Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 406

Are we underestimating the peak of the V-shaped recovery?

By now most investors are tiring of their email in boxes filling with economists and strategists talking about reflation (that is, a recovery in spending and economic growth), how much more optimistic they are relative to consensus, and for how much longer the reflation trade will persist.

There were very few people talking about a strong V-shaped recovery this time last year. Indeed, a scan of the forecasts of leading sell-side economists in April 2020 shows consensus forecasts of 3% for the CY21 for Australia and 3.8% for the USA.

A switch to stronger growth forecasts

Indeed, peak pessimism was not reached until September 2020, when economic growth downgrades ceased and modest upgrades commenced. Currently, consensus for CY21 has risen to 5.7% in the USA and 4.4% for Australia.

In contrast, our forecasts for the US in 2021 – which we published in mid-April 2020 – was 6.5% (represented by the cross in Chart 1). For Australia (Chart 2) we were even more optimistic, forecasting 7.0% economic growth. As we moved through 2020, it was clear the expected contraction in economic growth in 2020 was less than expected and we reduced our forecast rebound in Australia’s economic growth in 2021 to a still sizeable 6.0%.

Much of our more upbeat analysis was based on:

  1. the nature of the shock being more akin to a natural disaster
  2. the quantum of the fiscal packages
  3. excess credit growth
  4. the outlook for vaccine development
  5. the prospect of pent up demand.

One year on, the clambering to upgrade growth estimates has only intensified. Over the past two months, consensus forecasts for Australian economic growth in 2021 have been upgraded a further 0.7%. In the USA the revision over the past two months is a remarkable 1.6%.

For Australia. we remain 1.5% above the consensus forecast and around 1% above the most optimistic other forecaster. What supports our optimism?

1. Australia’s data consistently beats economic forecasters

Charts 3 and 4 show our calculation of economic data surprises for economic activity and inflation relative to consensus forecasts (US vs Australia). A positive reading represents economic data beating consensus expectations weighted by data importance and time decay.

Clearly, Australia’s economic activity data is not only continuing to beat increasingly upbeat economic forecasts, the positive data surprises are larger in Australia.

2. Real economic growth is expanding at pace

Our 'nowcasting' techniques (Chart 5) for gauging in real-time how fast the economy is expanding already suggest that real economic growth was expanding at 4% yoy by the end of 1Q2021. 

Note: Our nowcasting methodology is to estimate real time economic growth via both dynamic factor models and principal component models for each of the major economies to provide an alternative underlying picture of economic growth to the often noisier official GDP data.


Register here to receive the Firstlinks weekly newsletter for free

3. Treasury’s projections have been comfortably exceeded

Much stronger economic growth, much lower unemployment and much stronger commodity prices have combined to already deliver a $23 billion better fiscal outcome relative to Treasury’s December projections and closer to a $50 billion saving over the next four years.

The question for Q2 is how much more of an 'economic surprise' dividend will likely flow through the Budget and what will the Government do with it?

We believe the Treasury’s growth figures are 0.5% too low for 2020-21 and 1.25% too low for 2021-22. The unemployment rate is likely too high by as much as 2%. And an iron ore assumption of $55/tonne embedded in the Budget is one-third of the current iron ore price. Clearly there are further major revenue upgrades to come.

Our take is that the May Budget will be used mainly to evidence the vastly better Budget and economic outcomes that have been achieved. We expect the true election Budget will come in late 2021 (i.e. mid-year Budget), with more strategic spending and tax changes announced to setup a May 2022 Election. The combination of the Coalition’s political challenges and the Budget’s economic windfalls will likely spark additional fiscal spending later in 2021, sufficient to bolster economic growth expectations.

Momentum to continue over 2021

Mid-2021 will likely mark the peak of global economic data surprises and the final phase of economic growth upgrades. Nevertheless, we believe there is more oxygen in Australia’s economic recovery and that consensus has long been too slow to recognise the domestic economy’s capacity to expand at close to 6% through 2021. 

While this will set off expectations of a higher cash rate ahead of the RBA’s 2024 guidance, the RBA can be expected to attempt to allay those fears by making the case that inflation expectations and wage growth remains too low to be consistent with their inflation objective. Nevertheless, the likely RBA growth upgrades will almost certainly end the prospect of the RBA rolling the 3-year bond beyond the April 2024 target. Together with the end of the Term Funding Facility in mid-2021 the reality is that a very modest tightening cycle is already commencing.

 

Tim Toohey is Head of Macro and Strategy at Yarra Capital Management. To the extent that this article discusses general market activity, industry or sector trends, or other broad based economic or political conditions, it should be construed as general advice only. References to ‘consensus’ throughout relate to Bloomberg consensus unless otherwise stated.

 

RELATED ARTICLES

The coiled spring: markets are primed for the year ahead

The three prices that everyone should worry about

Rising bond yields complicate the COVID recovery

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

Latest Updates

Interviews

John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.

Infrastructure

Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?

Economy

The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.

Shares

Why green hydrogen is central to achieving net zero

Hundreds of green hydrogen projects show this energy opportunity is finally being taken seriously. While a cost disadvantage and technical challenges need to be overcome, it promises to deliver a path to net zero.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.