Investment markets and key developments over the past week
Share markets pulled back over the last week as oil prices fell further, not helped by very poor economic data. However, the falls were relatively mild compared to the 20% plus rally from the March low point. For the week, US shares fell 1.3%, eurozone shares fell 1.8%, Japanese shares fell 3.2% and Chinese shares lost 1.1%. Australian shares were dragged down by 4.5% for the week by the poor global lead, with energy shares down again, but the biggest falls were actually in property, industrial, retail and health stocks. Bond yields fell in the US and Japan, were flat in Germany and rose slightly in Australia. Oil, metal and iron ore prices fell and the Australian dollar was little changed.
Shares remain vulnerable in the short term to bad economic and corporate news flowing from coronavirus shutdowns. This was clearly evident in the past week:
- First, economic data continues to fall off a cliff – abstracting from a toilet paper, rice, pasta, flour and home office driven boost to Australian retail sales in March, which has just pulled sales forward. The plunge in economic conditions is evident in another sharp fall in April business conditions PMIs across the US, the eurozone and Japan, which fell an average of 12.5 points. PMIs also fell sharply again in Australia.
- Consistent with this, our 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 are well down, although there is actually some sign of stabilisation in Australia.
- Second, collateral damage from the shutdowns is continuing to become evident, as highlighted by the oil price going negative and Virgin Australia going into administration. The collapse of 2nd or 3rd airlines in Australia seems like a regular occurrence – remember Ansett went bust in the tech wreck just after 9/11. Put simply, there doesn’t seem to be room for two full-service airlines – but we need at least two for decent competition.
- The plunge in US spot oil prices (to -$US40/barrel briefly) reflected US storage facilities being totally full and so is a bit of a furphy, but it highlights the mess the oil market is in. The world normally consumes about 100 million barrels of oil a day (mbd). But the shutdowns have seen consumption fall between 20-30mbd and then a market-share war broke out amongst OPEC and Russia. They then agreed to cut production by 10mbd, but it’s obviously not enough with everyone stuck inside and not driving or flying. Abstracting from the negative US oil price for near term oil delivery, the oil price has crashed from around $US60-65 early this year to around $US15-20. This is bad news for producers, but low fuel prices are good news for consumers, because they are like a big tax cut, as it frees up spending power (for those who are still out there driving), which will eventually help consumer spending.
- Given the plunge in the oil price and the recent rebound in the A$, Australian petrol prices should be on the way to around $0.85 a litre. Some service stations are already there. Compared to where petrol prices were back in January, this would represent a saving of around $21 a week for the average motorist (assuming they can drive as normal!).
- Finally, the near-term outlook for company profits is bleak. This is highlighted by US March quarter earnings reports, which so far show only 48% of companies seeing positive earnings growth, earnings running down -18% compared to a year ago and a high proportion of companies not providing guidance – which is understandable.
However, policy support is continuing to flow and this is enabling markets to look through the short term hit to economic activity and profits.
- The US has agreed on another stimulus package totalling $US484bn (2% of GDP) mostly for small businesses, with more stimulus still being talked about.
- The ECB relaxed its lending criteria to include assets and issuers that might have been downgraded, but were investment grade on April 7; this looks to be designed to allow them to continuing buying Italian debt if Italy is downgraded.
- Meanwhile, European Union (EU) leaders made some progress on a future Recovery Fund – but typical of the slow pace things move at in Europe, there is as yet no agreement on the size of the fund and common bond issuance.
- A round of economic reforms looks likely in Australia. Reserve Bank of Australia (RBA) Governor Philip Lowe noted that the best way to deal with the reverberations from the shutdown was to reinvigorate the growth and productivity reform agenda (around tax, infrastructure, training, innovation and industrial relations) and Treasurer Josh Frydenberg said the Government and the RBA were on the same page with this, so a reinvigorated productivity-focus looks to be on the way in Australia. The case for this has been evident for a while now, but hopefully the current crisis will provide the ‘push-along’ for it to get through political hurdles – with positive signs so far from crossbench politicians.
And, news on coronavirus curve flattening remains positive.
- New global coronavirus cases have been trending sideways to down for the last three weeks now.
- The EU is seeing a clear downtrend in new cases and cases in the US appear to have peaked albeit without a strong downtrend yet.
- while Australia is getting close to zero new cases.
- 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 now ranks Australia at number 2, behind only China out of the top 50 countries in terms of the number of cases. Note we have had to expand the number of countries as Australia dropped out of the top 30 and then the top 50. Italy is ranked 31st, the US is ranked 47th and the UK is ranked 49th.
This is all consistent with talk of easing shutdowns. The risk of a “second wave” provides reason to move cautiously – particularly in the US where President Trump and some US state’s bravado does not provide a lot of confidence. However, providing any easing is gradual (and based on criteria around widespread testing, falling new cases and better containment and tracking) then this risk should be able to be managed. The approaching winter in Australia also points to the need for caution, but providing these criteria are met and foreign travel remains banned, then Australia should be able to see a gradual easing from mid-May and join other countries in the easing process. If this is the case, then April or maybe May should be the low point in economic data, with a gradual recovery underway through the second half.
Widespread testing showing a high level of herd immunity (possible), a break-through in anti-virals (maybe) and/or rapid development of a vaccine (unlikely, but you never know) would speed this process. I would be cautious about all these at this stage.
The bottom line is that after the strong run up in global and Australian shares since the low around 23rd March low, the markets is vulnerable to a period of weakness or consolidation in the very short-term, reflecting continuing poor economic data for the next few weeks. But providing we are right and shutdowns ease in the months ahead, resulting in April or May proving to be the low point in economic data, then given the massive policy stimulus, a sharp share market pullback is unlikely and shares should be able to resume their rising trend.
Australia (touch wood) looks to be coming through this period of global misery relatively well and this may mean that the Australian economy contracts less and rebounds faster, ultimately supporting Australian asset classes in a relative sense. First, Australia has performed far better than most countries in controlling coronavirus – thanks to a proactive and sensible public health response, Australians pulling together to do the right thing and possibly helped by better weather, less urbanisation and a younger population. As noted above, it ranks 2nd out of 50 countries in controlling the virus. Second, Australia has seen a superior policy response, focussed on keeping people in their jobs via wage subsidies, and the RBA helping banks provide debt-servicing holidays. Finally, we may benefit from our biggest export market – China - being ahead of the global recovery curve and its focus on infrastructure spending, which explains why prices for our key export - iron ore - are holding up relative to say the oil price.
You know what I miss about time in the car driving to work – time with music! Diana showed me this clever and thoughtful video of The Man just before the world went bonkers and then I forgot about it. But I like it.
Major global economic events and implications
Beyond the further plunge in US, eurozone and Japanese PMI global data was mostly weak. US home sales plunged and there was another strong rise in jobless claims, albeit it has slowed a bit over the last two weeks. March durable goods orders fell 14.4%, but capital goods orders excluding defence and aircraft were flat. Eurozone consumer confidence plunged, as did a survey of analysts regarding current conditions (but in good news – expectations rose sharply).
Australian economic events and implications
Australia got some good news on the data front, with preliminary data showing a record 8.2% gain in March retail sales and a huge surge in March exports relative to imports, indicating that the trade surplus remains in place. However, don’t get too excited because there was a lot of bad news too.
In particular, a couple of new ABS high frequency data releases, designed to shed light on how the shutdown is impacting the economy, show between a 3% to 6% hit to employment into early April. While it’s not clear as to how this will translate to actual measured employment, it is consistent with unemployment rising to around 10%. The hit to the labour market, combined with the surge in retail sales being driven by panic buying of things like toilet paper and pasta (which has just brought spending forward) point to a very sharp plunge in retail sales this month. The CBA’s composite business conditions PMI also fell to a record low of 22.4 in April, compared to a norm of just above 50. Finally, new home sales fell a sharp 23.2% in March, highlighting an early impact from social distancing.
The strength in March retail sales and goods trade holds out the possibility of March quarter GDP growth actually being positive. We think it’s unlikely though, given a likely drawdown in the inventory of toilet paper and other essentials, a hit to consumer services and a plunge in car sales already reported. But all of this is consistent with a 10 to 15% plunge in GDP in the first half, though mainly in the June quarter.
One thing worth mentioning though is that like all developed countries, the hit to domestic demand will weaken our imports, but our relatively high exposure to the Chinese economy (which now looks to be growing again and is looking to make up for lost activity by boosting infrastructure spending) should help support our exports. And this is consistent with the price of our biggest export, iron ore, remaining relatively high at around $US84/tonne, while the price of oil (which we import) has crashed. All of which combined with a far superior policy response in Australia to the crisis, could see the Australian economy as a relative outperformer over the next 12 months.
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 on progress towards an easing in lockdowns. Economic releases will continue to show the increasing impact of coronavirus shutdowns.
The US Federal Reserve (Fed) (Wednesday) is expected to make no major changes to its massive monetary stimulus program, but it may announce some fine tuning and could adopt stronger forward guidance regarding keeping policy ultra-easy until things return to normal. Fed Chair Powell’s press conference will be watched closely for clues regarding next steps. On the data front, consumer confidence (Tuesday) is expected to plunge, March quarter GDP (Wednesday) is expected to fall an annualised -3.7% (or about -0.9% quarter-on-quarter) and pending home sales (also Wednesday) are expected to fall 10%, personal spending for March (Thursday) is expected to have fallen by 3.3% and core Personal Consumption Expenditure (PCE) inflation is expected to fall to 1.7% year on year and the April manufacturing conditions ISM (Friday) is expected to plunge to around 39. Jobless claims (Thursday) are likely show another sharp rise. The flow of March quarter earnings reports will likely continue to show a steep fall, with negative/uncertain outlook comments.
The European Central Bank (ECB) (Thursday) is under pressure to do more to reduce Italian and Spanish bond yield spreads and so is likely to announce more aggressive action on this front, with an expanded pandemic quantitative easing (QE) program and a stronger commitment to narrowing these spreads. On the data front, economic confidence for April (Wednesday) is likely to show a further sharp fall, March quarter gross domestic product (GDP) is expected to fall 4% quarter-on-quarter, March unemployment is expected to rise to 7.7% and April core inflation is expected to fall to 0.8% year-on-year (all due Thursday).
The Bank of Japan (Tuesday) is likely to adopt unlimited QE, an increase in corporate bond purchases and possibly a low-cost bank funding program. Labour market data (Tuesday) and industrial production data (Thursday) are likely to be weak.
China’s business conditions PMI’s for April (due Thursday and Friday) are likely to pull back slightly after their strong rebound in March. The official composite PMI is likely to fall back to around 52 from 53 in March.
In Australia, March quarter CPI inflation data (Wednesday) is expected to fall -0.1% quarter-on-quarter, with annual inflation falling to 1.7% year-on-year from 1.8% year-on-year with the main drivers being a 6% fall in petrol prices and lower airfares. Prices for clothing and household equipment will likely also fall, but food prices likely rose amidst the bushfires, drought and panic-buying, so underlying inflation is likely to come in around 0.3% quarter-on-quarter or 1.5% year-on-year. June quarter inflation will be far more interesting though, with a collapse in petrol prices, free childcare, falling rents, freezes or rebates on many government charges and discounting in the face of a collapse in consumer demand, which is likely to see the CPI fall by around 2% quarter-on-quarter which will result in an annual decline of 0.9% year-on-year, which will be the biggest fall in average consumer prices since a 1.3% fall over the year to the June quarter in 1962. Underlying inflation will likely remain positive, but it will likely also fall.
In other Australian data, expect to see a slowing in March credit growth (Thursday) and a modest 0.3% gain in April capital city home prices based on CoreLogic data (Friday). Sydney will likely have remained a key driver but average capital city momentum will have slowed further from a 0.7% rise in March and prices are expected to decline in the months ahead as transactions dry up.
Outlook for investment markets
After a strong rally from their March lows, shares look to be vulnerable in the short term, as economic data to be released over the next month will show the devasting impact of the coronavirus-related shutdowns. On a 12-month horizon however, 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 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. However, expect a strong rebound once the threat from coronavirus recedes, particularly with the US expanding its money supply far more than Australia via quantitative easing and with China’s earlier recovery likely to boost demand for Australian raw materials.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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