Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Major global share markets, with the exception of Chinese shares, rose over the last week as US new coronavirus cases trended down and on optimism regarding a vaccine and the economic outlook. US shares briefly surpassed their February closing high and rose 0.6% for the week. Eurozone shares gained 1.5%, Japanese shares rose 4.3% and Chinese shares fell 0.1%. The positive global lead, along with a fall in new Victorian coronavirus cases, saw Australian shares rise 2% to the top end of the range they’ve been in since June, with strong gains in consumer staple, financial, real estate and retail stocks leading the gains. Bond yields rose sharply on the back of rising inflation expectations. Oil, copper and iron ore prices rose, but the gold price corrected as bond yields rose. The A$ rose slightly as the US$ fell.
The global news on coronavirus has been a bit more positive on three fronts recently. First, progress continues towards a vaccine, with several now in final trials to hopefully show that they work and some of the producers already manufacturing doses. While news that Russia had approved its own vaccine for use added to the excitement, it’s yet to undergo final trials.
Second, the number of new cases globally has been flat over the last two weeks, after rising since mid-April.
The improvement basically reflects a decline in new cases in developed countries, with falling new US cases more than offsetting a still-rising trend in Europe. New cases in Japan may also be slowing again.
Finally, the second wave of new coronavirus cases in developed countries has continued to be far less deadly than the first wave, with deaths running well below their April high while new cases have been well above. This continues to be evident in the US, where hospitalisations are now falling too, but it is also evident in Europe and Japan. This adds to confidence that a generalised lockdown will be avoided in most countries in favour of more surgical measures.
This in turn adds to confidence that the economic recovery that has been seen in developed countries since April can continue. With cases falling, deaths remaining relatively low and a return to a lockdown averted (at least for now), our US Economic Activity Tracker looks to be resuming its upswing, albeit gradually. Key components for consumer confidence, retail sales, mobility and job ads have turned up again.
Of course, Victoria has taken a much tougher stance, with a lockdown being implemented despite far less new cases than seen in other countries (and New Zealand has also gone down the same path after a rise in cases). We have however seen some better news on coronavirus over the last week, with new cases in Victoria trending down – highlighting yet again that lockdowns work. It’s still a horrible depressing situation in Victoria and I really feel for all those impacted, but at least there is a bit of light at the end of the tunnel (fingers crossed).
Reflecting the Victorian lockdown and some impact on confidence in NSW, our Australian Economic Activity Tracker fell further over the last week, with weakness pretty much across the board – in restaurant and hotel bookings, consumer confidence, shopper traffic and mobility indicators. However, if Victoria continues to come under control and NSW remains under control then hopefully the recovery should resume sometime in the next month.
Our view remains that the delay in the Australian GDP recovery out to the December quarter, along with the gradual and uncertain nature of the pace of recovery thereafter, will necessitate more policy stimulus in Australia. The bulk of this will fall to fiscal policy and this is where the biggest impact will come, but the Reserve Bank of Australia (RBA) will likely also have to ease further. While RBA Governor Lowe’s Parliamentary Testimony expressed a reluctance to do more on the grounds that it “wouldn’t get much traction” and “there are limits to what more we can do and the main instrument we have now is fiscal policy”, we think that with full employment and achievement of the inflation target on a sustainable basis likely to be years away, more RBA easing remains likely. Governor Lowe repeated again that monetary financing of the budget is not on the agenda and negative rates remain “extraordinarily unlikely”, but noted an openness to further reducing the cash rate to 0.1% and expanding bond purchases if needed and it’s down these paths that the RBA is ultimately likely to go.
One central bank that is a lot less hesitant than the RBA is the Reserve Bank of New Zealand (RBNZ). In the past week, it increased its quantitative easing (QE)/asset purchase program from $NZ40 billion to $NZ100 billion (which, given that the New Zealand economy is one sixth the size of Australia’s, makes the RBA’s bond buying so far of $55 billion look puny) and left negative interest rates well and truly on the table. This was despite upgrading its growth forecasts to the point that it now sees a stronger performance for the New Zealand economy than the RBA expects for Australia. The RBNZ is perhaps giving a greater weight to the downside risks than the RBA is and is clearly more comfortable in deploying alternative monetary policy measures and their efficacy than the RBA is.
Is inflation about to take off? Recent inflation readings in the US and elsewhere have surprised on the upside and market inflation expectations have surged higher. The latter may reflect a bet that policy reflation globally will ultimately work. The pickup in some inflation readings seems to reflect payback after very weak inflation/deflation over the March to May period (particularly in petrol prices) but also a bounce in goods prices as supply is constrained, but demand for household goods has gone up as people have been spending more time at home. The latter may have further to go in the next few months and on a medium-term view, massive monetary easing combined with fiscal stimulus likely does point to higher inflation. But on a 1-2 year view, it’s hard to see a lot of inflation, as goods production picks up (assuming shutdowns ease) and spare capacity remains intense, as evident in very high unemployment after adjusting for wage subsidies. That said, I find it hard to see much value in nominal bonds at these levels, unless there is a renewed downturn in global growth.
For share markets, it’s the same story. The negatives remain; the uncertainty around coronavirus, the pausing or reversal of reopening, very high unemployment, the hit to earnings, the US election, US/China tensions and the seasonally weak period of the year for shares that we have now entered. But these are arguably more than offset by a long list of positives, including continuing good news on coronavirus treatments and vaccines, the second wave in developed countries being less deadly than the first, several countries showing that it is possible to contain the virus, China tracing out a “Deep V” recovery, the safe haven US$ falling (which is normally a positive sign), monetary and fiscal policy remaining ultra-easy, low interest rates and bond yields making shares look cheap, plus there is still a lot of cash on the sidelines. Shares are still vulnerable to further volatility, with coronavirus and US/China tensions being the main risks, but the positives should keep any volatility to being a correction in a still-rising trend.
While watching The Sound recently on the ABC – which reminds me of a modern day Countdown and Sounds – I came across this excellent collaboration by JPY and a bunch of other Australian performers of The Easy Beats’ Friday On My Mind. What a classic! Harry Vanda and George Young were Australia’s equivalent of Lennon and McCartney, but they never quite get the recognition they deserve. So, do yourself a favour and check this one out.
And thankfully The Bachelor has taken over from The Bachelor in Paradise – providing another way to turn down the noise!
Major global economic events and implications
US data was good. Small business optimism fell a bit in July, but underlying retail sales rose again in July (and by more than expected), industrial production also rose, job openings recovered further in June and weekly initial jobless claims fell sharply, taking them below 1 million for the first time since March. Consumer and producer prices rose by more than expected in July, making up for the extreme weakness seen in March, April and May. Meanwhile, negotiations for the next stimulus package look to have stalled, with the further decline in jobless claims and Trump’s executive orders extending some stimulus reducing some of the pressure for now and aid for states being the main sticking point. Some sort of stimulus package however still looks likely, as this is still needed to keep the recovery going and both sides don’t want to get blamed for letting it falter. A deal may not come till September though.
UK GDP contracted a whopping 20% in the June quarter (and that’s not annualised!), but again this is ancient history with activity already starting to recover.
This is evident in more timely data for the eurozone, with industrial production up 9% in June and various business surveys up in July and August.
Chinese industrial production and retail sales data for July were a bit softer than expected, possibly reflecting widespread flooding, but indicative that the recovery remains on track. Annual growth in industrial production was unchanged at +4.8% year-on-year, retail sales growth improved to -1.1% year-on-year (from -1.8%), investment rose +6.1% year-on-year (up from +4.1%), unemployment was flat and new home prices continue to rise. Meanwhile, most high frequency data for August (for car sales, property transactions, traffic congestion etc) are running around normal levels and while credit growth in July was weaker than expected, it still edged higher. Inflation rose, though this was all due to higher food prices, with core inflation actually falling to just 0.5% year-on-year.
Australian economic events and implications
Australian jobs data surprised on the upside for July, with employment up by nearly 115,000 and unemployment “only” rose to 7.5%. The good news is that 343,100 of the 871,500 jobs lost between March and May have been recovered and “effective unemployment” (which is a guide to what unemployment would be were it not for JobKeeper and the decline in labour force participation) fell to 10.2% from 14.9% in April. The bad news is that effective unemployment of 10.2% is still very high, underemployment remains a very high 11.2%, the July jobs data relates to the first half of July (and so missed much of the Stage 3 lockdown of Melbourne) and unemployment is likely to rise significantly this month as the now tougher lockdown of Melbourne impacts. As a result, we remain of the view that official unemployment will rise to around 10% by year end. However, at least the decline in the effective rate shows that it can go in the right direction as the economy reopens.
Reflecting the hit to the labour market, wages growth slowed sharply in the June quarter, with more weakness likely on the back of high unemployment and underemployment. Meanwhile, on the back of the Victorian lockdowns, the NAB business survey showed a fall back in business confidence in July and consumer confidence for August fell back to near its April low. There was some good news though, with new home sales remaining strong in July as HomeBuilder provided assistance.
It’s still early days in the June half earnings season, with only around 18% of companies (representing 36% of market capitalisation) having reported so far, but it’s clear that company earnings have been hit hard by coronavirus. So far, only 25% of results have exceeded expectations (compared to a norm of around 44%), only 38% of results have seen earnings rise from a year earlier (compared to a norm of 66%) and 47% have cut dividends (compared to a norm of just 16%). Consensus earnings expectations so far for 2019-20 have fallen slightly to -21.6% (from -21% two weeks ago) and this will be worse than the -20% earnings decline in the Global Financial Crisis and the worst fall since the early 1990s recession. See the final profit chart below.
What to watch over the next week?
In the US, expect the minutes from the last US Federal Reserve (Fed) meeting (Wednesday) to remain dovish and commentary consistent with a move in September to inflation average targeting, which will imply a desire for a period of above-target inflation. On the data front, expect continued strength in home building conditions (Monday) and further gains in housing starts (Tuesday) and existing home sales (Friday), but a possible pullback in August business conditions PMIs (Friday) reflecting the July resurgence in coronavirus cases.
Note that the US and China have reportedly postponed talks to review progress on the phase one trade deal, which had been “scheduled” for August 15. Our view remains that while President Trump may have lost interest in the trade deal, he is unlikely to want to do anything that will dramatically damage the US growth outlook and hence his re-election prospects (like big broad based tariff hikes) at this stage, but with Trump, you never know! Larry Kudlow said the trade deal is going well.
Eurozone business conditions PMIs for August (Friday) are also at risk of some pullback, reflecting the second wave of coronavirus cases in parts of Europe.
Japanese June quarter GDP is expected to show a -7.6% quarter-on-quarter slump on the back of the coronavirus lockdown. Inflation likely remained low in July and August business conditions PMIs may also have been affected by the recent resurgence in coronavirus.
In Australia, the minutes from the last RBA board meeting are expected to show that it’s uncertain about the recovery and remains dovish with an easing bias. On the data front, expect preliminary retail sales data for July to remain flat, but the CBA’s composite business conditions PMI for August to have fallen slightly, reflecting the Victorian lockdown. Both are due Friday.
The Australian June half profit reporting season will ramp up, with many major companies due to report, including Amcor and JB HiFi (Monday), BHP, Cochlear and Coles (Tuesday), Boral, Brambles, CSL and Tabcorp (Wednesday), the ASX, Coca-Cola Amatil, Qantas and Wesfarmers (Thursday) and Suncorp (Friday). Consensus expectations remain for a -21% slump in earnings due to the hit from coronavirus. Financials will likely be the hardest hit, with an expected -29% slump in earnings led by insurers and the banks, followed by industrials, with a -15% fall in earnings and resources, with a -12% hit. Consumer discretionary may be the only sector to see a rise.
Outlook for investment markets
After a strong rally from March lows, shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery and US/China tensions. But on a 6 to 12-month horizon, shares are expected to see good total returns, helped by a pick-up in economic activity and policy stimulus.
Low starting-point yields are likely to result in low returns from bonds once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from a resumption of the search for yield, but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
Australian home prices are falling and higher unemployment, a stop to immigration and rent holidays will likely push prices lower into next year. Home prices are expected to fall by around 10%-15% from their April high into next year, with the risk of bigger falls if the renewed rise in coronavirus cases leads to a renewed generalised lockdown. Melbourne is particularly at risk on this front, as its Stage 4 lockdown pushes more businesses and households to the brink.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
Although the A$ is vulnerable to bouts of uncertainty around coronavirus, the economic recovery and US/China tensions, a continuing rising trend is likely – particularly with the US expanding its money supply far more than Australia is (via quantitative easing) and with China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).
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