Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Major global share markets, with the exception of Chinese shares, rose solidly over the last week on optimism regarding the development of a vaccine for the coronavirus, reopening from lockdowns, dovish comments from US Federal Reserve (Fed) Chair Powell and moves towards a common bond in the eurozone, despite escalating US/China tensions seeing some of the gains reversed. For the week, US shares rose 3.2% reaching a new recovery high, eurozone shares rose 4.4% and Japanese shares rose 1.8% but Chinese shares fell 2.3%. Despite giving up some of its gains later in the week on China trade fears, the Australian share market rose a solid 1.7% through the week as a whole and made it to a new recovery-high, with strong gains in materials, information technology, energy and property stocks offsetting weakness in defensive consumer staples, health and utility shares. Bond yields rose in the US and Germany but fell in Australia and the UK, with sharp falls in Italy and Spain. Oil, metal and iron ore prices rose, as did the Australian dollar, with the US dollar pulling back a bit.
New global coronavirus cases have ranged sideways since March, although a bit of an uptrend has emerged over the last few weeks.
While new cases are clearly trending down in Europe, the UK, Japan and to a lesser degree in the US, various less developed countries are driving a rising trend in the rest of the world. Brazil looks particularly bad (populist leaders who don’t like experts are not good for their people’s health!) and the trend is still up in India and Mexico. Iran now looks to be seeing a real “second wave” (in contrast to the second waves some claim to have occurred in Japan and Singapore, which were really still in first waves).
Australia is continuing to see few new cases. Australia’s low coronavirus death rate of 4 per million people in contrast to 290 in the US and around 535 in the UK and Italy is well known. Australia also continues to rank only second to New Zealand amongst OECD countries in terms of controlling the virus (as measured by recovery rates, cases per capita and testing per capita). The US is worst at 37th and Sweden is 36th.
There has also been some good news on the vaccine front, with Moderna reporting positive immune responses in volunteers injected with a vaccine. This is far more significant than news that Remdesivir had reduced recovery times by a few days for Coronavirus patients. However, there is a long way go in showing that the vaccine actually protects against the virus. There are now more than 80 vaccine projects around the world. Hopefully they are more successful than attempts to eradicate common colds caused by a different coronavirus!
Lockdowns are continuing to ease in developed countries, pointing to improved economic activity ahead. While economic data has been terrible for April, reflecting the full brunt of the lockdown (eg US housing starts down 30%, Australian retail sales down 17.9%), business conditions PMIs in May lifted after their sharp fall into April in the US, Europe, Japan and Australia. They are not yet available for all countries globally, but the rise in PMIs in the G3 (US, Europe and Japan) points a rise in the global PMI for May.
Consistent with this, high frequency data continues to indicate that activity may have hit bottom. 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, credit card data, mobility indexes & jobs data hit bottom in April and in Australia have trended up for five weeks in a row. I am now even finding it harder again to get a parking spot for the Holden in my local suburban shopping centre. Of course, it has a long way to go and our US indicator is lagging a bit.
On the policy front:
- The eurozone is taking another step towards the issue of common bonds, with a French-German plan for the European Commission to issue bonds to fund a €500 billion recovery fund. It’s too small, and some northern eurozone countries are not so keen, but it’s another step towards a more integrated fiscal policy to take pressure off the European Central Bank (ECB) and bring the Eurozone even closer together. Betting that the coronavirus will pull Europe apart is likely to be a losing bet, as it was with the Eurozone public debt crisis!
- Fed Chair Powell noted that the Fed is not out of ammunition by a long shot and is committed to use its full range of tools to support the economy. The minutes from the Fed’s last meeting showed it starting to discuss options for further easing. This did not include negative rates, but there does seem to be a solid leaning towards stronger forward guidance and regular monthly bond purchases.
- In Australia, Reserve Bank of Australia (RBA) Governor Lowe indicated no change to the Bank’s thinking that negative rates are “extraordinarily unlikely”. He did however note that jobs data suggest that the decline in hours worked may be less than earlier feared and that the RBA remains prepared to scale up bond purchases if needed.
- Sticking to Australia, the revelation from Federal Treasury that errors on JobKeeper applications had exaggerated the number of employees covered by the scheme, and that due to an earlier reopening of the economy JobKeeper is now expected to cost around $60 billion less than budgeted for (and likely to cover around 3.5 million workers as opposed to the 6.5 million workers expected) is mostly good news. It would indicate that the economy may not be as weak as first feared, as less workers work for companies that meet the required 30% or 50% hit to revenue to access the scheme and as the economy opens faster than the six month hibernation originally allowed for. As we saw with last week’s labour market report, JobKeeper is playing its role in keeping people employed and measured unemployment down and there is no change to that. The estimate that it was covering more than 6 million workers always seemed a bit over the top as that’s nearly half the workforce! Against this though, it means that the fiscal stimulus will be $60 billion, or 3% of GDP – less than originally announced, which could mean a less robust recovery than had been expected on the basis of that stimulus. However, the ideal response would be for the $60 billion saving to be used to relax some of the criteria to access JobKeeper and to extend it for those who need it. Given all this, I see no reason to change our forecasts for economic growth and unemployment in Australia.
One big threat to the recovery in markets is the escalating war of words between the US and China around the origin of the virus. With the World Health Assembly unanimously agreeing on an inquiry into Covid-19 (with the support of China), you would think Trump would wait for the outcome; but the Presidential election is less than six months away now and recession and a massive rise in unemployment may have messed up Trump’s chances. Therefore, Trump and the Republicans are keen to shift the blame to China and paint the Democrats as “soft on China”. Moves by China to tighten national security in Hong Kong may also add to the tensions. A war of words is one thing, but escalating tariffs and restrictions (with more in relation to Huawei and a Senate law which may make it harder for Chinese companies to list in the US) are another. With Trump’s approval around where it normally is, he may not want to do anything too much that threatens shares and the economy. However if it starts to look hopeless for him, then he may conclude he has nothing to lose from ratcheting up the conflict and trying to rally American’s around the flag.
Australia may be getting tangled up in this, with China putting an 80.5% tariff on Australian barley and concerns about possible restrictions on Australian coal and new inspection rules around iron ore (although the latter looks benign). Some see this as connected to China’s annoyance at Australia’s push for an inquiry into Covid-19, but then again China does have some concerns with Australia’s trade practices and such tensions have flared up before only to settle down again. Barley and affected meat exports only account for around 1% of Australia’s total exports to China but it would be a much bigger concern if iron ore and coal are impacted too. Ultimately, I expect that the disruption to trade between the two countries will be limited because it’s in both countries economic interest not to mess it up.
After a consolidation of several weeks, share markets broke to new recovery highs in the past week. The whole recovery since March has been driven by a combination of falling new Coronavirus cases in developed countries, positive news on the medical front, reopenings, stimulus measures, greenshoots of recovery and investors being underweight shares. A breakthrough of technical resistance around the 3,000 level for the US S&P 500 would possibly open up a run to 3,200. Failure to break higher could see a pullback. Such are technicals! Though if we are right, and April or May prove to be the low point in economic activity, then given the massive policy stimulus already seen, shares should be higher on a 12-month outlook. The three big risks remain: a second wave of coronavirus cases (that’s a low risk in Australia, but high in the US); collateral damage from the shutdowns resulting in a delayed or very slow recovery (as bankruptcies surge and unemployment goes even higher); and a serious escalation in US/China tensions.
Major global economic events and implications
US housing starts plunged 30% in April and permits fell 20%, but more recent/forward looking indicators were a bit more promising, with home builder conditions improving and new mortgage applications recovering much of their shutdown related slump. The latter tells us that low interest rates still work! Meanwhile, jobless claims remain high in the US but are down for the seventh week in a row. Further, as noted earlier, business conditions PMIs rose in May after their sharp fall in April, which is consistent with an easing in the shutdowns.
It was the same story in the eurozone, with business conditions PMIs rising in May and consumer confidence also up in May. PMIs also rose in the UK in May.
Likewise, in Japan, there was a small rise in business conditions PMIs for May. Meanwhile, Japanese GDP fell a less than expected (-0.9% in the March quarter) continuing a recession that was (yet again) triggered by a hike in sales tax. Everything except public spending detracted from growth. Headline inflation in April fell to 0.1% year-on-year and core inflation (ex food and energy) went negative, but at an emergency meeting the Bank of Japan made no changes to monetary stimulus, apart from starting a new lending program for small businesses.
China’s abandonment of a growth target for this year reflects the uncertainty caused by the coronavirus and should not be seen as reflecting a lack of determination to boost the recovery. In fact, the widening budget deficit target points to ongoing stimulus, with the Government saying it would increase stimulus. Premier Li has also stated that China remains committed to the Phase One trade deal with the US.
Australian economic events and implications
Australian retail sales fell a record 17.9% in April, but this was hardly a surprise given the inevitable reversal of panic buying in April and the shutdown that stopped many Australian’s from spending. In fact, given the latter, it’s surprising that it wasn’t even worse. Since February, retail sales have fallen 10.9%, which is bad, but nowhere near as bad as an 18.4% fall in comparable retail sales in the US, suggesting that JobKeeper is helping. With the shutdown easing, April is likely to be the low point, with consumer confidence up for seven weeks in a row, credit card and transactions data pointing to a recent pick-up in spending, mobility indexes confirming that there are more people out and about, an ABS survey showing that more had a job in early May than in mid-April and ABS payrolls data showing only a slight fall in jobs since mid-April, but a pickup in wages. The last two suggest little further deterioration in employment, or rise in unemployment, coming into early May. Consistent with all this, the CBA’s business conditions PMI’s rose slightly in May after their plunge in April. Finally, NSW’s decision to allow pubs, cafes and restaurants to host up to 50 people (albeit with strict rules) from 1 June is a big move in making such venues viable. Our view remains that April was the low point for economic activity in Australia. Although this still means a bad June quarter, our forecast (and those of the Treasury and RBA) for a 10% or so contraction in the June quarter GDP may prove to be too negative.
What to watch over the next week?
The main focus will likely remain on continuing evidence that the number of new Covid-19 cases is slowing in developed countries, progress towards medical solutions, the reopening of economies and signs that economic activity is picking up.
In the US, expect to see sharp 10 to 20% falls in April data for new and pending home sales (Tuesday and Thursday respectively), durable goods orders (Thursday) and personal spending (Friday), with another leg down in the core private consumption deflator inflation to 1.1% year-on-year. More timely consumer confidence data for May is expected to show a slight improvement consistent with the reopening.
Eurozone economic sentiment for May (Thursday) is expected to improve slightly, but core inflation for May (Friday) is likely to have fallen to around 0.8% year-on-year.
Japanese data for April (due Friday) is expected to show a fall in industrial production and rise in unemployment.
In Australia, expect March quarter data to show flat construction (Wednesday) but a 5% fall in business investment (Thursday). Investment plans will likely be soft, but may not fully capture the impact of the shutdown. Preliminary April goods trade data (Thursday) will likely show continuing strength in exports driven by iron ore and soft imports. Credit data (Friday) will likely show continuing strength in lending to business but soft housing credit.
Outlook for investment markets
After a strong rally from March lows, shares are vulnerable to short-term setbacks on news around the virus and economic reopening. But on a 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 the coronavirus.
Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from 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 the coronavirus. Social distancing has driven a collapse in sales volumes, and a sharp fall in employment, while a stop to immigration and rent holidays pose a major threat to property prices. Prices are expected to fall between 5% to 20%, but government support measures (including wage subsidies along with bank mortgage payment deferrals) along with a plunge in listings, will help limit falls, as will the reopening of the economy.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.
The Australian dollar has likely seen the low – at around $US0.55 in March. Although it’s vulnerable to bouts of uncertainty around the global recovery and US/China tensions, a rising trend is likely if as we expect the threat from the 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 are kept to a minimum).
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