Investment markets and key developments over the past week
Share markets continued to rally strongly over the past week as economic reopening in developed countries and stimulus measures continued but worries about an escalation in US/China tensions held gains back a bit.
In the event while President Trump further ramped up the war of words on Friday against China his latest actions were relatively mild. For the week US shares gained 3%, Eurozone shares rose 4.7%, Japanese shares rose 7.3% and Chinese shares rose 1.1%. Despite taking a bit of a hit on Friday from worries about US/China tensions, the Australian share market rose 4.7% for the week making it to a new recovery high with particularly strong gains in banks, property, telco, energy and consumer discretionary stocks through the week as a whole. Bond yields were little changed but they rose in Germany and fell significantly in Italy and Spain. Oil and metal prices rose but iron ore prices were basically flat. The Australian dollar rose to its highest since early March with the US dollar falling.
From their March lows global shares are up 32% and Australian shares are up 29%. A common concern I regularly hear now is that the rebound in share markets has left them out of touch with the reality of poor economic data, ongoing risks around coronavirus, the permanently changed world ahead and tensions between the US and China. Maybe they are and I too have been surprised at the strength of the rebound so far.
But then again I have seen this before – notably the rapid recovery seen in 2009 after the GFC and it reminds me of the quotation from John Templeton that “bull markets are born on pessimism, grow on scepticism, mature on optimism and die of euphoria” and this rally has certainly occurred against the backdrop of a lot of pessimism. After a consolidation of several weeks from late April share markets have now broken to new recovery highs with US shares up 35% from their March low and European, Japanese and Australian shares up by around 30%. The drivers remain a combination of falling new coronavirus cases in developed countries, positive news on the medical front regarding the virus, re-openings, stimulus measures, green shoots of recovery and investors being pessimistic and underweight – meaning that there are more who can be forced to buy shares than sell them. Many shares in major share markets are very overbought but that is quite common coming off major share market lows and is often a good sign. Technically the breakthrough of resistance around the 3000 level for the US S&P 500 opens up a run to 3200. If we are right, and April (or May) proves 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 over the next six months and unemployment goes even higher; and a serious escalation in US/China tensions (so far is been relatively mild).
New global coronavirus cases have continued to trace out a bit of an uptrend in recent weeks.
While new cases in Europe, the UK, Japan and to a lesser degree in the US have been trending down, various less developed countries are driving a rising trend in the rest of the world. This continues to include Brazil, India and Mexico.
Australia is continuing to see few new cases.
Reflecting the downtrend in new cases, lockdowns are continuing to ease in developed countries and so we are continuing to see a migration in countries from severe to intermediate lockdowns.
The re-opening is occurring much faster in OECD countries with most now seeing intermediate as opposed to severe lockdowns as they are ahead of the curve in controlling coronavirus relative to emerging countries. This includes Australia which has moved down from a (mildly) severe lockdown in April to an intermediate lockdown (albeit at the high end of intermediate).
Reflecting the progressive reopening, high frequency data continues to indicate that economic activity has likely 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, hotel bookings, credit card data, mobility indexes & jobs data hit bottom in mid-April. In Australia there has been a clear uptrend for six weeks in a row.
And policy easing continues to roll out:
- The European Commission proposed a bigger than expected recovery stimulus of €750bn composed of €500bn (3.6% of GDP) in grants to member countries and the rest as loans. This effectively endorsed the French-German proposal for common bond issuance and the response from the Frugal Four EU countries (Austria, the Netherlands, Sweden and Denmark) was less negative than feared. It may still take several months to get approved though but is another step towards greater European integration.
- US Congress continues to edge towards another stimulus package.
- Japan announced another $US1.1trn in stimulus (although its hard to tell how much is actual fiscal stimulus).
- Global interest rates have continued to fall with Turkey, India, South Africa and South Korea cutting rates in the last few weeks.
- RBA Governor Lowe reiterated that negative rates are “extraordinarily unlikely”, the cash rate will be on hold “for some years”, if the RBA has to do more it would buy more government bonds (signalling an openness to more QE) and said it was very important to keep fiscal support going and that an extension of JobKeeper may be necessary.
- Speaking of which, while the Australian Government has pushed back against using its $60bn saving on JobKeeper to expand and extend it, it hasn’t shut the door on more stimulus with a review in June and signalling an openness for more help for the tourist sector and for home building.
JobMaker to become the next big focus in Australia as the focus shifts to economic recovery…channeling Bob Hawke. The Prime Minister pushed further down the path of its economic reform agenda with a push to fix up skills training and a non-ideological consensus driven approach working with business and unions to fix things that are not working in the industrial relations system. This is good news – several years of ideological polarisation has not got anywhere in terms of reforming the industrial relations system. It further puts Australia in a good position relative to the US that remains beset by political polarisation.
US tensions with China continued over the last week – particularly in relation to how the US may respond to China’s new Hong Kong security law. My view remains that while this is a big issue and Trump will want to continue to highlight that he is tough on China in contrast to Biden, with Trump’s approval around where it normally is, he may not want to do anything against China that significantly threatens US shares and the US economy. And China will probably just bide its time and wait. But if it starts to look hopeless for him then he may conclude he has nothing to lose from ratcheting up the conflict – by say ramping up tariffs on China again – and trying to rally Americans around the flag. This would hold bigger risks for the economic recovery and shares.
There has been no further escalation in the Australia’s trade tensions with China, with the Chinese commerce minister describing the tariff on barley as cautious and restrained. I remain of the view that any disruption to trade between the two countries will be limited because it’s in both countries economic interest not to mess it up, but it’s a high risk if US/China tensions escalate dramatically.
Major global economic events and implications
US data was mostly better with a small gain in consumer confidence in May, regional manufacturing indexes rising sharply, April pending home sales falling sharply but new home sales up, mortgage applications to purchase properties rising above pre coronavirus levels and home prices continuing to rise in March. Durable goods orders fell sharply in April but by less than expected particularly for capital goods orders. The weekly increase in jobless claims is continuing to slow, but more importantly continuing claims fell for the first time since the crisis impacted suggesting some employment may be returning.
European business confidence measures rose slightly in May after sharp falls into April.
Japanese industrial production fell a greater than expected -9.1% in April and retail sales fell -9.6% but the unemployment rate rose only slightly to 2.6% despite a further fall in job openings because of a sharp fall in participation.
Chinese industrial profits and revenue continued to recover in April.
Australian economic events and implications
Australian economic data was soft but there were no real surprises. Construction and investment activity fell again in the March quarter and business investment plans for the year ahead point to a fall in investment with mining investment up but non-mining investment down. But the survey was taken a month ago so may now show some improvement with the reopening of the economy. Meanwhile an ABS survey of businesses for May showed 72% seeing a loss in revenue due to coronavirus with 53% reported reduced hours worked – but this is of no surprise. Credit growth fell to zero April with credit to housing investors falling further, personal credit contracting sharply and business credit growth slowing to near zero after a shutdown driven surge in March.
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, the focus will be back on jobs data (Friday) with May payrolls expected to fall another 8million pushing unemployment up to a whopping 19.5%…thank God Australia has seen a far more effective policy response. Wages growth will spike even further by 1% or 8.9% year on year reflecting the concentration of layoffs amongst lower paid workers pushing up average wages. Meanwhile, the timelier May ISM manufacturing and non-manufacturing indexes due Monday and Thursday respectively are likely to show small gains after their falls in April.
The ECB meeting (Thursday) will be watched to see whether it increases its QE Pandemic Emergency Purchase Program from €750bn to €1trn. It probably will as the PEPP is too small, but it may decide to wait till its July meeting as so far, its only spent about a third of its current program. Its response to the German Constitutional Court’s ruling on its QE program will also be watched. On the data front expect a rise in unemployment for April (Wednesday).
Chinese business conditions PMIs for May will be watched for an improvement. Chinese May trade data (7 June) is expected to show a fall in exports reflecting weak global conditions but an improvement in imports reflecting stronger domestic demand.
In Australia, the RBA is expected to again leave rates on hold at 0.25% and reaffirm its easing in March with the main focus on how it sees the economic outlook. RBA Governor Lowe has repeatedly indicated that 0.25% is the effective lower bound and that negative rates are “extraordinarily unlikely” so the RBA won’t be cutting rates and given the weakness in the economy its way too early to think about raising rates. In fact, we see the cash rate stuck at 0.25% for the next three years at least.
On the data front the big question will be whether Australia can avoid a technical recession by recording a small increase in March quarter GDP (due Wednesday), ahead of an almost certain contraction in the June quarter followed by a likely recovery from the September quarter and so avoid the “two consecutive declines in quarterly GDP” definition of a recession. Our base case is that GDP will contract by -0.3% quarter on quarter dragging annual growth down to 1.4% year on year with falls in consumer spending, business investment, housing investment and inventory more than offsetting small gains in public spending and net exports. But it’s a close call and we may just sneak into positive territory which would pave the way for Australia to retain its record run without a technical recession. The Lucky Country might ride again! Ultimately, this is all about semantics as whatever way you look at it, it’s still a horrible economic disruption. But Australia does seem to have fared better than many other comparable countries (despite the bushfires and hit to Chinese tourism in the March quarter) and this looks to have continued into the June quarter. Even a -0.3% fall in March quarter GDP would be a small fall compared to the hit seen in most other countries with the US -1.2%, the Eurozone -3.8% and Japan -0.9%.
In other Australian data, expect CoreLogic data to show a small -0.2% decline in home prices for May (Monday), building approvals (Tuesday) to show a -10% decline, retail sales (Thursday) to confirm a circa -17.9% decline for April and the trade surplus (also Thursday) to have fallen back to around $8bn from a record high in March.
Outlook for investment markets
After a strong rally from March lows and uncertainties around coronavirus, economic recovery and US/China tensions shares are vulnerable to short term setbacks. 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 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.
The Australian housing market has slowed in response to coronavirus. Social distancing has driven a collapse in sales volumes, and a sharp fall in employment, a stop to immigration and rent holidays pose a major threat to property prices. Prices are expected to fall around 10% into next year, but government support measures, bank mortgage payment deferrals and low mortgage rates are likely to help head off sharp worse case falls.
Cash & 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 its vulnerable to bouts of uncertainty about the global recovery and US/China tensions, a rising trend is likely if as we expect the threat from 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).