Why you need to resist fear and stay invested to grow wealth
One of our big reminders throughout the pandemic has been to stay invested. Uncertainty is the greatest driver for a buildup of cash reserves in investment portfolios. Here is why you need to resist the temptation to hold cash.
The problem with cash is low interest rates, and it is a global phenomenon. In the decade past, the inflation-adjusted return on US cash was a cumulative -12%. In the decade ahead, we expect a 15%-20% real wealth loss for cash.
If we bring it back to the Australian experience the average cash rate between 2010-2020 was 2.39% and the inflation rate was 1.9%, leaving a thin margin of real return that would likely be eaten up by tax. It's clear holding cash will not grow your wealth, and it gets worse.
Over the next five years, the interest rate average will be even lower, but we anticipate average inflation of 2.11%. On our modelling, cash holdings will equate to a 10.55% loss over the next five years.
What about the economic outlook?
Based on the ongoing lockdowns into the final quarter of 2021 and the slow recovery that's expected in the services sector, we now forecast a 3.1% contraction in the September quarter, followed by a 1.5% rebound in the December quarter, taking year-average growth to 3.5% this year. This is a far cry from the 5.7% we had projected prior to the NSW COVID-19 Delta variant outbreak.
However, as Australia learns to live with the pandemic, we believe the medium-term outlook is still for a solid domestic-driven recovery, underpinned by low interest rates and fiscal stimulus already delivered to households.
While we see inflation risks to the upside, our base case remains unchanged that underlying inflation will lift towards the RBA's 2-3% target by mid-2023, leading to an increase in rates in the second half of that year.
With vaccinations on track for 80% fully vaccinated by year end, the reopening this implies will likely see consumers become less obsessed with goods, and resume seeking out services, leading to a resumption in the downward trend of the unemployment rate.
In our outlook, we assume vaccination levels will allow for international borders to reopen for unrestricted tourism in the second half of next year.
There are wildcards that could make the slowdown in growth more dramatic, and they are mostly tied to China. China's growth is contracting more than most anticipated.
The world has become increasingly dependent on China's contribution to growth. A slowdown in China's activity due to the Delta variant outbreak, along with regulatory clampdowns, the Evergrande debt crisis, and recent power outages, have triggered a round of growth downgrades for China and other economies in Asia.
We have downgraded our economic growth forecast for China next year from 5.5% to 4.9%.
To account for the additional risk, we have shifted our market weightings away from the riskiest firms toward those with stronger long-term prospects, higher-quality balance sheets, and a strong outlook for future dividend payments.
Where to invest in this environment
Based on our research, we have in recent months continued to shift equity portfolios toward drivers of sustained returns, rather than mere recovery from the COVID-19 shock.
These areas include:
A large overweight position in the global healthcare sector to take advantage of its low valuation and persistent revenue and earnings per share (EPS) growth.
The US healthcare sector hasn't posted an annual decline in revenue or EPS since our records begin in the late 1980s.
As a sector well-positioned for growth in trending and sustainable themes, it also tends to exhibit relatively high environmental, social and governance (ESG) credentials.
Consequently, investing in these themes has the potential to go hand in hand with sustainable investing, which seeks to allocate wealth to companies that support the environment and society, and have strong corporate governance.
What is noticeable is that the digital revolution has created efficiencies in multiple sectors which have contributed to reducing the environmental impact of their respective companies.
As an example, data-driven analysis has helped wind turbine companies to increase the efficiency of how they produce power, consequently reducing the cost of this energy source and therefore making it more appealing for the end consumer.
Cyber security and productivity software
The must-haves in any modern corporate creates willing and able buyers of technology. These are necessary tools, and equivalent to the early days of selling picks and shovels to miners.
We expect in a post-COVID-19 world, with teams needing to accommodate more geographic separation, asynchronous work, and flexible schedules, this broad category of productivity/collaboration will continue to grow.
China accounts for 40-70% of the end demand for most commodities. Mining equities cannot completely side-step a China slowdown, but the magnitude of any pull back is likely to be lower than history for three reasons:
1. A China slow-down and lower spot prices has already been priced in by investors over the past 18 months.
2. The supply-side remains tight. ESG requirements have constrained investment in new capacity and projects. Mining capital expenditure this year is still about 30% below previous peaks, despite high metal prices and strong cashflow.
3. Global infrastructure spending to offset some of the impact from a slowing China.
It should also be noted our research indicates the metals industry is critical to facilitating the bulk of decarbonisation required by the Paris agreement by 2050.
This is because the metals industry enables the shift to renewable energy, provides for the electrification of transport, and will benefit from the development of carbon capture and storage.
As market growth moderates, the focus of investors will increasingly be on choosing companies based on expected dividend growth and sustainability.
Firms that pay and grow dividends tend to have stronger-than-average financial stability and have a long-term history of posting smaller declines during sell-offs. We favour dividend growth strategies, split evenly between Australian and non-Australian shares to deliver diversification benefits.
This information is not advice and has been prepared without taking account of the objectives, situations or needs of any particular individuals. Any individual should consider if the information is appropriate for your own situation. Individuals are advised to obtain independent legal, financial, foreign exchange and taxation advice prior to making financial decisions. Citigroup Pty Limited ABN 88 004 325 080, AFSL and Australian credit licence 238098.
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