Market Outlook

Australian & International Property — Outlook

The sector looks to be past its cyclical worst, but investors may continue to remain wary of large parts of it (ex industrial) while there are still sporadic outbreaks of COVID-19 and while there is ongoing uncertainty over the longer-term damage done to central business district offices and to brick–and-mortar shops. As the latest (March quarter) National Australia Bank survey of commercial property showed, sentiment has continued to improve but remains negative overall. The very strong industrial sector, where sentiment has reached an all-time high, has not been enough to carry the whole asset class up with it: Sentiment still remains deeply negative (unsurprisingly) for CBD hotels but is also still strongly pessimistic for retail and office property. While industrial is forging ahead, with respondents picking rental and capital gains over the next two years, the survey found that rents and capital values are expected to continue to decline in both the office and retail sectors over the next couple of years. A return to something like normality is still down the track: The office sector is expected to be in better shape in two years’ time – “likely reflecting vaccine rollout and more workers returning to the office”, as the NAB commentary said – but, even two years out, the retail sector expects to still be struggling. It does not yet add up to a strong outlook for the asset class.

The same patterns can be seen overseas. In its latest (March quarter) Global Commercial Property Monitor, the Royal Institution of Chartered Surveyors, or RICS, found that the cycle is turning in favour of property. In December, 51% had reported that they were in a downturn: This time round, the proportion is down to 40%, while those saying they are in an upturn have increased to 36% from 26%. Sentiment has correspondingly improved, led by prime industrial, data centres, apartment blocks, aged care, and secondary industrial, but sentiment remains pessimistic in the other subsectors, particularly for secondary office property, secondary retail, and hotels. So far, the recovery is not broad-based, and a large majority of the markets surveyed by RICS (including the key U.S., U.K., German, French, and Japanese markets) expect both lower rentals and lower capital values over the next 12 months. Respondents were asked how long they think it will take for property to get back to pre-COVID-19 levels of income stream: Ex industrial (about one year) and prime office (two years). The typical answer for everything else was around a three-year time frame. While there have been some spectacular increases for some REITs oversold in the early days of COVID-19 – U.S. REITs specialising in shopping centres and regional malls have more than doubled over the past year – further progress looks like it will be a long haul.

Australasian Equities — Outlook

Australia’s business prospects are robust. The latest (April) National Australia Bank business survey found a “very strong result, with many aggregate indicators reaching new highs. Business conditions reset last month’s record high, with trading, profitability and employment all reaching fresh highs. Business confidence also set a new record and implies that conditions will remain strong in the near term”. Consumer confidence measures are also supportive. In the latest (early May) weekly ANZ / Roy Morgan consumer survey, 38% of families expect to be better off over the next year, versus only 14% expecting to be worse off. The percentage expecting worse times ahead for the economy over the next year (only 14%) was at the lowest level since October 2010. The latest official forecasts, in the May 11 budget, suggest that the economy is set for 4.25% growth in the year to June 2022 and that the unemployment rate will drop to 5% by June 2022 and to 4.75% by June 2023.

Recent equity gains are understandable against this backdrop. The banks will continue to write back the provisions they had originally made against COVID-19-related losses, which did not materialise to anything like the extent first imagined; the resources sector is in strong shape; and, as in many other countries (as the recent performance of the consumer discretionary sector shows), there is a burst of previously pent-up spending on its way. With monetary policy remaining very supportive, fiscal policy has also come to the party with a significantly more expansionary budget than had been expected from a coalition government: It contained a wide range of business- and consumer-friendly initiatives and pushed deficit repair out into the medium term. COVID-19 continues to spring unpleasant surprises, and previous ideas about early travel ‘bubbles’ have had to be revised, but with that proviso, the outlook appears to be favourable for further equity gains.

International Fixed Interest — Outlook

The big issue for the bond markets is the prospect of higher inflation. The latest data from the U.S., for example, showed that prices in April were up 4.2% on a year earlier. Most analysts agree that the April outcome exaggerates the scale of the issue: Prices this April were being compared with the unusually low prices of last April in the early days of COVID-19; there are still COVID-19-related supply shortages that are likely to ease; and there were some one-offs, notably a large rise in the price of second hand cars. All that said, bond markets worry that, because of some combination of a sustained period of ultra-easy monetary policy and a strong economic rebound from COVID-19, inflation may have moved to a permanently higher level.

The Philadelphia Fed, for example, has a long-standing survey of U.S. professional forecasters, dating back to 1968. Usefully, it includes forecasts for the Fed’s preferred measure of inflation (what’s happening to the prices of ‘core’ personal consumption items). In its latest survey, the survey found that this core measure is expected to be 2.3% this year, 2.0% in 2022, and 2.1% in 2023, or, in other words, monetary policy will have achieved its objective of a steady 2% or so. Inflation sustained at 2% or a bit more means that current bond yields would not maintain investors’ real (after inflation) purchasing power, even before tax, and would need, at a minimum, to have a 2 at the front. The Fed itself is unlikely to take any explicit near-term tightening action. More likely, the bond markets will make the running themselves and take bond yields higher.

Other countries are not in America’s situation, but even in places like the eurozone, where inflation has stayed stubbornly below the European Central Bank’s target, the tide may also be turning. The minutes of its latest (April) policy meeting said that “while the policy-relevant medium-term inflation outlook was broadly unchanged from the March meeting, risks to this outlook could be assessed as tilted to the upside”. Like the Fed, central banks like the ECB and the Bank of Japan are not likely to make any near-term changes in policy, but, as in the U.S., bond investors are likely to draw their own conclusions about the direction of bond yields in a rebounding global economy. Macroeconomic conditions are likely to remain a challenge for the asset class.

Investors will need to be wary of the capital loss potential from rising yields, but another issue is the poor reward for taking on credit risk. Bond yields may have moved a bit higher, but in absolute terms remain very low: The ongoing hunt for yield means that credit spreads have been driven to ever lower levels. At the better end of the credit-quality spectrum, for example, Amazon.com has just issued bonds that, for some maturities, were at a record low credit spread relative to U.S. Treasuries. At the weak end, as a recent article in The Wall Street Journal said, “Risky companies are selling junk bonds at a record pace, getting ultralow borrowing costs and increasingly loose borrowing terms … Borrowers have been able to demand such easy terms because money has flooded into the junk-debt market and particularly into the riskiest parts, where the likelihood of default is highest”. At some point a normalisation of credit premiums is likely to add to the challenge for the asset class.