Investment markets and key developments over the past week
Global share markets had a rough week reflecting a confluence of bad news – Afghanistan, China’s continuing regulatory crackdown, worries about the Delta wave in the US and the US Federal Reserves’ (Fed) meeting minutes confirming that reduced bond buying (or tapering) is getting nearer. Helped by a Friday rally (as dip buyers kicked in near the 50-day moving average) US shares only fell 0.6% for the week, but Eurozone shares fell 1.7%, Japanese shares fell 3.5% and Chinese shares lost 3.6%. Reflecting the weak global lead, Australian shares fell 2.2%, not helped by a further rise in cases and more lockdown extensions locally, along with the continuing slide in iron ore prices, with resources and financials leading the fall. Consistent with the risk off tone, bond yields fell, as did oil and metal prices and the A$, as the US$ rose.
While the situation in in Afghanistan is terrible and reminds me of the mid 1970s malaise around the US withdrawal from Vietnam, it’s unlikely to have a major impact on global growth or markets unless it results in renewed and significant terrorist activity (and even there the impact is likely to be brief).
Share markets are at risk of a further short-term correction as the boost from earnings reporting seasons is discounted, the Delta wave continues to impact, Fed tapering continues to come into view, China’s moves potentially impact demand for Australian commodities and as the next six to eight weeks is often seasonally weak for shares. Looking through the short-term noise however, the combination of a likely continuation of the economic recovery beyond a near-term interruption, vaccines ultimately allowing a more sustained reopening and still-low interest rates with tight monetary policy being a long way off augurs well for shares over the next 12 months.
New coronavirus cases are continuing to rise globally, but there has been some slowing in the rate of increase, helped by a continuing downtrend in South America and a stabilisation in Asia – albeit with Japan, Malaysia and Thailand rising, but Indonesia and China slowing. China’s lockdown measures in particular seem to have slowed a Delta outbreak across several provinces, with new cases trending down over the last week, with the 7-day average of daily cases falling from 113 a week or so to now around 55, raising the prospect of some relaxation in its lockdowns.
While new cases are continuing to trend up in developed countries – this remains more of an issue amongst the unvaccinated. The UK, Europe and Canada have seen a hook up in new cases, but hospitalisations and deaths remain low compared to the last wave as vaccines continue to work in heading off serious illness.
While the US is continuing to see rising new cases resulting in a surge in hospitalisations – this mainly remains an issue in the lowly vaccinated South with President Biden referring to a “pandemic of the unvaccinated”. Hospitalisation rates are also running much higher during this wave for younger age groups (up 25% versus January for those under 40) than older age groups (down around 50% for those over 60) reflecting higher vaccination levels for older people.
On the latest count 33% of people globally and 63% in developed countries have had at least one dose of vaccine. The low levels in emerging (ex China) and less developed countries is a concern given the risk of mutations developing which could then find their way into developed countries.
Being vaccinated gives good protection, but not immunity which will impact reopening. The following table shows the effectiveness against coronavirus (particularly Delta) of the three main vaccines combining data from the UK Government and the Doherty Institute (in brackets). As they are from two different sources they will be differ slightly but the message is the same. It is also evident that vaccines lose some of their efficacy after 6 months or so (with one study showing this is more so for the AZ vaccine) – which is why some governments are now moving to provide booster shots (notably Israel which is advanced in this and now the US).
The key points from the table are that: the vaccines provide excellent protection against serious illness and death, but are less effective in preventing you from getting the Delta variant and once you get it even less effective in preventing you from passing it on. This partly reflects the greater transmissibility of Delta (with a reproduction rate of around 7 compared to 2.5 for the original version of coronavirus). This in turn has several implications for reopening:
- First, the achievement of herd immunity, where a population becomes immune to a disease as a result of a significant proportion of the population being vaccinated such that its transmission collapses, will be hard to achieve with Delta. It will likely require a much higher vaccination rates (say 80%, maybe even 95% of the whole population) than with other diseases and some epidemiologists say that herd immunity is now impossible.
- In the absence of very high vaccination rates, the unvaccinated can’t rely on the vaccinated to protect them and so are at high risk. Hence the “pandemic of the unvaccinated”, which we are seeing in the US and to some degree in NSW, with unvaccinated people dominating intensive care unit (ICU) wards.
- Case numbers will be high, e.g., the UK is seeing around 30,000 new cases a day (or about 11,000 cases a day adjusting to Australia’s population). Put simply, if 40% of the population is still unvaccinated and allowing for some vaccinated people getting infected, that leaves a lot of people who can potentially be infected, which still runs risks for the hospital system being overwhelmed.
- Having a high number of daily cases could leave households and businesses very cautious (even when they are vaccinated), which risks slowing the recovery – as evident to some degree in the US and Europe.
- The bottom line is that we may have to get used to a continuing high number of cases – potentially much higher than even now in Australia’s case. But the best way to make sure it’s manageable is to aim for a very high vaccination rate. This likely means 80% of the whole population at least, as Singapore has been targeting and has almost achieved, but probably even more.
The good news is that Australia’s vaccination rate reached 1.77 million doses over the last week, or 1% of the population each day, reflecting increased supply and reduced hesitancy. This is likely to speed up even more, with vaccine supply set to ramp up further. At the current rate of vaccination, we will reach the national objective of 70% of adults being vaccinated in 7 weeks and 80% of adults in 9 weeks. 80% of the whole population being vaccinated could now be met in 14 weeks (and as noted above this or even more may ultimately be needed). It will be made easier by the decision to allow 16-18 year-olds to get vaccinated (which makes sense, as about 30% of new cases in NSW and Victoria are under 19) and easier still when 12-15 year-olds are approved, as looks likely. It may however still require some ‘carrot and stick’ measures. Community pressure from the majority of vaccinated people wanting to get on with their lives will likely force the issue. Companies such as Qantas are mandating vaccination for front line workers and are starting to lead the way. NSW is reportedly planning to allow vaccinated people to have access to venues like bars, restaurants and gyms once the 70% target is met. So one way or another, vaccine passports are likely.
Unfortunately, the lockdown news in Australia remains bleak – with new cases continuing to surge in NSW, Victoria and the ACT and the ongoing extension of lockdowns. Fortunately, other states have managed to control Delta outbreaks – by stamping hard on them earlier. NSW is continuing to pay a huge price for not acting earlier and harder.
NSW is almost at the Premier’s target of 6 million vaccinations by 27 August – but it’s doubtful it’s enough to allow much of an easing of restrictions given still accelerating case numbers and the need for much higher vaccination rates to re-open safely. At this stage it looks like the NSW lockdown will mainly continue as is at least until the 70% of adult’s vaccination target is met in mid-October.
The economic impact of the lockdowns is evident in a further slight fall in our Australian Economic Activity Tracker. However, providing there are no new lockdowns in other states it’s likely to be at or close to the bottom as indicators for NSW and Victoria have likely hit bottom or come close to it.
The extension of the lockdowns announced over the past week, however, will mean a much bigger hit to the economic outlook than we were assuming just two weeks ago. The extension of the Victorian and ACT lockdowns for another two weeks and the extension of the Sydney lockdown at least until the end of September (basically another five weeks) means that the cost to the economy from the lockdowns announced since May will now be around $25bn (assuming the whole of NSW sees the same extension as Sydney). As a result, we now expect a hit to September quarter GDP of around -4% (we were assuming -2.5%) and, with case numbers still rising, there is an increasing threat to December quarter growth. It’s still likely however to be positive, as NSW and Victoria will likely hit bottom in the current quarter and other states will likely grow, but the high and rising number of cases means that the reopening (that will occur once vaccine targets are met later this year) is running the risk of being characterised in some states at least by high numbers of coronavirus cases, which could lead to consumer and business wariness and slow the initial economic rebound compared to last years’ experience. Combined, this all suggests a significantly lower profile for the level of GDP and a higher profile for unemployment through 2022 than the RBA has been assuming.
With the minutes from the RBA’s August meeting noting that “the board would be prepared to act in response to further bad news on the health front should that lead to a more significant setback for the economic recovery” our assessment is that the significant setback is now occurring and so we now anticipate that the RBA will decide to delay its decision to slow its bond buying from $5bn a week to $4bn at its September meeting. The timing of the first rate-hike is also looking like its slipping back into “2024 at the earliest.”
Delta outbreaks also appear to be constraining our US and European Economic Activity Trackers, with the US slightly off its June high and the European falling slightly. The absence of lockdowns however is heading off steep declines like we saw last year.
August 16th marked the anniversary of Elvis leaving the building for the last time – or so I am told. Here are two of his best songs. Suspicious Minds is number 1 in my view. It was first recorded in 1969 in American Sound Studios in Memphis, but this version was recorded live in Las Vegas for Elvis That’s The Way It Is. It was written by Mark James as was Moody Blue that was recorded at Graceland in the Jungle Room in 1976.
Major global economic events and implications
US data was mixed. Retail sales fell, but this likely reflects a rotation in spending back to services along with the end of stimulus checks. Industrial production rose more than expected. Manufacturing conditions fell in the New York and Philadelphia regions but remain strong. Housing starts fell, as did home builder conditions, but permits to build new homes rose and jobless claims fell sharply. Meanwhile, the minutes from the last Fed meeting signalled that tapering is getting closer, with “most” participants favouring a start in late 2021, although “several” preferred early 2022. However, there was nothing signalling an announcement in September and a start for later this year is hardly surprising. While US shares had some wobbles during the last taper talk in 2013, they actually rallied in the 2014 taper.
Japanese June quarter GDP rose a stronger than expected 0.3% qoq, reflecting stronger than expected consumer spending and capex, but the latest state of emergency may constrain the current quarter. Meanwhile the core CPI remained in deflation in July.
Chinese data for July remained on the soft side, with a bigger than expected slowing in industrial production, retail sales and investment, along with a rise in unemployment and a further slowing in property price growth. Key drivers were floods, the latest coronavirus outbreak, earlier policy tightening and carbon pollution reduction measures. Expect further policy easing ahead.
The Reserve Bank of New Zealand (RBNZ) delayed a rate hike, as New Zealand was placed into lockdown. The rate hike is likely to remain on hold for the duration of the lockdown.
Australian economic events and implications
In Australia, jobs data surprised on the upside in July, but is set to fall in the months ahead, before rebounding. The timing of the July labour market survey benefitted from Victoria’s June reopening, but mostly missed the impact of the NSW lockdown and Victoria’s July lockdown. Allowing for a fall in participation and an increase in those working zero hours indicates that “effective unemployment” actually rose to around 5.5%. Official unemployment is likely to rise to around 5.5-6% in August and September due to the lockdowns, but hours worked are likely to take the bulk of the hit. Meanwhile wages growth remained soft in the June quarter, with only “small pockets of wage pressure” flowing from international border closures. The immediate impact of the lockdowns and the set back in the achievement of full employment means that the 3% or so wages growth necessary is still a long way off.
The Australian June half earnings reporting season is now about half done in terms of companies and two thirds done in terms of market capitalisation. While the lockdowns are weighing on outlook statements, with many companies providing no guidance, the results have been strong. So far 44% of results have surprised on the upside, which is about normal, but 80% have seen earnings up on a year ago and 75% have increased dividends. The return of capital to shareholders will be big, with dividend payments on track for a record $30bn, which will exceed the August 2019 record of $27bn and adding to this is about $18bn in buybacks. Consensus earnings growth expectations for the last financial year have now increased to +50.5% (from +49.1% at the start of the reporting season) and those for the current financial year have only fallen from +8.6% to +8.2%. Resources are seeing a doubling in earnings and bank profits are expected to be up by nearly 60%. Dividend growth is coming in at around 57%.
What to watch over the next week?
In the US, the focus is likely to be on Fed Chair Powell’s comments at the Jackson Hole central banker symposium (Friday), where he is likely to indicate that the US economy is getting closer to meeting the conditions to start tapering the Fed’s bond buying. We expect a formal announcement at the Fed’s November meeting, with a start-up soon thereafter, but there is a risk that the announcement could come in September. On the data front, expect a slight fall in business conditions PMIs for August (Monday) reflecting concern about the Delta outbreak, a slight fall in existing home sales (Monday) but a rise in new home sales (Tuesday), a continuing rising trend in durable goods orders (Wednesday) and a rise in core private final consumption deflator inflation for July of around 0.3%mom/3.6%yoy (Friday).
Eurozone business conditions PMIs for August (Monday) will also be watched for any impact from Delta variant concerns, but are likely to remain strong.
Japanese business conditions PMIs for August (Monday) are likely to remain weak given the continuing surge in coronavirus cases in Japan.
In Australia, expect the lockdowns to drive a further decline in August business conditions PMIs (Monday) and an 8% fall in July retail sales (Friday). June quarter construction and business investment data (due Wednesday and Thursday) are both expected to show 3% gains, with construction helped by strong homebuilding and tax incentives helping capex. However, the lockdowns may impact business investment intentions, which are will be released with the capex data.
The Australian June half profit reporting season will see another big week ahead, with 100 major companies reporting, comprising about 26% of the share market’s capitalisation. This includes Ampol and Sonic Healthcare (Monday), Ansell and Boral (Tuesday), Nine, Seven and Worley (Wednesday), Blackmores, IOOF and Qantas (Thursday) and Wesfarmers and Village Roadshow (Friday). Outlook statements are likely to remain cautious given the uncertainty posed by lockdowns.
Outlook for investment markets
Shares remain vulnerable to a short-term correction, with possible triggers being the upswing in global coronavirus cases, the inflation scare and US taper talk, likely US tax hikes and a debt ceiling standoff and geopolitical risks. Looking through the short-term noise however, the combination of improving global growth and earnings helped by more fiscal stimulus, vaccines ultimately allowing a more sustained reopening and still-low interest rates augurs well for shares over the next 12 months.
Expect the rising trend in bond yields to resume as it becomes clear the global recovery is continuing, resulting in capital losses and poor returns from bonds over the next 12 months.
Unlisted commercial property may still see some weakness in retail and office returns, but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.
Australian home prices look likely to rise by around 20% this year before slowing to around 5% next year, being boosted by ultra-low mortgage rates, economic recovery and fear of missing out “FOMO”, but expect a progressive slowing in the pace of gains as poor affordability impacts, government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal levels. The lockdowns have increased short-term uncertainty though.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%. The setback from Delta coronavirus lockdowns could push the first rate-hike back into 2024.
Although the Australian dollar could pull back further in response to the latest coronavirus outbreaks, the threats posed to global and Australian growth and falling iron ore prices, a rising trend is likely to remain over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the Australian dollar up to around $US0.80 over the next 12 months (revised down from $US0.85).
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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