A message from MLC Asset Management’s Chief Investment Officer

CIO Market Insights: Omicron variant intrudes into inflation and interest rate preoccupations

  • The emergence of the Omicron variant of COVID-19 adds to the list of mutations, and level of uncertainty surrounding the pandemic.
  • The chances of getting assessments right at this stage remain problematic, so diversification and risk management are key. Given that diversification and risk management have been at the heart of our investment approach since 1985, our clients can be confident that our vigilance is very high.
  • Regardless of the evolution of the latest COVID-19 mutation, the inflation and interest rate outlook will continue to occupy a lot of investor attention.
  • Unlike the very low official interest rates that have persisted across many wealthy countries since the GFC, interest rate policy in China has been ‘normal’ and worked as it’s meant to. Higher interest rates have dampened economic activity, while lower interest rates have spurred activity.
  • We think that China’s relatively high real interest rate environment gives us an opportunity to harness return potential for MLC’s multi-asset funds – MLC Horizon, Index Plus and Inflation Plus portfolios.1

Dear Investors and Advisers

As I was getting ready to jot down my thoughts for this note, I was reminded of what former British Prime Minister Harold McMillan once said in response to being asked what worried him most: “Events, my dear boy, events.”

I had initially thought of starting this note by discussing a divergence that has appeared in financial markets over recent months. It was going to go along the following lines: major share markets continued to move forward,2  on the back of earnings growth driven by the release of pent-up demand from the time of COVID restrictions. Contrastingly, fixed income markets have been troubled by levels of inflation not seen in years.

But that was before the Omicron variant of COVID-19 appeared to give investors and policymakers something else to think about. At times, public commentary can add to apprehension rather than supply perspective.

We should neither underplay nor exaggerate Omicron because viruses mutate. That’s how they behave and adapt. Our knowledge of COVID-19 improves each day and medical scientists will be fighting a guerrilla war against the virus and its mutations for some years, in all likelihood.

The Delta variant is still present, and Omicron adds to the list of mutations, and the level of uncertainty surrounding the pandemic.

Early comments on vaccine efficacy and symptom severity, while cautiously optimistic, are probably too speculative to form any solid opinion on these matters, at the time of writing. Whether Omicron proves more virulent and whether vaccines still offer good protection are questions we will closely monitor.

CIO Market Insights: Possibility of a rethink by central banks

In terms of the economic and market impacts of Omicron; greater economic uncertainty probably pushes back the timing of interest rate increases, which looked like they were being brought forward based on central bank actions and changes in language before the latest events.

There have been official interest rate rises in sizeable emerging economies, such as South Korea, Brazil, and Mexico,3  as well as developed economies such as Norway,4 and New Zealand,5 in recent months.

Meanwhile, the Reserve Bank of Australia (RBA) Governor Philip Lowe’s November statement6 no longer included a crucial line saying official interest rates will remain on hold until 2024.

Over in America, the US Federal Reserve announced a US$15 billion a month reduction7 of its massive asset purchase program, which has suppressed US and global interest rates.

However, a serious outbreak of the virus would likely cause central banks to rethink their next steps.

For instance, another bout of pandemic-associated disruption may cause supply constraints to be resolved more slowly. If that happened, demand would be impacted, but at this stage, odds are better that the self-reinforcing cycle of spending has enough momentum to keep going.

So on balance, another wave, should it eventuate, would probably be more inflationary than deflationary, which would be negative for fixed income assets, and mixed for shares.

The chances of getting assessments right at this stage remain problematic, so diversification and risk management are key. Given that diversification and risk management have been at the heart of our investment approach since 1985, our clients can be confident that our vigilance is very high.

CIO Market Insights: Ultra low interest rates anything but normal

Regardless of the evolution of the latest COVID-19 mutation, the inflation and interest rate outlook will occupy a lot of investor attention.

The prolonged low interest rates of the post GFC era may have conditioned us to think of them as normal, but from an orthodox economic perspective there is nothing normal about official interest rates hovering near zero. It suggests something is very amiss across advanced countries that interest rates have stayed so low8  for so long.

Among major economies, China stands apart as a country where ‘normal’ interest rate policies have prevailed and worked. In January 2009, the 1-year Working Capital rate set by the People’s Bank of China was 5.31% and stood at 4.35% recently.9

On the other hand, official interest rates in the US, the Euro zone, and the UK were 0.13%, 2.0% and 1.5% respectively in January 2009, and 0.13%, 0% and 0.1% at the end of November this year.10

Admittedly, China is a middle-income country, at least on income per head measures, so critics could say that like-for-like comparisons with wealthy countries’ interest rates is unreasonable. Fair point.

Moreover, neither is China democratic or capitalistic. It also differs from the basket-case Soviet-model. It really is different from what we’ve seen elsewhere.

That said, China’s national wealth has grown mightily over the past four decades and the country is now either the world’s second largest or largest economy, depending on which measure you use.

So why is it that interest rates in China are higher, as well as more normal, compared to advanced countries?

The short answer is that interest rate policy in China has continued to work, as it’s meant to. Higher interest rates have dampened economic activity, while lower interest rates have spurred activity.

There’s been no need to go to zero interest rates just to keep the economy from coming to a standstill, as has been the case with many advanced economies.

CIO Market Insights: National strategy, local implementation

Digging deeper, Chinese interest rate exceptionalism has worked because Beijing allows national policy to take local conditions into consideration. It’s not one-size-fits-all monetary policy.

Recent ructions in China’s property market, exemplified by the deep troubles of Evergrande, one of the country’s largest property developers, is a good example of how the system manages centralised policy and localised implementation.

While the broad directive out of Beijing is for tightening of the property sector, weak conditions in predominantly tier-3 and tier-4 cities are being addressed by loosening of regional policy. Thus, while bustling new economic hot zones such as Hainan are restricting lending and inhibiting liquidity, stagnant markets such as Zhuhai are relaxing liquidity and supporting prices.

The dual-track approach also means that while the government is pulling the reins on large state-owned enterprises and property developers that previously gorged on easily accessible credit, or striking out at high-profile technology companies, it’s rolled out supportive policies for small to medium-sized enterprises ranging from access to credit, through to taxation and support for employees.

CIO Market Insights: ‘Normal’ interest rate policies provide investment opportunities

All up, we think that China’s relatively high real interest rate environment gives us an opportunity to harness return potential for MLC’s multi-asset funds – MLC Horizon, Index Plus and Inflation Plus portfolios.11

We have been expressing this positive view for some time through Chinese shares and bond positions within the MLC Inflation Plus portfolios, and more recently in the MLC Horizon portfolios through an emerging market shares overweight. Moreover, these positions are customised to achieve a targeted exposure to the Chinese assets that we believe will benefit most from government policy settings.

Furthermore, consistent with our ‘participate and protect’ investment approach, we’re accumulating returns from many sources, across many countries and assets. At the same time, we’re keeping a watchful eye out for potential threats to portfolios, such as Omicron.

Highest possible returns are the goal of any investor. But we believe the blind pursuit of outperformance isn’t always the way to deliver a goal.

We believe maximising returns over time is about getting the balance right between opportunity and defence. That’s why our investment philosophy is built around an agile process of understanding and capitalising on investment opportunities while also managing risks, both known and unknown.

This is my last note to you for the year as all of us look forward to a break. It’s our privilege to be stewards of so many Australians’ savings and investments, and we look forward to serving you again next year.

Until then, please accept, on behalf of my colleagues and I, our best wishes to you for a safe and restful holiday season.

Warm regards,

Jonathan Armitage
Chief Investment Officer, MLC Asset Management

1 The MLC Wholesale Inflation Plus, MLC Wholesale Horizon and MLC Wholesale Index Plus funds. The Product Disclosure Statement (PDS) for each of the MLC Wholesale Funds is available via https://www.mlcam.com.au/institutional-clients/mlc-wholesale/resources.

2 For major share market returns see https://au.finance.yahoo.com/quote/%5EFTSE?p=%5EFTSE

3 Brazil raises interest rates as it struggles to tame inflation. Michael Pooler, September 23, 2021, https://www.ft.com/content/2aba282a-e1ea-4533-ae36-375c16020565

4 Norway raises interest rates, says another hike likely in December. Victoria Klesty and Nerijus Adomaitis, September 23, 2021, https://www.reuters.com/world/europe/norway-raises-interest-rates-says-another-hike-likely-december-2021-09-23/

5 New Zealand hikes rates for second straight month as inflation risks grow, November 24, 2021, https://www.reuters.com/markets/rates-bonds/new-zealand-hikes-rates-second-straight-month-inflation-risks-grow-2021-11-24/

6 Media Release: Statement by Philip Lowe, Governor: Monetary Policy Decision. 2 November 2021, https://www.rba.gov.au/media-releases/2021/mr-21-24.html

7 FOMC Press Conference, and Federal Reserve issues FOMC statement, November 03, 2021, https://www.federalreserve.gov/newsevents.htm

8 F13 International official interest rates, https://www.rba.gov.au/statistics/tables/xls/f13hist.xls

9 There was no single official interest rate in China in 2009 as the People’s Bank of China used a range of monetary indicators. The 1-year Medium Term Lending Facility (MTLF) appears to have been adopted as the key benchmark rate since 2016. For the purposes of comparing and contrasting the closest approximation of official interest rates in China January 2009 and now, we have used the 1-year Working Capital interest rate set by the central bank found in
China interest rates: lending rate 15 December 1999 – 15 November 2021. Refinitiv data

10 F13 International official interest rates, https://www.rba.gov.au/statistics/tables/xls/f13hist.xls

11 The MLC Wholesale Inflation Plus, MLC Wholesale Horizon and MLC Wholesale Index Plus funds. The Product Disclosure Statement (PDS) for each of the MLC Wholesale Funds is available via https://www.mlcam.com.au/institutional-clients/mlc-wholesale/resources.

 

Important information

This information is current as at December 2021. This information is provided by MLC Investments Limited (ABN 30 002 641 661 AFSL 230705) as responsible entity of a series of managed investment schemes collectively known as the “MLC Investment Trusts” including but not limited to: MLC Wholesale Inflation Plus – Conservative Portfolio, MLC Wholesale Inflation Plus – Moderate Portfolio, MLC Wholesale Inflation Plus – Assertive Portfolio, MLC Wholesale Index Plus Conservative Growth Portfolio, MLC Wholesale Index Plus Balanced Portfolio, MLC Index Plus Growth Balanced Portfolio, MLC Wholesale Horizon 1 Bond Portfolio, MLC Wholesale Horizon 2 Income Portfolio, MLC Wholesale Horizon 3 Conservative Growth Portfolio, MLC Wholesale Horizon 4 Balanced Portfolio, MLC Wholesale Horizon 5 Growth Portfolio, MLC Wholesale Horizon 6 Share Portfolio, MLC Wholesale Horizon 7 Accelerated Growth Portfolio.

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