Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Share markets rose over the last week helped by a combination of better than expected earnings in the US, good economic data and positive vaccine news offsetting US/China tensions. This saw the US share market rise 2.5% for the week which left it just 1% below its February high. Eurozone shares rose 2.4%, Japanese shares gained 2.9% and Chinese shares rose 0.3%. The positive global lead offset the blow to the Australian economic recovery from Melbourne’s stage 4 lockdown and saw Australian shares rise 1.3% with strong gains in energy, material, IT, telco and consumer staple stocks offsetting weakness in financials. Bond yields generally rose slightly. Oil, gold and iron ore prices rose but the copper price fell. The A$ rose slightly but gave up most of its gains for the week as the US$ rebounded from oversold conditions on the back of a stronger than expected rise in July payrolls.
The global trend in new coronavirus cases showed a rare improvement over the last week with the 7-day moving average falling for the first time since early April.
This improvement reflects some stabilisation and/or slowing in various emerging countries (such as India, Brazil, South Africa, Saudi Arabia and Mexico) but also a further slowing in the US – notably in southern and western states, suggesting that the return of some restrictions and the mandated use of masks in many states may be working.
However, while the US is seeing a decline in new cases, Europe is seeing a rising trend (particularly in Spain where new cases have spiked to near April highs and to a lesser degree in France and the Netherlands) and Japan has seen new cases spike above its April high.
Apart from the stabilisation in new cases globally the second wave in developed countries has continued to be far less deadly than the first wave with deaths running well below their April high whereas new cases have been running well above. This is clearly evident in the US where hospitalisations have rolled back down and the fatality rate is around 1.5% compared to around 7% during the first wave in April. Relatively lower deaths this time around is also evident in Europe and Japan. This reflects a greater skew in new cases towards younger people (partly due to more testing), better protections for older people and better treatments. And it adds to confidence that a generalised lockdown will be avoided in most countries and people will not behave as if there is one.
And positive news on coronavirus vaccines is continuing with the latest being a vaccine being developed by Novavax.
So far while progress towards further reopening has stalled in OECD countries and some have seen some reversal of the earlier reopening, most countries have avoided a return to a hard lockdown. The resurgence in new cases and some partial reversal of re-openings had seen our weekly US Economic Activity Tracker move sideways from late June suggesting that recovery may have stalled – but it did not reverse and is now edging up again. And now with cases falling and deaths remaining relatively low we will be watching it closely to see whether a stronger recovery trend is resuming.
In Australia, Victoria has continued to see record new cases resulting in the commencement of a stage 4 lockdown of Melbourne and stage 3 lockdown for the rest of Victoria – but fortunately the other states have managed to keep new cases low (hopefully it can remain that way).
Based partly on New Zealand’s experience we estimate that the intensified and extended lockdown in Victoria will cost the Victorian and hence national economies $12bn to $14bn. This amounts to at least 2.5% of GDP and is enough to wipe out the national GDP growth we had previously been expecting for the September quarter. The Federal Government appears to have come up with similar estimates. As such it could push recovery as measured by GDP out to the December quarter. Consistent with this our Australian Economic Activity Tracker has fallen from mid-July with weakness over the last week in restaurant and hotel bookings, credit card data, retail foot traffic and mobility indicators.
More policy stimulus on the way in Australia. The hit to the Victorian economy and the resulting delay in the national economic recovery will put more pressure on unemployment – with effective unemployment (ie what it would be were it not for JobKeeper) likely to head back to around 14% this month from 11% now and measured unemployment likely to peak at around 10% by year end – and more business failures. All of which will necessitate more Government stimulus measures. The Government has already announced that JobKeeper eligibility rules will be relaxed and that this along with the blow to the recovery from Victoria will add $15.6bn to the cost of JobKeeper taking it to $102bn. We still expect another $10bn in stimulus to be announced and this along with a further hit to tax revenue will push the deficit out to $235bn this year or 12% of GDP (compared to the Government update two weeks ago that put it at $185bn). The hit to the economy from Victoria will also put pressure on the RBA to ease further.
While the RBA left monetary policy on hold at its August meeting its now less confident in the recovery in response to the latest coronavirus outbreak in Victoria. In response it has revised down its baseline GDP recovery for the next two years, sees unemployment reaching 10% by year end and sees it staying higher for longer and as a result of more spare capacity in the economy now sees lower for longer underlying inflation. With the second wave of coronavirus cases threatening the recovery it’s likely that the RBA will ease further in the months ahead. Having all but ruled out negative interest rates, foreign exchange intervention (as the A$ is in line with fundamentals) and direct monetary financing of government spending, further easing is likely to take the form of a rate cut to say 0.1% and more aggressive quantitative easing. The former may not be worth the effort, but the latter will likely see a specified monthly amount of bond purchases.
What about bitcoin and other crypto currencies? Bitcoin has received a boost (it’s up more than 25% over the last month) prompting some to ask whether they should jump on board. But there are several things to note. First its reflecting the same pressures as the gold price: the emerging cyclical fall in the US$; a desire by some for a hedge against a collapse in the real value of paper currencies if inflation picks up; low interest rates making it cheap to hold; and signs that global policy reflation may work which is also pushing up commodity prices generally. Second, bitcoin and other crypto currencies generate no income and so are impossible to value. Third, the supply of crypto currencies taken together is unlimited potentially making them less reliable than traditional paper money in advanced countries. Fourth, we quite possibly will go down the path of using crypto currencies, but I suspect governments will provide them. Fifth, if bitcoin is really a currency then it should be a good store of value – but it’s a been a poor store of value being highly volatile relative to the value of paper currencies (don’t forget it peaked at over US$19,000 in 2017 before falling to US$3,157 in 2018 and is now just below US$12,000). The A$50 in my wallet has been far more stable in terms of what it can buy. The US$ likely has more downside and so bitcoin may have more upside (albeit there is vulnerability to a short-term reversal in both) but there are fundamentally sounder ways to play a reflation trade than via bitcoin and other cryptos.
President Trump’s moves to ban TikTok and WeChat from the US further ramp up tensions with China and add to investor nervousness but so far are not significant enough economically to have a big impact on markets. A return to tit for tat tariff hikes or a military confrontation in the South China Sea could change that but may be unlikely if Trump concludes he still has a chance in November and so does not want to further damage the US economy. Time will tell with a US/China review of their trade deal being a big test in the week ahead.
The negatives for shares remain the uncertainty around coronavirus, the pausing or reversal of reopening, very high unemployment, the hit to earnings, the US election, US/China tensions and the seasonally weak period of the year for shares that we have now entered. But these are arguably more than offset by a long list of positives including continuing good news on coronavirus treatments and vaccines, the second wave in developed countries being less deadly than the first, several countries showing that it is possible to contain the virus, China tracing out a Deep V recovery, the safe haven US$ is falling which is normally a positive sign, monetary and fiscal policy remain ultra-easy, low interest rates and bond yields make shares look cheap and there is a lot of cash on the sidelines. Shares are still vulnerable to further volatility, with coronavirus and US/China tensions being the main risks. But the positives should keep any volatility to being a correction in a still rising trend.
When I was a pre-teen I asked my parents for a Beatles album and they got me a cassette (don’t ask “what’s that”?) with four pictures of beetles on the cover and it was something like James Last playing Beatles songs (not that I have got anything against James Last). Anyway, the next time around they got me something off their own bat called The Grassroots – Their 16 Greatest Hits and I thought they had the best songs ever. Funny thing is that nobody else seems to know of them. But Lou Adler (producer of The Mamas and Papas) was involved in their creation and they were pretty catchy. I still love them and recently discovered I’m Livin’ For You Girl. Really up there when it comes to head candy.
Major global economic events and implications
US data was generally good. July jobs data was solid, jobless claims resumed their fall and business conditions ISM indexes rose more than expected to levels consistent with solid growth. July jobs data was much better than feared with payrolls up by 1.76 million, unemployment falling to 10.2% and “temporary layoffs” still accounting for more than 50% of the unemployed. However, payrolls are still down 12.2 million from February so there is still a long way to go. This is evident in the next chart which shows this recession as having seen the fastest decline in employment in all post war recessions. This is to be expected given a big chunk of the economy was simply shut down. So far reopening has seen a rapid rebound in jobs, but it’s likely to slow going forward.
Negotiations for the next stimulus package in the US have made some progress and will probably get there but there is still a wide gap between the White House and Democrats. President Trump is set to issue executive orders to extend key support measures (including regarding enhanced unemployment benefits, the moratorium on evictions, forbearance on student loans and a suspension of payroll tax) and this along with the solid July jobs report may put pressure on Democrats to compromise or else they may miss out on some of the things they want like state & local government aid.
The US June quarter profit reporting season is now 90% complete & results have continued to come in much better than expected with a bigger than average 84% beating on earnings by an average 22.6% and 64% beating on sales. This has seen upwards revision to consensus earnings expectations, with earnings now expected to fall -28%yoy in the June quarter compared to -44% a few weeks ago. Hardest hit were energy, basic materials, financial & industrial companies.
Eurozone business conditions PMIs were revised up slightly in July with the composite at a solid 54.9 and June retail sales rose another 5.7% to be up 1.3% on a year ago which followed a similar Deep V pattern to that seen in in the US and Australia as pent up demand was unleashed supported by income support payments.
Japan’s composite business conditions PMI was revised up slightly for July but to a still relatively soft 44.9 and household spending surged in June, but wages growth remained negative or very weak over the year to June.
China’s Caixin composite business conditions PMI fell back slightly in July but to a still strong 54.5, confirming that recovery is continuing. Chinese exports rose a surprisingly strong 7.4%yoy, but imports were surprisingly soft at -1.4%yoy.
Australian economic events and implications
Australian economic data was mostly good.
- Business conditions PMIs were generally solid in July.
- Retail sales rose another 2.7% in June after the 16.9% rebound in May but this still left them down 3.4% in real terms in the June quarter. Credit card data suggests retail sales have held up well in July, but they are likely to be hit by Melbourne’s stage 4 lockdown this month.
- Housing finance rebounded in June and is likely to receive a boost from HomeBuilder but again the Melbourne lockdown will impact in the months ahead.
- The trade surplus rose in June and points to net exports contributing around 1 percentage point to June quarter GDP growth but only partially offsetting likely big falls in consumer spending (particularly on services and investment) leaving GDP still down -7 to -8% for the quarter.
- CoreLogic data showed that capital city home prices fell another 0.8% in July leaving them down 2% from their recent April high. JobKeeper and the bank payment holiday are preventing faster falls at present and the Melbourne lockdown will now see property sales in that city virtually grind to a halt making price data less reliable but further declines in national prices are likely as high unemployment, the depressed rental market and the collapse in immigration impact. We now see average capital city prices falling 10-15% from their April high out to mid-next year with Melbourne most at risk and likely to see a 15-20% decline.
What to watch over the next week?
In the US, expect further gains in July retail sales and industrial production (Friday) but a further fall in core CPI inflation (Wednesday) to 1.1% year on year. Data for job openings (Monday) and small business optimism (Tuesday) will also be released. The US and China are also scheduled to review their Phase One trade deal in mid-August.
Chinese activity data for July (Thursday) is expected to show a further improvement in growth with industrial production up 5.1% year on year and retail sales up 0.2%yoy with unemployment unchanged at 5.7%. July credit growth is likely to have remained strong. While CPI inflation (Monday) is likely to rise slightly to 2.6%yoy core inflation will likely remain very low with producer prices still falling.
In Australia, RBA Governor Lowe’s Parliamentary testimony (Friday) is likely to reiterate the RBA’s key messages from the past week that: recovery is now underway in most of Australia; but it remains highly uncertain; unemployment is likely to rise to 10% and stay higher for longer; and it remains committed to do what it can and will not increase the cash rate until progress is made towards full employment and its confident of inflation being in the 2-3% target band. Of particular interest will be any comments around further easing the RBA could do & what impact that might have.
On the data front in Australia, the focus is likely to be on labour force data for July (Thursday) which is expected to show just a 25,000 rise in employment with weakness driven mainly by Victoria with payroll jobs data pointing to a stalling in the jobs recovery. This combined with a further increase in participation to 64.5% (as JobSeeker recipients have to look for work again) will likely push the unemployment rate up to 8.1% (albeit with effective unemployment still being around 11%). The ABS’s weekly payroll jobs data (Tuesday) will provide some guide as to how the jobs market is faring into late July. The NAB business survey for July (Tuesday) is expected to show some slippage of the recovery in conditions and confidence reflecting the lockdown in Melbourne, and the Victorian situation will likely also see a further decline in consumer confidence for August as measured by the Westpac/MI survey (Wednesday). June quarter wages growth (Wednesday) is likely to have softened to 0.3% quarter on quarter or 1.9% year on year.
The Australian June half profit reporting season will also ramp up with several major companies due to report including GPT (Monday), James Hardie and Challenger (Tuesday), CBA, Computershare and Seek (Wednesday), AGL, AMP, Telstra and Woodside (Thursday) and Newcrest (Friday). It’s going to be the worst reporting season in years with consensus expectations for a -21% slump in earnings due to the hit from coronavirus which will be the biggest fall since the GFC. Financials will be the hardest hit with an expected -28% slump in earnings led by insurers and the banks, followed by industrials with a -15% fall in earnings and resources with -13%. Consumer discretionary may be the only sector to seeing a rise.
The RBNZ (Wednesday) will likely leave policy on hold.
Outlook for investment markets
After a strong rally from March lows shares remain 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 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.
Australian home prices are falling and higher unemployment, a stop to immigration and rent holidays will push prices lower into next year. Home prices are expected to fall by around 10%-15% from their April high into next year, with the risk of bigger falls if the renewed rise in coronavirus cases leads to a renewed generalised lockdown. Melbourne is particularly at risk on this front as its Stage 4 lockdown pushes more businesses and households to the brink.
Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
Although the A$ is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and US/China tensions, a continuing rising trend is likely. Particularly with the US expanding its money supply far more than Australia is via quantitative easing and with China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).
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