Forecast 2019-20: Tough times ahead

-- | 02/07/2019

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Glenn Freeman: I'm here with Peter Warnes, Morningstar's Head of Equity Research, and we're talking today ahead of the forecast 2019-2020 report.

Thanks for your time today, Peter.

Peter Warnes: Pleasure, Glenn. Always a pleasure to be here.

Freeman: Looking into this report that's coming out later next week, what are some of the key standouts for you in looking ahead into 2019-2020?

Warnes: Well, Glenn, strangely enough, it's a little bit of the writings of the French writer Jean-Baptiste Alphonse Karr, "the more things change, the more they stay the same." Because this time last year we were saying that the Australian focus would be on household consumption and the RBA and what was going to – what the policy track it was going on. And for the U.S. it was the three Ts; it was tariffs, trade and Trump. And I suppose we could have thrown in the fourth T being tantrums.

So, when you go forward to the present day, nothing has changed. But we have had some very, very rollercoaster type rides in the equity and bond markets since July last year. And if you look back, see how it unraveled, we had a run to a record in September last year, then we had a very, very sharp pullback in the December quarter bottoming on Christmas eve and markets did go – touched bear market territory, in other words, down more than 20% from that high. And then, since the Fed has – done in a bad phase we have had a very, very strong rally and recovery through the first half of this year and basically, really, the last couple of months have really been on the tear.

Can the second half replicate the second half of last year? In other words, can we get a sharp pullback in the market in the second half, and I suspect the answer is maybe. And I think the more I think about it, at least from a scenario and analysis point of view, I would suggest there's a greater possibility of that happening than not.

Freeman: When we're talking ahead of filming here, you were alluding to some of the cover photo options for this report and you were talking about this image of the climbers on Everest and being alluding to the dangers of the high altitude. And you said that the investors are at risk just as climbers would be in that situation. Can you just talk us through what you were referring to there?

Warnes: Yeah. Well, I think, it's a good analogy to take. Because when markets are – when you are on high altitude, you need support and those climbers that were clamoring to get to the to the top of Everest, they were all lining up and they needed support. They brought oxygen and they are in danger territory, so they need support to get to their goal.

Similarly, as the reserve bank or central banks have pushed investors further and further up and out the risk curve, they also are looking for support. And their support is the financial oxygen called lower interest rates. Look, never in my 50 years' experience in the markets have I observed central banks easing and aggressively easing when bond and equity markets are at peaks. And I think that investors are in high altitude and in dangerous territory. And the descent is as dangerous as the ascent. And so, I think there is enough evidence out there to suggest that things could get a little interesting.

And of course, we have had Osaka and we've got another truce. Well, seven months ago, we had a truce in Buenos Aires, and they got a bit argy-bargy after that. But there's no – like trust is at premium. The egos of the two people involved are – there's no surrender here and so the truce is not the end the war. They will have to get back to the negotiating table. I think this is kind of – this is going to erupt again. And I don't know what the central banks are going to achieve by driving the price of money down to ridiculous levels that hasn't worked for the last two years or three years where you've got liquidity all over the place. Just pushing the price of money down will not get the velocity of money and the circulation of money through the economy going. Central banks haven't found the answer to that and it's not going to do anything for productivity, because there will be no competition for scarce resources because the price goes down because there's too much of a commodity out there.

Freeman: It all comes back I guess to household wealth and that's something that you've spoken about at length for probably 12 months now and that it still at such low levels. Do you see any signs of that changing?

Warnes: Well, Glenn, look, the domestic economy is one that's – unlike all developed economies, household consumption is two-thirds roughly of GDP growth. We have still got credit growth falling. The last figures out only last Friday from the reserve bank have got total credit still falling, housing credit still falling, and they are the two big – housing credit is the big mover within total credit. Business credit has been reasonably positive, but it's nowhere near the housing credit.

So, you can't get the economic activity moving in a northerly direction unless you have more robust credit growth. So, you got to turn the credit growth around and get it going north. And until that happens, we are going to struggle in terms of GDP. We will have positive contributions coming from our net exports, obviously, because of iron ore and coke and coal prices are still on the ascendancy and affirm, thanks to China stimulus. And public demand through infrastructure spend and government spending will be supportive. But elsewhere, there will be – it will be hard going. I mean, there'd be no positive contribution from dwelling investment. And as I said, household consumption will be under pressure. So, we are very fortunate that net exports are where they are. Otherwise, I think that we would have seen the negative growth in this third or fourth quarter of 2019.

Freeman: Thanks very much for your time today, Peter.

Warnes: Pleasure, Glenn. And we will talk again shortly.

This report appeared on 2021 Morningstar Australasia Pty Limited

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