Market Update 30 April

Investment markets and key developments over the past week

Share markets were flat to lower over the last week. Good economic activity data, strong earnings and more US stimulus saw US shares push to a new record high, before ending flat for the week with inflation concerns resurfacing on Friday. Eurozone shares fell 0.5% over the last week, Japanese shares fell 0.7% and Chinese shares lost 0.2%. For April as a whole, US shares rose 5.2% and global shares gained 3.9%. While Australian shares gained 3.5% in April, they fell 0.5% over the past week as the local market continues to work off technically overbought conditions after its early April surge. Weakness in retailers, IT, health and telecommunications stocks particularly weighed on the Australian share market over the last week. Bond yields rose in most major countries. Oil, metal and iron ore prices rose. The A$ fell despite a fall in the $US.

First, the bad news. US inflation fears were boosted late in the last week by data showing a slightly stronger than expected rise in core personal consumption deflator inflation, as well as a pickup in wages growth. Meanwhile, the latest rise in new global coronavirus cases and deaths continued over the last week, with India accounting for over 40% of new cases globally. New cases and deaths are declining in developed countries, with the US trending down and Europe slowing again, although Japan still has a problem and has announced a third state of emergency.

Fortunately, new cases in Australia remain low (and due to returned travellers) and the snap lockdown in Perth worked in limiting another breakout from the quarantine system.

More broadly, the good news continues to dominate globally. First, the vaccination rollout is continuing - and they work. So far around 8% of the global population has now received one dose of vaccine – with 44% in advanced countries and 6% in emerging countries. Within developed countries, the UK is leading the charge at 51%, the US is at 44%, Europe is at 23% with Australia well behind at around 8% (but picking up).

In developed countries, the main risks relate to reopening before herd immunity is reached and hesitant take-up (following bad headlines around the vaccines). The damage from the former is being minimised by vaccinating older/at risk groups, while the issue of take up can be resolved by “vaccine passports”, with e.g., the European Union (EU) talking of allowing American tourists back if they are vaccinated. Meanwhile, surging vaccine production will see vaccination in emerging countries accelerate.

Secondly, stimulus continues. President Biden confirmed his American Families Plan with an extra US$1.8trn in spending over 10 years on childcare, education and paid leave, partly funded by tax hikes including an increase in the top income tax rate, an increased capital gains tax rate for very high income earners (just 0.3% of taxpayers) and increased auditing of high income earners. As with the proposed increase in the corporate tax rate under the American Jobs Plan, the increase in top personal and capital gains tax rates will likely be watered down by Congress. There is also an offsetting boost to spending, which given that it’s focussed on lower income earners, should boost corporate revenue. Hence, the US share market reaction was positive. Bear in mind though that both the US$2.25trn American Jobs Plan and the US$1.8trn American Families Plan are both spread out over a decade or so and won’t start till next year, so the additional stimulus is minor compared to the US$5trn paid out in relation to the pandemic stimulus. Both plans face challenges in getting through Congress.

Meanwhile, the US Federal Reserve (Fed) remains very dovish. While it was more upbeat on the economy and noted that inflation has risen, it still sees the latter as “transitory”. Fed Chair Powell indicated there is still significant slack in the economy, noting “it will take some time before substantial further progress” is made towards its goals and so it’s too early to be talking about tapering its bond buying. We expect the taper talk at the Fed to start around September though. Other central banks remain very dovish too, including the European Central Bank (ECB), Bank of Japan (BOJ) and the Reserve Bank of Australia (RBA), with inflation readings remaining soft in Europe, Japan and Australia over the last week in contrast to the increase underway in the US.

Thirdly, economic data remains consistent with a global recovery. US gross domestic product (GDP) surged 6.4% at an annualised rate in the March quarter and Eurozone economic sentiment surged to historically high levels in April, pointing to a strong recovery once COVID settles.

Finally, consistent with this, profits are continuing to surprise on the upside. This is most evident in the US, where consensus expectations for March quarter earnings per share growth have jumped from 21% year-on-year (yoy) at the start of the current earnings reporting season to +42%yoy now.

Given all this, our assessment remains that share markets will head even higher this year as recovery continues and this boosts earnings. However, investor sentiment is very bullish, which is negative from a contrarian perspective and we are coming into a seasonally softer period of the year for shares, as the old saying “sell in May and go away…” reminds us. A resumption of the bond tantrum as US inflation rises further in the months ahead, US tax hike concerns if Congress does not pare back some of Biden’s tax hikes, coronavirus setbacks and geopolitical risks (around US/China tensions, Russia and Iran) could all provide a trigger for a correction. It would likely be just another correction though. Our ASX 200 forecast for year-end remains 7,200.

In Australia, going by a speech by Treasurer Josh Frydenberg in the past week, the Budget on 11 May is likely to see a continuing focus on supporting recovery, prioritising job creation to push unemployment below 5%, to help drive the budget deficit lower, rather than adopting fiscal austerity. Key elements are likely to include:

• an upgrade to growth forecasts;
• an extra A$2.5bn a year in aged care spending;
• measures to help boost women’s economic security, including changes to help bolster their superannuation balances;
• possibly increased childcare rebates (although this could be delayed until closer to the next election);
• more targeted industry support measures;
• extra spending on mental health, disability services, climate, infrastructure and skills;
• some possible tax reforms and deregulation;
• a possible lifting of the home price caps for the First Home Loan Deposit Scheme;
• an extension of the Low and Middle Income Tax Offset (LMITO) to cover the next financial year; and
• much lower budget deficits of A$150bn this financial year and A$50bn next financial year. The faster than expected economic recovery, which means lower than expected welfare spending and increased revenue, along with the higher iron ore price (which has the potential to slice A$20bn alone of this year’s deficit), means that the starting point for the budget deficit this year could be as low as A$125bn (down from A$214bn projected in the October Budget last year and A$198bn in the Mid-Year Economic and Fiscal Outlook (MYEFO)) and A$40bn next financial year (down from A$112bn in the last Budget). However, we are assuming more conservative Government forecasts, extra spending, and a desire to leave some scope for surprise in the bag will see deficits of A$150bn and A$50bn reported on Budget night. The key though is that it’s possible a return to surplus could be on the cards in five years or so (assuming no new shocks along the way).
  
  

As to where the non-accelerating inflation rate of unemployment (the so-called NAIRU) sits in Australia – new Treasury research suggests it’s around 4.5% to 5%, the RBA prior to the pandemic suggested it was around 4.5% and Governor Lowe has agreed it could be below 4%. Therefore, it’s a bit of a guessing game – which is complicated by a still-high pool of underemployed. To get wages growth above the 3.5% necessary to sustain inflation around 2-3% will probably require labour underutilisation of around 10% or less, which, given that it’s now at 13.5%, means we still have a long way to go.

Our Australian Economic Activity Tracker fell over the last week, but remains very strong, suggesting recovery remains on track. Our US Economic Activity Tracker resumed its recovery, but remains down on pre coronavirus levels, while our European tracker rose, but remains very weak.

Back in the 1960s/early 70s Detroit didn’t just make great cars (over a few years at one stage I had four of them) but it also made great music, particularly that from Motown. Amongst the best at Motown were The Supremes with a string of hits including Baby Love, Stop in the Name of Love and Love Child with Diana Ross on lead vocals. Unfortunately, their songs after Diana left in 1970 are not as well known but are equally as good. I first came across them when listening to Bananarama in the 1980s when they pointed out that Nathan Jones was a cover of a Supremes song from the post Diana Ross period. The Supremes’ Nathan Jones was unusual for them in that it saw all three (Mary Wilson who by then was the only original member along with Jean Terrell and Cindy Birdsong sing lead in unison). Other excellent songs from this period included Stoned Love and Up The Ladder To The Roof. Unfortunately, Mary Wilson passed away early this year, leaving only Diana of the original Supremes – Florence Ballard left the group in 1967 and died in 1976.

Major global economic events and implications

US data remains very strong. March quarter GDP rose 6.4% annualised, but with trade and inventories detracting from growth, gross national spending rose 9.9%. US GDP is now just 0.9% below its pre coronavirus high and growth is likely to remain strong this quarter, as stimulus checks are partly spent and vaccine-rollout facilitates further reopening. Consistent with this, March data showed a 21% surge in personal income and a rise in the household saving rate (to 27.6%), reflecting the stimulus payments. While personal income will fall back in April, sky high savings will help drive strong consumer demand in the months ahead. Consumer confidence rose strongly in April, home prices are rising strongly, pending home sales rose in April and core capital goods orders are historically high.

Amid reopening, higher commodity prices and supply chain bottlenecks, inflation is rising in the US, with the core private consumption deflator rising slightly more than expected, at 0.4% month-on-month (mom) and 1.8%yoy in April and the March quarter Employment Cost Index rising a stronger than expected 0.9% quarter-on-quarter (qoq) and 2.7%yoy. Headline and core inflation are likely to rise further in the US, but should cool later this year as bottlenecks clear. It is notable that underlying measures of US inflation that strip out extreme moves remain soft. Similarly, the increase in wages costs will likely slow when enhanced unemployment benefits end in September, driving more workers back into the jobs market.

Meanwhile, the US March quarter earnings reporting season has been very strong. 60% of the S&P 500 have now reported, with 87% beating earnings expectations by an average +23% and 71% beating on revenue expectations. Consensus earnings expectations for the quarter have now risen to +42%yoy, from +21% two weeks ago. Tech sector earnings per share (EPS) are up 42%yoy, but cyclicals (like consumer discretionary, financials and materials) are outperforming.

Eurozone GDP fell -0.6% in the March quarter on the back of lockdowns and after a 0.7% fall in the December quarter, which means it’s back in recession. Economic confidence rebounded to near historical-highs in April though, and PMIs are strong, suggesting that, along with vaccines and reopening, growth will rebound this quarter. The setback in the recovery though, along with high unemployment (at 8.1% in March) and a fall in core inflation in April to just 0.8%yoy, will keep the ECB dovish.

The Bank of Japan left monetary policy on hold as expected, but it lowered its near-term inflation outlook slightly and only sees core inflation reaching 1% in fiscal 2023 - still well below the 2% target. Monetary tightening remains years away. Meanwhile, Japanese data was stronger than expected, with unemployment falling to 2.6%, the ratio of job vacancies to applicants rising slightly and industrial production up more than expected. Tokyo inflation data for April however was weaker than expected, with core inflation falling back to zero.

Chinese official business conditions PMIs were weaker than expected in April, but the composite remains solid at 53.8 and up from its February low. By contrast, the Caixin manufacturing PMI rose more than expected. This all suggests overall conditions remain strong in China.

Australian economic events and implications

Low inflation to help keep RBA dovish. While there is much concern about rising inflation, Australian March quarter CPI data surprised on the downside, coming in 0.3% below market expectations, at 0.6%qoq, or 1.1%yoy. At a headline level, the downside surprise reflected the impact of housing subsidies offsetting higher dwelling building costs, the Government’s Job-ready subsidy and lower than expected food prices that will likely not be sustained. However, the underlying measures of inflation screen out extreme moves and they were also weaker than expected, telling us that despite a few pockets of strength, underlying price pressures remain very weak. Producer price inflation was also on the soft side in the March quarter, despite big rises in commodity prices. Headline inflation will spike to around 3.7%yoy this quarter, as the 1.9% fall in the June quarter last year drops out. However, with general pricing power remaining soft, consumer spending likely to rotate back towards services (taking pressure off good prices) and wages growth likely to remain weak, underlying inflation is expected to edge up only gradually, resulting in both headline and underlying inflation being below target at the end of next year.  

In other data, payroll jobs fell in mid-April, but this appears to reflect seasonal weakness associated with Easter and school holidays rather than anything to do with the ending of JobKeeper. The goods trade surplus surged again in March, helped by another strong rise in exports, with March quarter data showing a 9% lift in export prices (mainly iron ore) and flat import prices, indicating another strong rise in the terms of trade and boost to national income.

Credit data picked up in March, particularly for housing, which is accelerating as record finance approvals flows through to actual lending. While total housing credit growth of 4.1% over the year to March is modest, the annualised pace has picked sharply to 8.4% for owner occupiers, which is at its fastest since 2017. Investor lending is also accelerating. A further rise in credit growth is likely as the housing boom continues and this will likely put further pressure on the RBA and the Australian Prudential Regulation Authority (APRA) to cool things down.

What to watch over the next week?

In the US, expect the manufacturing and services conditions ISMs for April (to be released on Monday and Wednesday) to remain very strong at around 65 and 64 respectively and jobs data (Friday) to show a 950,000 gain in payrolls, with unemployment falling to 5.8%. The US March quarter earnings reporting season will also continue.

Chinese Caixin PMIs (Friday) are likely to see the composite PMI remain solid. Trade data will also be released on Friday and is likely to show faster imports and slower exports.

In Australia, the RBA (Tuesday) is expected to leave monetary policy on hold following its meeting on Tuesday and reiterate that while the recovery is stronger than expected, it still sees wages and inflation remaining subdued for many years, with the weaker than expected March quarter inflation data being consistent with this. As such, it’s likely to repeat that it doesn’t expect to raise interest rates until 2024 at the earliest. The focus is likely to be on what it says about its bond buying programs, where we expect a tapering later this year. Its Statement on Monetary Policy (Friday) meanwhile is likely to see a slight upwards revision to near term growth and headline inflation forecasts and a downwards revision to its unemployment forecasts.

On the data front in Australia, expect CoreLogic data for April (Monday) to show a slowing in monthly home price growth from March’s breakneck pace of 2.8% to a still very strong 1.8%, the March trade surplus to increase to A$8.5bn (helped by surging iron ore exports), housing finance to rise further (both Tuesday) and building approvals to show a further 5% rise.

Outlook for investment markets

Shares remain at risk of further volatility, with possible triggers being a resumption of rising bond yields, coronavirus related setbacks, US tax hikes and geopolitical risks. Looking through the inevitable short-term noise however, the combination of improving global growth helped by more stimulus, vaccines and still-low interest rates augurs well for growth shares over the next 12 months.

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 5% grossed up dividend yield). Expect the ASX 200 to end 2021 at a record high of around 7,200 although the risk may be on the upside.

Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.

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 15% or so over the next 18 months, being boosted by record-low mortgage rates, economic recovery and fear of missing out “FOMO”, but expect a slowing in the pace of gains as government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal levels.

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$, probably taking the A$ up to around $US0.85 by year-end.