Investment markets and key developments over the past week
While shares rose strongly early in the past week, they then fell sharply on the back of bad economic data, profit warnings, increased tensions between the US and China and profit taking after a very strong gain in April. US shares fell 0.2% for the week due to a 2.8% decline on Friday. Eurozone shares were closed Friday so still managed a 4.2% gain for the week. Japanese shares rose 1.9% for the week and Chinese shares rose 3%. While the Australian share market fell a sharp 5% on Friday it still managed to eke out a 0.1% gain for the week. Bond yields fell in Europe, Japan and Australia but they rose slightly in the US. Oil prices rose on signs of improving demand, copper prices fell and the iron ore price rose slightly. The A$ rose as the US$ fell.
The past week saw more bad economic data globally with sharp contractions in US and Eurozone GDP in the March quarter and this will be a lot worse in the current quarter as the full brunt of the shutdowns impact June quarter economic data. We anticipate June GDP to contract by around 10% in the US, Europe, Japan and Australia. Consistent with this our weekly economic activity trackers for the US and Australia based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, credit card data, mobility indexes and jobs indicators are well down, although there is some sign of stabilisation in both countries.
This will clearly weigh on company profits which will take a 30% or so hit in the near term. The March quarter earnings reporting season in the US which is now more than half way through is seeing only 49% of companies reporting profit growth on a year ago and profits are running down around 14% from a year ago (helped a bit by better than expected results from big tech companies) and consensus expectations for second quarter earnings are down 36% from the 2019 high. The hit to profits was highlighted in Australia with banks announcing a hit to earnings, capital raisings and cuts to dividends.
But while economic statistics and profits will likely get even worse before they get better leaving share markets vulnerable to a pullback after the sharp rise since 23rd March, as long as investors remain confident growth will return in the second half of the year then any share market pullback will be limited. There are several points to note here.
First, the news on coronavirus curve flattening remains positive. New global coronavirus cases have been trending sideways to slightly down for the last four weeks now.
While various poorer countries are becoming more of a concern, Europe remains in a clear downtrend and the US looks to have peaked.
And Australia is continuing to see a very low number of new cases. Comparing OECD countries in terms of how they are performing in controlling the coronavirus outbreak (based around recovery rates, cases and testing) Australia ranks first, with New Zealand 2nd (guess where your next overseas holiday might be!) compared to the UK at 31st, Sweden at 36th and the US the worst performer in the OECD at 37th.
Second, consistent with this the movement towards an easing of lockdowns is continuing to gather pace across Europe and the US, and Australia is cautiously heading down the same path with several states announcing minor easings in rules around social gatherings. Providing any easing is gradual and based on criteria around widespread testing, falling new cases and better containment and tracking then the risk of a “second wave” should be able to be managed. The approaching winter in Australia also points to the need for caution but providing these criteria are met and foreign travel remains banned (except to NZ) then Australia should be able to see a gradual easing of restrictions weighing on economic activity from mid-May. This looks to be on track with the PM indicating national cabinet will meet on 8th May to discuss the relaxation of restrictions. If this is the case, then we remain of the view that April or maybe May will be the low point in economic data with a gradual recovery underway through the second half.
Thirdly, reports that a clinical trial of the anti-viral drug Remdesivir showed that it helped patients recover in 11 days on average as opposed to 15 adds to confidence that a pharmaceutical solution will be found. The US FDA also cleared Remdesivir for emergency use with Covid 19 patients. (That said there is still a way to go on all this, the 30% faster recovery rate with Remdesivir may not make a big enough difference and it’s not clear that President Trump’s Operation Warp Speed plan to speed up a virus solution will have much impact.)
Fourthly, while there weren’t any big new announcements on the policy front this week, G3 central banks remain committed to doing “whatever it takes”, although the ECB remains a laggard.
- The basic message from the Fed and Chairman Powell’s post meeting press conference was that it will use its “full range of tools” and act “forcefully, proactively and aggressively until it’s confident the economy is on the road to recovery and that it will do more if needed. Meanwhile it widened its Main Street lending program to reach more businesses.
- The Bank of Japan removed its upper limit on quantitative easing and substantially increased its limits on purchases of commercial paper and corporate bonds.
- The ECB provided more generous funding for banks (with a potential cut in their borrowing cost to -1%!) and indicated a willingness to expand its pandemic QE program (although given the failure of Italian/German bond spreads to narrow much it would make more sense to move faster now).
Finally, don’t forget this has so far turned out a lot better than feared in March when share markets had fallen around 35% and the worry was of a much longer lock downturn which would have had a far bigger impact on economic activity. In Australia the official talk was of a lockdown or hibernation of at least six months. Now the last time Australia’s PM referred to a six-month hibernation was back on 7th April. If the lockdown starts to ease through May as appears likely then it will have lasted 2 to 3 months depending on when measures are completely relaxed implying a smaller hit to the economy than originally feared. (Note also that if international travel does not return it will be a drag on Australia, but the travel ban has only accounted for a small part of the likely full hit to GDP from the shutdown. The trade surplus in tourism and education for Australia – which would be “lost” if global travel does not return - is 1% of GDP which is small compared to the estimated 10 to 15% hit to GDP from the shutdown as most of the hit is coming from reduced domestic demand.)
The bottom line remains that after the strong run up in global and Australian shares since the low around 23rd March they are vulnerable to a pullback on the back of the very poor economic and profit data we will see over the next few months. Increased tensions between the US and China may add to this and a retest of the March low still can’t be ruled out. But providing we are right and shutdowns ease in the months ahead resulting in April or May proving to be the low point in economic data then given the massive policy stimulus shares should be able to resume their rising trend and so we retain a positive 12 month outlook.
There are three big risks to keep an eye on over the next few months:
- First – a second wave of coronavirus cases. This should be manageable with ramped up testing, quarantining and contact tracing (as per the App Australia is deploying), but the US is perhaps most at risk on this front.
- Second – collateral damage from the shutdowns in the form of permanent company closures and rising defaults. So far so good but it’s early days and this will be critically important in terms of the speed of the recovery.
- Third – an escalation in US/China tensions. Given the hit to the US economy and its very poor performance in managing coronavirus, President Trump will find it hard to get re-elected and will be tempted to “wag the dog” in order to rally around the flag and distract voters. A fight with China over the source of the virus may be part of this and looks to be starting to escalate already. Mr Trump is limited in terms of what he can do without further damaging the US economy though, but it could still cause bouts of weakness in share markets.
Major global economic events and implications
US GDP fell 1.2% quarter on quarter in the March quarter or 4.8% annualised with much worse to come in the current quarter. The fall in GDP was driven by big falls in consumer spending, business investment & a detraction from inventories. With the shutdowns only commencing in the second half of March a much bigger fall in GDP is expected in the current quarter where we see GDP falling -10%qoq. Sharp falls in consumer confidence and business conditions along with a 21% plunge in pending home sales are consistent with this. While the April manufacturing conditions ISM fell less than expected to 41.5, new orders and employment fell sharply to readings around 27. Jobless claims came in at a still very high 3.8 million but at least they are slowing and maybe the Paycheck Protection Program is starting to help support jobs. Easing lockdowns plus policy stimulus are likely to drive a return to growth in the second half though, assuming there is no second wave.
It was a similar story in the Eurozone with March quarter GDP down -3.8%qoq, with 5% or so falls in France, Italy and Spain. Plunging economic confidence and the full brunt of the shutdowns point to a much bigger fall in GDP this quarter of around -10% to -15%qoq ahead of a return to growth in the second half.
Japan looks to be following a similar profile, with sharp falls in industrial production, retail sales and job openings in March and a plunge in consumer confidence to a record low in April and data for Tokyo pointing to a collapse in inflation.
China is 2-3 months ahead of the rest of the world in terms of coronavirus and its economic impact, with overall April business conditions PMIs rising slightly to an okay level of 53.4, suggesting that economic activity has continued to recover albeit it is likely still below normal. Services activity rose but manufacturing slipped slightly. China’s delayed National People’s Congress to now be held from 22nd May will be watched closely to see if it sticks to a 2020 GDP growth target of around 6% or accepts something more realistic like 2%. Given the 10% March quarter GDP slump both will require strong growth from here and anything like 6% will necessitate a lot more policy stimulus.
Australian economic events and implications
In Australia, the ABS’s survey of household coronavirus impacts showed one third of households being financially worse off, 10% drawing down savings, a quarter receiving government payments and a doubling in people feeling nervous or restless. Surprisingly only 3% have reduced home loan payments though. Credit growth surged in March, but this was all due to a surge in lending to businesses as the shutdown hit. The terms of trade rose in the March quarter providing an income boost to the economy and it also looks like net exports contributed positively to March quarter GDP growth which along with strong (albeit distorted by hoarding) retail sales suggests upside risk to our forecast that GDP fell in the March quarter. Finally, the ANZ Roy Morgan consumer confidence index rose for the fourth week in a row and has now recovered nearly half of its coronavirus related plunge. As in other countries we expect a -10% fall in Australian GDP in the June quarter, but with an easing of the shutdown and policy stimulus driving a return to growth in the second half.
Capital city home prices rose 0.2% in April but are set to go negative. Momentum has already slowed from 2% growth last November as the boost from the election, rate cuts and regulatory easing has run its course and as coronavirus shutdowns impact. Melbourne prices are already falling. We expect home prices to fall 5 to 20% as shutdowns and economic uncertainty impact via higher unemployment, falling rents, stalled immigration and rising vacancy rates. JobKeeper and bank payment holidays should help limit falls, but Sydney and Melbourne are most at risk.
March quarter inflation came in stronger than expected at 2.3% year on year (with underlying inflation at 1.8%yoy) but this was mainly due to the impact of the drought, bushfires and hoarding. The June quarter is likely to see a plunge in inflation into negative territory as a result of the collapse in petrol prices, free childcare, falling rents, freezes or rebates on government charges and discounting.
What to watch over the next week?
Markets will likely remain focussed on continuing evidence that the number of new Covid-19 cases is slowing and on progress towards an easing in lockdowns. Economic releases will continue to show the increasing impact of coronavirus shutdowns. Friday looks likely to be a key day on this front in Australia, with the Government likely to announce a progressive easing in the lockdown.
In the US, the focus will be on jobs data for April due Friday which based on jobless claims are likely to show a 22 million plunge in payroll employment and a massive rise in unemployment to 16% (from just 4.4% in March). In other data expect to see a deterioration in the US trade deficit for March and a sharp fall in the non-manufacturing conditions ISM index for April (both due Tuesday). The Fed’s lending officer survey (Monday) will provide some guide as how much banks have tightened lending standards.
The German Constitutional Court’s ruling on the legality of the ECB’s 2014-16 QE program will be watched for whether it has any bearing on its current program and whether it will reduce the ability of the ECB to limit the fallout of the current crisis. The Bank of England meets Thursday and is unlikely to make any major new changes to monetary policy.
China’s trade data for April (Thursday) is likely to show some slowing in exports and imports after surprisingly stronger March data. Caixin manufacturing and services conditions PMIs will be also be released.
In Australia, the RBA on Tuesday is likely to again reaffirm the significant monetary easing it announced in March. The cash rate is at the RBA’s long stated lower bound and there is no value in taking it negative, so it won’t be cut. And in the meantime, we are yet to see the full extent of the hit to the economy from the coronavirus related shutdowns and it will take several years to fully recover so a rate hike is years away. We expect the cash rate to be stuck at 0.25% for at least the next three years. The RBA may signal a further slowing in its bond buying as markets have settled down after March’s turmoil and it may provide more detail around how it sees the economic outlook – probably by way of various scenarios – particularly in its Statement of Monetary Policy to be released Friday. On the data front expect a 17% fall in March building approvals (Monday), continuing weakness in payroll employment and wages (Tuesday), an 8% rise in March retail sales (Wednesday) consistent with preliminary data already released which will result in a real rise of around 2% for the March quarter, a fall in housing finance (also Wednesday) and a rise in the trade surplus for March (Thursday) to $6bn on the back of strong export data already released.
Outlook for investment markets
After a strong rally from March lows shares are vulnerable in the short term as economic data to be released over the next month shows the devasting impact of the coronavirus related shutdowns. But on a 12-month horizon shares are expected to see good total returns helped by an eventual pick-up in economic activity and massive policy stimulus.
Low starting point yields are likely to result in low returns from bonds once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from the search for yield but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
The Australian housing market is weakening in response to coronavirus. Social distancing is driving a collapse in sales volumes, and a sharp rise in unemployment, a stop to immigration through the shutdown and rent holidays pose a major threat to property prices. Prices are expected to fall between 5% to 20%, but government support measures including wage subsidies along with bank mortgage payment deferrals along with a plunge in listings will help limit falls at least for the next six months.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
The hit to global growth from Covid-19 and its flow on to reduced demand for Australian exports and lower commodity prices still risks pushing the A$ lower in the short term. But expect a strong rebound once the threat from coronavirus recedes, particularly with the US expanding its money supply far more than Australia is via quantitative easing and with China’s earlier recovery likely to boost demand for Australian raw materials.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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