Market Update 6 November 2020

Investment markets and key developments over the past week

Global share markets rebounded over the last week as a resolution of the US election came into sight offering more fiscal stimulus, less trade wars and likely avoiding US tax hikes. For the week, US shares rose 7.3%, eurozone shares gained 7.5%, Japanese shares rose 5.9% and Chinese shares rose 4.1%. While the rebound in shares may be surprising given that the election is not fully resolved yet, US shares typically rally after close elections and as we move into the stronger seasonal months for share market performance of November, December and January. Reflecting the rebound in global shares and further Reserve Bank of Australia (RBA) easing, Australian shares surged 4.4% higher over the week, led by property, retail, industrial, information technology and telecommunications stocks, but with all sectors seeing strong gains. Bond yields generally fell, helped along in the UK and Australia by more monetary easing. However, consistent with the rally in shares, oil, metal and gold prices rose (with only iron ore falling) and the US$ dollar fell sharply, which pushed the A$ up. Were it not for the announcement of a formal quantitative easing (QE) program in Australia, the A$ would probably have risen to around $US0.74.

The surge in new global coronavirus cases continued over the last week, being led by developed countries, notably Europe and the US. Developed countries are now seeing a million new cases every four days.

Reflecting more tests, better treatments and better protections for old people, new deaths in developed countries remain well down from the levels of April, which in turn is helping avoid a return to lockdowns as harsh as those seen earlier this year. However, deaths are rising rapidly in Europe, as are hospitalisations, which is threatening to overwhelm the health system in some countries and as a result, more countries including the UK have joined France and Germany in returning to lockdowns, albeit in most cases they are not yet as severe as those seen earlier this year.

After a much stronger than expected rebound in the September quarter of 12.7%, we now expect Eurozone GDP to contract by 4% this quarter and we are assuming that US GDP will be flat, as rising coronavirus cases drive more distancing by people in the US.

Likely reflecting the continuing rise in US cases, our US Economic Activity Tracker dipped slightly over the last week and has now been flat since early September, suggesting the US recovery has stalled again. Restaurant and hotel bookings look to be winding back down again. This is yet to show up in most conventional economic data, but it comes out with a lag.

Australia is continuing to see new coronavirus cases stay very low, with few cases of community transmission, while deaths have collapsed. Our Australian Economic Activity Tracker rose over the last week and is trending up nicely, helped by Victoria’s reopening, consistent with an ongoing recovery.

Biden on track to win the US presidential election. The US election added to the long list of weird things this year, with President Trump doing far better than would have been suggested by the worst US economic downturn since the 1930s, high unemployment, the worst race riots since 1968 and the mishandling of the coronavirus pandemic that led to over 230,000 American deaths. That said, while counting is continuing in key states, Biden is ahead and Associated Press and major US TV networks have called the result in Biden’s favour. He has claimed victory, as it looks highly likely he will reach the 270 electoral college votes needed to win and possibly 306 if he wins all of Arizona, Nevada, Georgia and Pennsylvania. Final resolution could be further delayed towards the deadline of the 14th December Electoral College vote due to recounts and various legal challenges, but it’s looking increasingly doubtful that these will change the outcome, given how far Biden is ahead in key states. Seeing Trump supporters chanting “stop the vote” in Michigan (where Trump was falling behind) but “count the vote” in Arizona (where he is narrowing Biden’s lead) is just hilarious. Postal votes are a normal part of elections in the US (and Australia) and often delay final results in close races, so what’s the problem?... Unless of course they are going against you and you are someone who once said “I will totally accept the results of this great and historic Presidential Election, if I win”. Joe Biden has received a record 75.2 million votes (and still counting), which is over 4 million more than Trump.

With possible run-offs for both Senate seats in Georgia in early January, there is also the possibility that the Democrats ultimately achieve a “clean sweep”, having retained control of the House if they win both seats in Georgia, given that this would take them to 50 Senate seats plus one vote from the Vice President (Harris) in the event of ties. The likelihood of the Democrats winning both Senate seats in Georgia is low though, given Georgia is traditionally Republican and the Republican vote in both Senate races was above the Democrat vote.

Overall, there are three ways this could all go:

1. The return of Trump. This is now looking highly unlikely, but if it did occur, taxes and regulation will remain low but agreement is likely to be relatively quickly reached on fiscal stimulus (with Democrats likely to get what they can to help their constituents) all of which may provide a short term knee jerk boost to US shares, but trade wars with China and possibly Europe and Japan will likely ramp up again next year, which would be relatively bad for global shares and good for the US$. Therefore, this scenario would likely be a negative for the Australian share market and the A$, particularly as it could contribute to a further ramping up in tensions between Australian and China (which, as we have seen in the past week, are still on the rise).
2. Biden wins, but without getting control of the Senate. This is now the highly likely outcome. A Biden presidency with a Grand Old Party (GOP) senate is probably the best outcome for global and Australian shares, as it means no US tax hikes, some fiscal stimulus (but not over the top), less in the way of trade wars and a whole bunch of positive “soft things”, like less divisiveness in the US, increased presidential support for the rule of law, the US engaging better with allies, support for global institutions, etc. Historically, a Democrat president and divided government has been the best outcome for US shares. Australia would benefit from less tension with China and a focus on a diplomatic approach to resolving trade tensions.
3. Biden wins and gets control of the Senate via Georgia and the casting vote of the Vice President. Senate control via Georgia is possible but unlikely, but if it did happen this would clear the way for significantly more US fiscal stimulus, but higher corporate tax in the US and more regulation. Global shares would likely benefit more than US shares and the US$ would likely fall. Historically, this has been the second-best outcome for share markets. It would probably be the best outcome for Australian shares and the A$, as Australia would benefit from more US stimulus, our companies would be relatively more attractive (due to a higher tax rate in the US) and we would likely see less tensions with China.

In Australia, the RBA announced a broad based package of additional monetary stimulus, involving a rate cut to 0.1%, an additional $100bn bond buying program over six months and a formalised commitment not to raise rates until actual inflation is sustainably in the 2 to 3% target range. While the RBA revised up its GDP growth forecasts to 6% for the year to June 2021 (from 4%), it still doesn’t expect to meet its employment and inflation objectives over the next two years, which explains the additional easing and indicates that the RBA may yet do more. With the RBA still seeing negative rates as being “extraordinarily unlikely”, a further reduction in interest rates is not being contemplated, so any further easing will likely take the form of an extension of the bond buying program. We think that more QE is ultimately likely, but not for another six months. The latest round of easing should help the recovery by further lowering borrowing costs, encouraging investors to take on more risk and keeping the A$ lower than it otherwise would be. While the major banks left their standard variable rates on hold at around 4.5%, they cut their fixed rates (in some cases to below 2%) and I reckon if anyone wants a rate cut and they phone their bank and ask, they will most likely get it. A big risk of course is that it all contributes to a renewed surge in house prices and debt, leading to financial instability problems down the track.

Meanwhile, trade tensions between China and Australia appeared to ramp up another notch in the last week, with reports of bans on imports of wine, wheat, sugar, lobsters, copper, etc from Australia. This came on the back of recent reports about bans on imports of Australian coal. Some of these exports can be diverted to other countries, but that takes time. The value of the latest bans is around $6bn annually, which is only 0.3% of GDP, but if it continues to escalate it will start to have an economic impact on Australia. Hopefully a more diplomatic approach to resolving trade issues with China by the US under a Biden presidency will open the door to Australia and China resolving their issues.

Well that’s it for another year of The Bachelor and Bachelorette! So it’s back to YouTube for me – so here’s one of my favourite Beatle/George Harrison songs - While My Guitar Gently Weeps - with Ringo on drums. The thing that strikes me about this version is how strong George’s voice became as he got older compared to his Beatle/early 1970s years.

Major global economic events and implications

In the US, the US Federal Reserve (Fed) made no changes to monetary policy, but indicated that it’s considering options for adjusting its QE program, in a strong hint that its likely to provide more stimulus given the risks flowing from the latest rebound in coronavirus cases. US economic data was mostly good, with stronger than expected payroll jobs growth of 638,000 in October, a further fall in unemployment to 6.9% and solid business conditions ISM and PMI readings for October. Payroll employment has now recovered around 55% of its shutdown losses and a 2.2 million surge in employment in the household survey explains why the unemployment rate fell sharply to 6.9% in October. The pace of the recovery in jobs now looks to be slowing, though is consistent with a slowing rate of decline in jobless claims.

90% of US S&P500 companies have now reported September quarter earnings, with 83% surprising on the upside (compared to a norm of 75%) and 75% surprising on the upside regarding revenue. Consensus earnings growth expectations for the quarter have been revised up from a fall of -21% year-on-year to -8.5% year-on-year and this is now likely to end up at around -7% year-on-year, indicating a strong rebound in profits in the last quarter itself.

The eurozone business conditions composite PMI for October was revised up slightly, but at 50 is well down from recent highs, consistent with slower growth this quarter.

The Bank of England increased its QE program in the face of the latest partial lockdown, but pushed out its decision on negative interest rates.

Japanese household spending rose solidly in September and the pace of wage declines slowed.
Chinese business conditions PMIs for October were strong and consistent with ongoing economic expansion.

Australian economic events and implications

Australian economic data was all strong over the last week, with home prices turning positive for the first time since April, building approvals and housing finance surging higher (helped along by low interest rates and government incentives), retail sales down in September as earlier reported (but up 6.5% in real terms in the September quarter, pointing to a strong rebound in consumer spending), the trade surplus rebounding in September, the AIG’s business conditions PMIs rising to be more in line with the stronger CBA PMIs, car sales rebounding and job ads continuing to recover. In other words, the economy looks to have grown through the September quarter after the plunge in the June quarter. We are now looking for a 2% rise in September quarter GDP.

Meanwhile, the Melbourne Institute’s Inflation Gauge indicated continuing weak inflation in October, with underlying inflation of just 0.1% year-on-year, consistent with the still-huge level of spare capacity in the economy. See the next chart.

What to watch over the next week?

In the US, the resolution of the election will figure highly. Data on job openings and hiring, along with small business confidence for October, will be released Tuesday and core CPI inflation (Thursday) is expected to remain unchanged at 1.7% year on year. The Fed’s bank lending officer survey (Monday) will provide a guide to whether lending standards have eased.

Chinese CPI inflation for October (Tuesday) is likely to fall to 0.7% year-on-year, reflecting slower growth in food prices with underlying inflation remaining soft.

The Royal Bank of New Zealand (Wednesday) is expected to leave monetary policy on hold.

In Australia, the NAB business survey for October (Tuesday) is likely to show a further pick up in business conditions and confidence on the back of reopening and the Westpac/MI measure of consumer confidence for November (Wednesday) is likely to have hung on to recent gains.

Outlook for investment markets

Shares remain vulnerable to further short-term volatility given uncertainties around coronavirus, economic recovery and the US election outcome. We are however now into a seasonally strong period of the year for shares and on a 6 to 12-month view, shares are expected to see good total returns, helped by a pick-up in economic activity and 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 benefit 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.

Australian home prices at present are being boosted by ever lower interest rates, government home buyer incentives, income support measures and bank payment holidays, but higher unemployment, a stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney into next year. Outer suburbs, houses, smaller cities and regional areas are in much better shape.

Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.10%.

Although the A$ is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and China tensions and RBA bond buying will keep it lower than it would have been otherwise and we believe a continuing rising trend is likely to around $US0.80 over the next 12 months, helped by rising commodity prices and a cyclical decline in the US$.