Investment markets and key developments over the past week
Global share markets mostly fell over the last week. While shares initially rallied on the back of reasonable economic data, anticipation of Fed dovishness, positive vaccine news and M&A activity, the gains were given up later in the week as tech stocks came under renewed pressure and the Fed did less than some had hoped. US shares fell 0.6% for their third week of decline in a row, Eurozone shares lost 0.5% and Japanese shares fell 0.2% but Chinese shares rose 2.4%. Australian shares managed a small gain of 0.1% over the week after two weeks of falls with strong gains in resource, property, and IT stocks offsetting weakness in financials. Bond yields rose slightly in the US but fell elsewhere. The iron ore price fell, but metal and oil prices rose as the US$ fell, but the A$ was little changed.
September is often the month for corrections and we have seen a bit of that so far this month with the stretched US market having a top to bottom pullback of 7%, led by the very stretched Nasdaq which has seen a 10% top to bottom fall. In the process Australian shares have also pulled back 5% but Eurozone and Japanese shares have been little affected. The pullback has relieved overbought conditions while at the same time the resilience of credit spreads, metal prices and growth currencies like the A$ tell us its likely just a correction and not the start of a renewed bear market. Strengthening economic data and very dovish central banks should underpin share markets on a 6-12 month horizon, providing coronavirus is controlled. But right now it’s still too early to say the correction is over – seasonal weakness often continues into October, coronavirus could have a third wave into the northern winter, uncertainty remains around the next round of fiscal stimulus in the US and the US election is likely to add to volatility.
The past week or so has seen the trend in new coronavirus cases hook up after a period of stability through August.
The uptick reflects both emerging countries (particularly India) but also developed countries moving up again as new cases in Europe continue to trend up to be now above March/April highs and the US has hooked up again over the last few days (mainly in the south and mid-west).
Fortunately, the second wave of new coronavirus cases in developed countries has continued to be far less deadly than the first wave with deaths running well below their April high whereas new cases have been well above. This reflects a combination of more testing (picking up more younger people), better treatments and better protection for older people. This in turn is continuing to help avoid a return to generalised lockdowns in most countries (Israel and Victoria excepted) – in favour of targeted measures – and helping confidence hold up. Although Europe & the UK are at risk here.
The lower level of fatalities and absence of a return to a hard lockdown has seen economic recovery continue in most developed countries. However, our US Economic Activity Tracker had a setback over the last week with declines in restaurant and hotel bookings and mobility indicators.
Australia is continuing to see better news on coronavirus with new cases in Victoria pushing into the 30-50 range over 14 days which is necessary for a move to Melbourne’s Step Two reopening from 28th September.
And now with new cases sliding, deaths have also fallen sharply in Victoria. While the second wave proved more deadly than the first in Australia in contrast to other developed countries, coronavirus deaths per million people in Australia remain low at 33 compared to the US at 602, the UK at 627 and France at 423.
The decline in new cases has seen our Australian Economic Activity Tracker hook up from August lows but it had a set back over the last week with falls in restaurant bookings and shopper traffic. Expect a rising trend though as Victoria moves to a gradual reopening and other states continue to recover.
In vaccine news, UK trials of the University of Oxford/AstraZeneca coronavirus vaccine resumed after it was concluded that the illness of a participant was unlikely to be related to the vaccine. That said, the cause of the illness appears to remain subject to some debate.
The Fed followed through at its September meeting with its ultra-dovish shift to inflation average targeting that had been announced in late August. The Fed is now aiming “to achieve inflation moderately above 2% for some time so that inflation averages 2% over time” and it backed this up with forward guidance to keep rates unchanged at 0-0.25% until full employment has been reached and “inflation has risen to 2% and is on track to moderately exceed 2% for some time.” Consistent with this the Fed’s dot plot of Fed officials interest rate expectations shows no hike out to 2023 despite an expected fall in unemployment to 4% and a rise in inflation to 2%. While the Fed stopped short of providing more definitive guidance regarding its QE plans this is likely to come later when uncertainty has diminished.
The Fed’s move to inflation average targeting and guidance to match is a big deal and now means that the Fed will take into account periods of past inflation undershoot (or overshoot) relative to its target when setting monetary policy. For the current environment it means it will be a lot slower to raise rates than in the past. This is positive for shares and negative for the US dollar and will ultimately force other central banks including the RBA to do something similar to minimize upside in their currencies. Of course, it does shift the dial towards higher inflation risk longer term and the shift by Powell to take more inflation risk may ultimately be seen as akin to Volker’s move to squeeze out excessive inflation in the early 1980s.
So far, the ECB a week ago, the Bank of Japan, the Bank of England and the RBA via its minutes released in the last week show no sign of moving down the Fed’s path. But the BoE is now considering negative interest rates – perhaps as something it could do should Brexit turn into a hard Brexit later this year. And the RBA minutes did reiterate that it’s considering further monetary measures.
We expect further easing by the RBA possibly at its next meeting so as to present a united “Team Australia” front with the Federal Government as it’s the same day as the Budget. Further RBA easing is likely to involve a combination of cutting the cash rate and the three year bond yield target to 0.1%, tweaking forward guidance to not raise the cash rate until full employment is reached and inflation is sustainably within the 2-3% target band and possibly adopting a more traditional quantitative easing program. While other Anglo central banks – namely the RBNZ and the BoE - are now considering negative interest rates we remain of the view that the RBA will continue to avoid going down this path, particularly with RBA research indicating that it can get a bigger impact via other measures than further cuts in the cash rate.
Over the past week, apart from catching up with The Bachelor which seems to have come down to Bella v Irina, I watched I Am Woman the biopic about Helen Reddy. What a great song – catchy tune and inspiring lyrics that (as a pre-teen) made me aware about feminism and equal rights long before I actually read anything about it. And now it’s nice to know a bit more about where it came from.
Major global economic events and implications
US data was generally strong. While retail sales and industrial production rose less than expected in August they still rose despite the second wave of coronavirus cases, homebuilder conditions rose in September to their highest level in over 35 years, housing starts fell slightly but after a huge gain in July and remain in a strong uptrend, manufacturing conditions in the NY region rebounded and remained strong in the Philadelphia region and continuing jobless claims fell. September quarter GDP is now on track to expand 8% or so almost recouping the 9% decline seen in the June quarter.
The election of Yoshihide Suga as LDP leader in Japan making it almost certain he will be elected PM is unlikely to result in any significant departure from Abenomics for now. Meanwhile, Japanese core inflation plunged in August to -0.1%yoy.
Chinese economic activity data continued to accelerate in August with industrial production growth rising to 5.6% year on year, retail sales rising to 0.5%yoy, investment rising to 8.1%yoy and house price growth remaining solid. Production and investment have led the recovery in China (in contrast to most western countries) running the risk of a build-up in inventories. However, it reflects a different policy focus in China and may result in a more assured outlook for productivity and ultimately employment in the years ahead. Most high frequency data shows the Chinese economy operating around normal levels, including restaurant activity – see the next chart.
Australian economic events and implications
August jobs data was much stronger than expected in Australia with employment up by 111,000 which in turn pushed unemployment down to 6.8% (from 7.5%), but it was not quite so strong beneath the surface. The good news is that just over half the jobs lost in April and May have been returned, effective unemployment which assumes a constant participation rate since March and adds back in those on zero hours has fallen from a high of 14.9% in April to now 9.5% and a loss of jobs and hours worked in Victoria has been offset by strength in other states. However, the bad news is that the recovery in jobs has been skewed to part-time jobs with nearly 80% reinstated as opposed to only 20% of full time jobs which has left underemployment very high at 11.2%, most of the jobs growth seen in August was due to “sole traders” who may have been encouraged to return to the labour market due to the return of job search requirements for JobSeeker and the impending tapering of JobKeeper but who are not actually doing anything because hours worked barely moved in August and effective unemployment remains high at 9.5%. August’s fall in official unemployment holds out the promise that it won’t get as high as the 10% we expected by year end, but we still see it rising to 9% as more people return to the workforce and as JobKeeper is phased down.
What to watch over the next week?
In the week ahead the key focus is likely to be on business conditions PMIs for September to be released Wednesday. These are expected to remain strong in the US and improve in Japan and Australia as the number of new coronavirus cases has fallen in both countries but are vulnerable to a further decline in Europe where new cases are continuing to rise.
In the US, expect existing home sales (Tuesday) and new home sales (Thursday) to remain strong, a further rise in home prices along with continued strength in September business conditions PMIs (Wednesday) and a continued recovery in durable goods orders (Friday).
In Australia, expect preliminary retail sales for September (Wednesday) to have fallen 3% after several months of very strong gains with weakness concentrated in Victoria. Payroll jobs data for the period to 5th September will also be released (Tuesday) along with March population data (Thursday) which is likely to show some slowing in population growth due to lower immigration in March. A speech by RBA Deputy Governor Debelle (Tuesday) will also be watched closely for any clues regarding future monetary easing.
Outlook for investment markets
After a strong rally from March lows, shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. 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 continue benefitting 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 rent holidays will push prices lower into next year. Home prices are expected to fall by around 10%-15% from their April high. Melbourne is particularly at risk on this front as its Stage 4 lockdown pushes more businesses and households to the brink.
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 US/China tensions, a continuing rising trend is likely to around US$0.80 over the next 6-12 months helped by rising commodity prices, the return of a positive bond yield differential versus the US 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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