Economics & Markets

Market Update 31 July 2020

By Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia

Investment markets and key developments over the past week

Global share markets were mixed over the last week, with Chinese shares up 4.2% and US shares up 1.7% on the back of good earnings results, particularly for technology stocks, but eurozone shares fell 3.6% and Japanese shares fell 4.6% on uncertainty regarding the economic outlook. Australian shares fell 1.6% for the week thanks to a sharp fall on Friday on the back of concerns that the lockdown in Melbourne will be intensified and extended. Despite the fall, the ASX 200 still rose 0.5% in July. Bond yields generally fell again over the week, with US bond yields hitting a record low. Oil prices fell, but metals and iron ore rose and gold made it to a new record high, as the US dollar fell further. The falling US$ also saw the A$ rise briefly above $US0.72.

The rising trend in new coronavirus cases globally still shows no let up. This is primarily driven by emerging countries, with developed countries showing some signs of stabilisation over the last few weeks.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

The stabilisation in new cases in developed countries reflects some slowing in the US – notably in southern and western states, suggesting that the return of some restrictions and the mandated use of masks in many states may be working.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

The US is also seeing hospitalisations roll over and the fatality rate is around 1.5%, compared to around 7% during the first wave in April. This is consistent with a greater skew in new cases towards younger people, better protection for older people and better treatments. Further, it adds to confidence that a generalised lockdown will be avoided.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

Against this, Europe is seeing new cases edge up again, as is Canada; and Japan has seen a big rise. Even China has seen a pick-up in new cases (albeit it remains very low).

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

All of this highlights how hard it is to contain the coronavirus, as well as the importance of maintaining social distancing.

Unfortunately, Victoria in Australia, is also still struggling to put a lid on new cases, which are showing a continuing uptrend. So far so good in NSW, although the 7-day rolling average case count is trending up and the risk of a break higher is significant.

Sources: Covid19data.com.au, AMP Capital
Sources: Covid19data.com.au, AMP Capital

Meanwhile, June quarter GDP data for the US and the eurozone confirmed a huge hit from coronavirus shutdowns. US GDP plunged 9.5% quarter on quarter (or by -32.9% annualised) and eurozone GDP fell 12.1% quarter on quarter, with the falls being broad based.

Naturally for the US, (and Australia, as it too will also report a big fall when June quarter GDP data is released in a month) this is seeing comparisons to the Great Depression come up again – but there are big differences: First, there was no period of prior excess like the “roaring twenties” that needs to be unwound; second, the current slump was brought on by government decisions to lockdown society as opposed to being a cyclical economic downturn that has to run its course; and thirdly, the current period has seen rapid and massive monetary and fiscal stimulus, whereas the 1930s initially saw the opposite. All of which should mean a faster recovery once the virus is controlled. While terrible, the US and Eurozone June quarter GDP slump was also largely as expected back in late March/early April, so is already factored into our global and Australian GDP forecasts. Furthermore, this is old news, to the extent that the low was probably in April and since then economic activity has started to recover with “reopening”. The bad news is that the recovery will likely be slow after the initial bounce and its threatened by ongoing surges in coronavirus cases. This is evident in a rise in jobless claims in the US over the last two weeks.

The resurgence in new cases, the reversal of reopenings and the associated negative headlines are continuing to impact our weekly Economic Activity Trackers for the US and Australia, but so far it’s just seen the recovery stall since the second half of June, as opposed to collapse. These activity trackers are based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, hotel bookings, credit card data, mobility indexes and jobs data. Our Australian Economic Activity Tracker fell back again over the last week, reflecting weakness in consumer confidence, restaurants, job ads, credit card data, mobility, hotel bookings and retail traffic. Victoria appears to be the main driver of the weakness.

Source: AMP Capital
Source: AMP Capital

The US Federal Reserve (Fed) remained in a dovish, “whatever it takes” mode over the last week. While it left monetary policy on hold as expected, the clear message from Chair Powell is that the Fed is ready to stay accommodative for a very long time. Meanwhile, the Fed’s policy review is likely to be complete by September and is expected to see a move to a 2% inflation averaging strategy, which will imply a desire to overshoot the target after a period of undershooting. The Fed is also likely to move to outcome based forward guidance and more definitive quantitative easing (QE). All of which are very dovish.

Will rating agency Fitch’s move to put the US’s AAA credit rating on “negative” outlook have much impact? It may cause some consternation, but it’s unlikely to stop another big stimulus package in the US; and as we saw following S&P’s 2011 downgrade to the country’s credit rating (from AAA to AA+), US bond yields actually rallied on the news and it had no impact on America’s ability to borrow. It borrows in US dollars and despite the further surge in the budget deficit and debt this year, bond yields are now at record lows.

Should we worry about the rise in the gold price to a record high signalling some sort of flight to safety that we should all jump on to? Our short answer is no. The rise of gold partly reflects a desire by some for a hedge against quantitative easing causing a surge in inflation and a collapse in the real value of paper currencies. However it also reflects an emerging cyclical decline in the value of the US dollar versus other currencies (which is normally a good thing because it means that safe haven demand for it is falling and global reflation may be working) and a collapse in interest rates, which makes it cheaper to hold gold but also makes it cheaper to hold other assets. Furthermore, just as gold has gone up, so have other commodities; with oil having more than doubled since April and metal prices up nearly 30% from March lows. Again, this is normally a positive sign for global growth. Finally, while I think there is probably more upside for the gold price (albeit not in a straight line), it should be noted that it produces no income, is highly volatile and someone who bought into gold the last time everyone got excited back in 2011 has only now just broken into profit ,after suffering a near 50% plunge in value into 2015 - so it’s not always a safe haven. Of course, back then, the much-feared surge in inflation on the back of post GFC QE failed to eventuate; and it may take a while to eventuate in the years ahead as well, given such high levels of unemployment.

Is President Trump setting up a challenge to the election result if it goes against him and is close? For a while now he has been claiming that mail in voting leads to fraud and he has now suggested that the election should be postponed due to the pandemic. While he does not have the authority to postpone the election – that’s with Congress and both Republicans and Democrats have said no – he may be laying the ground for a challenge to the result if it goes against him. If so, this could make the 2000 election controversy look like a non-event. Trump’s comments on this may suggest he is not feeling that confident about the election – although out of interest, his approval has gone up a bit in the last few weeks.

Source: RCP
Source: RCP

The negatives for shares remain: rising new coronavirus cases, the pausing or reversal of reopening, very high unemployment, the hit to earnings, the US election, US/China tensions and we are now in a seasonally weak period of the year for shares. These factors however are arguably more than offset by a long list of positives, including continuing good news on coronavirus treatments and vaccines, the second wave in the US 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$ is falling (which is normally a positive sign), monetary and fiscal policy remaining ultra-easy, low interest rates and bond yields that make shares look cheap and a lot of cash on the sidelines. We believe Shares are still vulnerable to further volatility, with renewed lockdowns and US/China tensions being the main risks, but the positives should keep any volatility to being a correction in a still-rising trend.

Ever since Light Years, I have been a glued-on Kylie fan and she keeps churning out great songs, including her latest, Say Something, which marks a return to electropop after the country pop Golden. More nice head candy.

Lots of entertaining Bachelor in Paradise over the last week – bit sad to see both Helena and Jamie go though!

Major global economic events and implications

US June quarter GDP data showed a -9.5% hit to GDP (or -32.9% annualised). Thanks to the earlier than expected reopening, it was not quite as bad as had been expected several months ago and based on our US Economic Activity Tracker, the low point was probably in April, so it’s also rather old news. More current US data was generally better, with strong gains in durable goods orders, personal spending and pending home sales in June and a further recovery in several regional manufacturing indexes for July, but flat house prices in May. However, a fall back in consumer confidence in July and a second weakly rise in jobless claims highlights that the resurgence in coronavirus is threatening the recovery. Meanwhile, although the personal saving rate remains high, at 19%, personal income is set to fall sharply if income support measures, which expired at the end of July, are not extended.

So far, 62% of US S&P 500 companies have reported June quarter earnings and results have remained better than expected, with a bigger than average 85% of companies beating on earnings by an average of 22.2% and 66% beating on sales. This has seen upwards revision to consensus earnings expectations, with earnings now expected to be -34% year-on-year in the June quarter, compared to -44% a few weeks ago.

Source: Bloomberg, AMP Capital
Source: Bloomberg, AMP Capital

Eurozone June quarter GDP fell 12.1% in the June quarter, which was in line with the consensus, while eurozone unemployment rose to 7.8% in June. Against this, the German IFO business conditions index rose further in July, as did eurozone economic sentiment, pointing to a strong initial rebound in growth. Bank lending to corporates was strong, albeit it was soft to households. Core inflation ticked up to 1.2% year-on-year in July, but is likely to fall back in August.

Japanese retail sales rebounded sharply in June, industrial production rose more than expected and unemployment fell slightly. However, the ratio of job openings to applications fell to the lowest since 2014 and the resurgence of coronavirus cases this month in Japan will weigh.

Chinese business conditions PMIs remained solid in July, with the composite PMI falling just 0.1pt to 54.1, suggesting that the economic recovery is continuing.

Australian economic events and implications

Australia saw its biggest quarterly bout of deflation in the 72-year history of the Consumer Price Index (CPI) and its biggest annual decline since 1997 – expect a rebound in the current quarter but underlying inflation is likely to remain weak. The 1.9% plunge in the CPI was basically due to government decisions to provide childcare, pre-school (in some states) and before and after-school care for free, as well as a plunge in petrol prices. With free childcare having ended and petrol prices back up, the CPI is expected to rebound this quarter (probably by around 1.5% quarter-on-quarter). So, it’s best to focus on underlying inflation, as it excludes the volatile, often government related, moves in some components. Underlying inflation fell to just 1.25% year on year, which is its lowest on record and reflects the plunge in demand in the economy and huge amounts of spare capacity. With spare capacity likely to be with us for some time to come, expect underlying inflation and the trend in headline inflation to remain weak, notwithstanding volatility driven by government decisions and changes in petrol prices.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

Australian economic data was on the soft side, with payroll jobs falling over the three weeks to mid-July, particularly in Victoria (although this data has a tendency to get revised up), the terms of trade falling slightly in the June quarter (although this was after a huge surge in the March quarter), private sector credit contracting further in June and home building approvals plunging again. Fortunately, approvals for alternations and non-residential building rose and the HomeBuilder scheme, along with increased stamp duty concessions for first home buyers of new property, should provide some support for home building. Meanwhile, the July ABS Business Impacts of COVID survey found 42% were receiving some form of government assistance, but more businesses expect to raise headcount rather than cut it.

What to watch over the next week?

Trends in new coronavirus cases along with pressure on medical systems will continue to be watched closely, particularly in the US and Victoria.

In the US, jobs data (due Friday) will be the focus, with market expectations for the return of another 1.6 million payrolls jobs and unemployment to fall to 10.5%, but a renewed weakness in jobless claims on the back of the resurgence in coronavirus cases raising the risk of disappointment. In terms of other data, expect the July manufacturing conditions ISM (Monday) to show a further improvement to 53.5 consistent with regional manufacturing surveys and the non-manufacturing conditions ISM (Wednesday) to fall back slightly to 55. US June quarter earnings results will continue to flow. On the policy front, the key will be whether Congress passes a new stimulus package to extend or replace now lapsed income support.

In China, the Caixin manufacturing PMI (Monday) is expected to hold around 51.2 and trade data (Friday) is expected to show a further recovery in import growth, but softness in exports.

In Australia, the Reserve Bank (RBA) is expected to leave monetary policy on hold for the fifth month in a row on Tuesday and will release its quarterly Statement on Monetary Policy on Friday. Having provided massive monetary stimulus back in March, the RBA is still in “watch and wait” mode, and the policy focus now remains largely on fiscal policy. The RBA is unlikely to make any major changes to its economic growth forecasts, but it may lower its underlying inflation forecasts (given June quarter underlying inflation came in lower than it expected) and it will continue to emphasise the uncertainty surrounding the outlook. Its views on the further rise in the value of the Australian dollar will also be watched, although it’s unlikely to be too concerned as it’s still around fair value and its rise is consistent with higher commodity prices. Against this backdrop, and given the risks flowing from Melbourne’s renewed lockdown, the RBA is likely to reiterate its dovish forward guidance on rates and note that it stands ready to do more if needed. In terms of what it might do if it does ease further in the months ahead, it has all but ruled out negative interest rates, foreign exchange intervention and the direct monetary financing of government spending, but sees still lower (but positive) interest rates and the purchase of more government bonds as possible options. A rate cut to 0.1% would hardly be worth the effort, which leaves more QE as the main tool for any further easing. Meanwhile, rate hikes are at least three years away.

On the data front in Australia, expect CoreLogic home price data for July (Monday) to show a further -0.8% decline in average dwelling prices, June retail sales to show a 2.4% gain (consistent with preliminary data already released) resulting in a -3.3% decline in real June quarter retail sales and the trade surplus for June to remain strong, at around $8 billion (all due Tuesday) and June housing finance data (Wednesday) to show a 2% rise after a huge fall in May.

The Australian June-half profit reporting season will also get underway, but with only a handful of companies due to report including Resmed (Thursday), IAG, News Corp and REA (Friday). It’s going to be the worst reporting season in years, with consensus expectations for a ~21% slump in earnings due to the hit from COVID-19, which will be the biggest since the GFC. Financials will likely be the hardest hit, with an expected ~28% slump in earnings led by insurers and the banks, followed by industrials with a ~15% fall in earnings and resources with ~13%. Healthcare may be the only sector to see a rise in earnings (and even that’s iffy).

Outlook for investment markets

After a strong rally from March lows, shares remain vulnerable to short term setbacks given uncertainties around the coronavirus, economic recovery and US/China tensions. However, on a 6 to 12-month horizon, shares may 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 the 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 are falling and higher unemployment, a stop to immigration and rent holidays will pressure prices lower into next year. Home prices are expected to fall by around 5 to 10% into next year from this year’s highs, 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 renewed 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 Australian dollar is vulnerable to bouts of uncertainty about 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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Shane Oliver, Head of Investment Strategy & Economics and Chief Economist
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While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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