A VIEW FROM THE TOP END

Markets:

Following a two-week pullback at the end of February, the markets have been relatively sideways. The Federal Reserve in the US had their monthly meeting and reiterated that interest rates would stay lower for longer. With this message being digested, inflation fears are still permeating. Central bankers see inflation being transient, while markets are pricing broad inflation that will need to be addressed. Looking back at history, after the Global Financial Crisis, inflation fears proved to be overstated and we spent the last half of the decade attempting to stimulate inflation. No one ever said markets were rational. By the numbers, the ASX returned 0.40% the past two weeks, the SP500 was 2.04% as the rotation to value continues and the Nasdaq was down 1.24%. On the ASX, tech (-5.99%), healthcare (-3.98%) and materials (includes mining, -1.08%) fared the worst, while financials (led by the Banks, +3.01%), industrials (+2.33%) and consumer discretionary (+2.07%) sectors were positive.

China 5yr Plan (14th Edition):

A little over a week ago the 14th five-year plan (“FYP”) was officially announced in China. The list of policy targets reflects the Chinese leaderships mindset for structural change within the country on their path to becoming a modern developed economy by 2035. The release of the FYP marks one of the most important document releases of the year for markets. Original publications are over 1,400 pages and contain a wealth of information on where Asia’s dragon is focusing its energy and resources. We summarise what we feel are the key takeaways below for your information:

• GDP:No firm target set, which will allow greater fluctuations. Market consensus is still 6%+ for China, despite the lack of a formal target. The previous plan targeted 6.5% GDP growth and saw numerous fudging of the numbers in the final year to come close. Moving forward Chinese officials are signalling that not all growth is desired growth for the economy, and they are looking to boost domestic household consumption instead of piling into real estate or looking to export focused manufacturing. For context, the US is ~70% consumption/services compared to China at 54.5%.





• Urbanisation: The Chinese economy will be focused on unemployment figures for the first time in a five-year plan. This is a new target that will drive monetary policy (less than 5.5% unemployment in urban areas), such as it does in western economies. For instance, in Australia the RBA has a mandate for employment and stable prices, and it fulfils that mandate by controlling interest rates. The Chinese are likely to use similar mechanisms in the future to run their own economy.


• Share of Digital Economy: The fun stuff. China will be targeting AI, blockchain, fintech and cloud computing as they aim to have a 10% or greater share of the global digital economy by 2025. China is the first nation to have such a target, and they plan to get there by raising R&D spending by 7% each year that the plan is active. Previously, China was spending 2.2% of GDP on research and development. Compared to US figures, the 2.2% was behind the 2.7% that the US spends, so we can see why China is throwing money at the problem to play catch up.


• Green Development: It might be shocking to some, but environmental issues do rank highly amongst a Chinese citizen’s top concerns. In response President Xi has made efforts on numerous fronts to improve water and air quality in the nation. The latest FYP goes further, setting targets that drop energy consumption per unit of GDP by 18% over the next 5yrs, and clean air day targets up to 87.5% from 84.8%. Australian companies sell several clean tech solutions in China, so they are expected beneficiaries, as well as higher grade iron ore producers (higher grades are reduce environmental impact of refinement in China). The new tougher targets from the previous 5yr plan suggest a move to clean energy for the World’s largest polluter. Paired with the new green targets are increases in domestic grain and energy production. China wants to control their supplies, like any nation, and they want to do it from within their borders.


• Life Expectancy and Retirement Age: Current average life expectancy is 77yrs in China and is to be raised by 1yr for all citizens by 2025. On the social spending side, retirement age is 55yrs old for women and 60yrs old for men, for sustainability reasons it is expected retirement age will rise (95% of citizens have access to basic pension). Australia is set to benefit as Chinese funds search for yield providing investments, and any health care providers with a Chinese focus will be direct beneficiaries.


• Babies: The ‘one child policy’ ended in 2015 and fertility remains a barrier for China as their demographics are aging. When countries find themselves with a nice pyramid shape to their age demographics, they can excel. When the shape starts to get fat at the high ages and skinny at the young ages, a problem forms as younger generations carry more and more of the economic burden. The images for Japan in 1985 and 2015 look eerily like the images from China in 2020 and expectations for 2035. China’s low fertility during the ‘one child policy’ years, and low immigration, has set their demographics back. Chinese officials will now use relaxed regulations and incentives to try and reverse these trends. Australian milk producers are set to benefit from any surge in babies in China as the providence story from our shores is strong, and the Aussie brands are trusted.




• Political Development: China is looking to increase ties to Hong Kong and Taiwan to increase political influence in the region. This expansion of the Chinese state will lead to increased military spending for neighbour nations, which will include Australia. Homegrown defence stories will have tailwinds behind them as Australian military spending will top 4% of GDP and is expected to have a 70%+ Australian component.

China led the world out of the last recession. This version of the five-year plan is timely after the pandemic, with many nation’s sights set firmly on a recovery. China appears to be looking inwardly for solutions, but they will not be able to recover on their own. Not yet at least. There will be many opportunities out of the latest FYP, and Australian companies will be front of the line.

Updating our checklist:

• Valuation: The ASX200 P/Efwd is 19.28x and the S&P P/Efwd is 22.65x. We have noticed that profit margins are trending up, which is a good sign that earnings will follow, bringing the heightened valuations back to long term averages in time.


• Global PMIs: Industrial production figures in China exceeded expectations as did retail sales. Here in Australia the latest retail sales figures came in 1.1% lower than expectations but are not expected to derail the economic recovery. Culprits in the miss were Victoria and Western Australia that went under restrictions during February. Rising quickly domestically are the home loans figures as they smashed expectations by 8%+! The Aussie real estate boom is clearly ignoring the share market pull back.


• Downgrades on guidance: We do not have a lot of news on earnings or guidance this week as most majors have reported. We will note that CBA’s entry into the Buy Now Pay Later (BNPL) arena is of interest, as they are by far Australia’s most tech focused bank. The announcement is not a complete surprise as CBA owns part of Klarna. Klarna is a major competitor of Afterpay in the US, but do not have an Australian footprint, so entry into our market is no surprise. As a differentiator CBA is offering lower merchant payments, which we expect to be a factor moving forward in the sector. In a disruptive sector such as BNPL details matter. CBA and NAB last year released zero interest credit card products to compete in the space, but were disappointed with the uptake of the product, as subscription fees worked out to similar pricing as interest payments under old schemes. With CBA moving in the BNPL direction we note that their product will still require a credit check, while APT does not. It is a small difference, but will it be enough to keep Afterpay’s tribe growing fast enough for merchants to accept higher fees to be on Afterpay’s platform? One thing is true, BNPL is a model that will not be going away anytime soon.


• Infection rates to slow globally: On the positive side, vaccination rates in the US, UK and Canada have climbed. On the negative France has entered lockdown in Paris for 4 weeks as Europe continues to lag in the global race to vaccinate. At home, Australia’s official program began this month and is trending upwards…gradually. It is early and the program is supply limited. Other global programs started similarly and were able to ramp up. We expect that our domestic program will pick up the pace as the months tick by, ultimately reaching herd immunity before Xmas.
  
  You can follow Australia’s vaccination journey with our live vaccine tracker at the link below:
  
  TFM Vaccine Tracker




• Monetary and Fiscal stimulus announcements globally: US stimulus checks started hitting bank accounts this week. Will the money be saved, will it be spent, will it be gambled in the share market? It is the question on the tip of everyone’s tongue. Only time will tell. The US Central bank (“the Fed”) had their monthly meeting this week and reiterated that monetary policy would remain loose until 2023. We expect other nations will continue to follow the US lead and keep rates low. The RBA governor in Australia is in lock step as far as rates but are willing to play on the edges of policy by targeting Buy Now, Pay Later instead. With CBA moving into the BNPL space with an announcement this week, we suspect that Australia’s central bank will continue to take a keen interest in the sector without trying to stifle innovation. While the RBA focuses on Afterpay and the fast followers, the Aussie job market added 89k jobs in February, pushing the jobless rate down to 5.8%.

Inflation fears have been a pothole for the markets the last few weeks. As mentioned previously, we have been here before, after the GFC when Central Bankers developed the playbook they are pulling from now. Ultimately, we do not see structural inflation being a mainstay until wages begin to pick up and even the public sector was on wage freezes last year, joining 40%-60% of the private sector. We are a believer in the economic recovery of this country and of the globe, but we are a long way off sustained inflation. With that out there we do see this recent pullback as a great opportunity to enter the market if you do find yourself with some extra capital. If you are interested, please contact one of our advisors as they are trained to implement a financial plan to help you meet your goals. Until next time, take care, and we will be in touch in two weeks.

Regards,