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Recovery continues but at a more sustainable pace.
Close to 50% of the world’s population now has some immunity to COVID-191. Steady vaccine progress has seen the pandemic become a much-reduced drag on economic growth - while the rapid spread of the Delta variant has been more challenging, vaccination rates have dramatically reduced hospitalisations and deaths. The pandemic isn’t over yet, but many parts of the economy have shown an ability to continue ‘business as usual’ with other sectors now benefitting from re-opening.
For China, new consumer focused policies will hinder economic growth in the short term but mark a welcome re-orientation of the economy. Debt-led property investment has also pushed housing prices in China’s major cities to unsustainable levels which the monetary authorities are trying to address by cracking down on speculative property investments.
The severe shortage of electricity in China is due to a reduction in imported coal, weaker hydroelectric outputs due to drought, and government emission reduction targets that have forced coal mines to close. The shortage has caused blackouts and a need for energy rationing and is another factor shifting China towards lower but more sustainable growth.
While concerns about a permanent lift in the price of goods and services (inflation) are credible, central banks have undershot their inflation targets for some time and are still committed to getting back to target ranges. We think the current lift in inflation is temporary, but should labour shortages and rising wages become permanent, inflation would rise well above the central bank targets. The key risk is of higher inflation becoming entrenched leading to policy support being withdrawn much more rapidly than currently expected. This would likely result in a rise in interest rates, slowing company earnings and share market disruption.
The demand for consumer goods remains high, but many sectors haven’t been able to get production back up and running quickly as economies have re-opened and this has caused prices to lift. We consider that supply chains will eventually respond and the spike in the price of consumer goods is likely to ease as supply is ramped up, although this could take some time.
While the headwinds we’ve outlined have contributed to the recent pause in markets, we shouldn’t forget the incredible bounce back we’ve seen since the pandemic-driven recession. Considerable, unprecedented levels of policy support were put in place to sustain the recovery so it’s expected that markets will become concerned that this extreme policy support will eventually be removed.
Now Australia has relatively high vaccination rates, re-opening can begin. While slower Chinese growth may challenge the Australian economy, particularly as it has driven the recent plunge in iron ore prices, this has been offset by a surge in coal and gas prices. Although we don’t expect energy prices to continue to rise through to 2022, this price surge is supporting the Australian dollar and economic activity for now. We also consider the Reserve Bank of Australia (RBA) is likely to keep its interest rate policy highly supportive next year (2022) as the economy continues to heal.
Most market challenges should ease in time. While the outlook has clearly softened, supports remains in place with policy still incredibly stimulative and expected only to be removed gradually. Economies are continuing to re-open and social distancing will become less of a growth inhibitor.
This does not mean that the high ‘pandemic bounce back’, double-digit returns will last. We expect solid but more modest returns as the recovery matures - as growth eases and costs rise.
We believe we’re a long way from any sharp drop in economic growth that would justify more caution and a much lower allocation to growth assets such as shares. All up, it’s still a positive market outlook story.
1. Our World in Data, Data as at 25 October 2021 - https://ourworldindata.org/covid-vaccinations
Important information: This communication has been prepared by IOOF Investment Management Limited (IIML) ABN 53 006 695 021, AFSL 230524 as Trustee of the IOOF Portfolio Service Superannuation Fund ABN 70 815 369 818 (Fund). IOOF Employer Super is a Division of the Fund. IIML is part of the IOOF group of companies, consisting of IOOF Holdings Limited ABN 49 100 103 722 and its related bodies corporate (IOOF Group).
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