Investment markets and key developments over the past week
Equity markets continued to fall this week as the number of Coronavirus cases increased and individual countries adopted stricter quarantine measures. While the Chinese stock market was closed for Lunar New Year, US stocks fell by 2.1% (the worst week since August 2019), Japanese stocks were down by 2.6%, Eurozone equities fell by 3.7% and Australian shares were down by 1%. News that the World Health Organisation (WHO) declared the outbreak of Coronavirus as a global health emergency and solid US earnings saw some improvement in markets towards the end of the week but the imposition of some US travel bans to China sent sharemarkets lower (because of the impact on business revenue). US 10-year yields declined further to 1.50% (from 1.8% before the virus started) and the US 3 month 10-year yield curve has slightly inverted again, a sign of recession risks. Energy and metal commodity prices are down over the week and have pushed the A$ down to just below 0.67USD. Oil is tracking below US$52/barrel. Once it becomes clearer that the number of Coronavirus cases has peaked, risk sentiment should improve, and equity markets will be supported by signs that the global growth outlook remains positive. But we are not there yet.
The number of cases of Coronavirus continued to increase drastically over the past week, but the rate of change in daily cases has been less extreme (see chart below). It could be a sign that new cases will reach a peak over the next week or so.
So far, a total of 11,948 people have been infected with 259 deaths. This website is a good up-to-date visual guide to the spread of the virus. The good news is that the mortality rate at just over 2% hasn’t been rising and is still well below the mortality rate of other recent epidemics like SARS (10%).
The Chinese New Year holiday shutdown was officially extended until 2 February but is likely to be prolonged with numerous provinces already stating that business operations won’t be resumed for another week or two. The disruption to China’s economic growth will be mainly via lower retail spending, travel and closed or not fully operational businesses. There are some offsets, like a boost in medical supplies and a stockpiling of food. During SARS, China’s GDP fell by 2% over the June quarter in 2003. This time round we expect a fall in Chinese GDP of around 2-3% over the March quarter as Coronavirus is more widespread than SARS (although it is less lethal and there have been faster actions by authorities). GDP growth is likely to rebound in the June quarter, although the total losses from production are unlikely to be fully recouped. 2020 annual GDP growth is expected to be around 5.7% from previous estimates of 5.9%. The risk is that the situation worsens and disrupts economic growth for several months and chokes off the recent improvement in growth across China and other emerging markets. We think the People’s Bank of China is likely to loosen monetary conditions and keep liquidity elevated by cutting the level of reserves the banks are required to hold along with some interest rate cuts.
There will also be an impact to global growth. China makes up around 16% of the global economy (compared to 4% in 2003 during SARS) and the hit to Chinese growth equates to a 0.3% detraction from global growth in the March quarter. Some of the impact will be offset later in the year but our 2020 global growth forecast of 3.2% is at risk of being disappointed.
For Australia, there are also negative growth impacts as China accounts for a third of our exports. There will be a temporary disruption to tourism, education and commodities exports. During SARS, Chinese tourist arrivals plummeted in Australia (see chart below) and back then Chinese tourists were only around 4% of the total, now they make up a much larger 16% so the hit to tourism will be higher. There could also be an impact if Australians start staying home. On our estimates the total detraction to growth is worth around 0.2-0.3% of GDP. But there are offsets from the A$ depreciation (as a result of the risk-off global environment) and lower travel to China which is a reduction in imports (unless travellers choose to go to another offshore destination). Along with the bushfires, the total impact to March quarter GDP growth could be around -0.5%.
US December quarter earnings have been good with around 45% of companies reporting so far with most surprising to the upside. It looks like earnings will beat consensus by around 4% over the quarter to be around 2% higher over the year. 2020 earnings growth estimates (for ~10% annual growth) are probably too optimistic and will need to be revised down and we expect earnings to be closer to 5% over the year.
Democratic socialist Bernie Sanders is now leading the polls for the Democratic nomination, overtaking the moderate Joe Biden for the first time since April (see chart below). But a lot can change as the voting for the Democratic candidate begins next week in Iowa (on 3 February). Polling is very close amongst the candidates Joe Biden, Pete Buttigieg, Bernie Sanders and Elizabeth Warren.
On President Trump’s impeachment trial – the US Senate will vote on Trump’s impeachment or acquittal on Wednesday. As we have written before, the Republican-controlled Senate is unlikely to find Trump guilty.
Brexit date has finally approached (31 January). While it means that the UK will no longer be officially in the European Union, trade between the two regions will remain unchanged over the “transition period” (until 31 December 2020 and it cannot be extended) and the UK will still follow EU rules. This is done to give businesses time to adapt before new trade agreements are set, which will need to be done before the end of the year. It is an extremely tight deadline given that trade deals normally take years to finalise and given how hard it was to get a Brexit agreement done. So Brexit uncertainty will remain a theme for financial markets this year.
Major global economic events and implications
The US Federal Reserve kept interest rates unchanged at its meeting this week and sees the economy as healthy, especially in the labour market. Core inflation is still too low at 1.6% year on year to December which may force the Fed to cut interest rates again, especially with the risks to growth from the Coronavirus, but it is not our base case. December quarter GDP was slightly stronger than expected, up by 2.1% on average over the year. There were mixed signs on investment with a fall in core durable goods orders over December, but a large rise in the Richmond Fed manufacturing index over January but a smaller than expected fall in the Dallas Fed manufacturing index. Conference Board consumer confidence rose in January.
The official Chinese manufacturing PMI remained solid at 53 in January, slightly down from 53.4 in the prior month. Impacts of the Coronavirus would not be evident yet.
The Bank of England kept interest rates on hold, despite some forecasts of a cut. A rate cut is still possible later in the year.
Eurozone core inflation remains very low at 1.6% year on year, indicating that the European Central Bank will keep monetary conditions very easy for a while. And GDP growth is too low, at only 1.0% over the year to December, according to the data this week which missed expectations. The German IFO business climate measure fell again in January.
Australian economic events and implications
The December quarter inflation data showed that the RBA’s preferred measure of “core” inflation – the “trimmed mean inflation index” rose by 0.4% with annual growth remaining unchanged at 1.6% (see chart below). While this is in line with the RBA’s forecasts, inflation is still stuck well below the RBA’s 2-3% target (and has been undershooting the target since 2014). The solid December employment data and this week’s inflation numbers gives the RBA some breathing space for now and the central bank is unlikely to cut the cash rate at the February meeting next week. However, there is still the need for more stimulus in Australia and we expect more rate cuts this year – with another rate cut in March or April with the cash rate expected to reach 0.25% over the next 6 months.
The NAB December business survey showed some deterioration in both business conditions and confidence. Other data included the trade price data which showed a 5.2% fall in exports and a 0.7% rise in imports, which means the terms-of-trade fell in the December quarter which weighs on national income. Producer prices are only 1.4% higher over the year to December, another sign of low inflation. Private sector credit was up by 0.2% in December with housing credit growth rising but remaining well below levels that warrant any concern about financial stability.
What to watch over the next week?
The RBA meeting is key next week. We expect no change to the cash rate and the RBA’s post-meeting Statement is likely to be optimistic around the domestic economy, with the RBA holding the view that low interest rates are helping to generate a “gentle turning point” in the economy. RBA Governor Lowe speaks on Wednesday on “The Year Ahead”, Lowe also presents the semi-annual testimony before Parliament and the RBA release the quarterly Statement on Monetary Policy which should show some downgrade to near-term GDP forecasts but no change to inflation forecasts. The lower A$ since the last update will provide some boost to GDP forecasts.
CoreLogic home price data for January which will show another decent rise in home prices across Sydney and Melbourne. December building approvals should increase marginally which may be a sign that housing construction is bottoming. December retail sales are likely to decline by 0.4% after the Black Friday/Cyber Monday sales boosted growth in November. The retail volume data should show a small lift in retail volumes over December quarter. The December trade balance is likely to remain strong, at over $5bn which is good for national income. The AiG manufacturing PMI is also out along with ANZ job ads for January.
The US January manufacturing ISM should show a rebound, in line with the Markit index, but is likely to remain below 50. January payrolls are likely to see a rebound in monthly employment (+150K) with the unemployment rate remaining at 3.5% and a pick-up in hourly earnings to 3%pa.
Eurozone core CPI is expected to only have increased by 1.2% over the year to January, well below the 2% inflation target.
In China the Caixin manufacturing PMI is expected to remain around 51 in January (from 51.5 in the prior month) and the January trade balance is also released but it’s too early to see any impact from the Phase One US/China trade deal.
Outlook for markets
Improving global growth and still easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares and geopolitical risks are likely to constrain gains and create some volatility:
- After very strong gains and with investor sentiment now bullish, shares are due for a short-term correction or consolidation which is currently underway.
- But for the year as a whole, global shares are expected to see total returns around 9.5% helped by better growth and easy monetary policy.
- Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and the trade threat recedes as we expect.
- Australian shares are likely to do okay this year but with total returns also constrained to around 9% given sub-par economic & profit growth.
- Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
- Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns.
- National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
- Cash & bank deposits are likely to provide very poor returns, with the RBA expected to cut the cash rate to 0.25%.
- The A$ is likely to fall to around US$0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2020 little changed.
Subscribe below to Econosights to receive my latest articlesDiana Mousina, Senior Economist
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