Investment markets and key developments over the past week
Share markets were mixed over the last week. US shares rose 0.7% to a new record high and Chinese shares rose 0.3%, but Eurozone shares fell 1.2% and Japanese shares lost 1.6% after strong gains in the previous week. Australian shares fell 0.2% reflecting the mixed global lead, along with bad but better than feared overall earnings results. Very strong gains in Australian information technology, health and consumer discretionary stocks were offset by weakness in consumer staple, energy and financial stocks. Bond yields fell but oil, metal and iron prices rose. The A$ fell slightly as the US$ rose.
The flat trend in new global coronavirus cases is continuing. Emerging countries are mixed, with: a rising trend in Peru, Argentina, Indonesia and Columbia; a flattish trend in Brazil, India and Iran; and a falling trend in South Africa, Mexico, Pakistan and Saudi Arabia.
New cases in developed countries remain down from their recent highs, with a still-falling trend in the US offsetting a rising trend in Europe (led by Spain and France, but with Germany and even Italy and the UK on the way up). Japan remains elevated but is now down from its highs, but now South Korea is also rising and New Zealand has seen a spike.
The good news though is that 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 whereas new cases have been well above. This is helping to avoid a return to generalised lockdowns in most countries – in favour of targeted measures.
This in turn continues to add to confidence that the economic recovery that has been seen in developed countries since April can continue. With new cases and hospitalisations falling, the fatality rate remaining relatively low and a return to a lockdown averted, our US Economic Activity Tracker looks to be resuming its upswing, albeit it was flat over the last week, not helped by a fall in job ads.
In Australia, we have continued to see better news on the coronavirus front, with new cases in Victoria trending down as the hard lockdown impacts and new cases remaining low in NSW (suggesting that testing, tracking and quarantining programs outside Victoria are working well).
Unfortunately, unlike in many other developed countries, the second wave of coronavirus cases has been more deadly in Australia than the first, as it took hold in Victorian retirement homes. With new cases now falling though, deaths should soon follow, thankfully. Australia’s measured death rate, at 1.8%, remains low compared to the US at 3.1%, the UK at 12.9%, France at 13.5%, Italy at 13.9% and Sweden at 6.8%.
The Victorian lockdown is continuing to weigh on economic activity in Australia, with our Australian Economic Activity Tracker remaining well down from its July high (although it was basically flat over the last week helped by a slight rise in consumer confidence and restaurant bookings). If Victoria continues to come under control, we believe the economic recovery should resume sometime in the next month.
The US election is now hotting up and with new coronavirus cases declining, Trump’s approval rating has improved a bit and Biden’s lead in opinion polls has narrowed from around 10 points in late June to around 8 points. With the increasing focus on the election, it’s likely to add to market volatility, particularly if Trump’s prospects start deteriorating again (the market often favours the incumbent ahead of the election and prefers his tax policies). However, as long as Trump still sees some chance of being returned, we believe he is unlikely to ramp up tensions with China to the point of adversely affecting the economic outlook. Election pressures may be getting the US closer to a stimulus deal though, with House Speaker Nancy Pelosi indicating that the Democrats might agree to reduce their stimulus proposal in order to reach a deal to help the economy and then revisit it after the election.
Meanwhile, tensions between China and Australia continued in the last week, with China announcing an investigation into allegations of Australia dumping wine into China. Higher average prices for Australian wine in China compared to other countries may suggest otherwise, but then again, China does have some gripes too, with Australia putting tariffs on imports from China on the grounds of dumping. We have also seen an investigation into European Union (EU) wine before, only to see the Government find in favour of Europe and not levy tariffs. To put it into context however, Australian wine exports of about $1.2 billion pa to China compare to annual exports of iron ore at $80 billion, coal $14 billion and gas $16 billion. Therefore, it will be bad news if tariffs are levied for wine producers, but it won’t have a major impact on Australian exports to China overall.
For share markets, it’s still the same story. The negatives remain the uncertainty around coronavirus, the pausing or reversal of reopening, very high unemployment, the hit to earnings, the US election, US/China tensions and the seasonally weak period of the year for shares that we have now entered. Recent gains in US shares have also come on low breadth, suggesting the risk of a correction. However, these are arguably more than offset by a long list of positives including continuing good news on coronavirus treatments and vaccines, the second wave in developed countries being less deadly than the first, several countries showing it is possible to contain the virus, China tracing out a Deep V recovery, the safe haven US$ falling (which is normally a positive sign), monetary and fiscal policy remaining ultra-easy, low interest rates and bond yields making shares look cheap and a lot of cash remaining on the sidelines. We think 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.
I couldn’t resist including an Elvis song this week, as last Sunday 16 August was the 43rd anniversary of when he left the building (or so I am told). So here it is – The Edge of Reality which is one of his best and it’s from one of my favourite Elvis films, Live a Little, Love a Little.
Another great week on The Bachelor. I was thinking Bella or Irena gets Lochy’s heart – but it could be Nicole!
Major global economic events and implications
US data was upbeat over the last week. Housing starts and permits surged in July, as did existing home sales, with the August NAHB rising to its equal highest on record, pointing to further strength in housing construction ahead. US housing is looking like a clear Deep V. And despite falls in regional business conditions indexes, the US composite business conditions PMI rose strongly in August to a solid reading of 54.7, possibly reflecting renewed optimism following the recent decline in new US coronavirus cases. Meanwhile, initial jobless claims edged up but remain in a downtrend and continuing jobless claims fell.
A surge in US mortgage delinquencies is currently being managed by lender forbearance, so foreclosures remain low, enabling the US housing market to strengthen. Of course, this highlights the need for jobs to come back big time over the next six months, otherwise it could cause a problem.
Although the market reacted negatively to the minutes from the last US Federal Reserve (Fed) meeting, it should be recalled that Fed Chair Powell’s post meeting press conference was very dovish and the Fed still looks on track to move to inflation averaging, more dovish guidance & more definitive quantitative easing (QE) guidance soon.
Eurozone business conditions PMIs fell in August, probably reflecting concern about the rising trend in new European coronavirus cases with the composite PMI falling 3.3 points to a still reasonable 51.6, which is around pre-coronavirus levels. Against this, the UK’s composite PMI rose 3.3 points to 60.3.
Japanese June quarter GDP data confirmed a roughly as expected -7.8% quarter-on-quarter slump. This was at the low end of developed countries, with US GDP -9.5% quarter-on-quarter, the Eurozone at -12.1% and the UK at -20.5%. September quarter GDP should show some recovery, although Japan’s composite business conditions PMI was unchanged at 44.9 in August, not helped by a second wave of coronavirus cases there. Core CPI inflation was unchanged, at a low 0.4% year-on-year in July.
While composite business conditions PMIs were mixed in August (up in the US and UK, flat in Japan and down in Europe and Australia) depending partly on very recent coronavirus case trends in each country, the August average across all five countries/regions was a reasonable 52.1, which is well up on the average April low of 20.4.
Australian economic events and implications
Australian retail sales rose another 3.3% in July, led by large increases in household goods (reflecting people being at home, not going away on holidays and hence spending on refurbishment) along with a continuing recovery in clothing and café/restaurant sales. Victoria was the only state to see a fall (-2% month-on-month). With retail sales up 12% on a year ago and running well above pre-covid levels, some pullback is to be expected in the months ahead as demand looks to have been pulled forward and as government income support measures are reduced. Melbourne’s stage 4 lockdown will also likely depress August retail sales. However, the continued strength in July does tell us that people are still keen to get out and spend and that there is still some chance of overall positive GDP growth this quarter, despite the setback in Victoria. The problems in Victoria saw the CBA’s composite PMI fall back sharply, driven by a slump in the services sector, with the manufacturing index little changed.
The minutes from the last Reserve Bank of Australia (RBA) meeting provided no surprises and have been superseded by the Statement on Monetary Policy (SOMP) and Governor Lowe’s testimony. The RBA remains dovish and is not ruling out further easing. With negative rates, monetary financing of the government and foreign exchange intervention basically ruled, further easing is likely to come in the form of a rate cut to 0.1% and more QE
The Australian June half profit reporting season is now 70% complete by companies and 80% complete by market capitalisation. While it’s clear that company earnings and dividends have been hit hard by the coronavirus shock, the hit has not been as bad as feared and most companies appear quite resilient. This in turn has enabled a majority (or 59%) of companies’ share prices to outperform the market on the day they reported and for the market as a whole to rise so far through August. In this sense, it’s been similar to the US June quarter earnings reporting season. So far, only 28% of results have exceeded expectations compared to a norm of around 44%, but at least misses have only been 27%, so beats have roughly matched misses. Only 33% of results have seen earnings rise from a year earlier (compared to a norm of 66%) and 55% have cut dividends (compared to a norm of just 16%). So far, consensus earnings expectations for 2019-20 have fallen slightly to -22.3% (from -21% three weeks ago), and this will be worse fall in earnings since the early 1990s recession. Financials are being hit the hardest, with the consensus expecting a -29% slump in earnings led by insurers and the banks, followed by industrials with a -17.7% fall in earnings and resources with -14.4%.
What to watch over the next week?
In the US, the annual Jackson Hole central bank Economic Policy Symposium on Thursday and Friday will go virtual, with the rather vague theme: “Navigating the Decade Ahead: Implications for Monetary Policy.” It’s hard to see any near-term clues for monetary policy moves, but there may be some focus on the Fed’s likely impending shift to inflation average targeting, under which a period of inflation overshooting will be tolerated, providing an additional tail wind for investment markets. On the data front, in the US expect to see a rise in August consumer confidence and continued strength in July new home sales (both due Tuesday), a continued recovery in durable goods sales (Wednesday), a rise in pending home sales (Thursday) and a further recovery in pending home sales and core PCE inflation (Friday).
The German IFO (Tuesday) and French (Thursday) business conditions/confidence surveys along with Eurozone confidence data (Friday) for August will be watched to see how confidence has been impacted by the resurgence in coronavirus.
In Australia, the ABS’s weekly payroll jobs data (Tuesday) will likely have been dragged down by the Victorian lockdown, June quarter construction data (Wednesday) is likely to have fallen 7%, with business investment (Thursday) showing a similar fall reflecting the shutdown from late March. Preliminary July goods trade data (Tuesday) is likely to point to a continuing strong trade surplus.
The Australian June half profit reporting season will basically wrap up, with 41 major companies reporting including Fortescue and Super Retail Group (Monday), Ansell, Oil Search, Scentre and Stockland (Tuesday), Adelaide Brighton and Worley Parsons (Wednesday), Flight Centre and Nine (Thursday) and Woolworths (Friday).
Outlook for investment markets
After a strong rally from their March lows, shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. On a 6 to 12-month view however, shares are expected to see good total returns, helped by a pick-up in economic activity and 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 likely weigh heavily on near term returns.
Australian home prices at present are being protected to some degree by income support measures and bank payment holidays, but 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. Melbourne is particularly at risk on this front, as its Stage 4 lockdown pushes more businesses and households to the brink.
Cash and 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, we think a continuing rising trend is likely. Particularly with the US expanding its money supply far more than Australia is (via QE) and with China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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