An Update from our Director of Financial Planning – Matthew Tuton
Lockdown! A bump in the road…
▪ Industry experts expect that the Sydney lockdown to be a short-term speed bump for economic growth. As we have seen during other lockdown periods, growth has tended to bounce back sharply once social restrictions are lifted with the equity market all but looking through these economic interruptions.
▪ The impact on economic growth will depend on a number of factors including the length of the lockdown, the size of policy support and whether other parts of Australia can avoid further outbreaks at the same time as the current Sydney lockdown.
▪ Industry experts estimate that 2Q21 GDP will suffer a small hit (~0.2%q/q) from the late May 2-week lockdown in Melbourne, the beginning of Sydney’s restrictions and short lockdowns from late June in other regions. However, lockdowns in 3Q21 are likely to reduce GDP by ~1.0% translating into flat growth for the quarter, before bouncing back in 4Q21.
▪ Consumer spending will be the major drag on activity but, is likely to be more resilient compared to the national lockdown in 2020 given business and households are now better prepared for these economic sudden stops and fiscal support will help cushion the blow.
▪ Markets have become increasingly adept at looking through activity shutdowns and we do not expect the current lockdown to cause any lasting damage. In fact, equities have been a positive beneficiary of pandemic outcomes, supported by ever lower rates, market consolidation (strong taking over the weak), a rapid build-up in savings and elevated confidence driving strong flows into risk assets.
The Sydney lockdown has just been extended until at least July 30 and the risk of prolonged government restrictions has increased significantly as COVID-19 case numbers have accelerated. Currently it appears that Australia is likely to maintain an eradication strategy until vaccination rates are significantly higher. While vaccination rates amongst older, most vulnerable, age groups are already higher than 70% and continuing to increase, currently only 10% of Australians aged 16+ are fully vaccinated (one-third have had at least one). Industry experts currently estimate that a vaccination rate of 70-80% among 16+ year olds should be achievable by November, provided there is demand. In the meantime, the Sydney lockdown will weigh on economic outcomes.
Hit to near-term growth, how big is highly uncertain
Short lockdowns have to date only had transitory impacts on regional and the national economy. Recent lockdowns across Melbourne and Sydney are expected to weigh on Q2 GDP, with Industry experts revising its forecast to 0.8% q/q (versus previous expectation of 1.1% q/q). Assuming that the current NSW lockdown lasts for ~7 weeks, Industry experts expect output to barely increase in Q3 before bouncing back sharply in 4Q21. However, this is subject to both upside and downside risk. Upside risk from more resilient consumer spending than anticipated versus the clear downside risk of a longer lockdown and/or further outbreaks. A more prolonged Sydney outbreak and/or lockdowns elsewhere in Australia would see weaker forecasts for GDP.
It’s expected that the decline in the unemployment rate will temporarily slow (or even pause). The lockdown is anticipated to have a larger impact on hours worked than employment and mobility restrictions will most likely see a temporary drop in labour force participation. Difficulties in finding labour pre-lockdown and government assistance to businesses being tied to maintaining headcount provides confidence that declines in employment should be contained and relatively transitory.
It’s also expected that the decline in the unemployment rate will temporarily slow (or even pause). The lockdown is anticipated to have a larger impact on hours worked than employment and mobility restrictions will most likely see a temporary drop in labour force participation. Difficulties in finding labour pre-lockdown and government assistance to businesses being tied to maintaining headcount provides confidence that declines in employment should be contained and relatively transitory.
Policy support limits economic scarring
The announcement by the Federal and NSW state government of additional fiscal support will assist in limiting the risk of significant economic scarring. Policy support will remain crucial until the economic recovery becomes self-sustaining and the health crisis is under control. Industry experts remain confident that more support will come if conditions dictate.
This support applies to monetary policy as well. At the beginning of the month, the RBA announced its intention to taper its bond buying program to $4bn a week (from $5bn a week) when the current program expires in September. At the same time and in line with expectations, the RBA kept the yield curve target at 10bps for the April 2024 bond, rather than extend the maturity out to the November 2024 bond. This maintains the strong forward guidance of the cash rate being on hold for at least 18-24 months. However, as we have seen from previous policy adjustments, policy makers remain willing to adapt policy settings as the health crisis and the economic recovery evolves.
Consumer spending to be more resilient this time around
Greater Sydney directly accounts for one-quarter of Australia’s GDP and 22% of employment. Government restrictions associated with lockdowns clearly dampen economic activity. The greatest impact on economic growth is likely to be via consumer spending.
Mobility data clearly shows the sharp fall in NSW to date as day-to-day movement is curtailed. A high share of consumer spending is on services – hospitality, personal services, leisure and obviously travel – and these areas bore the brunt of the fall in spending in the lockdown in 2Q20. Large falls were also recorded in clothing & footwear as well as vehicle purchases & operation. However, this time around we expect consumer spending to be more resilient because:
- Consumers and businesses will transition to online spending more seamlessly given the experience of last year.
- Government restrictions are not as tight. Health services (including elective surgeries) remain open as well as do a wider range of retail stores in contrast to the lockdown in 2020.
- The very sharp fall in spending on transport services, and to a lesser extent accommodation, can’t be replicated as compared to pre-COVID, spending has not yet recovered.
In contrast, we do not expect a repeat of the strength in household goods, tools & appliance spending as we saw a year ago since most households are well prepared for the return of home-schooling and working from home.
What does this mean for equities?
We don’t expect to see any lasting damage to the equity market, which has successfully looked through prior activity shutdowns. In fact, one might argue that the pandemic has been a positive driver for risk assets and in particular the equity market.
With financial conditions remaining supportive and global markets continuing to recover, high savings levels and elevated confidence mean equity inflows are strong. As the chart above illustrates, the Australian market has at worst, paused during shut down periods.
In addition, the distinction between winners and losers from COVID-19 continues to fade, despite bouts of volatility. There is already evidence that with each lock-down, the initial price action is less severe, and the time taken for prices to recover is becoming shorter.
Long-term investors need to look through the noise and focus on those sectors that will benefit as the cycle continues to mature. We see no reason to move portfolios more to a more defensive position and believe that an overweight in equities versus bonds would suit long-term investments.
* This paper contains general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider if it is appropriate for you. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. Past performance is not a reliable indicator of future performance. You should consider all factors and risks before making a decision.
*Reference ‘Macquarie Investment Strategy Update’ 15th July 2021
Director of Financial Planning