Economist – Investment Strategy & Dynamic Markets
Investment markets and key developments over the past week
The equity market correction that started last week, driven by falls in tech stocks, has continued, and has now broadened out to other sectors. US shares are down by 2.5% and the tech-heavy NASDAQ is down by a larger 4.6% over the week. But, all sectors (except for materials) in the S&P500 fell over the week and energy was down heavily as the Brent oil price fell to $39/tonne, from $45 earlier this month. The US share correction has seen the S&P500 fall by 6.7% so far and the NASDQ down by 10.7%. The declines in other global sharemarkets has been more modest (which also reflects the lower concentration of the tech sector in non-US markets). Australian shares are down by 1.1% over the week, European equities are actually up by 1.7%, Japanese equities are up by 0.9% and Chinese shares are 2.8% lower. While the start of the tech correction didn’t have a direct catalyst, it has brought to light valuation concerns in the sector. We have been talking about the rising risk of a sharemarket contraction for a while (especially in the US market) because of: pockets of rising COVID-19 cases, US/China trade tensions, US election risks and no sign of another US stimulus package. And there are now renewed Brexit risks which resurfaced this week. So, this correction is likely to have further downside in the absence of some positive news (like a US fiscal package or vaccine developments). In the environment of weaker tech performance and a falling US dollar (although it was up this week), US shares will fare worse than non-US equities. The $A is still trading around 0.72 US dollars, US 10-year bond yields fell to 0.66% this week from higher risk aversion. Commodity prices were generally lower, especially across energy but gold, copper and aluminium prices rose.
Global COVID-19 cases continue to trend sideways at around 260,000 new cases/day. European cases are rising fast (especially in France and Spain), and are close to their previous highs (see chart below), US cases have fallen to their lowest level since mid-June (before the start of the second wave) but cases in India and Brazil are still a big problem. India now has the second highest number of global COVID-19 cases (after the US). Rising European cases may see some localised mobility restrictions back in place, but a large-scale lockdown is unlikely. The UK put some more restrictions in place this week around keeping personal gatherings to a maximum of 6 people.
Australian cases continue to trend down, becaue of declines in Victoria (see chart below) with just over 60 cases/day on average over the past 7 days, which is the lowest number of cases since early July before the second wave escalated. NSW has managed to keep its various clusters under control (for now) with less than 10 new cases per day over the past week.
Australian Victorian Premier Dan Andrews gave an update on the roadmap out of the Victorian COVID-19 restrictions. The stage 4 metropolitan Melbourne lockdown will be extended for another two weeks (until 28 September, from 14 September). But most businesses won’t return to more normal operations until 26 October or later. Reopening of the economy is tied to the number of daily COVID-19 cases with the 26 October date dependent on less than 5 new cases and less than 5 unknown cases across the state over a fortnight which is a very ambitious (but in my view unattainable) target to reach (NSW wouldn’t be operating in its current capacity on these figures). Our previous view was that the lockdown would drag $12-$14 billion from September quarter GDP (around 2.5% of quarterly GDP) but this is now likely to be higher at around 4-4.5% of GDP (but spread over the September and December quarters) given the extension in the restrictions. This means that the expected rebound in December quarter growth will be lower than previously assumed. Hopefully the recovery in other parts of Australia (outside of Victoria) will offset the weakness in Victoria. The table below is a good visual of the Vic roadmap.
Our Weekly Activity Trackers (which includes high frequency economic indicators like credit card spending, mobility, job advertisements, foot traffic and confidence) show a continued slow trend up in US economic activity (see chart below) from improving restaurant reservations, retail traffic, mobility, hotel bookings and job advertisements.
The Australian Weekly Activity Tracker ticked up (see chart below) on improving confidence, restaurant bookings, credit card spending, hotel bookings and retail foot traffic.
There was a setback in vaccine news during the week, with one of the leading potential vaccine candidates AstraZeneca/Oxford University pausing its third phase trial after a trial patient became ill in the UK with serious spinal inflammatory symptoms. While the patient is expected to recover and it’s unclear whether these are symptoms are completely related to the vaccine, it is still a hit to confidence about a vaccine coming to market and people’s willingness to take it. However, setbacks were always likely in this process and once the patient recovers, the trial will be restarted.
Brexit issues were back in the headlines this week with an “Internal Markets Bill” now being proposed by UK PM Boris Johnson which seeks to change parts of the Withdrawal Agreement (signed in January) related to state aid and Northern Ireland customs’ issues. If this bill passes, it would start on 1 January 2021 and is effectively a safety guarantee for the UK that it will not be tied to EU rules and legislation after the transition period ends. Under this bill, goods from Northern Ireland (part of the UK) would have complete access to Britain and EU state aid rules (which will continue to be applied in Northern Ireland because of the border with the Republic of Ireland) will not apply to the rest of the UK. If this bill were to be passed it would technically break international law. This proposal has increased the probability of a “hard Brexit” (the UK leaving the EU with no trade agreement in place) at the end of the year. The EU has issued the UK an ultimatum to scrap the internal markets bill by the end of the month. The pound depreciated by around 3% during the week on hard Brexit concerns.
More bad news on US/China trade tensions. The Trump administration is looking at whether to put another Chinese entity (Semiconductor Manufacturing International Corp) on the Commerce Department’s “entity list” which would restrict US exports of semiconductor manufacturing equipment to the company, similar to the restriction placed on Huawei. This may be Trump trying to appease his voter base with his “tough China” stance in comparison (to his characterisation) of his opponent “Sleepy Biden”.
No signs of a US fiscal package with Democrats blocking a stimulus package worth $500 billion, which was put forward by Senate Republicans saying it was too small compared to the $3 trillion stimulus package previously proposed by the Democrats.
In New Zealand, it was the first time that government bonds traded at a negative yield. The 3-year bond yield traded just below zero. Expectations that the RBNZ will cut interest rates to negative are driving bond yields lower.
Major global economic events and implications
US data is holding up. The August NFIB small business confidence rose again, July JOLTS job openings were also better than expected, increasing to 6.618 million openings which is an improvement but not quite back to its pre-COVID levels. However, initial jobless claims over the week to 5 September remained high at 884K (unchanged on a week ago and above market expectations) so unemployment is still clearly a problem. August consumer prices rose by more than expected (again), lifting by 0.4% in August or 1.3% over the year. Core CPI is running at 1.7% over the year. Consumer price growth is likely to slow from here given the large amount of spare capacity created by the collapse in GDP.
China’s trade surplus increased in August. Export growth was stronger, rising by 9.5% over the year to August and import growth fell by 2.1% (weaker than expected). Exports were boosted by personal protective equipment and work from home goods. There was some weakness in coal imports. China’s CPI data showed an increase of only 0.1% for headline and core inflation in August, with annual growth at 2.4%, down from 2.7% last month. Food inflation is low and will be a drag on inflation.
The Bank of Canada (BoC) left its current monetary settings on hold. The BoC is continuing to purchase at least C$5bn/week of government bonds. Interest rates will remain unchanged until the 2% inflation target is “sustainably achieved”.
The outcome of the European Central Bank meeting was disappointing as there was some expectation of more dovish communication, even if a change in policy settings was unlikely. The Fed’s change in monetary policy strategy puts pressure on the other central banks to also adopt a more dovish stance on current settings, to avoid an appreciating currency. The ECB are actually doing their own strategy review but no details on this review are available yet. On the exchange rate, the ECB said it would “carefully assess” exchange rate developments. The GDP outlook was a little stronger, based on good data recently and core inflation in 2022 was revised up slightly by 0.2 percentage points to 1.1% per annum. While the latest economic data has shown a solid bounce back in growth, the more subdued medium-term outlook (with rising COVID-19 cases, Brexit risks and some expiring wage subsidy schemes) argues for more policy support from the central bank.
Australian economic events and implications
ANZ job advertisements growth lost momentum in August, rising by 1.6% compared to 16.7% in the prior month. The NAB business survey showed a fall back to negative business conditions in August (with an index reading of -6 from 0 in the prior month). Confidence rose (from -14 to -8), and is negative but well up from its bottom in March (of -66). The employment sub-index fell significantly. This survey was taken after the stage 4 lockdown started in Melbourne and Stage 3 in Victoria and Victorian business conditions fell but conditions actually fell by more in Queensland, Tasmania and South Australia. Consumer confidence, according to Westpac/Melbourne Institute surged by a surprising 18% in September after decent falls in the last two months. Confidence is now back to levels seen earlier this year before the COVID 19 pandemic started. However, confidence is still negative overall (and it was already trending down and negative for many months before COVID-19) and is down by 4.5% year-on-year.
Housing finance data for July showed another huge lift in new housing commitments (up by 8.5% in July), driven by owner-occupiers (which rose by 10.3%). Investor lending was 3.4% higher. The recovery in housing finance over the last two months has been very strong. While owner-occupied housing is back to its pre-COVID levels, investor lending is still well below its levels earlier this year which is also in line with the big fall in rents and higher vacancy rates which dent investor housing returns. Housing finance growth is likely to slow over the next few months from declining housing activity in Victoria (evident in much lower auction clearance rates).
Weekly ABS payrolls showed that momentum in jobs creation continued to stall in August, which is not surprising given the Victorian lockdowns. Payrolls fell by 0.4% over the month of August. Stronger payrolls growth in states outside of Victoria was not enough to offset weakness in Victoria. However, the pace of job losses in Victoria has slowed down recently (see the chart below).
What to watch over the next week?
The US Federal Reserve meets. The Fed needs to follow up on its refreshed strategic monetary policy review with an update in its forward guidance, otherwise it risks yields rising. The Fed meeting includes the economic projections of Fed members and the “dot plot” of participants expectations for interest rates. It will be interesting to see how many participants (if any) expect interest rate rises in 2023. August retail sales should show another rise, albeit slower growth compared to recent months. Other cyclical indicators out include August industrial production, the Empire Manufacturing index and housing indicators like starts and permits.
Chinese data includes industrial production, retail sales and fixed asset investment for August.
Australian August employment data is expected to show a fall in jobs around 20K with a fall in the participation rate leading to a small rise in the unemployment rate to 7.6% (from 7.5% last month). The RBA September meeting minutes are due and the ABS June quarter house price figures are likely to show a fall in home prices around 1% (or -7% year-on-year).
The Bank of Japan meet next week along with the Bank of England. No major change to policy or communication is expected at either meeting, but more stimulus is still likely over the next 6 months from both central banks. Japanese August inflation data is expected to show a fall back to deflation in the core readings.
Outlook for markets
After a strong rally from March lows shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. But 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 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 at present are being protected by income support measures and bank payment holidays but 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. 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).