Investment markets and key developments over the past week

While the US S&P 500 fell slightly over the last week on the back of rising new coronavirus cases and tightening restrictions in the US, other major global share markets rose helped by good vaccine news. Australian shares continued to recover with hopes that quick action will limit a covid outbreak in South Australia and as economic data continued to surprise on the upside with gains being led by financials, energy, retail, health and industrial stocks. Bond yields fell and oil, metal and iron ore prices rose as did the Australian dollar against a falling $US.

While shares are vulnerable in the short term to rising US coronavirus cases and possible hand grenades from President Trump the break higher in many share markets including Australian shares in recent weeks has paved the way for more gains over the next 6-12 months on the back of ultra-easy monetary policy, massive fiscal stimulus and the recovery in economies and profits getting a boost next year as vaccines are deployed.

The past week saw more good news on vaccines with Moderna’s vaccine showing 94.5% effectiveness in preliminary results and Pfizer’s moving up to 95% as more results came through and both showed no significant safety problems. Pfizer is now applying for US emergency use. This is all good news in that now two vaccines based on similar technology (called messenger RNA) have had very good results. There is a fair way to go yet as we still don’t know how long protection lasts, whether there may be resistant strains and more results are needed regarding safety and while wide distribution could start in months if they are approved it will probably take at least 6-9 months for broad enough coverage in developed countries (longer for the whole world) to get back to normal. But the light at the end of tunnel is getting brighter.

However, the problem right now with coronavirus remains intense. While Europe has seen new cases roll over reflecting the return to lockdowns a few weeks ago which will take pressure off hospitals, the US is seeing a continuing surge in cases, Japan is seeing a third wave, Canada is running at 5000 cases a day and emerging countries have ticked up again.

Deaths in the US are rising rapidly and hospitalisations continue to rise above their August high which is forcing tightening restrictions, including New York City which has shut schools, to avoid an over run of the medical system.

This is all seeing more countries migrate from moderate and intermediate lockdowns to severe lockdowns, albeit for the most part they are not as severe as seen earlier this year.

European economic data is slowing down again reflecting the return to lockdowns. This is evident in our European Economic Activity Trackers which continued to slow over the last week.

Our US Economic Activity Tracker rose slightly over the last week, but remains in a slight downtrend as the resurgence of new coronavirus cases and tightening restrictions impacts in the US. Some slowing in the US recovery looks certain in the months ahead. The good news is that stimulus negotiations look set to resume and Congressional leaders are in talks to head off a December 11 government shutdown. The bad news is that Treasury Secretary Mnuchin has declined to extend five of the nine Fed emergency credit programs beyond 31 December and asked for the return of unused funds. The Fed has rightly objected to the instruction as it risks tightening financial conditions at the wrong time. The Fed is likely to ramp up QE in response but it’s a second-best move in terms of credit conditions. Mnuchin’s move looks designed to make life tougher for Biden.

Unfortunately, while new coronavirus infections remain very low in Australia (still averaging less than 20 a day with most being returned travellers) it has seen a new scare in South Australia with a cluster of cases linked to transmission from hotel quarantine. While local transmission is small (26 at the time of writing) the strain of covid brought in from the UK is reported to be highly contagious and has a 24 hour incubation and the lesson from China, Victoria and elsewhere is that the earlier a lockdown is started the quicker the outbreak is brought under control and economic damage can be minimised. So, SA has introduced a severe six day lockdown as a circuit breaker – which should more than cover the incubation period for the current strain. The national economic impact from SA’s lockdown is likely to be minor versus Victoria’s as hopefully this lockdown being earlier will be far shorter and because SA is only 7% of the Australian economy compared to 25% for Victoria. Fingers crossed but yet again Australia’s ultra-low tolerance for the virus is being demonstrated which adds to confidence that deaths will be minimised and the economy can continue to reopen with confidence. So far Australia has had 907 deaths from coronavirus. If we had the same approach as the US with the same deaths per capita we would have had 19000. So that’s more than 18,000 people saved. Thankfully I live in The Lucky Country run by sensible people.

In the meantime, helped along by the reopening in Victoria our Australian Economic Activity Tracker rose further over the last week and is trending up nicely helped by Victoria’s reopening consistent with ongoing recovery. Most components are trending up.

Squattergate is dragging on in the US with Trump still tilting at election result windmills and sacking those who disagree. But it’s looking ever more hopeless for him. Biden is now nearly 6 million votes ahead in the popular vote. He has decent margins in the states Trump is contesting on the grounds that votes for Biden were “illegal” (being 10,000 ahead in Arizona, 12,000 ahead in Georgia and that’s after a recount, 20,000 ahead in Wisconsin, 82,000 ahead in Pennsylvania and 156,000 ahead in Michigan). Trump’s court actions have not met with much success after failing to produce evidence to support his claims of fraud. And it’s doubtful that Trump’s fall-back plan of convincing Republican state legislatures that the election was fraudulent and that they should pick their own pro-Trump electors will meet with much success either with eg Republican leaders in Pennsylvania saying it’s not an option. The increasing hopelessness of the cause may explain Rudy Giuliani’s press conference meltdown. Of course, Trump’s actions all seem aimed at increasing division within the US with the result that US democracy gets trashed in the process. The risk remains that between now and Biden’s inauguration Trump will do things to make things more difficult for the new Administration with Mnuchin’s move to end various Fed credit programs being a possible example.

The return of cryptocurrency mania – well maybe not quite – but should investors jump aboard the bitcoin bandwagon? Bitcoin has surged nearly 80% from its September low and its up 260% from its March low and looks to be pushing towards its 2017 high – so what’s driving it and should investors jump on the bandwagon? As we noted back in August there are several things to bear in mind in relation to bitcoin. First the rebound in bitcoin and other cryptos is reflecting the same pressures as the rebound in several commodities: a 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 helped by an eventual vaccine may work which is also pushing up commodity prices generally. Second, bitcoin and other crypto currencies generate no income directly (although with some financial engineering some may claim otherwise) and this makes them hard to value and so highly speculative – which in turn leaves them very vulnerable to speculative booms and busts. Third, the supply of crypto currencies taken together is unlimited potentially making them less reliable than traditional paper money in advanced countries. Fourth, we will likely go down the path of using digital currencies, but I suspect governments and traditional central banks will provide them (eg various central banks including the RBA are looking into them). Fifth, if bitcoin is really a currency then it should be a good store of value – but it’s a been an unreliable store of value being highly volatile relative to the value of paper currencies (don’t forget it peaked at over $US19,000 in 2017 before falling to $US3,157 in 2018 and is now just getting back to $US18,000 again). The $A50 in my wallet has been far more stable in terms of what it can buy. The $US likely has more downside and bitcoin may have much more upside – but there are fundamentally sounder ways to play the global reflation trade than via bitcoin and other cryptos.

Is this the beginning of the end for stamp duty on property transactions in Australia? Normally Australian state budgets are rather boring – but not this year. The NSW state budget certainly offered plenty of excitement with around an extra $15bn in stimulus this financial year with more spending on infrastructure, vouchers to boost spending in restaurants and increased payroll tax thresholds for business. But of most interest is a plan conditional on community consultation to give home buyers the choice of paying stamp duty up front or a much smaller annual property tax levied forever on the property. This would be a hugely positive tax reform as stamp duty is a very distortionary tax which weighs on GDP and such a reform would make it easier to get into the property market, upgrade and downsize which would make for better use of our stock of homes. A shift to property tax from highly cyclical stamp duty would make for a much smoother revenue stream for the government but since there would be a revenue short fall up front that would have to be covered by state government borrowing it makes sense to do it now as borrowing costs are ultra-low. While the government will still aim to collect the same revenue over time from property the shift (that is estimated to take 20 years just for half the state’s property) should not alter the underlying value of properties. But as we have seen with other tax changes it could cause a short term distortion – with some homebuyers holding off purchasing ahead of the change (slated for second half 2021), then a rush into the market when the change occurs (pushing prices up) and then a longer term settling down. No doubt there will be a few hiccups, but it makes sense for other states to do the same.

While noting that the pandemic will leave its mark on the economy including via higher unemployment, RBA Governor Lowe struck a generally optimistic note over the last week seeing Australia as being “on the road to recovery”. But from his speech and the minutes from the last board meeting the overall dovish message from the RBA remains – while negative interest rates can’t be ruled out if say the Fed goes down that path they remain extraordinarily unlikely with the focus now being on quantitative easing of which the RBA is prepared to do more of if needed. However, its hardly surprising that he is not too keen on Modern Monetary Theory (of which he points out there is not much really off all three in MMT) on the grounds its hard to fine tune fiscal policy, the pollical system may find it hard to just turn off monetary financing once inflation picks up and there is no free lunch. While I have no problem with what the RBA is doing now in terms of QE, I must profess to having similar concerns to Governor Lowe with full blown MMT.

Sticking to the California folk/pop/rock sound, The Beach Boys have to be included as they played such a huge role in the evolution of that sound. God Only Knows is one of their best – its almost like a hymn and starts off with an argument and highlights Carl Wilson’s beautiful voice. Paul McCartney described it as “the greatest song ever written” which made Brian Wilson uncomfortable because if that was true “what was there left for me to do?”. Brian and Paul actually sang it as a duet together in 2002 at an Adopt-A-Minefield benefit concert.

Major global economic events and implications

US data was mixed with strength in home building conditions, housing starts, home sales and industrial production, but a slowing in retail sales growth and business conditions in the New York and Philadelphia regions although both are still solid and a rise in initial jobless claims. Fed Chair Powell remained dovish.

The European Union’s €750bn recovery fund hit a snag with Poland and Hungary seeking to veto it in retaliation for a condition that funds can only be disbursed to countries that meet key democratic requirements. This could just be usual 11th hour EU negotiations stuff and a way around it could be to exclude Poland and Hungary from the fund but in the meantime it puts more pressure on the ECB to do more.

Japanese September quarter GDP rebounded by a stronger than expected 5%qoq on the back of a shutdown driven 8.2% slump in the June quarter. Unfortunately, Japan’s composite business conditions PMI for November fell slightly to 47 suggesting some loss of recovery momentum and lots of spare capacity is still bearing down on inflation with core CPI inflation falling to -0.2%yoy in October.

Chinese economic activity data for October showed its economic expansion continuing with growth in industrial production remaining strong at 6.9% year on year and growth in retail sales and investment accelerating, unemployment falling and home prices continuing to rise albeit at a slower rate.

Australian economic events and implications

Australian economic data was mostly good consistent with reopening and the uplift in the Economic Activity Tracker referred to earlier. On the jobs front employment rose by a surprisingly strong 179,000 in October as Victoria started to reopen but unemployment rose to 7% as participation rose. So far 75% of the jobs lost in April and May have been recovered. The bad news is that unemployment and underemployment remains high and the return of the remaining 225,000 or so lost jobs will likely occur more slowly and this will weigh on wages growth which slowed to a record low of 1.4% over the year to the September quarter. The good news is that recovery so far has come through faster than expected – thanks to good virus control and massive government support measures – and effective unemployment has plunged to 7.8% from 14.9% in April holding out the prospect that we may now have seen the worst in terms of unemployment.

In terms of other data, retail sales rose 1.6% in October as Victoria started to reopen leaving them well above trend partly due to the diversion of spending from services and travel to retail goods and eating out, SEEK new job ads continue to recover, new home sales remained elevated in October helped by HomeBuilder and the value of loans with deferred repayments has fallen 65% from its mid-year peak as more borrowers resume repayments in turn heading off a surge in distressed property sales.

According to an ABS survey 40% of Australian’s are still working from home at least one day a week and 30% are doing so on most days. Working from home will likely drift down as the medical threat eventually declines but its likely to settle around 2-3 days a week for most office workers being an optimal trade-off in terms of the need for team work and collaboration versus productivity, work life balance and reduced transport costs.

What to watch over the next week?

In the US, expect November business conditions PMIs (Monday) to fall back a touch from strong readings for October due to rising coronavirus cases and tightening restrictions, consumer confidence to also weaken but home prices to show solid gains (both due Tuesday), growth in durable goods orders and personal spending for October to slow a bit but new home sales (all due Wednesday) to show a solid rise. The minutes from the Fed’s last meeting (also Wednesday) are likely to be remain dovish and core private final consumption deflator inflation for October is expected to have fallen to 1.4% year on year.

Eurozone business conditions for November (Monday) are likely to be softish reflecting lockdowns as are confidence readings (Friday).

Australian business conditions PMIs for November (Monday) are likely to have remained solid reflecting Victoria’s reopening. September quarter construction data (Wednesday) is expected to show a 0.6% gain and September quarter business investment (Thursday) is expected to have risen 0.4% – both after falls in the June quarter. Key to watch will be business investment intentions for the current financial year which we expect to rise. Victoria’s budget (Tuesday) will be watched for more policy stimulus and for whether it follows NSW down the path away from stamp duty.

Outlook for investment markets

Shares remain vulnerable to further short-term volatility given uncertainties around coronavirus, economic recovery and President Trump. But we are now into a seasonally strong period of the year for shares and on a 6 to 12-month view shares are expected to see good total returns on the back of ultra-low interest rates and a pick-up in economic activity helped by a possible vaccine.

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 benefit 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 boosted by ever lower interest rates, government home buyer incentives, income support measures and bank payment holidays but higher unemployment, a stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney into next year. Outer suburbs, houses, smaller cities and regional areas are in much better shape.

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 China tensions and RBA bond buying will keep it lower than otherwise, a continuing rising trend is likely to around $US0.80 over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar.