Investment markets & key developments
Global share markets mostly fell over the past week with worries about the latest coronavirus wave and central bank monetary tightening, as well as technology stocks remaining under pressure. For the week, US shares lost 1.9%, Eurozone shares fell 0.9% and Chinese shares fell 2%, but Japanese shares rose 0.4%. The soft global lead, not helped by surging coronavirus cases locally, saw the Australian share market fall 0.7%, with declines in health, information technology and retail stocks offsetting gains in material, utility and property stocks. Long-term bond yields and the oil price fell, but metal and iron ore prices rose. The A$ fell as the US$ rose.
While there are numerous risks around – Omicron, inflation, tensions with China and Russia, etc – the Santa rally normally kicks in around mid-December on the back of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings. Over the last 10 years the period from mid-December to year end has seen an average gain of 0.4% in US shares, with shares being up in this two-week period 6 years out of 10. In Australia over the last ten years, the average gain over the last two weeks of December has been 1.4%, with shares up in 7 years out of 10, although it hasn’t worked over the last 2 years.
Central banks heading towards tighter monetary policy – but at different speeds; and monetary policy looks likely to remain easy next year. The US Federal Reserve (Fed) has sped up the taper and is now flagging three hikes next year, with Chair Powell sounding more hawkish. Quantitative easing in the US is now set to end in March, clearing the way for the first hike in the June quarter. The European Central Bank (ECB) confirmed it will end its pandemic emergency quantitative easing (QE) program as scheduled in March but will increase its regular bond purchases to smooth the adjustment. The ECB remains relatively dovish and rate hikes look unlikely until 2023. The Bank of England (BoE) raised its cash rate for the first time, to 0.25%, with inflation concerns dominating Omicron uncertainty. The Bank of Japan (BoJ) largely left its monetary stimulus unchanged, although it will pare back its holdings of corporate debt. In Australia, Governor Lowe flagged a likely end to QE in May, but continued to push back against expectations for rate hikes in 2022. The upshot is that key central banks are moving towards monetary tightening, but at different speeds. However, monetary policy at major central banks looks like it will be very easy into next year – just less so.
The dot plot of Fed officials’ interest rate expectations does not see rates getting above its perceived neutral or long run level out to 2024. This may pose risks for inflation – but it’s also important for the economic cycle. While first rate hikes in tightening cycles can cause corrections, its usually only when monetary policy becomes tight after numerous rate hikes (17 by the Fed prior to the Global Financial Crisis, 9 prior to the 2018 US share market slump) that it becomes a problem for the economy and share markets. Tight monetary policy however still looks to be a long way off. It’s the same in Australia – our expectation for two rate hikes next year, taking the cash rate to 0.5% by year end, will still leave Australian monetary policy ultra-easy.
Christmas has crept up rather fast this year and with covid it doesn’t seem much has changed since last year (I was locked down last Christmas – fingers crossed for this one!). This is a season for lists so here’s a list of my top 8 Christmas songs: #1 Kelly Clarkson Under the Tree; #2 Mariah Carey All I Want for Christmas is You; #3 The Beach Boys Little Saint Nick; #4 Paul McCartney & Wings Wonderful Christmastime; #5 Elvis Presley Merry Christmas Baby; #6 Jose Feliciano Feliz Navidad; #7 The Pet Shop Boys It Doesn’t Often Snow At Christmas; #8 Kylie Minogue Christmas Isn’t Christmas ‘Til You Get Here; #9 Darlene Love Christmas (Baby Please Come Home). And do yourself a favour and check out this seemingly Elvis influenced song by Mud Lonely This Christmas which a friend recently pointed out.
Global coronavirus cases flattened out a bit over the last week, as cases in Europe fell slightly (with Germany, Austria and the Netherlands down, but France, Italy and Spain up). It’s still early days though in the Omicron wave, which is now combining with the latest Delta wave, the northern hemisphere winter, waning immunity and inadequate booster rollouts to push cases higher. US data has meanwhile been a little volatile of late. That said, its still nice to see the level of deaths relative to new cases remaining subdued compared to that seen in prior waves.
What we know about Omicron so far. This is still evolving, but the bad news is that: Omicron is still looking a lot more transmissible than Delta (possibly 4 times more) and will likely quickly come to dominate global cases (its already about 98% of new cases in South Africa); it results in substantially less protection from prior coronavirus infection (down to around just 20%) and from vaccines against infection (possibly to zero for AstraZeneca and to around 35% for Pfizer 15 weeks out from the second dose); China’s Sinovac vaccine may provide no protection; and it may take out to the June quarter to devise Omicron specific vaccines. Against this though: it seems to result in milder symptoms (with South Africa seeing a lower share of patients in ICU and on ventilators and shorter hospital stays); the Pfizer vaccine may provide 70% protection against being hospitalised; and a booster shot from a mRNA vaccine (Pfizer or Moderna) appears to offer significant protection (up to 98%) against severe disease and hospitalisation.
It’s still too early be definitive, particularly given that much of the information has come from South Africa, which has a high level of prior exposure and a younger population, which may help to keep serious illness down. Nevertheless, the news on booster shots, which has been confirmed by several studies, is positive.
The optimistic scenario is that if Omicron is confirmed to be less virulent but due to its greater transmissibility comes to dominate the other variants, it could turn out to be a good thing, as it could put COVID-19 on to a path to becoming like the common cold or flu. The high risk though is that if too many get it at once due its greater transmissibility, hospitals could still be overwhelmed, even if only a smaller proportion of those who get it get seriously ill – so in my view, it makes sense to use various restrictions (like mask and vaccine mandates) to slow its transmission down, particularly until more have had booster shots and new COVID-19 treatments become widely available. This explains why various countries, including the UK, have returned to some restrictions after virtually eliminating them, in order to slow new cases and ensure hospitals can cope. So far, hospitalisation and death rates in Europe remain subdued relative to the wave one year ago. This is also the case in the UK, where new cases are now rising rapidly.
45% of the global population are now fully vaccinated – but in poor countries it’s just 18%. Australia, at 76% of the population fully vaccinated, is at the high end of developed countries, where the average is 69%. Given the importance of vaccines in protecting against Omicron however, the focus will now shift to booster shots. So far, a little less than 4% of Australia’s population has had a booster – which, along with a low degree of natural immunity, leaves Australia very vulnerable to the Omicron wave.
NSW and Victoria are now seeing the reopening surge in cases that has been common to many other countries after reopening; and with state border reopening, cases are surging in other states too. This is being made worse by the more transmissible Omicron variant. A further massive surge in new cases is looking inevitable as Omicron spreads, helped along by Christmas gatherings and the ill-timed further reopening measures seen in the last week. So far, hospitalisations and deaths remain subdued, but these figures lag, while hospitalisations are starting to pick up – these will be key figures to watch.
Is NSW playing Russian Roulette with its economic recovery? This week’s further reopening moves - notably in NSW, which relaxed mask and vaccine mandates, along with check in requirements and removed gathering density limits - at a time of surging new cases, continuing uncertainty around Omicron (in terms of its transmissibility and virulence) and when other countries are going in the opposite direction - has added to the coronavirus risks to the near-term economic outlook. Maintaining the rules as they were for another month or so would have imposed little cost on the economy and may have helped slow the number of cases to make sure the hospital system can cope. Their removal however adds to the risk of a spike in cases and hospitalisations that is so large that it necessitates a return to hard lockdowns, which would be far worse for the economy. Hopefully this risk can be managed by high vaccination rates helping prevent serious illness, an acceleration in the roll out of booster shots, the Omicron variant resulting in less severe illness and many people engaging in self-regulation and avoiding large groups. The economy does seem to have become better at handling coronavirus outbreaks and restrictions. The further relaxation of restrictions however has unnecessarily and significantly added to the risk of another setback in the economy. Hopefully the relaxation in NSW will quickly be reversed in the interest of public health and the economy and the return of a mask mandate in Queensland makes sense. Further, as cases are rocketing, up a return to tougher distancing restrictions is highly likely.
Economic activity trackers
Our Australian Economic Activity Tracker edged higher again over the last week, with broad based gains in mobility, restaurant and hotel bookings and shopper traffic. However, it’s likely that self-regulation in the face of surging COVID-19 cases will start to weigh in the weeks ahead. Our European and US Economic Activity Trackers also improved slightly, although rising cases and restrictions could start to become more of a drag.
Major global economic events and implications
Business conditions PMIs in Europe, the US, the UK, Japan and Australia all fell slightly in December, with rising COVID-19 cases impacting. They remain at solid levels, however. Price indicators generally remain high (down in Europe, but up in the US).
US data was mixed. Retail sales and industrial production rose, but by less than expected. Business conditions PMIs and surveys pulled back a bit on average, but remain very strong. Jobless claims rose but remain historically low. Housing starts, permits to build new homes and the NAHB home building conditions index were all strong. The downside is that producer price inflation rose to a new high of 9.6% year-on-year (yoy).
Eurozone business conditions PMIs fell further in December but remain reasonable. Price pressures eased though. PMIs also fell in the UK.
The Japanese Tankan business survey showed that conditions were mostly firm in the December quarter, while the PMI fell slightly in December.
Chinese economic activity for November was mostly weaker. Growth in industrial production accelerated but retail sales and investment growth slowed, home prices fell for the third month in a row and unemployment rose slightly. The fall in retail sales growth may have been impacted by COVID-19 restrictions and a shift in the iPhone release cycle, but the data overall is consistent with more policy easing ahead, as signalled by the recent Politburo meeting.
Australian economic events and implications
Australian economic data was mostly solid. Employment rebounded by 366,000 in November, fully recovering the east coast lockdown-hit and pushing unemployment down to 4.6%. The latest lockdowns clearly had a far less negative impact on businesses and labour demand than last year’s lockdowns, as Australians seem to be better at managing them. While labour force participation is not the issue that it is in the US, strong demand for labour is still resulting in a very tight market and we expect unemployment to fall to 4% by the end of next year, putting in place the conditions for the Reserve Bank of Australia (RBA) to start hiking rates in November. Meanwhile, business confidence, as measured by the NAB survey, December business conditions PMIs and consumer confidence, remain solid and new housing demand, according to the latest HIA survey, remains strong.
While RBA Governor Lowe continues to push back against the prospect for 2022 rate hikes (and we agree that market expectations for 4 hikes next year, starting in the first half, look too aggressive), the RBA will ultimately be governed by “data and forecasts” rather than calendar years; and our view is that the data and forecasts will ultimately justify late 2022 rate hikes. In the interim, we continue to see the RBA further reducing its bond buying in February to $2bn a week, ahead of an end to bond buying in May. This appears to be consistent with the RBA’s central case as noted by Governor Lowe.
Of course, the main and now rising threat to this would be a severe new coronavirus wave that threatens to overwhelm the hospital system, necessitating a return to hard lockdowns and a delay to the removal of monetary stimulus.
The Mid-Year Economic and Fiscal Outlook (MYEFO) sees more revenue, but more spending too and ever bigger government. While the combination of a stronger jobs market, higher wages forecasts and higher corporate revenue saw the Government revise up its revenue estimates by $47bn for the four years to 2024-25, this was largely offset by extra spending on COVID-19 support, the National Disability Insurance Scheme (NDIS) and unspecified election promises. So over four years, the budget deficit is projected to be only fractionally lower, while projected longer-term government spending has crept up yet again to 26.5% of GDP (from the 24.8% average that prevailed pre COVID-19). Bigger government looks to be becoming entrenched.
What to watch over the next three weeks?
In the US, expect a slight rise in consumer confidence (due 22 Dec), solid gains in durable goods orders and personal spending and a further acceleration in core private final consumption deflator inflation to 4.5%yoy (23 Dec), a slight fall back in the December manufacturing ISM index (4 Jan) and a 500,000 rise in payrolls, with unemployment falling further to 4.1% (7 Jan). The minutes from the December Fed meeting will be released on 5 Jan.
Eurozone core inflation for December (7 Jan) will likely show a further rise to 3%yoy.
Japanese core inflation for December (24 Dec) will likely remain around zero.
China’s business conditions PMIs (due 31 Dec and early Jan) will likely remain around 50.
In Australia, November credit growth (31 Dec) is likely to pick up to around 0.6% month-on-month (mom) with faster home investor lending, but to remain soft and CoreLogic home price data for December (4 Jan) will likely show a further slowing in home price growth to 0.5%mom, leaving prices up 21% for 2021. The minutes from last RBA meeting (21 Dec) are unlikely to add much.
Outlook for investment markets for 2022
Global shares are expected to return around 8%, but expect to see the long-awaited rotation away from growth & tech heavy US shares to more cyclical markets in Europe, Japan and emerging countries. Inflation, the start of Fed rate hikes, the US mid-term elections & China/Russia/Iran tensions are likely to result in a more volatile ride than 2021. Mid-term US election years normally see below-average returns in US shares and since 1950, have seen an average top-to-bottom drawdown of 17%, usually followed by a stronger rebound.
Australian shares are likely to outperform (at last), helped by stronger economic growth relative to other developed countries, leverage to the global cyclical recovery and as investors continue to search for yield in the face of near-zero cash deposit rates, but a grossed-up dividend yield of around 5%. Expect the ASX 200 to end 2021 around 7,800.
Still very-low yields and a capital loss from a rise in yields are likely to again result in negative returns from bonds.
Unlisted commercial property may see some weakness in retail and office returns, but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.
Australian home price gains are likely to slow, with prices falling later in the year as poor affordability, rising fixed rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
Although the A$ could fall further in response to coronavirus and Fed tightening, a rising trend is likely over the next 12 months helped by still strong commodity prices and a decline in the US$, probably taking it to around $US0.80.
Subscribe below to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Chief Economist
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