Investment markets and key developments over the past week
Most major share markets fell sharply over the last week on concerns about a second wave of coronavirus cases in several US states and the pace of economic recovery after cautious US Federal Reserve (Fed) comments. This came after a huge rally since the March lows (US shares rising 44% and Australian shares rising 35%), which left shares appearing to be overbought and due for a pause or pullback. For the week, US shares fell 4.8%, eurozone shares declined 6.4% and Japanese shares lost 2.4%, but Chinese shares were close to flat. Reflecting the weak global lead, Australian shares fell sharply on Thursday and Friday resulting in a loss of 2.5% for the week, with falls in energy, property and financial shares leading the way down with defensives like utilities, consumer staples and health shares holding up better. The return to “risk off” also saw bond yields fall back sharply. Commodity prices were mixed, with oil down but metals and the iron ore price up. The Australian dollar fell, consistent with the return of investor risk aversion.
While worries about the coronavirus perked up again over the last week, there has been little change to the broad trends in terms of cases. New cases continue to trace out an uptrend.
New cases are trending down in developed countries, albeit more slowly over the last month, but the trend remains up in emerging countries, notably Brazil, India, Pakistan, Mexico, Saudi Arabia, Bangladesh & Indonesia.
But what about the risk of a “second wave”? While the big picture trends have not changed, concern about the coronavirus came back into focus over the last week, with US infectious disease expert Anthony Fauci warning it’s not over and that we are going to need billions of vaccine doses globally, and talk of a “second wave” of cases in US states following reopening. Mass anti-racist protests have probably added to the renewed unease. The US is at greater risk than most other developed countries of a second wave because reopening started before a sharp downtrend in new cases and many US states moved ahead of the US Government’s own medical guidelines to reopening, egged on by President Trump. Around 20 states are seeing an increase in new cases (with about half just seeing a continuation of the initial rising trend and the rest seeing “second waves”). A renewed broad-based intensification of shutdowns would be a big concern. However, there are several points to note. First, the total number of new US cases on a daily basis has been fluctuating in a range around 20,000 to 25,000 for a month now, with some states seeing falls and others rises – so there is nothing really new here. (See the next chart). Second, a renewed official shutdown may not occur, as many are suffering quarantine fatigue (although the Swedish experience would suggest many people will behave as if there is one anyway). Third, the US may have learned to trace and quarantine better and to better isolate those most at risk of dying from a second wave while enabling the economy to remain open (although I am a bit sceptical of that). The bottom line is that it’s a risk we will have to keep an eye on.
Fortunately, other developed countries have proceeded more carefully in reopening than many US states, waiting until there was a bigger decline in new cases. This includes countries in Europe, Japan and of course New Zealand (which now has no cases and has removed its lockdown, although international travel restrictions still apply) and Australia. Australia is continuing to see few new cases.
Headlines continue to focus on the huge hit to economic activity this year from the coronavirus shutdown, with both the World Bank and OECD following the International Monetary Fund (IMF) two months ago in forecasting the worst global recession since the 1930s and the US National Bureau of Economic Research (NBER) declaring that the US entered recession in February. As with the revelation a week ago that Australia has probably entered recession, this is all old news and not really surprising given the hit to economic activity that follows from telling people to stay at home and the associated uncertainty. It was anticipated by investment markets back in February and March; and by the time the US NBER declares recessions they are often over. As we have been noting for several weeks now, more timely high frequency data continues to indicate that economic activity is picking up after the easing of shutdowns. This is confirmed by our weekly economic activity trackers for the US and Australia based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, hotel bookings, credit card data, mobility indexes & jobs data which hit bottom in mid-April. The Australian Economic Activity Tracker has now risen for eight weeks in a row. My experience over the long weekend highlighted how things have returned to normal with traffic jams going to and getting back from our brief getaway, restaurants and cafes filled to their distancing limited capacity and crowds of people in shops and on walking tracks.
It seems the OECD agrees with our assessment the Australian economy will come through this period better than many countries. There are three reasons (see The Lucky Country) why Australia should perform better: it has seen better virus control; it has seen a stronger government support response; and our key trading partner is recovering ahead of the rest of the world benefitting key exports like iron ore.
Our updated ranking of OECD countries in terms of controlling coronavirus – based on new cases, deaths, total cases and tests per capita – shows Australia and New Zealand at the top and the US and UK towards the bottom. (See the next table.) This provides greater confidence in Australia’s ability to reopen with minimal risk of a second wave. Unlike the US, which some may fear has taken The Pet Shop Boys “Let's Give Stupidity a Chance” seriously.
Ranking of OECD countries in “controlling” coronavirus
On the fiscal stimulus front, Australia’s stimulus (at nearly 8% of GDP), while down from 11% prior to the realisation that JobKeeper will cost less because the economy is stronger, is stronger than most countries’ and better-targeted, as evidenced by a lower measured unemployment rate. I also agree that now that the economy is reopening and recovering faster than envisaged back in March it makes sense to reduce support for those that no longer need it (and where it may be acting as a disincentive to return to work) and reallocate it to parts of the economy that will need it for longer (such as the extension to the instant asset write off, and assistance for industries like the arts, tourism, travel and higher education). The A$60 billion JobKeeper saving helps provide flexibility to do this.
While Australia’s trade tensions with China continued over the last week - with China’s cautioning of tourists and students about coming to Australia posing a longer term risk to the relationship if the issue is not sorted; though it’s academic in the short term, given the travel ban (although that may change for students next month) and Australia is seeing the benefit of China’s recovery in strong export volumes of raw materials and the very high iron ore price. The latter helps drive stronger returns for shareholders in the big miners and helps tax revenue in Canberra.
Meanwhile, on the government stimulus front globally:
- France announced a third round of fiscal stimulus of around 2.1% of GDP, coming on top of recent additional stimulus announcements from Germany and the European Commission.
- The US still looks to be heading towards another $US1 trillion in extra stimulus.
- The Fed, following its latest meeting, backed up its concern about the outlook by remaining very dovish, with Chairperson Powell saying that the Fed “is not even thinking about raising rates”, 13 of 15 Fed meeting participants seeing rates staying at 0 to 0.25% out to 2022, Quantitative Easing (QE) to continue at the pace of $US120 billion a month and Powell effectively reiterating that the Fed will do whatever it takes until it’s confident the US is on the road to recovery.
After a huge rebound in share markets since March, which left them technically very overbought and a bit too far ahead of the economic recovery, they were vulnerable to a pullback like we saw in the last week. However, if April proves to be the low point in economic activity, as we expect then given the massive government policy stimulus seen since March along with ultra-easy monetary policy shares, should be higher on a 6 to 12-month outlook.
The three big risks remain: a second wave of Coronavirus cases (which is a big risk in the US as noted earlier); collateral damage from the shutdowns resulting in a delayed or very slow recovery as bankruptcies surge and unemployment goes higher; and a serious escalation in US/China tensions.
The latter flows from broader risks associated with the approaching US presidential election. Polls now give Biden an 8 percentage point lead over Trump and Trump’s approval rating has continued to slide to 42%. There are still five months to go, but past Presidents seeking re-election started to see an upswing in approval from here. If Trump’s prospects continue to deteriorate, then the risk may rise that he will seriously ramp up tensions with China, in a way that threatens the economic outlook on the grounds that he will have nothing to lose and can take a punt on trying to rally American’s around the flag. Investors may also start to fear higher taxes and more regulation under a Democrat victory across the Presidency, House and Senate (although I suspect that the return to more reasoned policy making under a different president may be positive for shares).
Major global economic events and implications
US data showed sharp falls in job openings and hiring in April, but a rise in small business optimism for May, confirming what we all know now - that April was horrible, but May started to see recovery. Jobless claims continued to fall. Consumer Price Index (CPI) Inflation fell more than expected, to 0.3% year-on-year in May, with core inflation of just 1.2% year-on-year.
German industrial production fell 17.9% in April, but various eurozone sentiment readings point to an upswing in May.
Japanese wages fell in April, but the Economy Watchers household and business conditions indexes for May turned up.
Chinese exports and imports fell in May, but credit growth continued to accelerate, consistent with policy easing.
Australian economic events and implications
Australian housing finance fell sharply in April and new home sales fell in May as the coronavirus hit to the economy started to hit the housing market. Consumer and business confidence however rebounded sharply, consistent with the reopening of the economy and the message from other, more-timely confidence readings. So far, the rebound looks like a deep-V shape, but confidence levels are still well below normal and I suspect their recovery may be a bit slower going forward.
What to watch over the next week?
Trends in new coronavirus cases will continue to be watched closely, particularly in several US states which are seeing rising trends.
In the US, expect data to confirm the start of a recovery in economic activity. May retail sales are expected to show an 8% rebound, industrial production is expected to rise 3% and the June NAHB home builder index is expected to show another rise (all Tuesday) and May housing starts are expected to gain 24% (Wednesday). New York and Philadelphia regional manufacturing conditions surveys for June are expected to show a further recovery.
The Bank of Japan is expected to maintain ultra-easy monetary policy on Wednesday. Japanese inflation data for May (Friday) is expected to show core inflation remaining very low, but rising slightly to 0.4% year on year.
The Bank of England (Thursday) is also expected to remain on hold.
Chinese data for May is likely to show a further improvement in economic activity, with a rise in industrial production to 5% (from 3.9% year-on-year in April), a pick up in retail sales growth to -2% year-on-year (from -7.5%) and a pick-up in fixed asset investment to -6% year-on-year (from -10.3%).
In Australia, the big focus is likely to be on May labour market data (Thursday), where we expect employment to be down another 70,000 and unemployment to rise to 7%... but to be honest, which way this one goes is anyone’s guess – Reopening points to some improvement in employment, but it only got underway late in the survey period, which was the first half of May. The ABS Household Impacts of Covid survey points to a further fall in employment into mid-May, but it’s not clear how this interacts with JobSeeker and JobKeeper in relation to measured employment and unemployment… and Of course, US and Canadian employment surprisingly rose in May. Meanwhile the latest ABS Household Impacts of Covid survey (Monday) and Weekly Payroll Jobs and Wages (Tuesday) are likely to show some pick up in employment reflecting the easing of lockdown measures. Retail sales data for May (Friday) are expected to show an 8% rebound after the 17.7% fall in April. ABS March quarter home price data (Tuesday) is likely to confirm the 2-3% or so rise in dwelling prices already reported in the March quarter by private surveys, but this is very dated. The minutes from the last Reserve Bank of Australia (RBA) meeting (Tuesday) will likely confirm that the RBA remains very dovish despite an earlier than expected reopening and pick up in the economy.
Outlook for investment markets
After a strong rally from March lows, shares are vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery and US/China tensions. But on a 6 to 12-month horizon shares are expected to see good total returns, helped by a pick-up in economic activity and massive policy stimulus.
Low starting-point yields are likely to result in low returns from bonds once the dust settles from coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from a resumption of the search for yield, but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.
The Australian housing market has slowed in response to Coronavirus. Social distancing has driven a collapse in sales volumes, home prices are starting to fall and a sharp fall in employment, a stop to immigration and rent holidays pose a major threat to property prices into next year. While government policies to support jobs and incomes (and the bank payment holiday out to September has headed off the risk of a 20% plus fall in prices), they are still expected to fall by around 5 to 10% into next year.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
Although the Australian dollar is vulnerable to bouts of uncertainty about the global recovery and US/China tensions, a continuing rising trend is likely if, as we expect, the threat from Coronavirus continues to recede - particularly with the US expanding its money supply far more than Australia is (via quantitative easing) and with China’s earlier recovery likely to boost demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economics and Chief Economist
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