Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Most major share markets rose over the past week as positive news on vaccines and mostly good economic data offset a continuing rise in new US coronavirus cases.Â US shares rose 1.2% and Eurozone and Japanese shares gained 1.8%. Australian shares rose 1.9% and benefitted from the positive US lead with strong gains in materials, utilities, retail and financial shares helping to offset concerns about the continuing surge in cases in Victoria. Chinese shares fell 4.4% though after a very strong gain so far this month with a bit of profit taking after data showed Chinese June quarter GDP rebounded by more than expected. Bond yields were generally little changed, and oil, metal and iron ore prices rose. The Australian dollar also rose as the US dollar fell.
The past week has seen some bad news in four key areas. First, itâ€™s been more of the same with a continuing rise in new coronavirus casesÂ with this being driven globally by emerging countries and the US amongst developed countries â€“ where case growth remains strong in the south and west.
Several countries have also had â€śsecond wavesâ€ť, including Japan and Israel. In Australia, Victoria has seen a continuing surge in new cases with fears about a spread to NSW.Â With more community transmission this time in Victoria (as opposed to returning travellers) it may take a bit longer for lockdowns to work this time around compared to March/April. Fortunately, NSW seems to be keeping new cases down.
Second, the re-acceleration of coronavirus cases in several countries has seen reopening pause in the OECD (and reverse in some areasÂ â€“ notably California in the last week in relation to bars and restaurants) with speculation of further reversals to come, including in Victoria.
Third, the surge in coronavirus cases, the reversal of re-openings and the associated negative headlines is starting to impact confidence and economic activityÂ with our weekly Economic Activity Trackers for the US and Australia faltering and losing some of their upward momentum over the last few weeks. These activity trackers are 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. While our Australian Economic Activity Tracker rose over the last week this reflected gains in some components as weakness in Victoria was offset by continued improvement in other states.
Finally, US/China tensions continued with the US rejecting Chinaâ€™s claims in the South China Sea and President Trump ending Hong Kongâ€™s special trade status with the USÂ and signing legislation to sanction Chinese officials repressing dissent in HK.
But there has also been some good news. First there have been more positive developments on the health front.Â Coming on the back of positive news about Remdesivir a week ago, Moderna reported that trials of its vaccine produced anti-bodies in all test patients and the University of Oxfordâ€™s vaccine was reported in Phase 1 trials to produce anti-bodies and â€śkiller T-cellsâ€ť. The latter is significant because various studies suggest anti-bodies to coronavirus may not last more than a few months, whereas T-cells can remain for several years. This has led to firmer hopes of a vaccine by year end and as early as October. Even Anthony Fauci expressed optimism about a vaccine by year end (or maybe he is just trying to make up with President Trump!). That said the tests have a way to go yet in proving that the vaccines protect people.
Second, while hospitalisations and deaths are escalating in the US in response to its second waveÂ both are continuing to run proportionally well below what was seen in the first wave. The fatality rate of new cases is still running around 1% compared to around 7% in April. This may partly reflect more young people being confirmed with coronavirus (due to a big increase in testing which is picking up more people with mild or no symptoms), better protections for older people (who have a much higher chance of dying) and better treatments. If hospital systems generally continue to cope (notwithstanding problems in some US states) and death rates remain low then a return to a mandated generalised lockdown or people behaving as if there is a generalised lockdown is less likely and the focus will remain on only partial and targeted lockdowns, travel restrictions and rigorous testing, tracking and quarantining and a renewed emphasis on social distancing such as limits on gatherings and making masks compulsory.
Third, several countries are continuing to successfully contain outbreaks with a combination of tracing, quarantining and quickly applied targeted lockdowns and social distancing – and so are learning to live with the virus.Â Several Asian countries stand out on this front â€“ notably China, South Korea, Taiwan, Vietnam and Thailand. And so far, so good in Europe. This approach looks preferred in NSW (which is managing so far to keep new cases low) and Australia generally in preference to complete elimination and return to lockdowns. While the news has been bleak in Australia over the last two weeks â€“ new daily cases of around 12 per million are still running well below the out of control US at around 200, so we should have a good chance at controlling it again (if we get quarantining down pat) without wiping out the nascent economic recovery.
Fourth, Chinese economic data traced out a Deep V recovery in in the June quarterÂ highlighting that if the virus is controlled then with stimulus measures growth can rebound quickly. China is leading developed countries by around two to three months in terms of the economic impact from coronavirus.
Fifth, President Trump has reportedly indicated to aides that he does not want to further escalate tensions with China.Â Maybe he believes that with his approval rating showing signs of bottoming around 42% and within its usual range he still has a chance in November without having to â€śwag the dogâ€ť. Then again, this might change again next week.
Sixth, the ongoing downtrend in the â€śsafe havenâ€ť US dollar and rising commodity prices (with metal prices back to their pre-coronavirus levels) is normally a sign of global reflation and recovery.
Finally, easy monetary and fiscal policy is continuing to support markets in contrast to the situation when the first wave started in developed countries in late February.Â Congress returns to Washington in the week ahead to start negotiating the next US stimulus package and in Australia the Government is continuing to announce further support measures, including $2bn of Federal funding and $0.5bn of state funding for apprentice subsidies and vocational training, and will announce more in the week ahead.
Given these conflicting forces, our base case remains for the economic recovery to continue but the Deep V rebound evident in much recent data to give way to a slower bumpier recovery going forward.Â Shares are still vulnerable to a further correction or consolidation, with renewed lockdowns and the US presidential election being the main risks. But the positives outlined above along with still record amounts of cash on the sidelines, cautious investor sentiment should keep any volatility to a correction which ultimately gives way to a resumption of the rising trend.
At last The Bachelor is back â€“ well The Bachelor in Paradise anyway, ahead of the real thing â€“ providing a distraction from endless depressing coronavirus news updates. Nice to see Helena and Timm back too.
Back to Ringo again â€“ well it was hisÂ 80th BirthdayÂ last week â€“Â It Donâ€™t Come EasyÂ is another great song of his and reminds me of right now. Itâ€™s amazing that one band had all members being so talented.
Major global economic events and implications
Conventional US economic data releases were pretty good over the last week with strong gains in retail sales, industrial production and housing starts in June and further increases or solid readings for small business optimism, home builder conditions and manufacturing conditions in the New York and Philadelphia regions. Furthermore, the Fedâ€™s Beige Book noted an increase in activity in almost all districts. That said, as noted earlier timely data has faltered lately, including the University of Michiganâ€™s consumer sentiment index, as coronavirus cases have surged suggesting a rougher road ahead. This is also evident in a slowing in the decline of initial jobless claims. CPI inflation came in a bid stronger than expected for June with gasoline prices rebounding but spare capacity in factories and the labour market suggests very low underlying inflation pressure. Comments from Fed officials suggest its heading towards guidance to the effect that it wonâ€™t raise rates until inflation is back at 2% and will tolerate some overshooting on inflation â€“ all of which is very dovish. Meanwhile, its early days in the June quarter earnings reporting season with less than 10% if S&P 500 companies reporting so far but we have seen some better than expected results from JPMorgan Chase, Citi, Goldman Sachs, Johnson & Johnson and Abbot Labs.
The ECB made no changes to monetary policyÂ as expected, having ramped up its QE program last month, but President Lagarde stated that all of the pandemic QE budget of â‚¬1.35trn will be spent unless there are significant upside surprises. Eurozone industrial production rebounded in May but is still down 21% on a year ago.
The Bank of Japan also made no changes to its ultra-easy monetary stance.
China shows that successful control of the virus and stimulus can drive a strong growth rebound.Â Chinese June quarter GDP rebounded a stronger than expected 11.5% quarter on quarter reversing March quarterâ€™s 10% slump. Momentum in industrial production, investment and retail sales continued to improve. While the recovery is uneven with production and investment accelerating ahead of consumer spending, retail sales momentum has recovered strongly from -20.5%yoy in January/February to -1.8%yoy in June. Unemployment fell and exports and imports rose as did house price growth. The rebound in economic activity came despite floods in southern China and Beijingâ€™s partial lockdown in June but is consistent with a rebound in most high frequency economic data in China and strong metal and iron ore prices. Going forward growth is likely to slow though as weak global demand crimps exports and consumer spending in China continues to lag.
Australian economic events and implications
Employment bounced back in Australia into June, but unemployment remains very high.Â The good news is that employment rose by a stronger than expected 210,800 in June, with the result that about a quarter of the jobs lost into May have been regained. However, workforce participation rose as some of those who gave up looking for work started to look for jobs again (possibly in order to retain JobSeeker as the mutual obligation to look for a job was reinstated last month) and this pushed unemployment up to 7.4%. Whichever way we look at it, unemployment is very high:
- the 7.4% official rate is the highest itâ€™s been since 1998;
- if we adjust the unemployment rate for those who are employed but are working zero hours (as a proxy for the impact JobKeeper has had in supressing measured unemployment) and for those who have left the workforce since March the â€śeffectiveâ€ť unemployment rate is very high at around 11.3%, albeit its down from around 13.9% in May and 14.8% in April; and
- labour underutilisation is very high at 19.1%, reflecting unemployment of 7.4% and underemployment of 11.7%.
The good news is that the reopening of the economy has seen jobs regained and both the effective unemployment rate and underutilisation rate have declined from their highs. However, only a quarter of jobs lost have so far been regained, weekly payroll jobs data suggests slowing in jobs into late June (although it has a tendency to subsequently get revised up), unemployment remains very high and the resurgence of the coronavirus cases in Australia with Melbourneâ€™s lockdown threatens further progress in reducing unemployment. All of which suggests that effective unemployment will be still be very high (maybe around 10% at best) at the end of September when JobKeeper and other supports are scheduled to expire highlighting the need for government support to be extended. The Federal Governmentâ€™s $2bn spending on additional subsidies for apprentices and vocational training is part of this.
In other data releases business confidence rebounded in JuneÂ but may be yet to reflect the resurgence of coronavirus cases more recently in contrast to consumer confidence for July which has retraced some its gains since April in response. Itâ€™s worth noting that while businesses were feeling happier in June, they were still indicating a reluctance to invest. Meanwhile, new home sales surged in June helped by HomeBuilder, but this only partly reversed the record lows of recent months.
In terms of housing demand â€“ data for permanent and long-term population flows for May confirmed that net immigration has likely plunged to near zeroÂ from around 240,000pa and population growth is likely heading to its slowest pace since WW1. This would suggest a hit to underlying dwelling demand of around 80,000 dwellings and is another factor likely to depress house prices for some time to come.
What to watch over the next week?
Trends in new coronavirus cases along with pressure on medical systems will continue to be watched closely,Â particularly in the US and Victoria.
On the data front the main focus in the week ahead will be July business conditions PMIs for the US, Eurozone, Japan and Australia (most of which are due on Friday).Â These saw a strong rebound from April lows as economies reopened but will be watched for any pullback due to the resurgence of coronavirus cases and some reversal of reopening notably in the US and Australia.
In the US expect to see a strong gain in June data for existing home salesÂ (Wednesday) and new home sales (Friday). June quarter earnings results will ramp up with the consensus expecting earnings to fall -43%yoy due to the lockdown. Outlook statements will be watched particularly closely given the reversal of the reopening recently in several states. Companies due to report include IBM, Coca Cola, Lockheed Martin, Microsoft, Intel and Amazon.
Japanese core CPI inflation for June (Tuesday) is likely to have remained weak.
In Australia, the main focus will be on the Treasurerâ€™s economic and fiscal update on ThursdayÂ which is expected to provide the Governmentâ€™s first set of economic forecasts since last November, an estimate of the budget cost of support measures announced so far (which we put at around $145bn), plans for future support measures and budget projections for this financial year and next. We expect:
- the Government to forecast GDP contracting -0.5% for 2019-20 and by -2% this financial year with very weak nominal growth ahead of a 5% rebound in 2021-22. This of course masks a sharp contraction in the June quarter but a forecast recovery thereafter around which there is much uncertainty flowing from the latest wave of coronavirus cases;
- budget deficits of $95bn for 2019-20, $223bn (or 11% of GDP) for 2020-21 and $73bn for 2021-22 â€“ of course the budget projections will come with much greater than usual uncertainty given the uncertainty around the recovery and the amount of fiscal stimulus ultimately needed to be delivered;
- additional fiscal stimulus including an extended and revamped JobKeeper, some paring back of JobSeeker but to a level above the prior $40 a day, a likely bring forward of the 2022 tax cuts (at a cost of around $15bn pa), more investment incentives and additional industry support measures (including additional apprentice subsidies and JobTrainer as already announced). This additional support will have the effect of turning the fiscal cliff after September into a fiscal slope.
Meanwhile, expect the minutes from the last RBA board meeting (Tuesday) to remain dovish but a speech by RBA Governor Lowe on â€śThe Labour Market and Public Sector Balance Sheetsâ€ť on the same day will be watched more closely as it will provide more insight into the RBAâ€™s current thinking.Â Governor Lowe is likely to reiterate that RBA measures are working, and that the RBA stands ready to do whatever it can but add that the recent rebound in coronavirus cases has added to the uncertainty around the recovery. On the data front expect preliminary June retail sales (Wednesday) to rise 5% after a 17% surge in May and preliminary trade data will also be released Friday.
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.
The Australian housing market has already slowed in response to coronavirus. 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 5% to 10% into next year from this yearâ€™s highs, 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 renewed 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 Australian dollar is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and US/China tensions, a continuing rising trend is likely if the threat from coronavirus recedes. Particularly with the US expanding its money supply far more than Australia is via quantitative easing and with Chinaâ€™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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