Investment markets and key developments over the past
Share markets rebounded over the last week as bond markets outside the US settled down a bit helped by central bank action and as $1.9 trillion in additional US stimulus was signed into law by President Biden. This saw the US share market rise 2.6% for the week to a record high despite US bond yields making a new sell off high on Friday and the bond sensitive Nasdaq remaining down 5.5% from its high. Eurozone shares rose 4.1% reaching their highest since the GFC and Japanese shares rose 3%. Chinese fell -2.2% though and are down -11.4% from their February high. Australian shares rose 0.8% helped by strong business and consumer confidence readings and very dovish comments from the RBA with retail, industrial, utility and health care stocks leading the market higher. Bond yields rose to a 13-month high in the US but were flat to down in Europe and Australia helped by the RBA and ECB. Metal prices rose but oil and iron ore prices fell. The return to “risk on” saw the A$ rise and the US$ fall.
It’s too early to conclude that the tantrum in bond markets is over and there could still be more upwards pressure on yields in the months ahead as headline inflation spikes higher and economic recovery continues. This could in turn drive more volatility in shares. However, we remain of the view that cyclical bull market in shares that started in March last year still has a long way to go given spare capacity in jobs markets and still low underlying inflation, shares still offering a decent earnings yield gap to bond yields all combined with the economic and profit recovery and central banks including the RBA being a long way from rising interest rates.
Massive US stimulus passed by Congress could push US GDP growth to 10% this year. When President Biden announced plans for a $1.9 trillion coronavirus stimulus in January the initial expectation was that it would be wound back in the Senate to around $1.2-$1.5 trillion. But over the last month or so it became clear that it would all get through and that’s now been confirmed with its passage through Congress. This is a massive 8.6% of US GDP. And combined with the $900bn stimulus paid out in January means up to $2.8 trillion, or 12.7% of GDP, in stimulus going into the US economy in a short period of time. The key component is $1400 stimulus checks to Americans (earning up to $75k) and this is coming on the back of $600 checks just paid out. And even more is likely later this year with an infrastructure and climate package of around another $2 trillion although this will take longer to pass through Congress, will be spread over several years and will be partly offset by corporate and top marginal tax rate hikes (which could cause a bit of concern in share markets although the tax hikes will likely be wound back from what President Biden initially asks for). This will all swamp last year’s $2.3 trillion stimulus package. The combined total of $5.1 trillion amounts to 23% of US GDP over two years and could push US GDP growth this year above 10%. It’s the biggest stimulus since the New Deal that amounted to around 40% of US GDP spread over 6 years. The Biden Administration is clearly focussed on addressing high unemployment, inequality and division in the US economy and is making the most of the opportunity it now has with control of Congress ahead of the mid-terms next year. The risk is that the stimulus may be too much and cause the US to overheat, which is what bond markets are fretting about.
By comparison, the extra $1.2 billion Australian travel industry stimulus package announced in the last week was puny at 0.1% of Australian GDP. Travel is lagging in the recovery thanks to travel bans, periodic border closures and consumer caution regarding travel and so employees and businesses in the sector are highly vulnerable to the ending of JobKeeper later this month. So, measures to encourage more domestic travel and support the industry are welcome. But at just 0.1% of GDP, it’s not going to have a huge impact.
Meanwhile RBA Governor Lowe reiterated his ultra-dovish stance. Related to this he has two key messages in my view. First, the RBA’s response function has now changed from what the bond market appears to be expecting – it won’t raise interest rates until inflation is sustainably in the 2-3% range and to get this will require at least 3% wages growth which with NAIRU now possibly being below 4% means the labour market needs to be a lot tighter - all of which will take time. Wages growth has not been above 3% for eight years. Hence the constant RBA reference to not expecting to raise rates until at least 2024. Second, don’t expect the RBA to hike rates just because the housing market is hot – with CoreLogic daily data now showing Sydney and 5 Capital City Average prices now surpassing their 2017 record high. The RBA does not target house prices (and nor should it) and will use macro prudential controls to control lending if it looks like lending standards are getting too lax. In our view, this is likely from later this year and could include a return to speed limits on investor loan growth and limits around loan to value ratios, debt to income ratios and interest servicing to income. The best ways to make Australian housing more affordable are to limit the return of immigration to enable housing oversupply to build up and to reinforce the pandemic in encouraging people to relocate from expensive inner-city areas to more affordable suburbs, cities and regional centres.
In Europe, the ECB surprised with an announcement that it expects to significantly increase its bond purchases under its pandemic QE program out to end June in order preserve favourable financial conditions that are under threat from higher bond yields. This makes sense given that Europe is not seeing the same sized fiscal stimulus as the US and still sees a weaker inflation outlook. There was no change to the overall size of the program, but the announcement led to a fall in European bond yields.
On the coronavirus front global new deaths are continuing to fall but the decline in new cases since January remains stalled, mainly due to rising trends in Europe (particularly in Italy which is now returning to lockdown, but also in France and Germany) and a renewed surge in Brazil.
The US is continuing to see a significant fall in new cases, deaths and hospitalisations with the later back to levels last seen around October. This along with more fiscal stimulus will contribute to a huge growth rebound this year in the US.
The vaccine rollout continues and is set to accelerate as production ramps up. 56% of Israel’s population has now received one dose, 34% in the UK and 19% in the US. And the evidence from various studies in the UK and Israel continues to indicate that the vaccines are working. Europe and Brazil continue to see problems but note that only 7% of Europeans have received one dose and only 4% of Brazilians.
New coronavirus cases remain very low in Australia – That said while Australia went two weeks without a new local case this has now been interrupted in Brisbane and Sydney with local cases likely connected to the hotel quarantine system, potentially threatening more snap lockdowns. Providing any lockdowns are short and geographically contained then the economic impact should be minor - like the snap lockdowns already seen this year. 0.5% of the population has now had one dose of vaccine with a ramp up likely in the months ahead.
Our Australian Economic Activity Tracker saw a further sharp broad-based gain over the last week, suggesting that the economy is continuing to recover. The gains were particularly strong in restaurant and hotel bookings. Our US Economic Activity Tracker also rose sharply suggesting a reacceleration in US growth on the back of reopening and stimulus. But our European Economic Activity Tracker stalled and remains weighed down again by rising coronavirus cases in parts of Europe. All our trackers will benefit from easy year ago comparisons in the weeks and months ahead.
Elvis Presley’s movie career spanned 33 films – the last two of which were concert performance documentaries. In the US alone total box office revenue exceeded $2.2bn in today’s money. Most spawned hits and singles but I tend to thing his best movie songs came later in his movie career. The best movie for Elvis songs I reckon is Live a Little, Love a Little from 1968 which included two classic Elvis songs. The Edge of Reality reached #2 in Australia in 1969 with If I Can Dream and A Little Less Conversation as remixed by Junkie XL reached #1 in 2002.
Major global economic events and implications
US economic data releases over last week were a bit light on and so didn’t really tell us much that was new. Small business confidence rose slightly in February but remains weak in contrast to large business confidence that is very strong. Consumer sentiment is up solidly in March helped by vaccines and stimulus. Job openings rose in January and initial jobless claims fell. Meanwhile core inflation was weaker than expected in February falling to 1.3% year on year but is likely to spike higher in the months ahead as the coronavirus driven weakness a year ago drops out of annual calculations and higher commodity prices and goods production bottlenecks impact. The latter is evident in higher February producer price inflation. The spike in CPI inflation is likely to be transitory though in the absence of much stronger wages growth.
Japanese household spending declined in January reflecting the state of emergency, but economic confidence rose solidly in February helped by the decline in new coronavirus cases.
Chinese economic data was generally strong. Annual growth in exports and imports surged in January/February partly due to the easy growth comparison of a year ago, but monthly growth was also strong. Money supply and credit growth also ticked up a bit in February. And deflationary pressure may be easing with core CPI inflation rising from -0.3%yoy to flat and producer price inflation rising to 1.7%yoy from 0.3%.
Australian economic events and implications
Australian economic confidence has continued to improve. The NAB business survey for February showed a solid rise in business conditions and business confidence and the Westpac/MI consumer confidence index also rose. Both are around their highest levels since early last decade and are positive for investment and consumer spending.
Interestingly while consumers are feeling confident, they are still cautious when it comes to investing with the proportion seeing shares, super and even real estate as the “wisest place for saving” remaining relatively low and bond deposits and paying down debt remaining far more popular. This is still positive though for shares and real estate from a contrarian perspective.
What to watch over the next week?
In the US, the focus is likely to be on the Fed (Wednesday) which is not expected to make any changes to monetary policy but will continue to stress that while the outlook has improved the US economy is still a long way from meeting its goals and so it’s too early to consider starting to reduce monetary stimulus. Most interest will centre on whether the Fed and Powell push back more aggressively against the rise in bond yields that we have seen this year.
On the data front in the US expect to see February retail sales remain strong reflecting stimulus checks, further gains in industrial production and continuing strong home builder conditions (all Tuesday), but a slight fall in housing starts (Wednesday) due to bad weather. New York and Philadelphia regional manufacturing conditions indicators for March will also be released and are likely to remain solid.
The Bank of England (Thursday) and the Bank of Japan (Friday) are both unlikely to change monetary policy, but both will be watched in terms of whether they push back against the rise in bond yields.
Japan’s core inflation rate (Friday) for February is expected to have remained around zero.
Chinese activity data for January/February (Monday) is expected to show a huge rebound from the coronavirus shutdown depressed levels a year ago with industrial production and retail sales both up by around 32% and investment up by around 41%.
In Australia, the RBA minutes (Tuesday) are likely to remain ultra-dovish consistent with the post meeting statement and Governor Lowe’s speech in the last week. On the data front ABS home price data for the December quarter (Tuesday) is expected to show a solid 2% quarterly rise in prices consistent with private sector data already released, February labour market data (Thursday) will likely show a 15,000 gain in jobs but with unemployment unchanged at 6.4% and retail sales data for February (Friday) is expected to show a 0.5% gain as Queensland bounces back. September quarter population growth data (Thursday) is expected to confirm the hit to immigration and payroll jobs data will be released Tuesday.
Outlook for investment markets
Shares remain at risk of further volatility from rising bond yields. But looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and still low interest rates augurs well for growth assets generally in 2021.
We are likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns - like technology and health care stocks and bonds - to investments that will benefit from recovery - like resources, industrials, tourism stocks and financials.
Global shares are expected to return around 8% this year but expect a rotation away from growth heavy US shares to more cyclical markets in Europe, Japan and emerging countries.
Australian shares are likely to be relative outperformers helped by: better virus control enabling a stronger recovery in the near term; stronger stimulus; sectors like resources, industrials and financials benefitting from the rebound in growth; and as investors continue to drive a search for yield benefitting the share market as dividends are increased resulting in a 4.5% grossed up dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7200.
Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds this year.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield but the hit to space demand and hence rents from the virus will continue to weigh on near term returns.
Australian home prices are likely to rise another 5% to 10% this year and next being boosted by record low mortgage rates, government home buyer incentives and the recovery in the jobs market but the stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney. Outer suburbs, houses, smaller cities and regional areas will see relatively stronger gains in 2021.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
Although the $A is vulnerable to bouts of uncertainty and RBA bond buying will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar, probably taking the $A up to around $US0.85 by year end.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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