Investment markets and key developments over the past week
Global share markets mostly fell again over the past week on the back of rising new coronavirus cases in Europe and the US, new lockdowns in Europe, signs of a tightening election in the US raising the prospect of a contested result, the absence of any progress towards a pre-election fiscal stimulus in the US and uncertain earnings outlook comments from some tech stocks. For the week US shares fell 5.6%, Eurozone shares lost 6.7%, Japanese shares fell 2.3% and Chinese shares lost 0.5%. Reflecting the weak global lead Australian shares fell 3.9% led by declines in cyclical sectors including energy, industrial, retail and financial stocks. Bond yields rose in the US but fell in Europe and Australia. Consistent with the risk off tone commodity prices fell and the Australian dollar fell as the US dollar rose.
Global new coronavirus cases continued to surge over the last week driven mainly by Europe, the UK and the US which is now surpassing its July high.
New deaths in developed countries remain way below April highs despite new cases being far higher. However, deaths are rising rapidly in Europe as are hospitalisations which is threatening to overwhelm the health system in some countries.
As a result, France and Germany have announced a return to lockdowns for at least a month. The risk is that they will need to be longer as was seen in Melbourne. The French lockdown looks a bit like that seen until recently in Melbourne in terms of severity and the German lockdown is more like that seen in regional Victoria. This will see a renewed progression from intermediate to severe lockdowns in terms of the next chart.
Assuming other countries in Europe do something similar to France and Germany our rough estimate is that this could see Eurozone GDP contract by around 2% this quarter after a 12.7% rebound in the September quarter.
The US is also at risk of seeing more stringent social distancing rules in response to its own renewed surge in cases. This may particularly be the case if Joe Biden wins the presidency as he is likely to take a stronger approach to controlling the virus. In any case, likely reflecting the continuing rise in US cases, our US Economic Activity Tracker has been flat since early September now suggesting the US recovery may be slowing and highlighting the need for more stimulus. So far this is not yet evident in most other conventional economic data, but it comes out with a longer lag.
Australia is continuing to see new local coronavirus cases remain very low at around 20 or less a day with few cases of community transmission and deaths have fallen sharply. This has enabled Victoria to substantially relax its hard lockdown enabling all shops and activities to return albeit with restrictions on groups. Our Australian Economic Activity Tracker rose only slightly over the last week but is likely to accelerate higher following Victoria’s significant reopening in the past week.
The US election has tightened further over the last week, making it harder to call. The tightening is likely weighing on shares as it implies an increased risk of a contested election and less chance of substantial post-election fiscal stimulus to the extent that a “blue wave” that sees the Democrats win the presidency, control of the Senate and the House may be somewhat less likely.
Trump has the benefit of incumbency - as incumbents usually get re-elected, crowds - as his big rallies generate enthusiasm, shy voters, his better rating on the economy, the economic recovery seen since the lockdown and the fear amongst some that Biden will take a hard left turn if he wins.
Biden has the benefit of the recession, high unemployment, low consumer confidence, the rising trend in coronavirus cases and a mostly wider and more stable poll lead compared to Hilary Clinton’s in 2016 (see the next chart). And opinion polls have historically tended to be fairly accurate on sitting presidents but tend to underrate challengers.
Record high early voting further complicates the picture as it may just reflect the virus and Trump motivating more to vote on both sides. But if anything, it’s more likely to favour Biden. So far over 86 million have voted early which is around 62% of all votes cast in 2016. Of that nearly 56 million have been mail in and just over nearly 31 million have been in person. Based on data from states where its available 46% of the early votes so far have been Democrats and 29% Republicans – but of course this may just mean less Democrats voting on election day itself.
All up these considerations lean in favour of Biden as does most polling and betting markets and for what it’s worth I think Biden will win but it’s a close call as the race has tightened in the last week or so. Biden’s polling lead has fallen to around 7.9% from above 10% a few weeks ago, his average poll lead in battleground states which is what counts has fallen to around 2.8% from 4.1% two weeks ago and is now down to zero in some. That said, the PredictIt betting market puts Biden’s probability of winning at 66% and the probability of a Democrat clean sweep at 56%.
Interestingly financial markets are now sending more consistent messages: a rise in the US share market in the 3 months prior to the election has historically pointed to a victory by the incumbent and vice versa for a fall (with 87% accuracy since 1928) and after the falls of the last week the US share markets is now down 0.7% since August 3rd and the relative performance of US stocks likely to benefit from Biden versus those likely to benefit from Trump is up according to research house Strategas pointing to a Biden victory.
The main issues in the US election of relevance for global investment markets are tax, fiscal stimulus, regulation and trade wars. Since there is very little chance that the Republicans will retake the House, there are basically three possible outcomes:
- Trump wins with Democrats retaining the House – taxes and regulation will remain low which may provide a short term knee jerk boost to US shares but trade wars with China and possibly Europe and Japan would likely ramp up again next year which would be relatively bad for global shares and good for the US$. So, this scenario would likely be negative the Australian share market and the A$.
- Biden wins but with the Republicans retaining the Senate – this would mean Biden’s proposed tax hikes for high income earners, capital gains, dividends and corporates won’t pass into law, less fiscal stimulus (as Republican Senators would likely revert to fiscal conservatism) and periodic fiscal battles but less trade wars and more predictable US policies. This would be neutral for US versus global shares, but historically this combination has been the best outcome for share markets (beyond the initial knee jerk reaction which may be negative on expectations for less fiscal stimulus).
- Biden wins with a Democratic clean sweep (the “blue wave” scenario) – this will likely mean significantly more US fiscal stimulus, less trade wars and more stable US policies but higher corporate tax in the US and more regulation. Global shares would likely benefit more than US shares and the US dollar would likely fall. Historically this has been the second-best outcome for share markets. It would probably be the best outcome for Australian shares and the Australian dollar as Australia would benefit from more US stimulus, our companies would be relatively more attractive with a higher tax rate in the US and we would likely see less tensions with China.
Of course, the worst outcome for share markets in the short term would be a contested election, but a clear initial win by either side would head this off. The problem is that the record level of early postal votes means that it may take longer to get a result as it takes longer to count them, and counting can’t start till after polls close.
Major global economic events and implications
US GDP showed a sharp 7.4% rebound in the September quarter after the 9% slump seen in the June quarter. This was broad based and pretty much as expected reflecting the reopening of the economy. More timely data was mostly good with solid gains in durable goods orders, regional manufacturing conditions surveys and house prices, stronger than expected growth in personal spending, new and pending home sales remaining strong despite slight pull backs and initial and continuing jobless claims falling. Consumer confidence was weaker than expected though. After the September quarter rebound the level of US GDP is still 3.5% down from its December high and the recovery is likely to be a lot slower going forward as rising coronavirus cases constrain activity and some parts of the economy take longer to recover.
So far around 64% of US S&P 500 companies have reported September quarter earnings with 85% surprising on the upside regarding earnings (compared to a norm of 75%) and 77% surprising on the upside regarding revenue. Consensus earnings growth expectations for the quarter have been revised up from a fall of -21%yoy to -11%yoy and this is now likely to end up at around -8%yoy.
Eurozone GDP rebounded by a stronger than expected 12.7% quarter on quarter on the back of reopening after the 11.8% slump in the June quarter. However, it’s still 4.3% below its pre coronavirus level and rising coronavirus cases and renewed lockdowns are expected to drive a 2% contraction in the current quarter. Unemployment rose to 8.3% in September, the recovery in economic confidence stalled in October and core inflation remained weak at 0.2%yoy. While the ECB left monetary policy on hold, it indicated that it will “take action” and “recalibrate all our instruments” at its December meeting on the back of the threat from rising new coronavirus cases and a loss of momentum in the recovery. We expect this additional easing to take the form of more bond buying and extended cheap bank financing.
EU and UK trade negotiators reportedly made progress towards a Brexit trade deal.
The Bank of Japan left monetary policy on hold as expected and revised up slightly its assessment of current conditions. On the data front consumer confidence continued to recover in October, as did industrial production in September, unemployment was unchanged but the jobs-to-applicants ratio fell slightly further.
Korea and Taiwan also saw a return to positive growth in the September quarter after two quarters of contraction.
Australian economic events and implications
September quarter inflation data provided no surprises with a sharp rebound at the headline level on the back of the ending of free childcare and a rebound in petrol prices. Underlying inflation remains a much better guide to inflation pressures in the economy and it remained weak at 1.2% year on year and consistent with the RBA providing more monetary easing in November. Producer price inflation also remained weak at -0.4%yoy in the September quarter.
Meanwhile, growth in the stock of total credit remained soft in September with a slight uptick in housing credit suggesting growth in new loans is just starting to offset the more rapid repayment of existing loans. And the terms of trade looks to have fallen again in the September quarter with export prices declining faster than import prices (with sharp falls in gas and coal prices). This will cut into national income.
What to watch over the next week?
In the US, it’s going to be a big week with the election on Tuesday being the main event. The Fed meets Thursday and is likely to stress the uncertain economic outlook with coronavirus cases on the rise again, highlight the need for more fiscal stimulus and may announce more definitive guidance regarding its quantitative easing program. On the data front regional manufacturing conditions indexes point to a solid October manufacturing conditions ISM reading of around 55.6 (Monday), the services ISM (Wednesday) is also likely to remain solid and jobs data (Friday) is expected to show a 635,000 gain in payrolls with unemployment of 7.7%. September quarter earnings reports will also continue to flow.
China’s Caixin business conditions PMIs for October will be released on Monday and Wednesday and are likely to be solid.
In Australia, the RBA (Tuesday) is expected to announce significant further monetary easing across multiple fronts. We expect the key elements to be:
- A cut in the cash rate, the term funding facility rate and the three-year bond yield target to 0.1% (from 0.25%)
- An additional bond buying (or QE) program beyond what would occur for maintaining the three-year bond yield at 0.1% of around $12bn a month with the RBA saying something along the lines that “it will be continued for as long as necessary”. This will amount to nearly $150bn over a year and will focus on bonds beyond the three-year maturity. It may also come with a yield target for the five-year bond.
- A formal revision to forward guidance along the lines that “the RBA will maintain highly accommodative monetary policy settings as long as is required and will not increase the cash rate until full employment is reached and actual inflation is sustainably within the 2-3 percent inflation target.”
Further easing has already been foreshadowed by various RBA communications over the last month or so and the RBA will likely tie the need for more stimulus back to revised economic forecasts which will likely continue to show that it does not expect to meet its inflation and employment objectives over the next two years. Friday will also see the release the RBA’s Statement on Monetary Policy which will contain its latest economic forecasts.
On the data front in Australia expect to see CoreLogic report a 0.2% gain in dwelling prices for October and September data show a 3% rise in building approvals (both Monday), final retail sales to confirm a 1.5% fall in September but with real retail sales up 5% in the September quarter (Wednesday) and trade data to show a $3.7bn trade surplus (Thursday). Payroll jobs data will also be released Wednesday.
Outlook for investment markets
Shares remain vulnerable to further short-term volatility given uncertainties around coronavirus, economic recovery and the US election. But on a 6 to 12-month view shares are expected to see good total returns helped by a pick-up in economic activity and stimulus.
Low starting point yields are likely to result in low returns from bonds once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
Australian home prices at present are being protected by income support measures and bank payment holidays but higher unemployment, a stop to immigration and weak rental markets will push prices down by another 5% into next year. Melbourne is particularly at risk on this front as its Stage 4 lockdown has pushed more businesses and households to the brink. Smaller cities and regional areas are in much better shape.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
Although the A$ is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and China tensions and further RBA easing including QE will keep it lower than otherwise, a continuing rising trend is likely to around US$0.80 over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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