Turn over these stones in 2021
While 2020 will always be remembered for the global lockdowns associated with COVID-19, many will also remember it was the year the Reserve Bank of Australia’s monetary policy acquiesced to the big momentum of Modern Monetary Theory. It was the year the RBA embraced an assortment of avant-garde actions in a continuation of the measures adopted by its contemporaries, since the GFC, in most other jurisdictions.
As I write the RBA’s cash rate of 0.1 per cent is at its chosen lower bound. And given Phillip Lowe has indicated the rate won’t rise until inflation is “sustainably” in the target band, we won’t garner much about whether the RBA is hawkish or dovish by looking at the rate. For insights, we instead need to watch for the consequences of quantitative easing (QE) and the loans made to banks under its Term Funding Facility (TFF) by turning to the composition and size of the RBA’s balance sheet.
Some economists and bank analysts estimate that through QE and the TFF the Reserve Bank’s balance sheet could triple and reach 27 per cent of GDP by the middle of next year. By keeping the cash rate at close to zero and by buying longer-dated bonds, the RBA will keep the yield curve flat while funding the government deficits it unprecedentedly and outspokenly encouraged earlier this year.
The Narcotics Anonymous organisation wrote in November 1981; “The price may seem higher for the addict who prostitutes for a fix than it is for the addict who merely lies to a doctor, but ultimately both pay with their lives. Insanity is repeating the same mistakes and expecting different results.”
One wonders whether the same observations might be directed to proponents of Modern Monetary Theory. Does anyone seriously believe that ‘more of the same’ policies – those that have delivered only a misallocation of resources, the adoption of unprecedented risk, asset bubbles and inequality but preciously little productivity growth will miraculously begin to (gently) deflate the bubbles while delivering employment growth, rising productivity and standards of living?
Moving up the risk spectrum
A flat yield curve is an incentive for investors to eschew saving and seek higher yields by moving up the risk spectrum. The consequence of course is higher asset prices wherever that migration happens to perch.
Thus far the search for better returns has alighted on long duration opportunities that are currently profitless. This can be seen, for example, in the capitalisation of Afterpay, a profitless company now with a market value half of the ANZ Bank. It can also be seen in the market capitalisation of Xero, which can be justified if today’s customer base quadruples while maintaining current margins.
Two things investors shouldn’t miss
We believe there are at least two things investors shouldn’t miss. The first, is the search for better returns should be undertaken amongst the boring and relatively unloved stocks, those hurt by COVID lockdowns as well as those offering steady annuity-style incomes.
A rotation from COVID winners to COVID losers is already underway, with the advent of successful phase 3 clinical trials by Pfizer and Moderna focusing investor attention on businesses with recovering revenues but with shares priced as if the pandemic will continue indefinitely.
A second category of businesses worth investigating are those developing boring and steady annuity style income streams or already doing so. The reason for our excitement in this space is global pension funds are not immune to the mounting pressure to deliver their retired investors a return better than the zero available elsewhere. Consequently, we believe, these pension funds will be willing to apply much lower capitalisation rates, to steady income streams, than equity investors are currently prepared to. Telstra monetising its towers and the proposal by the New South Wales government to sell its gambling taxation revenues is testament to mergers and acquisition activity ramping up for hitherto mundane income streams. And of course, a pension fund that privatises an asset need not worry about subsequent stock market volatility.
Watch for an adverse shift in sentiment
Also, not to be missed in 2021 (although I am less certain about its timing) is an adverse shift in sentiment about the effectiveness of Modern Monetary Theory. As I mentioned earlier, monetary and fiscal stimulus in 2020 and 2021 is merely a continuation of the policies implemented when the Financial Crisis began.
Interestingly, where such policies have been implemented elsewhere, there has been little to show for it except for very high levels of debt. Think of Japan where productivity remains quagmired and per capital GDP is unchanged from nearly 30 years ago. The consequent budget deficits ensure only that the country remains burdened by a heavy debt load. Low rates then become a permanent necessity and the cycle is perpetuated.
It is indeed curious that in 2020 the lower-rates-for-longer narrative is accepted without question. Few are currently discussing the withdrawal of stimulus measures or its consequences. Nobody is talking about inflation or a normalisation of interest rates anymore. Nobody asks how inflation will be contained if it ever does return. And I haven’t seen much on the risks of surplus nations turning the taps off to spendthrifts.
All this and more, no doubt, in 2021.