Perhaps one of the biggest questions about the economic recovery in Australia is whether too rapid a reopening in NSW and Victoria will lead to a resurgence in cases, triggering a return to some restrictions?
If it does, what does that mean for the economy? And what about the share market?
As we head towards a more open economy, the outlook is positive, though perhaps not as upbeat as last time the states of NSW and Victoria came out of lockdown, as that was against a backdrop of near covid zero.
It’s almost certain that the economy will expand this quarter after what we estimate to have been a minus four per cent hit during the September quarter - recession averted.
However, given the high number of coronavirus cases present in the community, there could well be a degree of consumer and business caution in the coming months.
The risk of setbacks, and the fact that only the vaccinated can initially participate in the reopening of the economy, means the recovery might initially be more gradual than was the case after last year’s lockdowns. At least until we learn to live with covid.
The main risk in Australia is that too rapid a reopening in NSW and/or Victoria leads to a resurgence in cases. It happened in Singapore where new cases are running around 3000 a day.
Too high a number could overwhelm the hospital system, necessitating some reversal in reopening to slow new cases, which is what Singapore has done.
That would provide a speed bump for the economy and any reversal in reopening could set back the recovery.
This could particularly be a risk in the months ahead if vaccine efficacy for those vaccinated earlier this year starts to wear off.
A fall in the time gap between vaccine doses in Australia also runs the risk of them being less effective.
A less risky approach is rather than just tying reopening steps to vaccine levels, allow three weeks or so between each reopening stage in order to ensure that new cases, and most importantly hospitalisations, are not surging and overwhelming the hospital system.
However, at present this is all just a risk.
The good news is that vaccinations are continuing to help keep serious illness down. Coronavirus case data for NSW shows that the fully vaccinated continue to make up a low proportion of cases, hospitalisations, and deaths.
Assuming the reopening in NSW, the ACT and Victoria is handled well, we should see clear evidence of recovery in the months ahead.
The Australian Bureau of Statistics (ABS) labour force figures for September showed another 138,000 job losses, reflecting the lockdowns on the east coast.
From its June pre-lockdown high, employment has fallen by 330,000 but thanks to a plunge in participation the workforce has fallen by 281,000. That’s has delivered an unemployment rate of 4.6 per cent1, down from 4.9 per cent2.
But if you allow for those working zero hours and the decline in participation, the “effective unemployment” rate has risen to around 7.6 per cent.
The good news is that with NSW and Victoria reopening, employment is likely to start recovering although the ABS jobs survey may not pick this up till November.
The relative resilience in job vacancies through these lockdowns compared to last year is a positive sign for the labour market. But with reopening, labour force participation will rebound probably back to where it was in June and the unemployment rate will move up to around 5 per cent by the year end, before it resumes its downtrend through next year.
Confidence readings in the economy have been mixed recently. Business confidence is up according to the National Australia Bank survey. Consumer confidence is up according to the ANZ/Roy Morgan survey but down according to the Westpac/Melbourne Institute survey.
The key fact is that all readings are around reasonable levels and well above last year’s lows which bodes well for recovery.
What does the macro-economic outlook mean for investment markets?
There is still a risk of a correction in the equity market, but cyclical indicators are positive, and US shares have been breaking through technical barriers.
There’s plenty for equities to contend with and shares remain vulnerable to short-term volatility. Possible triggers include the coronavirus, global supply constraints and the inflation scare, less dovish central banks, the US debt ceiling debate (which will return in a few months) and spending and tax plans, and the slowing Chinese economy.
But we remain of the view that the issues will largely be resolved in a way that does not severely threaten global growth. A US default is most unlikely. China won’t bail out Evergrande but will restructure it to limit damage to the rest of the economy and will provide economic stimulus.
Supply constraints will ultimately be resolved as the pandemic recedes, workers return, and spending rotates back to services from goods.
Looking through the short-term noise, the combination of improving global growth and earnings, 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 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 demonstrate some weakness in retail and office returns but industrial is likely to be strong.
Unlisted infrastructure should provide solid returns.
Australian home prices look likely to rise by around 21 per cent this year before slowing to around 7 per cent next year. Price rises are still being encouraged by ultra-low mortgage rates, the economic recovery and fears of missing out.
But house prices won’t grow as fast as they have been. There’s plenty of reasons for that - poor affordability is kicking in, government home buyer incentives will be cut back, listings will return to more normal levels, fixed mortgage rates will rise, macro prudential tightening will slow lending and immigration remains down relative to normal.
Cash and bank deposits are likely to provide poor returns, given the ultra-low cash rate of 0.1 per cent.
The Australian dollar could pull back further in response to the latest threats to global and Australian growth and weak iron ore prices. But a rising trend is likely over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the local unit up to around $US0.80.
The signs are positive for the economy and investment markets. But just like we’ve been saying for 20 months, so much of the outlook depends on what happens with the coronavirus.
Subscribe to SMSF using the form below to receive all of my articlesShane Oliver, Head of Investment Strategy & Chief Economist
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