Investment markets and key developments over the past week
Share markets, with the exception of European shares, pushed higher again over the last week on ongoing signs that the coronavirus curve is flattening in a number of countries which is resulting in a move towards relaxing lockdowns amidst promising reports regarding anti-viral drug tests. For the week US shares rose 3%, Japanese shares gained 2%, Chinese shares rose 1.9% and Eurozone shares fell 0.3%. While Australian energy stocks were hit as oil prices fell, the local share market rose 1.9% boosted by a strong global lead with particularly strong gains in IT, industrial, consumer, material and health shares. From their lows around 23rd March global shares are up 24% and Australian shares are up 21%, which means they have recovered around 40% of the plunge from around 20th February. Despite the strength in shares, bond yields fell in the US, Germany and Australia as economic data worsened. Oil prices fell as OPEC+ production cuts were judged to be not enough to offset the slump in global oil demand, but metal and iron ore prices rose.
After a powerful 20% plus rally from lows around 23rd March shares are a bit vulnerable in the short term as the economic and profit news is likely to be pretty bleak over the next month:
- Economic data now looks like it’s falling off a cliff with a record plunge in US March retail sales, plunging consumer and business confidence readings and signs of collapsing employment. We have constructed weekly economic activity trackers for the US and Australia based on high frequency data for things like restaurant bookings, confidence, foot traffic and jobs indicators. Both are down sharply although there is some sign of stabilisation in Australia. (Note that because they have different components the levels of each are not comparable – rather the focus should be on direction.)
- With the shutdowns really only getting underway in the second half of March, April data is likely to be a lot weaker than March data with unemployment in the US looking like it’s on the way to 20% and in Australia to around 10% (with JobKeeper wage subsidies helping to keep it down relative to the US).
- While, it’s just catching up with market expectations the IMF’s updated forecasts for a 3% contraction in global GDP this year provided a reminder of the scale of the hit to the global economy, particularly given that this masks contractions in the US, Europe, Japan and Australia averaging around 6%. To put this in context the GFC saw global growth contract around 0.1%. The scale of the IMF’s growth downgrade for this year makes the fine tuning of its growth forecasts over the last few years when growth ended around 3% look trivial!
- Our own expectation is for advanced countries including Australia to contract by 10% to 15%, mainly concentrated in the June quarter.
- This is all likely to drive a sharp 30% or so slump in profits and this is starting to become evident in March quarter earnings reports in the US.
- At the same time the blame game looks to be ramping up in the US, with numerous signs pointing to this leading to a ramp up in US/China tensions, although this is mainly an issue for later this year in the run up to the Presidential election.
However, beyond the near-term uncertainty there are a number of positives investors need to allow for which point to share markets being higher on a 12-month horizon:
- First, evidence of coronavirus curve flattening is continuing, with new global cases trending sideways for two weeks now. (The volatility appears to reflect new French cases which seem to spike every so often.)
- The EU appears to be seeing a downtrend in new cases (after adjusting for volatility in French new cases).
- The US looks to be following Italy with a two-week lag – although its yet to show a clear downtrend.
- And here in Australia, we look to be continuing to follow South Korea.
- Our ranking of how well countries have grappled with coronavirus based on the percentage of cases that have recovered, total cases relative to each countries outbreak duration, active cases per capita and tests per capita still ranks Australia at number 3, behind only China and South Korea out of 40 countries. Italy is ranked 28th, the US is ranked 36th and the UK is ranked 38th.
Second, with various countries and regions including Australia following the pattern set by China that saw a peak in new cases around 11 to 21 days after its lockdown, which then allowed a relaxation of the lockdown a month or so later, the focus is now shifting towards an easing of the lockdowns. Some countries have already announced some easing including Germany, Austria, Spain and Italy. The US has released guidelines for state and local governments to follow in a three-phased easing process contingent on meeting various criteria (including falling new cases and in relation to hospitals) over a two week period before proceeding to each stage that could allow some states to reopen in a month. Australia is a bit stricter with the PM saying that current restrictions will remain in place for at least the next four weeks and noting three criteria that need to fall into place: better testing; better contact tracing; and confidence in containing outbreaks. Australia’s tougher approach makes sense given the risks around the coming winter and the absolute necessity of being far better at quarantining new cases going forward. But the bottom line seems to be that if the number of new cases continues to trend down an easing of the various lockdowns will be common from around May.
Third, pharmaceutical solutions could speed the easing of lockdowns and here there are two positive developments. First, there are reports that patients treated with Gilead’s anti-viral drug remdesivir were seeing “rapid recoveries in fever and respiratory symptoms.” Second, antibody testing for exposure to coronavirus is now starting up and may enable estimates of “herd immunity” and the possible provision of “immunity passports” for those who test positive to return to normal life.
Fourth, if May starts to see a generalised and gradual easing in the lockdowns then April is likely to be the low point in economic data in Australia and other developed countries, much as February looks to have been in China. If so, shares should then start to look forward to better times ahead, albeit it may still be a rough ride.
Finally, although policy stimulus announcements may start to slow for the simple reason that so much has already been done, they are still continuing with progress towards another US fiscal stimulus and stimulus handouts to households on the way in South Korea and being considered in Japan.
So even though economic data will be bleak for a while, there seems to be an increasing amount of light at the end of the tunnel. But the world still needs a lot of love to get there. Through our Love is one of Paul McCartney’s best songs from the 1980s.
Major global economic events and implications
In the US, March retail sales, industrial production and housing starts all plunged as a result of the shutdown and uncertainty regarding the outlook, jobless claims rose by another 5.2 million, April data showed a plunge in manufacturing conditions in the Philadelphia and New York regions and in home builder conditions and the Fed’s Beige Book painted a bleak picture of the US economy with employment falling everywhere, wage pressure disappearing and inflation slowing.
Chinese March quarter GDP fell 9.8%qoq or -6.8%yoy reflecting the shutdown seen through late January and February. This was in line with our expectation for a 10% fall but better than market expectations for a 12% decline. The good news is that with the shutdown being relaxed through March, GDP is likely to rebound this quarter. Consistent with this daily and weekly activity indicators continue to trend up and momentum in activity data for March improved with industrial production rising 1.1%yoy which is up from a fall of 13.5%yoy over January and February, retail sales fell 15.8%yoy but this is up from -20.5% and investment fell 16.1% but this is up from -24.5%. Exports and imports also rose in March consistent with a pick-up in economic conditions, although poor global conditions will weigh on exports going forward. Home prices rose 0.2% again in March which isn’t bad given the collapse in property transactions through February.
Australian economic events and implications
Consistent with indicators that had already been released, business confidence as measured by the NAB survey and consumer confidence as measured by the Westpac/MI survey plunged in March and April respectively.
While jobs data was better than expected in March with employment up by nearly 6000 and unemployment only rising to 5.2% this looks to have been because the survey related to the first half of March whereas the shutdowns and layoffs only started in the second half. So, April is likely to show a sharp fall in employment and spike in unemployment. However, it is worth noting that growth in employment and hours worked had been slowing before coronavirus shutdowns came along and labour underutilisation rose to a high 14% March. Our assessment remains that unemployment is on its way to around or just below 10% by June assuming the shutdown is no more than six months. Were it not for the JobKeeper wage subsidies – with the ABS confirming that people paid through JobKeeper will be classified as employed - unemployment would probably be on its way to 15% or more.
What to watch over the next week?
Markets will likely remain focussed on continuing evidence that the number of new Covid-19 cases is slowing and increasing talk of an easing in lockdowns. Economic releases will continue to show the increasing impact of coronavirus shutdowns. Key to watch on this front in the week ahead will be April business conditions PMIs to be released Thursday for the US, Europe, Japan and Australia all of which are likely to remain weak or fall further from the levels of around 30 to 40 seen in March. If the shutdowns ease in May then April should prove to be the low point.
In terms of other data, in the US expect to see sharp falls in existing and new home sales (due Tuesday and Thursday) and in durable goods orders (Friday) and jobless claims (Thursday) are likely show another sharp rise. The flow of March quarter earnings reports will ramp up and are likely to show a steep fall with negative/uncertain outlook comments.
Japanese core inflation (Friday) is likely to have fallen further in March to around 0.5% year on year.
In Australia, the minutes from the last RBA board meeting (Tuesday) are unlikely to say anything new, but a speech by RBA Governor Lowe also on Tuesday may shed more light on how the RBA is seeing the impact of the shutdown and whether it sees the need to do more. One area where the RBA could do more is to extend its bond buying to corporate bonds to get the corporate bond market working again. On the data front new ABS publications to track the economic impact of coronavirus on the economy will shed light on the impact on households (Monday) and weekly payrolls and wages (Tuesday) and preliminary retail sales data for March (Wednesday) are likely to show a sharp decline. Skilled vacancies for March (Wednesday) will likely show a sharp fall.
Outlook for investment markets
After a strong rally from March lows shares are vulnerable in the short term as economic data to be released over the next month shows the devasting impact of the coronavirus related shutdowns. But on a 12-month horizon shares are expected to see good total returns helped by an eventual pick-up in economic activity and massive 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 the search for yield but the hit to economic activity from the virus will weigh heavily on near term returns.
The Australian housing market is weakening rapidly in response to coronavirus. Social distancing is driving a collapse in sales volumes, and a sharp rise in unemployment, a stop to immigration through the shutdown and rent holidays pose a major threat to property prices. Prices are expected to fall between 5% to 20%, but government support measures including wage subsidies along with bank mortgage payment deferrals along with a plunge in listings will help limit falls at least for the next six months.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
The hit to global growth from Covid-19 and its flow on to reduced demand for Australian exports and lower commodity prices still risks pushing the A$ lower in the short term possibly to a re-test of its low three weeks ago of US$0.55. But expect a strong rebound once the threat from coronavirus recedes, particularly with the US expanding its money supply far more than Australia is via quantitative easing.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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