWDUdLouyLHVy7qTgDDiqkj4DCVMLXl-pTuQmmupxL23y3wHb3M12fQAooA&amp;disp=emb&amp;realattid=176caec726b25664d67" tabindex="0" width="620"></p>

<p><em>Source: ABS, AMP Capital</em></p>

<p align="left">Inner city Melbourne and Sydney are the most vulnerable to the hit to immigration, but this may not become fully apparent for another six months or so. Outer suburban areas and houses in these cities are likely to continue seeing solid price gains reflecting the “escape from the city” phenomenon against a backdrop of very low mortgage rates. On average Sydney and Melbourne price gains are likely to be modest at around 2 to 3% through 2021.</p>

<p align="left">Other cities and regional areas are likely to perform well reflecting lower levels of debt and less exposure to immigration and as such as likely to see rising average prices with record low mortgage rates dominating. Adelaide and Brisbane are playing catch up after years of underperformance compared to Sydney and Melbourne, Canberra is benefitting from strength in public sector employment and Perth and Darwin are starting to recover after bear markets ever since 2014 helped by the recovery in mining investment in WA. Expect average price gains of close to 10% in Adelaide, Brisbane, Perth, Darwin and regional areas and around 5 to 7% in Canberra and Hobart.</p>

<p align="left">The next chart puts the relative performance of the capital cities into perspective by focussing on rolling 5 year price gains. Basically, Sydney and Melbourne lead the longer term cycle and the other cities follow. Right now, Brisbane, Adelaide, Hobart and Canberra dwelling prices are playing catch up after underperforming Sydney and Melbourne through much of last decade and Perth and Darwin home prices are finally recovering from a multi-year bear market that went bust with the end of the mining investment boom. The surge in immigration played a big role in the outperformance of Sydney and Melbourne into 2017 and this is now going into reverse.</p>

<p align="left"><img data-image-whitelisted="" height="355" id="m_-6478027253593781169m_-4542295210685584014Picture_x0020_9" src="https://mail.google.com/mail/u/0?ui=2&amp;ik=134db8e8c7&amp;attid=0.8&amp;permmsgid=msg-f:1687916156705272432&amp;th=176caecd330f7270&amp;view=fimg&amp;sz=s0-l75-ft&amp;attbid=ANGjdJ_gH4A3QD-fRbFPZ5uL1acBi9UQclRFlZW5h5YkYBpGbsseFJmIcT8l9FO0gBY-fXqDo6QcHXR13csczrDC4G-2YcCyYnxgAhCDQLHlYLdwZt4SAXlNf5KFFwY&amp;disp=emb&amp;realattid=176caec726b3a898ee8" tabindex="0" width="545"></p>

<p align="left"><em>Source: CoreLogic, AMP Capital</em></p>

<p align="left">Outer suburban houses and dwellings in regional centres are likely to perform better than inner city units in most capital cities as a continuing trend to working from home and a greater focus on lifestyle dominates.</p>

<p><strong>SHANE OLIVER </strong><em>is the Head of Investment Strategy and Chief Economist at AMP Capital </em></p>
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At the current rate of increase average capital city dwelling prices will surpass their September 2017 record high by March

2020 property market far stronger than anticipated when the pandemic first hit: Shane Oliver

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<p>For some years now Modern Monetary Theory (MMT) has been gaining prominence as a solution to the perceived failure of traditional economic policies to achieve full employment and meet inflation targets, despite at or near zero interest rates.</p>
<p>MMT basically advocates using printed money from the central bank to directly finance government to spending, which boosts the economy. This concept is not new.</p>
<p>However, it has been given added impetus by the hit to economic activity from coronavirus. And with even Reserve Bank of Australia Governor Philip Lowe referring to it in question time after an address last week.</p>
<p>But can it help or is it just another fad like monetary targeting?</p>
<p><strong>MMT does provide some useful insights or reminders</strong></p>
<p>The experience over the last decade has highlighted the already well-known failings of the quantity theory of money.</p>
<p>Put simply there are different forms of money and its speed of circulation in the economy (or V) is not constant.</p>
<p>For example, quantitative easing (QE) led to an increase in the money supply in Europe, the US and Japan last decade but it was narrow money (like cash and bank reserves) not credit and the circulation of money through the economy slowed so there was not much, if any, increase in inflation.</p>
<p>MMT reminds us that, as long as there is spare capacity in the economy, using printed money to finance public spending should not be inflationary.</p>
<p>This is consistent with the experience of last decade which was characterised by spare capacity globally and taken together with a fall in the velocity of circulation of money in the economy explains why inflation did not take off despite QE boosting the money supply.</p>
<p>After all, using government spending to employ unemployed workers also has merit. In fact, it’s standard Keynesian economics.</p>
<p><strong>But what are the problems with MMT?</strong></p>
<p>While MMT provides some useful insights it has big problems:</p>
<p>First, it gives the impression there is always some sort of free lunch. That the central bank can just print money – like some sort of Magic Money Tree – and all economic problems can be solved. But as an old friend of mine used to repeatedly remind me, “you can’t make something out of nothing.” Of course, in the current environment of high unemployment and inflation below target, there perhaps is a bit of a free lunch if more government spending financed by money printing can result in full employment and boost inflation back to target.</p>
<p>But contrary to what some MMT supporters imply, the economy is not always in a position of spare capacity.</p>
<p>Second, the traditional concern about budget deficits and rising public debt is not always overblown. When the economy is strong, it can cause overheating as the competition for workers and funding can push up wages, prices and interest rates “crowding out” more productive private sector activity. Budget deficits and high public debt are not a problem now as there is spare capacity, economies are not overheating and interest rates are low but this won’t always be the case.</p>
<p>Third, MMT underestimates the costs and low productivity associated with large scale public employment programs. This has been evident in the failure of “work for the dole” schemes in Australia to make much headway. The more fundamental problem with MMT is that governments may have trouble turning off the monetary and fiscal stimulus when spare capacity is used up and inflation hots up.</p>
<p>Not only is it hard to get the timing right economically, but it’s compounded by politicians in government having an incentive to keep the stimulus going to get re-elected. Politicians risk becoming addicted to the flow of money from the central bank’s Magic Money Tree, resulting in wasteful government spending and eventually high inflation or hyperinflation.</p>
<p>And once the inflation genie gets out of the bottle, it’s hard to get it back in as we saw in the 1970s.</p>
<p>This is precisely why central banks are independent of politicians.</p>
<p>For now, spare capacity is massive which is keeping inflation is below target and so there is plenty of room for big budget deficits and this may remain the case for a while – so interest rates could remain low for several years.</p>
<p>But the combination of massive quantitative easing and fiscal spending along with increasing talk of MMT highlights that policy makers are increasingly focussed on taking more risks with inflation.</p>
<p>Ultimately the combination of ultra-easy monetary policy, huge budget deficits and a retreat from globalisation will add to the risk of an eventual pick-up in inflation - but at this stage this looks like something to be wary of on a five to ten-year horizon, but not right now.<span style="font-size: 12.16px;"> </span></p>
<p><strong>SHANE OLIVER</strong><span> |</span><em> Head of Investment Strategy and Chief Economist</em><span> | </span><em>AMP Capital</em></p>
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Policy-makers focussed on taking more risks with inflation: Shane Oliver

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<p>EXPERT OBSERVATION</p>
<p>The past week has seen a flurry of concerns about a “second wave” of coronavirus cases.</p>
<p>It started when US infectious disease expert Anthony Fauci warned the coronavirus outbreak is not over and media started to focus on more than 20 US states seeing a rising trend in new cases, and then over the weekend, China reported a cluster of cases in Beijing around a market.</p>
<p>Mass anti-racist protests have probably added to the renewed unease. (While there is no place whatsoever for racism, unfortunately in the current environment, large protests that gather people together increase the risk of the virus spreading). And even in Australia we have seen new clusters – mainly in Victoria – although the daily number of new cases remains around or below 20, so it’s not a major issue in Australia. See next chart.</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO1.png" alt=""></p>
<p>These second wave concerns have come at a time when share markets had become vulnerable to a pullback after huge rallies since the coronavirus panic low around 23rd March which had seen US shares gain 44% and Australian shares rise 35%. We discussed this last week in Shares climb a “wall of worry”. And so, shares have seen a 6 to 7% correction in the last week before recovering some of that decline in the last few days.</p>
<p>After major bear market lows associated with recessions its common for shares to surge higher, get very overbought, and then see a pullback on concerns about a “double dip” back into recession. The pullback then sees shares shake off some excesses which then allows the rising trend to resume. Second wave virus concerns and fears it may result in a renewed lockdown and double dip in economies looks to have triggered the pullback over the last week. But the question is whether it’s just a correction in a rising trend or will it turn into another big leg down in shares? A key determinant could be how serious any second wave is. This note looks briefly at the main issues.</p>
<p><strong>But first, where are we with coronavirus globally?</strong></p>
<p>While worries about coronavirus perked up over the last week, there has been little change to the broad trends in terms of coronavirus cases. New cases continue to trace out an uptrend globally, driven by emerging countries, but new cases in developed countries are well below their early April highs (and this played a big role in the rally in share markets since March).</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO2.png" alt=""></p>
<p><strong>What about a second wave in the US?</strong></p>
<p>The US is at greater risk than most other developed countries of a second wave because reopening started before a sharp downtrend in new cases had really taken hold and many US states moved ahead of the US Government’s own medical guidelines to reopening. Around 23 states are seeing an increase in new cases (with about half just seeing a continuation of the initial rising trend and the rest seeing “second waves”). However, there are several points to note. First the total number of new US cases on a daily basis has been relatively stable fluctuating in a range around 20,000 to 25,000 for a month now, with some states seeing falls and others rises – so there is nothing really new here.</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO3.png" alt=""></p>
<p>Basically, a rising trend in new cases in southern states (including Texas, Arizona and Florida) and to a lesser extent in western states, has over the last month offset a falling trend in the north east (led by New York) and the mid-west to result in a flat trend overall. And so far, the cities that saw big protests recently have not seen an increase in new cases.</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO4.png" alt=""></p>
<p>Second, the rise in cases in the south and west is partly due to an increase in testing with the positive test rate stable to slightly down over the last month in the US as a whole (although some states have seen an increase in positive test results including</p>
<p>Third, hospitalisations and new deaths have been trending down. This is not the case in all states (notably Texas and Arizona are on the rise in terms of hospitalisation) but overall it suggests less pressure on the health system. As can be seen in the next chart, daily deaths have been trending down both in the north east and in the rest of the US.</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO5.png" alt=""></p>
<p>Fourth, the lower level of deaths in the US (both in the northeast and the rest of the US) despite a flat trend in new cases, may reflect that the US has learned to better manage new cases and treatments to minimise hospitalisation and deaths. Note that we are seeing more reports of breakthroughs in the treatment of coronavirus and over 100 trials of vaccines around the world.</p>
<p>Finally, the hurdle for a renewed shutdown may now be greater with people suffering quarantine fatigue. A more targeted approach may be more likely (at least initially).</p>
<p>The bottom line is that it’s inevitable that some US states will see flare ups, but as long as hospitalisations stay manageable and deaths stay down a return to a broad-based lockdown threatening a double dip in economic activity in the US is low.</p>
<p>In the meantime, this week’s move by the Fed to start buying corporate bonds directly through its main street lending program (called the Secondary Market Corporate Credit Facility) has underpinned the degree of liquidity support for the US economy that wasn’t there when coronavirus first flared up.</p>
<p><strong>What about a second wave in China?</strong></p>
<p>Over the last three days China has reported an average of 50 new cases a day compared to an average of seven a day over the prior 30 days. Most of these have been linked to a Beijing market with the possibility that the virus may have been connected to salmon imported from Europe. In response several areas of Beijing have been locked down with schools closed and restrictions placed on people leaving the city. This could escalate into something serious. Then again, there has been several flare ups in China in the last three months that have been brought under control with very rigorous testing, tracing and quarantining, as has been the case in South Korea and various other countries including Australia.</p>
<p><img src="https://www.urban.com.au/images/2020/6/17/SO6.png" alt=""></p>
<p><strong>Concluding comment</strong></p>
<p>A serious second wave of coronavirus cases in major developed countries is the biggest risk facing equity markets, and one investors will need to watch closely. However, provided any second wave is relatively mild in terms of pressure on health systems and the number of deaths, its unlikely to reap the havoc seen back in March. Particularly, given the degree of government and central bank support now in place. The risk should be able to be minimised with lots of testing, tracking and quarantining. As such, our base case remains that the pullback in shares over the last week is part of a correction in a broader rising trend.</p>
<p><em><strong>Shane Oliver</strong> is the <span style="font-size: 12.16px;">Head of Investment Strategy and Chief Economist at AMP Capital</span></em></p>
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Investors could be hit hard by “second wave” of coronavirus: Shane Oliver

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<p>After a roughly 35% plunge from their February high point to their lows around 23 March on fears regarding of global recession on the back of the coronavirus shutdowns, share markets have since rebounded sharply, led by US shares.</p>
<p>The rally has pushed the Australian ASX 200 back through 6000 for the first time since March.</p>
<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%201.jpg" target="_blank">Click here</a> enlarge: </p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/6/10/share%20market%201.jpg" alt=""></p>
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<p><span>A common concern is that the rebound in share markets is </span><span>“too optimistic” and “irrational” – </span><span>how can share markets rebound so rapidly when economic conditions are so weak, coronavirus uncertainty remains high, the US is seeing civil unrest and US/China tensions are rising? </span></p>
<p><span>I must admit that I have also been surprised by the speed of the rebound and think maybe the markets are ahead of themselves. But I have seen this happen before and it reminds me of the quotation from the investor Sir </span><span>John Templeton “bull markets are born on </span><span>pessimism, grow on scepticism, mature on optimism and die of </span><span>euphoria” as this rally has occurr</span><span>ed against a lot of pessimism with shares climbing a wall of worry. </span></p>
<p><span>But as the quote reminds us, </span><span>that’s </span><span>what they often do. The plunge in shares into March led the coronavirus hit to activity &amp; fear of recession on the way down and in the process surprised many at the severity of the fall and now it</span><span>’</span><span>s led on the way up despite still lots of worries.</span></p>
<p><strong>Key drivers of the rally</strong></p>
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<p><span>So </span><span>what’s </span><span>driven the rally? In early April we listed </span><span>signposts </span><span>to watch as to whether shares have bottomed. The key signposts are updated in this table.</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%202.jpg" target="_blank">Click here</a> to enlarge: </p>
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<p><span>Virtually all of the signposts now tick off positively for developed countries. These are highlighted in green. So, put simply the rebound in shares has been driven by a combination of:<br></span></p>
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<li>Falling new coronavirus cases in developed countries.</li>
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<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%203.jpg" target="_blank">Click here </a>to enlarge: </p>
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<li>Positive news regarding anti-virals and vaccines.</li>
<li>The reopening of developed countries as lockdown measures have been eased. This includes Australia which has gone from mildly severe lockdown to intermediate.</li>
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<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%204.jpg" target="_blank">Click here</a> to enlarge: </p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/6/10/share%20market%204.jpg" alt=""></p>
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<li>Massive fiscal and monetary support measures which have swamped those seen in the GFC. This has helped preserve businesses, jobs and incomes preventing defaults. Low interest rates also help make shares attractive for investors.</li>
<li>Green shoots of recovery. With the progressive relaxation of lockdowns, timely measures of economic data such as consumer confidence, restaurant bookings, retail foot traffic, credit card data, mobility indexes and jobs data suggest that US and Australian economic activity bottomed in April. See the next chart. Global business conditions indicators often referred to as PMIs also started to turn up in May after a plunge into April. This follows a similar pattern in China.</li>
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<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%205.jpg" target="_blank">Click here </a>to enlarge: </p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/6/10/share%20market%205.jpg" alt=""></p>
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<li>Investors being pessimistic and underweight shares after the plunge in March. This has meant there has been more investors who can be motivated to buy shares than sell.</li>
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<p><span>These considerations have simply swamped concerns about civil unrest in the US (which now appears to be settling down anyway) and US-China tensions.</span></p>
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<p><strong>Confirmation from other markets</strong></p>
<p><span>It</span><span>’</span><span>s not just shares that have rebounded as the rally has been confirmed by other growth sensitive assets/yields. In particular:</span></p>
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<li>Oil and metal prices are up sharply from their lows.</li>
<li>Commodity currencies like the $A have rebounded at the same time that the safe haven US dollar has fallen.</li>
<li>Bond yield have lagged the upswing in share markets, but they have now started to rise, albeit they remain very low.</li>
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<p><strong>So why has the US share market led on the way up?</strong></p>
<p>The US share market has a relative high exposure to tech and health care stocks that have been key beneficiaries of the coronavirus shock, Amazon is now 55% of retail stocks’ market capitalisation and the US has also seen more money printing or QE by the Fed compared to other countries including Australia.</p>
<p>By contrast, non-US and Australian shares are more cyclical – but should start to benefit as the recovery continues.</p>
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<p><strong>Correction risk</strong></p>
<p><span>After huge rallies most shares are technically overbought which could mean we see a correction over the next few months. </span></p>
<p><span>But many shares in many share markets are at overbought extremes often seen in the aftermath of major bear market lows and this augurs well for returns on a 6-12 basis.</span></p>
<p><strong>But what about the slump in earnings?</strong></p>
<p><span>Earnings are taking a big hit from the impact to economic activity and this has seen earnings estimates slump and price to earnings multiples surge. This is clearly a concern but note a typical </span><span>“cyclical” </span><span>rebound in shares goes through three phases.</span></p>
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<li>Phase 1 sees an unwinding of cheap valuations helped by easy monetary conditions but with receding downside risks causing some investors to snap up undervalued shares. This is the phase where shares climb a “wall of worry”.</li>
<li>Phase 2 is driven by strengthening profits.</li>
<li>Phase 3 sees euphoria with very bullish investors pushing shares to extreme levels. This is despite shares becoming expensive and central banks raising interest rates.</li>
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<p>Right now, we are nearing the end of Phase 1. As economic conditions recover profits are likely to strengthen and we will move into Phase 2.</p>
<p>While PEs are now high, it’s noteworthy that the equity risk premium which can be crudely measured as the gap between earnings yields (using forward earnings) and bond yields is still reasonable reflecting ultra-low bond yields. But an improvement in earnings will be a key thing to watch for.</p>
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<p><a href="https://www.propertyobserver.com.au/images/2020/6/10/share%20market%206.jpg" target="_blank">Click here</a> to enlarge:</p>
<p><strong><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/6/10/share%20market%206.jpg" alt=""></strong></p>
<p><strong>What are the key risks? </strong></p>
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<p><span>The three big risks are: a second wave of coronavirus cases </span>(which should be able to be avoided with lots of testing, tracking and quarantining and even if it does occur may not have the same negative economic impact as any renewed lockdown is likely to be milder and deaths are likely to be lower given greater preparedness); collateral damage from the shutdowns resulting in a delayed or very slow recovery as bankruptcies surge and unemployment goes higher (so far so good – with government and central bank support hopefully heading this off); and risks around the US election (such as Trump ramping up tensions with China if he feels he has nothing to lose or investors fretting about higher taxes and more regulation under a Democrat victory across the Presidency, House and Senate).</p>
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<p><strong>Concluding comment</strong></p>
<p><span>Shares are vulnerable to a short-term consolidation or pullback. But if we are right and April was the low in economic conditions then shares are likely to be higher on a 6 to 12-month horizon.</span></p>
<p><span> The experience of the last few months highlights just how hard it is to time market bottoms </span><span>– </span><span>a good approach for long-term investors is to average in over several months after major falls.</span></p>
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<p><span>SHANE OLIVER </span><em>is the Head of Investment Strategy and Chief Economist at AMP Capital</em></p>
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Shares climb a “wall of worry” but is it sustainable? Shane Oliver 

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<p><strong>Introduction</strong></p>
<p><span>There has been much debate about the short-term economic and investment impact of coronavirus </span><span>– </span><span>on economic activity, unemployment, interest rates, house prices, shares, etc. However, the magnitude of the shock means it will have medium to longer-term implications as well. </span></p>
<p><span>Of course, there is a danger in placing too much weight on current circumstances in assessing the future. Given this, we need to be a bit cautious, but here are 10 medium to longer-term impacts.</span></p>
<p><strong>#1 Lower interest rates for even longer</strong></p>
<p><span>The hit to economic activity has been huge, resulting in a lot of </span><span>spare capacity that will take years to be used up. We don’t see </span><span>global and Australian economic activity getting back to pre- coronavirus levels until late next year or 2022.</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2020/5/25/covid%201.jpg" target="_blank">Click here</a> to enlarge: </p>
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<p><span>Unemployment will take even longer to fall </span><span>– </span><span>it tends to go up via the lifts and down via the stairs. This will mean low inflation or deflationary pressure for the next three years at least. Which will mean central banks will be biased towards low interest rates for several years which will keep bond yields ultra-low.</span></p>
<p><span>Another way of looking at this is that given the hit to economic activity, interest rates would normally fall a lot further. In the GFC the Australian cash rate was cut by 4.25%. But because </span>rates are already at or near zero, they can’t – so monetary easing is being achieved by quantitative easing. But an unconstrained cash rate for Australia would see it fall to around -3% not getting back to 0.25% until 2023 at the earliest.</p>
<p>In the meantime, it means several years of very low rates. It’s little wonder the RBA is targeting a 3-year bond yield of 0.25% and its low-cost funding rate for banks is also 0.25% for three years.</p>
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<p><span>Implications </span><span>- Low rates mean very low returns from bank deposits and ultimately bonds but they make higher yielding shares and assets like property and infrastructure relatively attractive to investors once the hit to earnings and rents passes.</span></p>
<p><strong>#2 A further blow to globalisation</strong></p>
<p><span>Recent years have seen a backlash against globalisation evident in the rise of Trump, Brexit and a backlash in some countries against immigration. The coronavirus disruption has added to this. </span></p>
<p><span>Worries about the supply of medical items have led to pressure for their domestic supply. This could move on to food security and looks to be morphing into a push to bring supply chains </span><span>“</span><span>back home</span><span>”</span><span>. Borders have been closed for health reasons and it is unclear when they will all reopen.</span></p>
<p><span>Implications </span><span>- While the outcome may simply be a diversification in reliance away from China to other emerging countries, the risk is that this all leads to reduced growth potential for the emerging world generally. </span></p>
<p><span>Longer term it could reduce productivity if supply chains are managed on other than economic grounds and could remove a key source of disinflationary pressure from the global economy.</span></p>
<p><strong>#3 Another leg up in the US/China “cold war”</strong></p>
<p><span>The trade war of 2018 and 2019 turned into a truce with the mini Phase One deal signed in January. However, with the coronavirus-driven shutdown, China is behind in its agreed purchases of US </span><span>goods. </span></p>
<p><span>What’s more</span><span>, President Trump now faces a difficult task in winning the November presidential election - US presidents have not been re-elected when there is a recession and rising unemployment. This has been made </span><span>worse by Trump’s inept handling of the </span><span>crisis. This has left Trump keen to shift the blame over the virus and China is an easy target. He has already made some threats on this front and imposed some minor sanctions on China.</span></p>
<p><span> At present </span><span>Trump’s approval rating </span><span>is around where it</span><span>’</span><span>s always been and is not weak enough for him to conclude that he has nothing to lose by taking big risks on this front (such as tearing up the trade deal and imposing more tariffs). But if his prospects start deteriorating dramatically, he may conclude that he has nothing to lose, particularly with 66% of Americans now having a negative view of China, up from 48% in 2018. The latter also suggests a Democrat president may also take a tough stance with China </span><span>– </span><span>although likely with more of a diplomatic focus. The point is that the US/China trade war risks ramping up.</span></p>
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<p><span>Implications </span><span>– </span><span>this could act as a negative for growth, work against multinationals and become a rising negative for shares. It also poses a threat to Australia but if Australia remains broadly neutral it may be minor (despite recent tensions around barley and beef) given that most Australian exports to China are for domestic use, not for reexport to the US.</span></p>
<p><strong>#4 Bigger government and bigger public debt</strong></p>
<p><span>The GFC brought an end to economic rationalism and support for smaller government and was associated with a leg up in public debt levels. Fading memories of the problems of too much government intervention added to this.</span></p>
<p><span> The coronavirus crisis has likely added to support for bigger government intervention in economies and the tolerance of higher levels of public debt.</span></p>
<p><span> Particularly given that it may have enhanced perceptions of inequality with well-paid white-collar workers being able to isolate and work at home whereas lower paid workers have been stood down or have to continue working in less safe conditions.</span></p>
<p><span> Safety regulations to ensure distancing will also add to business costs, although hopefully this will just be for the short term if a medical solution to coronavirus is found.</span></p>
<p><span>I</span><span>mplications </span><span>– </span><span>bigger government and aggressive measures to address inequality could reduce productivity growth and hence economic growth. Although it</span><span>’</span><span>s worth noting that if the Australia adopts a productivity enhancing agenda it may buck this trend.</span></p>
<p><strong>#5 Higher inflation with money printing</strong></p>
<p><span>While it</span><span>’</span><span>s hard to see inflation becoming an issue in the next three years, the combination of rising public debt, money printing and more protectionism risks a longer term pick-up in inflation to say above 4%, particularly if central banks </span><span>don’t </span><span>reverse easy money quickly once spare capacity is used up.</span></p>
<p><span>Implications </span><span>– </span><span>a resurgence in inflation to high levels would be bad for productivity and negative for assets that benefitted from </span><span>the “search for yield”. But it’s a </span><span>much longer-term issue.</span></p>
<p><strong>#6 Consumer and investor caution reinforced</strong></p>
<p><span>The GFC led to a wariness and a degree of investor caution on the part of households. This has been evident in around 50% of Australians nominating bank deposits and paying down debt as </span><span>the “wisest place” for their savings </span><span>compared to around 30% before the GFC, and scepticism of shares. </span>The coronavirus pandemic and its hit to incomes and job security has likely reinforced this.</p>
<p>Some even argue that the period of self- isolation will drive a rethink in terms of what’s important in life resulting in more mindful consumers focused on “do I really need it?” I am not so sure about the latter beyond the short term as people have short memories, but it is likely that household caution will remain, resulting in higher precautionary saving and more conservative investment strategies.</p>
<p><a href="https://www.propertyobserver.com.au/images/2020/5/25/covid%202.jpg" target="_blank">Click here </a>to enlarge:</p>
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<p><span>Implications </span><span>- this will weigh on discretionary retailers, banks and wealth managers.</span></p>
<p><strong>#7 Faster embrace of technology</strong></p>
<p><span>Self-isolation has dramatically accelerated the move to a digital world. Workers, consumers, businesses, schools, universities, health professionals, young &amp; old have been forced to embrace </span>new online ways of doing things. Many more have now embraced on-line retail, working from home &amp; virtual meetings.</p>
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<p><span>Implications </span><span>– </span><span>there are six big implications from this:<br></span><span>• </span><span>The challenge to traditional retailing has been ramped up dramatically putting more pressure on traditional retailers </span>and shopping centre owners to improve their offering.</p>
<p><span>• </span><span>Less office space demand </span><span>– </span><span>but this may be offset if more </span>space per person is needed in the absence of a vaccine. • A shift from cities to suburbs/regions – as the shutdown shows that a “sea or tree change” is viable for many.</p>
<p><span>• </span><span>This in turn may mean the beginning of the end for peak </span>hour traffic congestion (although it could spike in the short term as people prefer to drive as long as Covid is still a risk). • Virtual meetings may see less demand for business travel.</p>
<p><span>• </span><span>This is positive for IT tech stocks facilitating online activity.</span></p>
<p><strong>#8 Bad for airlines</strong></p>
<p><span>Which brings us to airlines. Less business demand for travel points to lasting damage. Some say the same may apply to tourists </span><span>– </span><span>but if a medical solution is found or the virus just dies out I suspect tourism will bounce back but based on the experience after 9/11 it may take a decade to fully recover.</span></p>
<p><span>Implications </span><span>– </span><span>airlines have already taken a big hit, but they are likely to be the slowest industry to recover.</span></p>
<p><strong>#9 Another test for the Eurozone?</strong></p>
<p><span>Slow progress towards providing support for Italy has led to renewed concerns that the Euro area may break up. Populist anti Euro leaders may get a boost from the crisis, particularly if there is a new wave of migrants from Libya. </span></p>
<p><span>However, Europe seems to be doing what it always does </span><span>– </span><span>gradually heading towards a solution with Germany agreeing with France for the common issuance of bonds and shifting in favour of fiscal stimulus. </span></p>
<p><span>The pressures to keep the Eurozone together (safety in numbers, a high degree of identification as Europeans, solid public support for the Euro, Germany benefitting from the EU and Germany</span><span>’s </span><span>huge exposure to Italian bonds via the ECB) remain far stronger than the forces pulling it apart.</span></p>
<p><span>Implications </span><span>– I wouldn’t bet on the Euro breaking apart.</span></p>
<p><strong>#10 Lower immigration</strong></p>
<p><span>This is already a reality in Australia with travel bans and since immigration normally accounts for around 1 percentage point of population growth in Australia its absence knocks up to 1% off economic growth. The issue is how long immigration remains low. </span></p>
<p><span>Australia would likely be a popular destination for migrants and students given its success in limiting coronavirus. And a rigorous testing/quarantine regime could allow both back sooner rather than later. That said I suspect while students will return faster, political pressures associated with higher unemployment will allow only a gradual recovery in immigration.</span></p>
<p><span>Implications </span><span>– </span><span>this is bad for home building &amp; home prices as the hit to immigration has cut underlying dwelling demand by 80,000pa. But I suspect it creeps back over the next five years.</span></p>
<p><strong>Concluding comments</strong></p>
<p><span>Several of these longer-term implications will constrain economic growth and hence potential investor returns </span><span>– </span><span>notably the reversal of globalisation, bigger government, consumer caution &amp; lower immigration. The faster embrace of technology will work in the other direction though to boost productivity and lower for longer interest rates are positive for growth assets.</span></p>
<p><span>Finally, a word of caution - anyone who got too negative for the long term in the last really major pandemic of 1918-19 might have </span><span>missed out entirely on the “Roaring Twenties!” </span><span>It</span><span>’</span><span>s much easier to think up negative things.</span> </p>
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<p><span><span>SHANE OLIVER</span> <em>is the Head of Investment Strategy and Chief Economist at AMP Capital</em></span></p>
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10 medium to longer-term implications from the coronavirus shock: Shane Oliver 

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<p>EXPERT OBSERVATION</p>
<p>As widely expected, at its May meeting the RBA made no further changes to monetary policy having undertaken a substantial easing in March via a cut in the cash rate to 0.25%, targeting the three year bond yield at 0.25% to be supported by quantitative easing and providing funding to the banks for three years at just 0.25%.</p>
<p>So right now and given the expected and still unfolding hit to the global and Australian economies from coronavirus related shutdowns the RBA is basically in a wait and see mode.</p>
<p>The Bank reiterated that it has scaled back the size of its bond purchases as the 3 year bond yield is around its target of 0.25% and as the functioning of the bond market has improved.</p>
<p>So far it has purchased around $50 billion of bonds but has indicated that it's prepared to scale them up again to do “whatever is necessary” to ensure functional bond markets and achieve the 3 year yield target.</p>
<p>It also announced a slight broadening in the range of corporate debt that it is prepared to accept as collateral as part of its open market operations.</p>
<p>RBA Governor Lowe restated the base case Australian economic forecasts that he first ran through in his 21<sup>st</sup>April speech.</p>
<p>These basically see a 10% hit to growth in the first half of the year with around a 6% decline in GDP for 2020 as a whole, followed by 6% growth next year, unemployment to peak at around 10% in coming months and still be above 7% by end 2021, and inflation going negative in the current quarter and remaining below 2% over the next few years.</p>
<p>These are fairly similar to our own forecasts and assume some easing in the lockdown in the months ahead. </p>
<p>The RBA repeated its commitment to do “what it can” to support jobs, incomes and businesses and affirmed that it will “not increase the cash rate until progress is made towards full employment and it is confident that inflation will be sustainably within the 2-3% target band.”</p>
<p>For those focussed on the RBA’s cash rate, the next few years are likely to be pretty boring.</p>
<p>The cash rate is at the RBA’s long stated lower bound and there is no value in taking it negative, so it won’t be cut any further.</p>
<p>And in the meantime, we are yet to see the full extent of the hit to the economy from the coronavirus related shutdowns and it will take several years to fully recover so a rate hike is years away.</p>
<p>We expect the cash rate to be stuck at 0.25% for at least the next three years.</p>
<p>The extraordinary monetary and fiscal policy response seen from March won’t stop the hit to the economy from the shutdowns and a sharp rise in unemployment, b<span style="font-size: 12.16px;">ut they should help minimise the fall out in terms of jobs, incomes and businesses such that we can recover more quickly once the virus is better controlled.</span></p>
<p><span><strong>Shane Oliver</strong> <em>is the Head of Investment Strategy and Chief Economist at AMP Capital</em></span></p>
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Cash rate to stay at 0.25% until at least 2023: Shane Oliver

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<div class="column"><strong>Expert Observation by Dr Shane Oliver, head of investment strategy and chief economist of AMP Capital</strong></div>
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<div class="column">As we’ve seen recently growth assets like shares have periods of bad short-term performance versus bonds &amp; cash. But they provide superior long-term returns which is essential to grow retirement savings. It makes sense for superannuation to have a high exposure to them. The best approach is to simply recognise that super and investing in shares is a long-term investment.</div>
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<p><span>This is an update of a note I wrote last November, but after the recent plunge in shares and the associated ten per cent or so loss in balanced growth superannuation funds through the March quarter, it</span><span>’</span><span>s particularly relevant now. When share markets plunge as they did into March the standard questions are: What caused the fall? W</span><span>hat’s the outlook? </span><span>And what does it mean for superannuation? The correct answer to the latter should be</span><span>“nothing really</span><span>, as super is a long-term investment and share </span><span>market volatility is normal.” </span><span>This may sound like marketing spin. But, except for those who are into trading or are close to or in retirement - shares and super really are long-term investments.</span></p>
<h2><span>Super funds, growth assets &amp; compound interest</span></h2>
<p><span>Superannuation is aimed (within reason) at providing maximum (risk-adjusted) funds for use in retirement. So typical Australian super funds have a bias towards shares and other growth assets that grow in value with the economy, particularly for younger members, and some exposure to defensive assets like bonds and cash to avoid excessive short-term volatility. These approaches aim to make the most of the power of compound interest which sees returns build on returns over time. The next chart shows the value of a $100 investment in Australian cash, bonds, shares and residential property from 1926 assuming any interest, dividends and rents is reinvested along the way.</span></p>
<p><span><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/14_1.jpg" alt="" width="460" height="276"></span></p>
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<p><span>As return series for commercial property and infrastructure only go back a few decades I have used residential property as a proxy. Over the period shown since 1926 cash has returned 5.4 per cent per annum, bonds 6.9 per cent pa, property 10.7 per cent pa and shares 10.9 per cent pa. Because shares and property provide higher returns over long periods the value of an investment in them compounds to a much higher amount over long periods. So, it makes sense to have a decent exposure to them when saving for retirement. The higher return from shares and growth assets reflects compensation for the greater risk in investing in them </span><span>– </span><span>in terms of capital loss, volatility and illiquidity.</span></p>
<h2>
<span>But </span><span>investors don’t have 90 years</span><span>?</span>
</h2>
<p><span>But while the above chart covered more than 90 years of returns, our natural tendency is to think very short term. Particularly so in times of uncertainty like now. And this is where the problem starts. On a day to day basis shares are down almost as much as they are up. See the next chart. So, day to day, it</span><span>’</span><span>s pretty much a coin toss as to whether you will get good news or bad on shares. But if you just look monthly and allow for dividends, the historical experience suggests you will only get bad news around a third of the time. If you go out to once a decade, positive returns have been seen 100 per cent of the time for Australian shares and 82 per cent for US shares. So while it</span><span>’</span><span>s hard given the bombardment of financial news these days it makes sense to look at your returns less because then you are more likely to get positive returns and less likely to make rash decisions based on short term bad news.</span></p>
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<p><span>This can also be demonstrated in the following charts. On a rolling 12 month ended basis the returns from shares bounce around all over the place compared to the relative stability of cash (and bonds). See the next chart.</span></p>
<p><span><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/14_3.jpg" alt="" width="456" height="269"></span></p>
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<p><span>However, over rolling ten-year periods, shares have invariably outperformed, although there have been some periods where returns from bonds and cash have done better, albeit briefly.</span></p>
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<p><span><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/14_4.jpg" alt="" width="455" height="260"></span></p>
<p><span>Pushing the horizon out to rolling 20-year returns has almost always seen shares do even better, although a surge in cash and bond returns from the 1970s/1980s has seen the gap narrow. Over rolling 40-year periods </span><span>– </span><span>the working years of a typical person </span><span>– </span><span>shares have always done better.</span></p>
<p><span><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/14_5.jpg" alt="" width="465" height="241"></span></p>
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<p><span>This is all consistent with the basic proposition that higher short- term volatility from shares - often reflecting exposure to periods of falling profits and a risk that companies go bust - is rewarded over the long term with higher returns.</span></p>
<h2><span>But why not try and time short-term market moves?</span></h2>
<p><span>The temptation to do this is immense. With the benefit of hindsight many swings in markets like the tech boom and bust, the GFC and maybe in the years ahead the current episode look inevitable and hence forecastable and so it</span><span>’</span><span>s natural to </span><span>think “why not give it a go?” </span><span>by switching between say cash and shares within your super to anticipate market moves. Fair enough if you have a process and put the effort in. But without a tried and tested market timing process, trying to time the market is difficult. A good way to demonstrate this is with a comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The next chart shows that if you were fully invested in Australian shares from January 1995, you would have returned 8.5 per cent pa (with dividends but not allowing for franking credits, tax and fees).</span></p>
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<p><span><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/14_6.jpg" alt="" width="469" height="295"></span></p>
<p><span>If by trying to time the market you avoided the 10 worst days (yellow bars), you would have boosted your return to 11.7 per cent pa. And if you avoided the 40 worst days, it would have been boosted to 17.1 per cent pa! But this is not easy as many investors only get out after the bad returns have occurred, just in time to miss some of the best days. For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 6.3 per cent pa. If you miss the 40 best days, it drops to just 1.9 per cent pa.</span></p>
<p>The following chart shows the difficulties of short-term timing in another way. It shows the cumulative return of two portfolios.</p>
<p style="padding-left: 30px;"><span>• </span><span>A fixed balanced mix of 70 per cent Australian equities, </span>25 per cent bonds and five per cent cash;</p>
<p style="padding-left: 30px;"><span>• </span><span>A </span><span>“switching </span><span>portfolio</span><span>” </span><span>which starts off with the above but </span>moves 100 per cent into cash after any negative calendar year in the balanced portfolio and doesn't move back until after the balanced portfolio has a calendar year of positive returns. We have assumed a two-month lag.</p>
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<p><span>Over the long run the switching portfolio produces an average return of 8.6 per cent pa versus 9.9 per cent pa for the balanced mix. From a $100 investment in 1928 the switching portfolio would have grown to $185,869 compared to $595,510 for the constant mix.</span></p>
<h2><span>Key messages</span></h2>
<p><span>First, while shares and other growth assets go through periods of short-term underperformance relative to bonds and cash, they provide superior returns over the long term. As such, it makes sense that superannuation has a high exposure to them.</span></p>
<p><span>Second, switching to cash after a bad patch is not the best strategy for maximising retirement savings and wealth over time as it locks in the loss with no hope of recovery.</span></p>
<p><span>Third, the less you look at your investments the less you will be disappointed. This reduces the chance of selling at the wrong time or adopting an overly cautious stance.</span></p>
<p><span>The best approach is to simply recognise that super and investing in shares is a long-term investment. The exceptions to this are if you are really into putting in the effort to getting short- term trading right and/or you are close to, or in, retirement.</span></p>
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Why super and growth assets like shares have to be seen as long-term investments: Shane Oliver

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<p><strong>Expert Observation by Dr Shane Oliver, head of investment strategy and chief economist at AMP Capital</strong></p>
<p>The Australian March quarter Consumer Price Index showed headline inflation rising by 0.3 per cent over the quarter with annual inflation up by 2.2 per cent which was higher than market expectations of a 0.2 per cent quarterly increase or 1.9 per cent over the year.<br> <br>The RBA’s preferred measure of “core” inflation, as measured by the “trimmed mean” index rose by 0.5 per cent or 1.8 per cent, also above market expectations of a 0.3 per cent increase or 1.6 per cent over the year.<br> <br>Usually the inflation data is a key component of the Reserve Bank’s policy deliberations but its importance has been reduced (for now) as the impacts of the coronavirus on the economy takes hold.<br> </p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/4/29/15_1.jpg" alt="" width="443" height="280"> </p>
<p>In a pre-coronavirus world, today’s inflation data would have given the Reserve Bank confidence that its low interest rate settings were making inroads into lifting inflation, with underlying inflation showing its strongest quarterly rise since early 2018.</p>
<p>However, this has all changed because from the impacts of COVID-19 and associated shutdowns to economic activity. Inflation is expected to go backwards in the near-term (i.e. deflation) from the impacts of the virus and low inflation could persist for a while if the economic recovery is slower than expected.</p>
<p>The key points from the March quarter inflation data are: </p>
<ul>
<li>The largest upside surprise was from higher food prices, from drought and bushfire impacts (bushfires increased transport costs for some fresh produce). The largest price rises were in fruit and vegetables (+6.0 per cent) and meat and seafood (+2.05). Covid-19 panic buying was evident towards the end of March for products like rice and pasta which lifted the prices for these items.<br><br>
</li>
<li>Tobacco prices rose by 2 per cent from the tobacco tax excise increase. <br><br>
</li>
<li>There were less signs of discounting in the March quarter in clothing &amp; footwear but this is likely to be reversed in the June quarter as stores try to increase sales in the current environment.<br><br>
</li>
<li>The early signs of Covid-19 impacts were evident in higher prices for non-durable household products (up by 3.4 per cent) with rises for things like toilet paper, soap, hand sanitiser. Most of these increases are unlikely to be sustained as the surge in demand for such items has simply brought spending on them forward.<br><br>
</li>
<li>Health costs rose (+1.7 per cent) due to the way the Pharmaceutical Benefits Scheme works, which usually see seasonal rises in prices for pharmaceutical products and in medical and hospital services in the March quarter.<br><br>
</li>
<li>A large fall in fuel prices (-6 per cent) from a lower oil price reduced transport costs. Expect even lower fuel prices in the June quarter given the collapse in the oil price over recent weeks.<br><br>
</li>
<li>Recreation prices fell by 1.7 per cent (mainly due to holiday travel and accommodation) which is a usual seasonal effect after the peak holiday period in the prior quarter. There were no signs of Covid-19 impacting travel prices because the social distancing restrictions only came into effect in late March and also because the ABS would have measured the cost of travel done in March at the time it was booked which wouldn’t give enough time for price discounts to be evident.<br><br>
</li>
<li>Education prices rose by 2.6 per cent from the usual rises in school feels in the March quarter.<br><br>
</li>
<li>Insurance and financial services prices were up by 0.7 per cent over the quarter.</li>
</ul>
<p> </p>
<p><strong>Implications</strong></p>
<p>Looking ahead, June inflation is expected to be negative in Australia, possibly as weak as -2 per cent quarter on quarter or -0.5 per cent year on year which would be the biggest fall in annual consumer prices since a 1.3 per cent decline over the year to the June quarter in 1962.</p>
<p>Petrol prices (in Australia) are already down by around 35 per cent compared to the March quarter, childcare prices will fall sharply as a result of the Government subsidy up until the end of June, rents are declining, many government charges are seeing price freezes or rebates, some non-government education providers are providing discounts, communication costs will decline due to providers offering larger internet plans with no extra costs (recorded as a price fall by the ABS), finance and insurance costs are being cut and retailers are discounting in areas of weak demand.</p>
<p>While there might be some offset from higher food prices given supply constraints, below-capacity economic activity and much higher unemployment will likely keep inflation weak and well below target for several years.Inflationary pressures could rise once economic activity recovers, spare capacity is used up and unemployment falls below full employment levels helped by significant monetary and fiscal stimulus, but this is unlikely to be the case until sometime after 2022. As a result the RBA’s cash rate is likely to be stuck at 0.25 per cent for the next three years at least.</p>
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March quarter inflation higher than expected but irrelevant given the Covid-19 disruption: Shane Oliver

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<p><strong>EXPERT OBSERVATION </strong></p>
<p>Australian capital city dwelling prices rose 2% in November according to CoreLogic. This was their strongest monthly increase since September 2003.</p>
<p>After a 10.2% decline over 21 months, average prices have now had their fifth rise in a row. Capital city dwelling prices are now up 0.4% from a year ago.</p>
<p>Sydney dwelling prices surged 2.7% and Melbourne prices rose another 2.2%. This is the sixth gain in a row for both cities. </p>
<p>As a result Sydney prices have now risen 8.2% from their May low and have recovered 46.5% of the fall since their 2017 high. </p>
<p>Melbourne prices have now risen 8.3% from their May low and have now recovered 66.6% of the fall since their 2017 high.</p>
<p>Just as house prices fell faster than unit prices on the way down they are now rising faster.</p>
<p>Price gains are continuing to gather pace and are broadening out from Sydney and Melbourne with Brisbane up 0.8%, Adelaide up 0.5%, Canberra up 1.6%, Hobart up 2.3% and even Perth up 0.4% (where prices had a 21.6% from their 2014 high). Darwin prices fell 1.2%.</p>
<p><em><a href="https://www.propertyobserver.com.au/images/2019/12/2/price%201.png" target="_blank">Click here </a>to enlarge:</em></p>
<p><img src="https://www.urban.com.au/images/2019/12/2/price%201.png" alt=""> </p>
<p><em>Source: CoreLogic, AMP Capital</em></p>
<p>The Australian property market – particularly Melbourne and Sydney – has gone from boom and FOMO in 2017 to slump and FONGO last year and now looks like its heading back to boom again with FOMO returning! (FOMO = fear of missing out, FONGO = fear of not getting out.)</p>
<p><span>The boost from the election result, RBA rate cuts and the relaxation of the 7% mortgage rate serviceability test are continuing to drive a surge in home prices as demand that was pent up over the period of falling prices between September 2017 and June this year has been unleashed. </span></p>
<p><span>The rebound in demand continues to be evident in strong auction clearance rates in Sydney and Melbourne. See the next two charts.</span></p>
<p><em><a href="https://www.propertyobserver.com.au/images/2019/12/2/price%202.png" target="_blank">Click here</a> to enlarge:</em></p>
<p><span><img src="https://www.urban.com.au/images/2019/12/2/price%202.png" alt=""></span></p>
<p><em><a href="https://www.propertyobserver.com.au/images/2019/12/2/price%203.png" target="_blank" style="font-size: 12.16px;">Click here </a><span style="font-size: 12.16px;">to enlarge: </span></em></p>
<p><span><img src="https://www.urban.com.au/images/2019/12/2/price%203.png" alt=""> </span></p>
<p><em>Source: Domain, CoreLogic, AMP Capital</em></p>
<p><span><span>While this initially came on very low volumes, listings have now picked up following the normal pattern that sees clearances lead volumes. </span></span></p>
<p><span><span>As a result sales at auctions are now running 70 to 80% up on year ago levels.</span></span></p>
<p><em><a href="https://www.propertyobserver.com.au/images/2019/12/2/price%204.png" target="_blank">Click here</a> to enlarge: </em></p>
<p> <img src="https://www.urban.com.au/images/2019/12/2/price%204.png" alt=""></p>
<p><em>Source: Domain, AMP Capital </em></p>
<p>The high level of auction clearance rates points to a continuing rebound in home prices in Sydney and Melbourne into early 2020. Based on past relationships the current level of clearances points to annual house price growth of 10 to 15% over the next six to 12 months. In fact over the last four months annualised price growth in Sydney and Melbourne has been running at 23%.</p>
<p>Our base case remains that after an initial bounce house price gains will be more constrained than what we saw through the 2012-17 property price boom.</p>
<p>Compared to past recovery cycles household debt to income ratios are much higher, bank lending standards are much tighter, there are still more units to hit the Sydney and Melbourne property markets and unemployment is likely to drift up as overall economic growth remains weak. This should see property price gains slow to a more moderate pace of say around 5% per annum once the initial rebound runs its course.</p>
<p>However, this looks unlikely to occur until around April-June next year by which time property prices will have surpassed their 2017 highs in Melbourne and Sydney (by around February and May respectively on our estimates).</p>
<p>For 2020 as a whole average capital city property prices are expected to rise by around 10%, with continuing strong gains in the first quarter giving way to a more constrained pace from around April-June. </p>
<p>However, the rapid rebound in Sydney and Melbourne property prices since mid-year poses the risk that we will see much stronger gains for longer as price gains feed on themselves attracting more buyers back into the market who fear that they will miss out. </p>
<p>The extent of the rebound in the last few months also highlights ongoing issues around the undersupply of housing relative to strong population driven demand.</p>
<p>There are three key things to watch going forward:</p>
<ul type="disc">
<li>First, if auction clearances remain elevated as listings continue to pick up into next year then it will be a “positive” sign that the pick-up in the property market has more to go. So far this has been happening.</li>
<li>Second, housing finance commitments – recent months have shown an upswing and this will need to pick up a lot further for rapid price gains in Sydney and Melbourne to be sustained. Total credit is less relevant as it reflects both the flow of new lending and the flow of repayments, with the latter having been strong in recent times as existing borrowers focus on paying down debt in the face of economic uncertainty.</li>
<li>Finally, unemployment will be critical. If it picks up significantly in response to slow economic growth then it will be a big constraint on house prices and could result in forced property sales and another leg down in property prices. A sharp rise in unemployment is not our base case but is the key downside risk in terms of the property outlook. But we do see weak economic growth and an upwards drift in unemployment ultimately constraining property prices gains.  </li>
</ul>
<p>A big issue remains whether the rebound in the Sydney and Melbourne property markets will present a problem for the RBA in terms of further easing whether by rate cuts, quantitative easing or both. This will no doubt cause some consternation at the Bank. But as we saw over the 2012-17 period the RBA will do what it believes is right for the “average” of Australia as opposed to a couple of cities.  </p>
<p>However, it may have to return to tighter regulatory controls again if housing credit growth starts to get out of hand again.</p>
<p>In other words, we don’t see the rebound in the Sydney and Melbourne property markets as a barrier to further monetary easing, but if it continues to gather pace leading to a rebound in credit growth to levels that causes the RBA to worry about financial stability then expect a new tightening of the screws from bank regulators.</p>
<p>With housing credit currently benign at 3% year on year any such tightening looks at least six months away.</p>
<p><em><strong>Shane Oliver</strong> is Head of Investment Strategy and Chief Economist AMP Capital.</em></p>
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