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Economics & Markets

Market Update 26 November

By Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia
Source: Bloomberg, FXStreet, AMP Capital
Source: Bloomberg, FXStreet, AMP Capital

Investment markets & key developments

Global share markets fell sharply over the last week with first inflation and interest rate concerns and rising new cases in Europe, and then news of a new worrying coronavirus variant that appears to have originated in South Africa really rattling investors resulting in sharp falls later in the week. Travel stocks were particularly hard hit as new travel bans were announced. For the week US shares fell 2.2%, Eurozone shares lost 5.2%, Japanese shares fell 3.3%, Chinese shares fell 0.6% and Australian shares lost 1.6%. After initially rising, bond yields fell sharply on the back of safe haven buying later in the week. While the iron ore price rose slightly over the week, oil and metal prices fell on growth concerns as did the Australian dollar.

New coronavirus variant posing a renewed threat to global growth – but too early to tell how significant it is. The new variant looks to have originated in South Africa, is technically called B.1.1.529 and has now been named Omicron by WHO which has labelled it a variant of concern. Its early days yet as we don’t know how significant the threat posed by it is. We know Omicron has more mutations than Delta (32 in the spike protein and 10 in the receptor binding domain compared to only two for Delta) and its likely more transmissible as its rapidly dominating new infections in South Africa. But it’s not clear yet that it results in more severe infections and by how much it will impact vaccine effectiveness against infection and importantly against serious illness. In theory vaccines may be able to be tweaked to combat it if necessary, although this takes time. And we have seen several variants of concern so far which have not proved to be as threatening as first feared. That said we just don’t know yet which is why shares and commodity prices sold off on Friday and the A$ fell. It may take a few weeks to get a clearer picture. So far the falls in markets just look like normal corrections in a bull market but of course much will depend on what we learn about the new virus and its impact in the next few weeks.

Inflation and central banks removing stimulus remains a key issue for markets. The past week saw solid business conditions PMI readings across major countries including Australia but continuing high or in some cases record high price pressures. Americans of course will be reminded of the spike in inflation by the most expensive Thanksgiving meals on record – not that that on its own tells us much as even in low inflation they went to new records most years, but they are up nearly 14% this year which is the highest increase since 1990. Against this backdrop both the RBNZ and the Bank of Korea raised rates for a second time with both hawkish and various Fed officials now appear to support a faster taper. It’s possible that the December Fed meeting could see the reduction in bond buying speed up to around US$25bn a month and this could clear the way for a rate hike mid next year. This is all covid permitting of course.

Aside from the threat posed by Omicron, the ongoing spike in inflation and several central banks turning more hawkish creates a tougher backdrop for share markets, but it’s not all bad news.

  • While inflation will likely get worse before it gets better signs of some easing in bottlenecks are continuing to appear with the Baltic Dry index (a guide to shipping costs) down more than 50% from its October high.
  • Even if the Fed does end bond buying before mid-next year and then starts raising rates monetary policy in the US will still be very easy through next year with tight monetary conditions unlikely until a few years away.
  • Not all central banks are so hawkish – while the minutes from the last ECB meeting had a bit of a hawkish tilt commentary from most ECB officials leans against rate hikes before late 2023 and the BoJ remains ultra-dovish.
  • This includes the RBA – while we think RBA rate hikes will start late next year money market expectations for three or four RBA rate hikes next year (compared to only two expected by the Fed) appear to reflect an irrational market hissy fit at the RBA’s abrupt ending of its 0.1% yield target rather than fundamentals (where price and wage inflation is roughly half that in the US and the household debt to income ratio is nearly double that in the US making Australian households far more sensitive to rate hikes).
  • While the rise in the US dollar index is a bit of a concern as its sometimes a sign of “risk off” it appears to reflect expectations for more aggressive tightening from the Fed than the ECB and BoJ rather than risk aversion with cyclical share market sectors performing well.
  • And of course, if the Omicron variant poses a big threat to the growth outlook, then the timing of central bank tightening, including by the Fed, will likely be pushed out. Global and Australian policy makers are likely to give priority to supporting growth as opposed to fighting inflation if we do see another wave of coronavirus driven lockdowns.

Powell nominated for another term at the Fed – more of the same. President Biden’s decision to nominate Powell for another term avoids the uncertainty that would have been associated with a difficult Senate approval for say Lael Brainard and the uncertainty that would have come with a new Chair. So more of the same at the Fed.

Meanwhile the US debt ceiling is approaching yet again. Technically it should be reached early in December but the US Treasury may be able to hang on into January. Resolution of the Build Back Better bill in the Senate – which is likely to be cut back to well below US$2 trillion under pressure from Joe Manchin will clear the way for an increase in the debt ceiling either as part of the same reconciliation bill or maybe as part of a separate deal with Republicans.

Germany’s new coalition Government means more Europe. While the Free Democrats will constrain the more left leaning policies of the Greens and Social Democrats – spending to speed up the move to a green economy and build more homes without hiking taxes on balance means easier policy and its even more pro Europe stance will furher help integrate Europe.

La Nina rules. The Southern Oscillation Index which tracks surface air pressure across the Pacific tipped into La Nina last year and remains there and that suggests ongoing cooler wetter conditions down the east coast. Which is precisely what we are seeing this month in Sydney! For Australia its usually positive for farm production (beyond the flood risk) and helping keep bushfires mild.

Source: ABS, Bureau of Meteorology, AMP Capital
Source: ABS, Bureau of Meteorology, AMP Capital

Taylor’s version of All Too Well surpasses American Pie as the longest song to reach No 1 on Billboard’s Hot 100. Since 1972, Don McLean’s American Pie had been the longest song (at 8.37 minutes) to make it to No 1 on the Hot 100 . But it’s now been surpassed by Taylor’s From The Vault 10.13 minute version of All Too Well. Its complicated a bit because Billboard combined the 5.29 minute version with the 10.13 minute version – but the long version does seem to be dominant. Of course, a purist might say the comparison is not entirely fair as today’s Hot 100 combines streaming with radio and sales data whereas back in the 1970s radio and suitability for radio dominated how long a song would be.

Coronavirus update

Global coronavirus cases are continuing to rise globally, but its noteworthy that deaths are so far more subdued.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

The surge is mainly being driven by Europe where new cases are at record levels - notably in Germany, Austria, the Netherlands, Denmark, Belgium and Finland but France, Italy, Spain and the UK have also started to pick up. The US is also starting to head higher as well.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

The surge in new cases reflects a combination of the earlier almost complete removal of restrictions, the onset of cold weather, stalling vaccination rates at or below 70% of the whole population, fading efficacy against new infection and a slow start to boosters. Israel in the September quarter and more recently Singapore have seen the same but managed to control it with booster shots and only some restrictions.

While the latest coronavirus wave poses a significant threat to the economic outlook the key remains whether vaccinations are successful in keeping hospitalisations down such that hospital systems can cope so hard long lockdowns can mostly be avoided. This also remains the key issue in relation to the new Omicron variant – but it’s too early to tell at present what impact it will have on vaccine effectiveness. So far hospitalisation and death rates in Europe remain subdued relative to the wave a year ago. But with big parts of the population still unvaccinated in Europe and the US there is still a risk that many could get sick at once overwhelming hospital systems. The only way to avoid that is to get vaccination rates to very high levels, quickly roll out booster shots to those whose last shot was 5 months or so ago and only remove restrictions gradually. Singapore is probably the best example of how to handle this – 92% of its population is fully vaccinated and booster shots are being rapidly rolled out and it’s seeing cases trend down again.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

68% of people in developed countries are fully vaccinated, 48% in emerging countries but its only 16% in poor countries. A key problem though is that some advanced countries (notably the US and Europe) have seen vaccination programs stall at low levels leaving them vulnerable to this latest wave as we are now seeing. An even bigger risk is that poor countries are lowly vaccinated which increases the risk of mutations that are more transmissible and deadly. Whether Omicron poses a major threat or not, its arrival highlights the high risk on this front. Only 24% of South Africans are fully vaccinated and vaccine suppliers had been asked to pull back on new deliveries due to reduced demand. The rest of Africa is only 7% vaccinated. It all highlights the need for the whole world to be vaccinated as fast as possible to head off mutations.

Source: ourworldindata.org, AMP Capital
Source: ourworldindata.org, AMP Capital

Australia at 72% fully vaccinated (and that’s before Queensland and WA have met their targets) is well above the developed country average. On current trends Australia will average 90% of the adult population fully vaccinated by mid-December and 80% of the whole population around mid-January. New coronavirus scares and the likely approval of vaccines for 5 to 11-year olds should take the percentage of the population fully vaccinated well beyond 80%.

Source: covid19data.com.au, AMP Capital
Source: covid19data.com.au, AMP Capital

A resurgence in new cases in Australia looks almost inevitable given the experience of Israel, the UK, the US, Europe, Singapore, etc. Australia’s relatively high vaccination rate have helped keep hospitalisation and deaths subdued relative to last years’ experience through the recent wave (see the next chart) and the fully vaccinated remain a very small share of new cases (just 8% in NSW). But as seen in Israel and Singapore if new cases rise too quickly it can still threaten to overwhelm hospital systems. So the key to minimise the risk of a surge in new cases necessitating new lockdowns is to get vaccination rates up to very high levels (90% plus), rapidly roll out booster shots to those whose last dose was 5 months or so ago and maintain social distancing requirements and aids such as QR check ins. The risk posed by new variants (as the new South African variant may demonstrate) suggests a strong case also to go very slowly and cautiously in reopening the international border.

Economic activity trackers
Our Australian Economic Activity Tracker rose again over the last week with broad based gains on the back of reopening and is now back at pre-Delta levels and well above that in Europe and the US. It’s an amazing turnaround from back in July when it was claimed that Australia was being left behind…but covid has a way of impacting different countries at different times. The Economic Activity Tracker points to points to a very strong rebound in Australian December quarter GDP, but its pace of improvement is likely to slow going forward. By contrast our European Economic Activity Tracker fell again in response to rising cases and restrictions in Europe and our US Tracker remains stalled.

Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debit card transactions, retail foot traffic, hotel bookings. Source: AMP Capital
Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debit card transactions, retail foot traffic, hotel bookings. Source: AMP Capital

Major global economic events and implications
Business conditions PMIs remained strong in November – down slightly in the US but still strong and up in Japan, Australia, the UK and surprisingly Europe. So global growth likely remains solid, although the latest covid wave in Europe and the US will act as a dampener.
 

Source: Bloomberg, AMP Capital
Source: Bloomberg, AMP Capital

The sting in the tail though is that price inflation readings are very high and still rising in many countries.

Source: Bloomberg, AMP Capital
Source: Bloomberg, AMP Capital

US economic activity data was mostly strong again. Consumer sentiment fell further but consumer spending surged in October, home sales rose, underlying durable goods orders continue to rise and jobless claims fell to their lowest since 1969. September quarter GDP growth was revised up slightly to 2.1% annualised but data so far suggests growth has accelerated to around 8% annualised this quarter. Inflation remains the main problem though with core private final consumption inflation rising again to 4.1%yoy.

Germany down, France up. While European PMIs rose, the German IFO business index fell reflecting rising coronavirus cases and restrictions but the French INSEE index rose.

Japan recovering again. The removal of covid restrictions saw Japan’s business conditions PMI rise solidly in November.

Policy easing bias more apparent in China – but it’s likely to be gradual. The PBOC’s latest monetary policy report was dovish suggesting more easing may be on the way and a State Council document pointed to more support for small and medium enterprises, but with the economy not in freefall and a reluctance to ease property tightening measures a significant easing still looks unlikely just yet.

Australian economic events and implications
Australian business investment hit by lockdowns but its old news now. Business investment fell 2.2% and construction fell 0.3% in the September quarter as lockdowns weighed. However, the impact on construction was less than expected with strength in other states offsetting weakness in NSW. More significantly this is rather dated given the reopening this quarter. In particular business investment plans for this financial year rose a solid 8.6% and now point to a 15 to 20% lift in business investment this financial year.

Retail sales and jobs up with reopening. Confirming the rebound in the economy following the east coast reopening retail sales surge a far stronger than expected 4.9% in October and payroll jobs recovered further in the last two weeks of October to be around where they were before Delta.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

What to watch over the next week?
In the US, the focus is likely to be on November jobs data (Friday) with payrolls expected to show a 500,000 gain and unemployment likely to fall to 4.5%. The participation rate will be key to watch to see if it finally starts to rise. Meanwhile November manufacturing and services ISMs (due Wednesday and Friday) are expected to be strong, pending home sales (Monday) are likely to rise as are home prices (Tuesday) but consumer confidence (also Tuesday) is likely to fall.

Eurozone inflation for November (Tuesday) is likely to show a further rise in core inflation to 2.2%yoy, unemployment for October (Thursday) is likely to edge down to 7.3% but November confidence readings (Monday) are likely to fall reflecting the latest covid wave.

Japanese industrial production data for October is expected to rise and jobs data also comes out Tuesday.
Chinese official business conditions PMIs for November (Tuesday) are expected to remain around 51 and the Caixin PMI (Wednesday and Friday) are expected to show a fall in the composite reading to around 51.

In Australia, September quarter GDP (Wednesday) is expected to show a 3%qoq decline resulting in annual growth falling back to 2.8%yoy reflecting the hit from the NSW, Victorian and ACT lockdowns to consumer spending which is likely to be down 7% and investment but with flat dwelling investment and a positive contribution from net exports. The good news is that this a smaller fall than we had been expecting and its old news anyway with economic activity having rebounded sharply since reopening. Meanwhile, October data for housing credit growth is likely pick up a bit further reflecting the past surge in finance approvals and building approvals are likely to be flat (both are due Tuesday), CoreLogic data for November is expected to show a further slowing in home price growth (Wednesday) but to a still strong 1.2%mom (led by very strong gains in Brisbane and Perth), the trade surplus for October will likely remain high given the lagged strength in energy prices and housing finance commitments are likely to rise 1% (with both due Thursday).

Outlook for investment markets
Shares remain vulnerable to further short-term weakness with possible triggers being the rebound in coronavirus cases globally and the new Omicron variant, the inflation scare, less dovish central banks, the US debt ceiling and the slowing Chinese economy. But we are now coming into a stronger period seasonally for shares and the combination of solid global growth and earnings, vaccines hopefully still allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months. However, continuing inflation and interest rate concerns will likely result in rougher and more constrained gains than what we’ve seen since March last year.

Expect the rising trend in bond yields to continue 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.

After rising by around 21% this year Australian home price gains are likely to slow to around 5% next year as poor affordability, rising fixed rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact. Ultimately giving way to a 5-10% price fall in 2023.

Cash and bank deposits are likely to provide poor returns, given the ultra-low cash rate of 0.1%.

Although the A$ could pull back further in response to the latest coronavirus threats, tightening US monetary policy and the weak iron ore price, a rising trend is likely over the next 12 months helped by still strong commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around US$0.80.

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Shane Oliver, Head of Investment Strategy & Chief Economist
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