“Genius is one percent inspiration, ninety-nine percent perspiration.” Thomas Edison
The RBA kept the official rate at 10bps this week following its monthly meeting. Policy changes will centre around an extension of the Yield Curve Control Policy (YCC) to target the November 2024 bonds from the April 2024 bonds; and a third QE program of $100 billion to begin in the first week of September. This will come at the time of the August Board meeting and the August Statement on Monetary Policy on August 3 and August 6 respectively. It is a widely held view that monetary policy will have to remain highly stimulatory, and the Reserve Bank may decide to support that approach by announcing the extension of policy stimulus potentially earlier than the timing in our central view (August Board meeting).
In other news inflation seems to be under control for now coming in at 0.6% for Q1 vs expectations of 1%. Despite continued steady progress in reducing the unemployment rate, we believe the RBA will need to continue asset purchases in 2022, with the final program to run to July 2022. Offshore, the week was dominated by a run of US data. Durable goods orders were more indicative of a solid more than strong underlying investment trend in Q2; however, the regional industry surveys suggest the case for capacity expansion is building. Meanwhile household wealth is supportive of sustained strength in consumption, particularly as wealth is rising strongly at the same time the labour market recovery is producing rapid income gains and stimulus is taking effect.
Based on the Committee’s April post-meeting communications, the FOMC is determined to do all they can to help the US thrive post COVID-19. Very clearly, while aware of potential risks related to inflation, the focus of the Committee is on rapidly reducing labour market slack. This includes both the 8.4 million jobs which remain lost to the pandemic as well as the circa 4 million jobs we project would have been created had trend growth instead being seen through 2020-2022. There is therefore no reason to begin talking about tapering. This is unlikely to occur formally before late-2021, with the taper to then proceed in the second half of 2022.
This week we look at the historical value deviation between bonds and equities. The chart below is another way to illustrate just how extreme the differential between bonds and equities has become with the spread between the 10-year bond yield and equity valuations (P/E’s) has reached a historical high.
The chart below tells a very compelling story just how overvalued equity are. Valuations as measured by historical P/E’s have reached what can only be described as extreme levels. This in turn has also had a dramatic impact on dividend yields, the staple income provider for most investors (chart below). Most people feel that there is a lack of options when it comes to investing and end up putting most of their money into risky assets like equities. We believe most people would be surprised to know that the average SMSF holds a very meagre 1.6% in fixed income, and the average retail portfolio holds approx. 15%. This is way below the OECD average of approx. 40%. The point being that Australians are taking unnecessary risks when it comes to their investments.