Investment markets and key developments over the past week

While US shares fell fractionally over the last week despite a bounce in tech stocks, Eurozone, Japanese and Chinese shares rose. Australian shares also fell fractionally over the last week with strong gains in industrial and material shares being offset by weakness in utilities, energy, retail and health care stocks. Bond yields generally rose slightly but metal, iron ore and oil prices fell with the latter down on forecasts for reduced oil demand. The $A fell with the $US continuing to rise.

Markets had a brief flutter over the last week on news of the liquidation of holdings of Archegos Capital Management and the usual “worries that there may be more out there”. With a name like arch egos I fear it may have been doomed to failure from the start! I guess there is always something – but at least the previous week’s doom and gloom story about a ship stuck in the Suez Canal gave way as it became unstuck. I reckoned that if the Pasha Bulker can be dislodged from the surf beach in Newcastle then surely it was going to be easier to free the Ever Given in the Suez Canal. Funnier was VW’s (April Fool’s Day joke) announcement that it would rebrand VW America as Voltswagen – some thought it was serious though and went bonkers on social media.

Bond markets have been a bit more stable lately – particularly outside the US – helped by a combination of central bank action, the renewed rise in global coronavirus cases and a pause after bond markets became oversold. But it’s still too early to conclude that the bond tantrum is over and there could still be more upwards pressure on yields ahead as headline inflation spikes higher and economic recovery continues. This could in turn drive more volatility in shares. However, we remain of the view that the cyclical bull market in shares that started in March last year still has a long way to go given spare capacity in jobs markets and still low underlying inflation, shares still offering a decent earnings yield gap to bond yields all combined with the economic and profit recovery and central banks including the Fed and the RBA being a long way from rising interest rates.

President Biden confirmed that even more government spending is on the way in the US with the announcement of a planned $2.3 trillion infrastructure spending program. This is expected to be part of a total $3trn to $4trn plan with more to come on health care, education and possibly climate. Coming on top of last year’s $2.3trn stimulus, $600bn earlier this year and the just passed $1.9trn coronavirus package it is seen by some as adding to concerns about too much stimulus. However, the latest package comes with lots of qualifications: the spending will be spread over eight years; it will be partly financed by tax hikes (with a plan to hike corporate taxes including taking the corporate tax rate to 28% already announced and other tax hikes including for the top income tax rate yet to be announced); and it will face more challenges in getting through Congress so may be watered down and will take longer to pass. Moderate Democrats will likely also water down some of the tax hikes weakening concerns share markets may have about them. In terms of overall fiscal policy, after this year’s huge stimulus fiscal policy will move into fiscal drag next year as the next package is spread over many years and with tax hikes being front loaded (even if they are lower than Biden has proposed) this will particularly be the case. But with reopening and massive pent up demand this fiscal drag may matter less than normal.

In Australia, surging house prices are becoming an increasing concern with March CoreLogic data showing their fastest monthly increase since the late 1980s.

The booming property market indicates that macro prudential tightening is likely getting closer in Australia. While APRA and the RBA don’t have a mandate to target house prices and are of the view that we have not yet seen a significant deterioration in lending standards on the metrics they look at, past experience indicates that surging house prices like we are seeing now leads to a deterioration in lending standards and increasing financial stability risks. And the metrics they look at are starting to push in the direction of a deterioration in lending standards with record housing finance pointing to an acceleration in housing credit growth, an increasing share of lending at high loan to valuation ratios and a rising share of interest only loans (albeit both from a low base but the data only goes up to late last year with further increases likely since then – see the next chart). All of which suggests that it makes sense to start tapping the lending standard’s brake soon. The first thing to do would be to increase interest rate buffers used by banks to assess how much people can borrow, but limits on high loan to valuation ratio lending and high debt to income ratio lending may make sense too.

So far, the surge in housing finance in Australia has been driven by first home buyers and owner occupiers generally but their share looks to be peaking (with both down in February) and investor lending is continuing to hot up with a 4.5% rise in February suggesting the property market may be becoming more speculative.

Global vaccine rollout continues to gather pace and numerous studies across several countries now confirm their efficacy in preventing infection and particularly in heading off serious illness, hospitalisation and death. Concerns remain in some countries about the Astra Zeneca vaccine and blood clotting although it’s not clear how big an issue this is. Vaccine production is also continuing to ramp up and herd immunity (at around 70% of the population) in most developed countries should be reached in the second half, although it may be earlier in the US where 30% have had one dose but vaccination is now running at nearly 3 million people a day.

Despite the good news on vaccines, new coronavirus cases globally have been trending up for a few weeks now and new deaths are starting to follow. To a large degree this reflects emerging countries like Brazil and India, but is also evident in Europe apart from the UK and Japan and Canada where vaccination is still low. However, new cases are also edging up in a majority of US states albeit from a low base, providing a reminder that there is a danger in reopening too quickly well before herd immunity is reached – even though the vaccine rollout in the US is rapid and speeding up herd immunity is still 3 months or so away.

While new coronavirus cases remain low in Australia, the latest “escapes” from the returned traveller quarantine system in Queensland have led to more clusters of local cases and led to brief lockdowns in Brisbane and tighter distancing restrictions around Byron Bay. Providing any lockdowns remain short (with the Brisbane lockdown ending after just one more local case was reported on Thursday) and geographically contained then the economic impact should be minor – like the snap lockdowns already seen this year. But they are still very disruptive to those affected and put a big dampener on Australians booking interstate holidays. More rapid vaccination should help put an end to the lockdowns, but with only around 2.6% of the Australian population having been vaccinated herd immunity is likely six months or more away.

Our Australian Economic Activity Tracker held at a strong level over the last week suggesting the recovery continues, although the brief Brisbane lockdown may depress things a little in next update. Our US Economic Activity Tracker was little changed and remains down on a year ago and our European tracker softened a bit not helped by news of ongoing lockdowns.

One of my favourite songs is Frankie Valli’s Can’t Take My Eyes Off You from 1967. This is pop at its best! It was quickly covered by other singers including Andy Williams which resulted in my favour version which Andy revisited with Denise Van Outen in 2002. The Pet Shop Boys did a clever cross of U2’s Where The Streets Have No Name with Can’t Take My Eyes Off You showing that the former is as much light pop as the latter.

Major global economic events and implications

US economic data releases have remained strong with good gains in consumer confidence, solid house price increases, strong jobs data and strong business conditions indicators for March, although pending home sales were depressed by the bad weather in February.

Eurozone economic sentiment across consumers and businesses rose strongly in March consistent with a stronger than expected improvement in business conditions PMIs. Headline CPI inflation rose as last year’s deflation started to drop out but core inflation actually fell to 0.9%yoy from 1.1% in February.

Japanese data was mixed with an improvement in Tankan business sentiment readings, flat unemployment in February but a slight fall in the ratio of jobs to applicants and a fall back in industrial production.

Chinese official business conditions PMIs rose solidly in March particularly for non-manufacturing after a brief covid/policy tightening lull in January and February suggesting that growth remains strong. The Caixin manufacturing PMI softened slightly though.

Australian economic events and implications

Australian data was mostly strong. The ABS confirmed that retail sales fell in February but by a less than first reported decline of -0.8% as lockdowns in Victoria and WA impacted but with a rebound likely in March. Meanwhile, home prices rose 2.8% in March which was their fastest pace since 1988, credit growth was soft but another strong reading in housing finance commitments (they fell -0.4% but after a 10.5% surge in January and they are up 49% on a year ago) points to a further acceleration in housing credit growth, building approvals surged in February helped along by HomeBuilder, the AIG’s manufacturing PMI was very strong in March, the ABS’ survey of job vacancies confirmed the strength in the labour market with a 13.7% rise over the 3 months to February leaving them up nearly 27% on a year ago as did a rise in payroll employment above year ago levels and the trade surplus remained big in February, albeit less so than expected.

Don’t expect a flood of forced property sales following the end of bank payment holidays. APRA data shows that the share of home loans by value still on payment deferrals had collapsed to just 0.7% in February. Small business loans on deferrals have also collapsed. Government support measures and record low rates have done their job.

What to watch over the next week?

In the US, the services conditions ISM (Monday) is expected to rise to a strong reading of 58, job opening and hiring data for February (Tuesday) is expected to show a further improvement, the minutes from the Fed’s last meeting (Wednesday) will likely reinforce the Fed’s dovish message and producer price inflation (Friday) is likely to show ongoing inflationary pressures.

Chinese CPI inflation for March (Friday) is likely to show a further lift to 0.4%yoy (from -0.2%) with PPI inflation rising to 3.3%yoy. Money and credit data may also be released.

In Australia, the RBA is expected to leave monetary policy on hold following its meeting on Tuesday and reiterate that: it does not expect to raise interest rates to 2024 at the earliest as it wants to see a much tighter jobs market and much stronger wages growth; that it remains committed to the 0.1% three-year bond yield target; and that it is prepared to make further adjustments to its bond purchases if necessary. Fortunately, the stabilisation in bond markets and some softening in the $A has taken some pressure off. The focus will likely be on the RBA’s assessment of the resurgence in the property market which will also be the main thing to watch in the RBA’s Financial Stability Review to be released Friday.

Outlook for investment markets

Shares remain at risk of further volatility from rising bond yields and coronavirus related lockdowns. But looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and still low interest rates augurs well for growth assets generally over the next 12 months.

We are likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns – like technology and health care stocks and bonds – to investments that will benefit from recovery – like resources, industrials, tourism stocks and financials.

Global shares are expected to return around 8% over the next year but expect a rotation away from growth heavy US shares to more cyclical markets in Europe, Japan and emerging countries.

Australian shares are likely to be relative outperformers helped by: better virus control enabling a stronger recovery in the near term; stronger stimulus; sectors like resources, industrials and financials benefitting from the rebound in growth; and as investors continue to drive a search for yield benefitting the share market as dividends are increased resulting in a 5% grossed up dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7200.

Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.

Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield but the hit to space demand and hence rents from the virus will continue to weigh on near term returns.

Australian home prices are likely to rise another 15% to 20% over the next 18 months to 2 years being boosted by record low mortgage rates, economic recovery and FOMO, but expect a slowing in the pace of gains as government home buyer incentives are cut back, macro prudential tightening kicks in and immigration remains down relative to normal.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.

Although the $A is vulnerable to bouts of uncertainty and RBA bond buying will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar, probably taking the $A up to around $US0.85 by year end.

Important information

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.