Investment markets and key developments over the past week
Share markets had a bit of a rough ride over the last week, with inflation fears continuing to impact along with taper talk in the US and maybe some impact from the fall in crypto currencies, forcing some crypto speculators to sell shares to help cover margin calls on their losses. This left US shares down 0.4% for the week, while Eurozone shares still gained 0.3%, Japanese shares rose 0.8% and Chinese shares gained 0.5%. Australian shares were hit hard early in the week by inflation fears and concerns about China diversifying its iron ore supply away from Australia (which is not likely in the short term as there is not much spare capacity outside of Australia, with Australia accounting for 50% of global iron ore exports), but managed to claw back, resulting in a 0.2% rise for the week. Strong gains came from information technology, health and retail shares and were partly offset by weakness in utilities, materials and energy shares. Bond yields actually fell, while commodity prices were soft, with metal and iron ore prices down, as well as oil prices, on reports of progress in US/Iranian talks to return to the nuclear deal and end sanctions on Iran. The A$ meanwhile fell despite a further fall in the US$.
The current inflation scare continued to worry investors over the last week and likely has further to go yet. Our view remains though that the spike in inflation is largely transitory and reflects distortions caused by the pandemic and reopening, which should fade as global production returns to normal and consumer demand shifts back to services from goods. There are signs that some commodity prices may be starting to roll over (with lumber down) or slow and semiconductor chip prices may also be starting to fall. As such, central banks are unlikely to rush in with an early and debilitating monetary tightening that brings an end to the bull market in shares. Thanks to ongoing easy monetary policy and rising earnings, we continue to see share markets being higher by year end. However, the inflation scare is likely to linger for a while yet, as the earlier surge in commodity prices and bottlenecks continues to feed through, which is likely to push bond yields higher and risk a further correction in shares in the next few months.
Us Federal Reserve (Fed) edging towards taper talk, but a long way from rate hikes. The message from Fed speakers and the minutes from its last meeting is that it’s cautiously optimistic, but that it will be some time until “substantial further progress” has been made towards its goals; though as the economy recovers, a discussion about tapering its bond buying is getting closer. This is as it should be – We expect Fed discussion about tapering to get underway in the next three months, with tapering starting around year end. However, it should be noted that tapering is just reducing the amount of bond buying and is not monetary tightening. The US share market rose through the 2014 taper and rate hikes are still a long way off – last decade, it took two years from the start of tapering in December 2013 to the first rate-hike in December 2015.
The minutes from the Reserve Bank of Australia’s (RBA) last meeting offered little that was new – but its approach looks similar to the Fed’s. We expect the stronger than expected recovery to see the RBA announce in July that it will stick with the April 2024 bond for its three-year bond yield target and that it will taper its weekly bond buying from $5bn to $2.5bn in September, when the current bond buying program ends. However, the RBA wants to see wages growth “sustainably above 3%” in order to be confident of sustainably achieving the 2 to 3% inflation target. Unemployment and underemployment are falling faster than expected, but at 5.5% and 7.8% respectively, we are likely a long way from full employment, which is likely to be nearer to 4% and 6% respectively. Therefore, sustained 3% plus wages growth is likely still several years away. Ergo it follows that so too is the first rate-hike – We expect this to come in 2023, which is a bit earlier than the RBA’s “2024 at the earliest” message.
Meanwhile, fixed mortgage rates are continuing to edge up in Australia, reflecting the rise in bond yields and hence longer-term funding costs, particularly as the RBA’s Term Funding Facility comes to an end next month. So far, the moves are only small, but with 40% of new housing loans being fixed rate over the last year or so, this will act as a bit of a dampener on house price growth, which we expect to gradually slow over the next year.
Sticking to Australia – just as it was surprising to some to see the Federal Coalition Government deliver another stimulatory Budget with no budget repair in sight, it was also surprising to see Victoria’s Labor Government deliver a budget with $15bn of budget repair. There were some winners, but the danger is that the tax hikes and public sector cost-savings will weigh on the recovery at a time when Victoria has been harder hit by the pandemic than other states. The various tax increases risk further distorting the tax system and the property tax increases risk adversely affecting affordability (particularly as those buying $2 million plus properties are forced into slightly cheaper property, having a cascade effect down through the market) and the windfall property developer tax risks adversely affecting property supply.
Bitcoin rollercoaster. The wild slide in Bitcoin and other cryptocurrencies over the past week or two reminds us of three key things. First, - while it beats me as to why Elon Musk just discovered this – it uses a massive amount of electricity, so is far from environmentally friendly. The claim by some that because it uses so much electricity it will incentivise investment in solar and other sustainables is an environmental nonsense akin to saying that the path to sustainable power is to all use more energy! Second, cryptos face massive threats from governments not wanting to give up the revenue they get from issuing their currencies – as the PBOC highlighted by reiterating that digital tokens cannot be used as a form of payment in China. Third, they are highly speculative, as indicated by their sensitivity to tweets from digital gurus and “influencers”. They may be great for a bit of noisy volatility and excitement, but that’s not the same as investing. To adjust Paul Samuelson’s comment “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800...” and put it in Bitcoin. Interestingly while Bitcoin has been sliding, gold has been trending up again.
The crypto slide may be having a negative impact on share markets in the short term (as crypto speculators sell shares to cover their crypto losses) but it looks marginal, with Bitcoin having had a 50% fall since mid-April, but shares remaining near record highs. The crypto plunge is unlikely to have much impact on broader economic conditions, as most have no exposure to crypto currencies and any negative wealth-effect will be swamped by ongoing stimulus. The banking system also has little exposure to them.
The Bee Gees are maybe best known for disco and Barry Gibb’s falsetto. But they had many iterations and in their Beatlesque 1960s period, Robin Gibb’s beautiful vocals on I Started A Joke would rank amongst my Bee Gees favourites. As with Elvis’ Always On My Mind, The Pet Shop Boy’s recorded a brilliant cover of I Started A Joke as a tribute to Robin a few years ago.
New global coronavirus cases and deaths have slowed further, with developing countries figures in a downtrend and emerging countries’ starting to slow, as India slows. This of course masks various countries which are seeing renewed upswings including South Africa, Malaysia, Vietnam and Taiwan. Singapore meanwhile has tightened restrictions, providing a reminder of the dangers of reopening too fast before herd immunity is reached.
Despite ongoing scares in relation to outbreaks from the hotel quarantine system for returned travellers, new cases remain very low in Australia.
10% of the global population has now received at least one dose of vaccine, with 7% in emerging countries and 35% in developed countries. Within developed countries, the UK is at 56%, the US is at 48%, Europe is at 35% and Australia is at 14%. As of 16 May, 7.6 million doses of vaccine had been delivered in Australia, but so far only 3.5 million doses have been administered, although this appears to be slowly speeding up. The success of the vaccines is indicated in Israel, where new cases and deaths have fallen to around zero. New cases, deaths and hospitalisations have also collapsed in the UK and the US. A key risk remains of further coronavirus breakouts (eg, of the more virulent Indian variant) if reopening proceeds too quickly before herd immunity is reached (e.g., as seen in Singapore, where around 35% of the population have had one dose). Another risk that remains is hesitancy to getting a vaccine before herd immunity is reached – this is evident in the US, where take up is slowing and in Australia, where one survey showed 29% if people saying they are unlikely or very unlikely to get vaccinated. This can be addressed by better information on the benefits of vaccination (the carrot) and “vaccine passports” (the stick), under which vaccinated people are allowed to travel and avoid lockdowns and other restrictions. This is being considered in Australia and the European Union (EU) is planning to let in travellers who are vaccinated.
Our Australian Economic Activity Tracker rose over the last week and remains very strong indicating that recovery remains on track. Our US and European Economic Activity Trackers also rose with our US Tracker almost back to pre-coronavirus levels but our European Tracker still well down.
Major global economic events and implications
US data was a mixed bag. Housing starts fell more than expected in April, but this may just reflect monthly volatility after a huge rise in March and home builder conditions and permits point up. Existing home sales also fell in April. Meanwhile, the Markit business conditions PMIs rose even further in May and manufacturing conditions for the New York and Philadelphia regions fell, but remain very strong. All showed a further rise in price pressures. Jobless claims also fell sharply.
US March quarter earnings reports are now 95% done. Earnings growth for the year to the March quarter is now +49.7% year-on-year (yoy), up from expectations of +23% at start of April. 87% of companies have beaten on earnings, 71% on sales. Consensus earnings growth expectations for 2021 are now at +33% (from 21% at start of the year), led by cyclicals and financials.
Eurozone and UK business conditions PMIs also rose further in May.
Japanese March quarter GDP fell back by -1.3%, reflecting the latest COVID state of emergency. Expect a rebound mainly in the second half. Japan’s composite business conditions PMI for May fell back to 48.1, not helped by the latest state of emergency. CPI inflation fell back to -0.4%yoy in May and core inflation fell back to -0.2%yoy…no inflation scare here!
Chinese economic activity data for April was mixed, with unemployment lower than expected and solid house price growth, growth in industrial production and investment in line with expectations, but retail sales growth slower than expected. The mixed data, along with slowing credit growth, may reflect policy normalisation and should keep any further tightening cautious.
While Japan’s PMIs fell in May, the further rise in the US, European and the UK PMIs points to a further rise in global PMIs when full results are released in a week or so. The downside is that input and output price pressures continue to build, consistent with the inflation scare continuing for a while, but the ratio of new orders to inventories may be starting to roll over, which is a possible sign of easing price pressures ahead as inventories catch up with demand.
Australian economic events and implications
Australian data looked a bit confusing over the last week – but it was mostly strong beneath the surface. Despite a favourable reaction to the Budget, the Westpac/MI measure of consumer confidence fell in May, though remains at its second strongest level since 2010. Meanwhile, retail sales were up more than expected in April and look on track to see a solid rise this quarter. That said, they remain far above their long-term trend and are likely to gradually move back in line with this, as spending rotates back to services amid reopening.
Employment fell by nearly 31,000 in April, which was weaker than expected. This however suggests that there has been a minimal loss of jobs from the ending of JobKeeper. In fact, the fall-back likely just reflects normal monthly volatility after several far stronger than expected months and a seasonal distortion due to Easter. What’s more, full time employment rose and unemployment fell, which is often a better guide to the state of the jobs market than monthly swings in employment. Further, our Jobs Leading Indicator points to a resumption of strong jobs growth ahead. Unemployment is on track to fall to 5%, or maybe just below, by year end. Consistent with this, while Australia’s composite business conditions PMI fell slightly in May, it remains very strong at 58.1 (see chart above), with the employment component rising to its highest on record.
The continuing fall in unemployment & underemployment to 5.5% and 7.8% respectively is good news. However, we likely still have a fair way to go to get to full employment, let alone wages growth sustainably greater than 3%, which was the norm up until 2013. As the next chart suggests (and the RBA has stated), is necessary for inflation to be sustained in the 2 to 3% target range. While wages growth was stronger than expected at 0.6% quarter-on-quarter (qoq) in the March quarter, this was exaggerated by the phased increase in the minimum wage and by a return to pre coronavirus wages for those who saw pay-cuts last year.
What to watch over the next week?
In the US, expect a continuing solid rise in home prices, but slight falls in consumer confidence and new home sales (all due Tuesday), continued strength in durable goods orders and pending home sales (Thursday), a fall back in April personal income (after stimulus checks boosted March data) and a modest gain in personal spending (both Friday) driven by services. Based on the stronger than expected CPI, the core personal consumption deflator for April (Friday) is expected to show a 0.8% month-on-month (mom) gain or 3%yoy.
Various business surveys for May will be released in Europe, including the German IFO and French INSEE, along with Eurozone confidence data on Friday.
Japanese jobs data for April will be released Friday.
In Australia, expect a 4% gain in March quarter construction (Wednesday) and 3% rise in new capital spending (Thursday), along with a further lift in business investment intentions as indicated by various business surveys. Weekly payrolls and preliminary trade data will also be released Tuesday.
Outlook for investment markets
Shares remain at risk of a short-term correction, with possible triggers being the inflation scare, US taper talk and 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 and earnings helped by more stimulus, vaccines and still-low interest rates augurs well for 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 is 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 ultra-low mortgage rates, economic recovery and fear of missing out (‘FOMO’), but expect a progressive 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.
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 mo¬¬¬¬nths, helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around $US0.85 by year-end.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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