Market update with Shaw and Partners, October 2021

Interviews

by Clive Tompkins

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Shaw and Partners Chief Investment Officer Martin Crabb discusses central banks and their responses to inflationary pressures, the Chinese property market, carbon usage and labour supply pressures.

Thanks Clive, and welcome, everyone, to today's Investor Event. Shaw and Partners have been working with Financial News Network for a couple of years now on these presentations, and I have the distinction of spending five to 10 minutes at the start just trying to set the scene, really, for investors – which, as you can imagine, with everything going on in the world, is much easier said than done. But I will do my best to distil my thinking about markets just to set preamble, I suppose.

Having said that, I mean, I'm going to be talking a lot about macro factors, and a lot of the companies today are really micro stories, if that makes sense. So, what's going on necessarily in the macro may or may not have a significant bearing on those businesses. A lot of them are quite unique and special in their own way. So, what's happening macro may be of less relevance. So, I just thought I'd throw that out there.

But, obviously, a lot going on at the moment. The big issue really at the moment, the major focus, is really central banks and their response to rising inflationary pressures on the one side. The reopening trade and what that looks like on the other. And then developments in China in terms of their slowing economy and their zero tolerance to property developers taking on more debt.

So, there's quite a lot going on. So, let's just sort of unpack that a little bit. Let's talk about China first. So, when Xi Jinping was elected a decade or so ago, he set a target to double China's GDP per capita over the next decade and also to achieve common prosperity. So, he gets a big tick on the first because he has managed to double GDP per capita in China. It's now over 11,000 US. It was less than 5,000 when he came into office.

But, on the common prosperity, you probably have to give him a thumbs down on that one because it's very difficult for Chinese people to afford housing. It's about 24 or 25 times income to buy a house in Beijing. It's seven in Sydney, which is insanely expensive. It's kind of four in the United States. So, they probably get the thumbs down on that. And, obviously, there's a big income inequality in China, as well as a lot of people have got very rich but there's still a large number of people who are pretty much living in relatively subsistence lifestyle.

So, obviously, China needs to tilt its economy more towards achieving common prosperity. And that probably means slowing down real estate speculation and real estate building. There is apparently 90 million empty apartments in China, just to give you a sense of how much construction has been going on. And companies such as Evergrande have borrowed upwards of $300 billion to achieve that level of pre-construction.

So, China's unwinding that property industry and that property speculation, and that's going to have impacts, obviously, on anyone who's supplying raw materials into that economy.

You've also got the carbon usage. So, we're about to head into COP26, and that'll be on the papers all through next week. China has already made some commitments ahead of that about reducing their fossil fuel consumption. So, again, that's aimed at the environment, obviously, as well. But that's also an issue for Australia, which produces a lot of iron and coal into that market.

So, you've kind of got this headwind from China. China's been the biggest tailwind of all time for Australia in the past decade, 15 years, and may actually start heading into a little bit of a tailwind. So, just something to keep in mind.

Going, I suppose, more towards the flip side to that, which is inflation. So, we do have producer prices, which are the prices that companies pay for goods as opposed to the prices that companies receive. Producer price has been running very high. So, think of raw materials. Think of anything from what it costs to freight things from overseas to energy prices, an obvious one. But also prices of things like lumber. If you're trying to build a house at the moment, it's very difficult to get hold of raw materials. So, prices are going up right across the board.

And a number of companies are mentioning these supply constraints and higher prices on their earnings call. So, we're sort of in the early stages of the US quarterly reporting season and also the Australian AGM season, and we are seeing an increasing number of companies talk about supply chain issues on the material side, but it's also morphing into discussion about labour.

So, if you think about costs, most companies, their biggest cost is not raw materials, it's wages, it's labour. And that, like everything else, is in short supply because we don't have global mobility, we don't have 300,000 or 400,000 new people coming into Australia every year. The US doesn't have almost a million and a half immigrants a year going into that country, which it would normally have. And so, labour markets, as the economies recover, are tightening up quickly, and like the supply and demand of anything, wages are starting to go up.

So, as we're coming out of lockdown, the supply side of the economy is not reacting as fast as the demand side. So, we have this period where we get price pressure. Now, the word that gets bandied around is "transitory", because it's just basically a timing issue. Once we open borders, once people can travel again, we'll have half a million people coming into Australia. We'll have lots of workers. It won't be a problem. But that's, I suppose, a little bit of speculation.

What we are seeing right now is wage pressures right across the board, and a lot of industries are really struggling to get workers. Domino's Pizza are struggling because they can't get enough people to drive the pizza from their shop to your house, for example. So, we are seeing, anecdotally, quite a lot of that going on.

So, that leads into central bank behavior. So, why do central banks matter? Well, they set the price of money, which kind of sets the price of everything else of value. So, as you know, we've got pretty much a zero interest policy right around the world. When the COVID crisis hit in March last year, pretty much every central bank cut interest rates as low as they could go. In fact, some of them, as you would know, are negative interest rates.

So, we've got this very, very loose monetary policy. It's been accompanied by very, very loose fiscal policy. And governments are still looking to spend more. So, you know, Joe Biden's trying to get an Act through their Congress to spend another trillion and a half dollars on infrastructure, for example. So, there's still a lot of money being printed, and that's just going to cause more demand and more inflationary pressure.

So, central banks were created, really, to control inflation. And they've been trying, obviously, to stoke it, and that seems to be working. At what point do they start saying well, okay, we need to slow things down to get inflation out of the system? And, if that happens, because there's so much debt out there, it's probably not going to take a much of a change in monetary policy to see that go, again, from being a headwind, like China -- going from being a tailwind to a headwind.

So, that's, I suppose, keeping markets a little bit nervous at the moment. So, how are we seeing that? At the end of the day, the economy's still opening up. There is a lot of cash that's sitting on the sidelines, and something like $5 trillion globally sitting in people's bank accounts that wasn't there pre-COVID. That's a big number. It's something like 200 billion or 10 per cent of GDP in Australia. So, that money's going to find its way into investments and find its way into experiences once we can travel again, etc.

So, there's a lot of dry powder. So, the economy looks okay. We just have to be wary of these macro issues.

So, we're just starting to get a little bit cautious. I think, when it comes to investing, it does really boil down to the investments and the people that are running companies. But it's just worth having that sort of macro backdrop. So, with that, Clive, I'll hand back to you.


Ends

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