The Wrap: Stagflation? Asian Savings Slump, Insurers & Healthcare

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–What is the risk of 1970’s style stagflation?
-A savings slump in parts of Asia may prevent a return to neutral monetary policy
-Will rising bond yields lift all insurers?
-Winners from increased covid testing

By Mark Woodruff

A savings slump in parts of Asia

It may take a few years of rebuilding household savings in parts of Asia before consumption can return to pre-pandemic levels. At present, a strong re-opening rebound in private consumption cannot be relied upon.

A lasting dent has been inflicted upon the financial position and incomes of households particularly in Indonesia, the Philippines and Thailand, explains ANZ Bank.

An unexpectedly prolonged pandemic, alongside diminished income growth, has forced householders to drawdown on savings. As an example, household savings as a share of incomes have dropped to the lowest on record in Indonesia.

Unfortunately, the situation is unlikely to be rectified quickly by a rise in incomes, as various economic indicators in all three countries point to slack in the labour markets.

As a result, governments are expected to have larger budget deficits for longer. Monetary policy normalisation will also be slow and independent of the US Federal Reserve. 

More importantly, it is conceivable that the terminal (natural or neutral) policy rate may well settle at lower than pre-pandemic levels, suggests ANZ Bank.

Will rising interest rates lift all insurers?

Government bond yields have risen sharply since the beginning of the December 2021 quarter.

This is mirroring trends in the US and particularly in the UK, where government bond yields are at their highest levels in two and a half years.

Credit Suisse believes there are strong indications these bond yields are likely to continue to rise, and sets about investigating potential earnings upsides from the large fixed income portfolios that insurers hold.

The broker concludes QBE Insurance ((QBE)) has around 2% earnings upside for every ten basis points rise in bond yields, and double the sensitivity compared to both Insurance Australia Group ((IAG)) and Suncorp Group ((SUN)).

The order of Credit Suisse’s investment preference in the sector remains QBE, followed by Suncorp and IAG.

Winners from increased covid testing

In August, domestic polymerase chain reaction (PCR) covid testing in Australia increased to more than four times the monthly average in the second half of FY21.

The broker expects Sonic Healthcare ((SHL)) will provide around 11.5m tests globally in the current half while Healius ((HLS)) will undertake circa 5.5m tests, and raises near-term earnings for both companies' estimates accordingly.

Despite this, JP Morgan retains its FY23 forecasts for the two domestic laboratory operators. This is on the expectation that covid testing will fall in 2022 due to widespread vaccinations, and a cut in the PCR reimbursement rate.

Sonic Healthcare remains focused on using testing proceeds to fund the expansion of its global business, with the focus likely to be on the US and Europe. The broker retains its Neutral rating and $45 target price.

Meanwhile, the analyst points to a positive operating environment outlook for diagnostics, which now represents the majority of Healius’ business. Despite some execution risk associated with a number of strategic initiatives and spending on diagnostic programs, the broker retains its Overweight recommendation and $5.50 target price.

What is the risk of 1970’s style stagflation?

There is no risk of 1970s-style stagflation and there is no comparison to the 1970’s supply shock in the recent commodities price surge and 13-year highs for US inflation.

The vaccine-driven restart of economic activity after shutdowns has caused a major supply shock and inflation pressures remain persistent, concedes Black Rock. The investment manager remains pro-risk and prefers inflation-protected securities over nominal bonds and is overweight European equities versus a neutral stance on US equities.

In some minds, this year’s oil price surge raises the prospect of stagflation, which by definition is a period of high inflation coupled with weak growth. However, growth is currently powering ahead and the investment manager would expect oil to be in demand under such conditions.

Looked at a different way, inflation is being driven by the restart, not the oil price. Moreover, supply is expected to rise to meet demand, instead of the 1970s experience of demand going down to meet supply. For Rudi's view on stagflation see the section entitled Jumpin' Jack Flash lives in the seventies at https://www.fnarena.com/index.php/2021/10/21/rudis-view-adairs-gentrack-readytech-macquarie-qantas-and-nufarm/

Black Rock expects restart pressures to persist well into 2022 and feels those central banks with credible policy frameworks will look through most of them. Later on, pressures should fall away as near-term supply-demand imbalances ease.

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