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What is in store for 2022?

On behalf of the team here, I wish you a happy and healthy 2022.

Over the break I visited western NSW and the Flinders Ranges in SA. It made me appreciate the sheer size of this wide brown land, to see first-hand its beauty and its terror.  There is a lot to love about this sunburnt country.

Despite the anxiety caused by Covid and uncertainty perhaps about the year ahead, I remain positive about the future.

There is beauty around us and terror with the Omicron version of Covid sweeping through our plains. However, this land that Dorothea Mackellar so eloquently wrote about in 1908 is really not too different today. Through droughts, rains, war and peace, diseases, and troubles Australians have managed to be quite resilient and forge a unique and prosperous country. We are fortunate to call this place home.  It’s staggering to see the war memorials in every tiny country town and the names of those fallen from the great wars. The loss, the pain, and the time it took these towns and farms to recover through the Depression and then the Second World War is hard to imagine.

There is no doubt that Covid is not easy and it’s challenging for us all in different ways. History shows that there is a way forward.

The reality kicked in as I drove back through the vast plains of south-western NSW, as news came in of more and more cases and this time around, many from close friends and colleagues. 

While in 2021 it was rare to know someone close that had the virus, now it is almost a matter of who has not had the virus. Every day I am hearing of someone we know who is positive as well as those who have thankfully recovered.

Please take care out there and if you do become ill and are isolated from family or for any reason need any assistance, we are here to help. If you have not had the chance to go west and see some of this wide brown land and escape the crowds, it’s waiting for you.

As we enter the new year, we are again holding our breath as the pandemic takes hold and disrupts our lives.  What does this mean for the year ahead? Are there lights of hope for this wilful lavish land?    

So, what is in store for 2022 and what to look out for that may affect investments, taxes, and superannuation.

On the economic front:

  • As we know, market returns have been positive, buoyed by low interest rates, government stimulus and business spending. A year ago, this certainly was not “forecasted” by many so as we start a new year, trying to forecast or even believing any forecasters would not be a sensible approach.
  • What may help this year, however, is that global growth measured by Gross Domestic Product (GDP) is expected to have grown nearly 6% in 2021, in comparison to 2020’s slump of -3%.
  • In Australia, GDP is expected to have risen by 5.5% despite a setback in the September quarter after slumping -2.2% last year. This in turn underpinned strong gains in profits and dividends.

Source: Thomson Reuters, Morningstar, REIA, AMP

The big issues for 2022 – these will not be catastrophic, but will create media headlines and nervousness, no doubt.

  • One of the biggest issues, I believe, is how the US manages the transition from a low interest rate environment, with inflation in the US now at 39-year highs. Can Biden manage this as his support drops to 33%. The Federal Reserve Chairman Jerome Powell has now indicated rates will rise.  This is not such a bad thing; the world of low interest rates continuing, I believe, is a bigger risk. It’s far better for world economies to run on what may be seen as “normal” rates. The issue is the transition back to this “normal”.
  • While the mid-term elections are this November and the full election in 2024, the likely Republican candidate to run against Biden appears to be none other than Donald Trump. This will be divisive in the US and not great for stability in world markets. Americans are always optimistic, but I fear this spells instability for their economy in a few years if the transition is not managed well and, therefore, ours. Having said that, despite the unique political landscape in the US, their economy has fared well.
  • The China situation will continue to make headlines.  This is not going away and is the geopolitical risk for the next few decades.  How far will China go to exert its influence over the world?   This may affect markets if trade tensions continue and affect Australia’s trade and stability in the region.

To date we have shown great resilience and pivoted to develop new markets and align with old friends like the UK. Our trade numbers are very strong, but can they be sustained? I’m all for foreign investment but must admit some of the material I read makes me worried about Australia’s future for future generations. “The Silent Invasion” by Clive Hamilton is a good start to get informed if, like me, you thought these issues were being exaggerated.

  • The impact of inflation and how this will flow through to interest rates and asset prices. As above it’s better for rates to go up; the issue is just how the global central banks manage the process.
  • Housing prices will continue to be a major headline.  Can the market continue at this rate? It appears not but two years ago not many predicted such a surge in prices. I am concerned that while an increase in variable rates from 2% to 3% may not appear drastic, it will see mortgage repayments for many increase by 50%.

If interest rates rise and inflation becomes a real factor, you would expect an easing of house prices.

  • Covid will of course continue to cause uncertainty. How many variants are there yet to come? Will vaccines be effective? Are we reaching a stage where risk is a permanent “flu” season or something much worse? The bad news is there are 24 letters in the Greek alphabet, let’s hope we don’t have to get through them all!
  • The Reserve Bank does not make advance calls on rates; however, markets are factoring in a rise to 0.5%. This is still very low, but as mentioned above the actual increase in repayments resulting from such an increase will be very significant.
  • The impact on share prices is that the discount factor used to value cash flows is now so low that valuations can be “justified”. This will change as rates increase. It’s just simple mathematics.
  • There will be a Federal Election in Australia as early as March which perhaps is unlikely or what seems more likely is that Prime Minister Morrison will meet with the Governor General after the federal budget which will be handed down in April this year, resulting in a May election.
  • Now when we talk about forecasting politics appears even tougher despite being only a two-horse race here in Australia. If we recall the last election not many polls gave Morrison and the Coalition any chance, yet they won on the day winning 77 seats to Labor’s 68. The pollsters have revised their methods this time and it is looking close again and will come perhaps down to key independent seats. Many of these are coalition seats with the independents running a more aggressive climate change policy.

Will those independents, if they win, still align with the coalition or cross over?  Now the key issues for Mr Albanese are that Labor is struggling to gain more than 33% of the primary vote and they have lost some connection with the traditional working class. How will they appeal to their mixed voter base?  While they would perhaps love to be more aggressive on their energy and climate policy, turning up to marginal seats in Australia where there are workers that will lose their jobs if the policy is too aggressive is a difficult proposition.  Will they take that risk? To win they need to see a large swing against an incumbent government.  

Normally to do this requires massive disharmony (Covid could provide this opportunity) and a need for change, or significant and different new policies (Shorten via superannuation tax changes, capital gains tax and franking credits and before that Hewson via the GST, tried this approach with dismal outcomes).

I’m interested to see how Mr Albanese and Labor play the game.  I can’t see them announcing radical tax reform or risking too many marginal seats via a more aggressive climate policy. While the vaccination roll out was a blunder, and the current Covid blowout will be difficult to explain to voters, is that enough ammunition for Mr Albanese? Will that be enough to swing the votes? Who knows? It’s going to be close.

  • From a market point of view, both parties are similar in policy really.  Can Mr Albanese win the hearts and minds like Kevin Rudd did to oust John Howard with “Kevin 07”. It will be fascinating and could come down to how well or poorly Mr Morrison handles Covid Omicron and potential other variants between now and May. The Coalition will be hoping that the economic recovery gets them through, and inflation does not poke through until June.  Despite all this, I don’t think that either outcome will affect our local markets too much in the short term. Larger global factors will make a bigger impact. One thing that should be safe is franking credits!
  • Whoever wins will have a tough term ahead managing the economy and working out how to reduce debt. The handouts can’t last forever without taxes being increased. There is $3trillion in super at relative low tax rates. The GST is so difficult to change. I cannot see how the next government cannot make changes to the tax system again which will be a challenge.

There is some good news by the way!

There is good reason for optimism about continuing economic recovery in the year ahead.

The Virus

We still don’t know, of course, but there are some suggestions that after Omicron we will be more immune to future variants, and this will become like normal flu seasons. We are all well and truly over Covid so let’s hope so.

Savings

Excess savings of around $US2.3trn in the US and $250bn in Australia will provide an ongoing boost to spending.

Rates

Gradual increase in interest rates is a positive for many – retiree income from cash and bonds, and new home buyers may see some light at the end of the tunnel.

Inventories

While supply chain shortages are causing issues here and abroad, the pent-up demand is potentially positive for economic growth in 2022.

The Wealth Affect

Australia is still relatively a lucky nation. With many Australians now millionaires simply by buying and holding a home, and via growth of their super and other assets, this provides comfort and spending. Of course, this only persists if jobs remain plentiful and at some stage wage growth will kick in.

Business Sentiment

Despite the ongoing Covid issues, business spending and surveys remain optimistic which is creating good signs for economic growth in Australia.

In Australia, recovery from the recent lockdowns supported by excess saving, strong business investment & high confidence levels suggest growth of around 5.5% according to economist Shane Oliver. This is likely to support profit growth albeit at a slower pace than in 2021.

Implications for Investors

While Australian shares provide attractive yield to cash, and other growth markets have always outperformed cash over time, and cash of course has no inflation hedge, we need to be aware of the downside risk as global markets transition.

Any significant changes in asset allocation should be well considered and part of a long-term plan.

There is no need for short term radical changes.

Source: Bloomberg, AMP Capital

The main things to keep an eye on in 2022 are as follows:

  • Coronavirus – new variants could set back the recovery but keep an eye on GDP numbers.  It again may be surprising how economies manage through.
  • Inflation – US figures are high and global figures are heading north. This may not be so bad as interest rates return to some normal levels.
  • US Politics – Biden is losing support and may lose control of congress in the mid-term elections. The next election is not until 2024, however the ability of the US under Biden to manage the recovery will be critical to global markets and the prospect of a Trump v Biden 2024 campaign may cause instability.
  • The Australian Election – however if the policy differences remain minor, a change in government would have little impact.

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