US shares hit another record high mid-week only to be reversed by the end of the week because of a big fall in tech shares, which have been driving the rebound in US equities since the March lows. The US S&P is down by 1.5% over the week, with the tech sector (which has the biggest weight in the index) down 2.8%, consumer discretionary (which includes Amazon) is down 1.1%, health care and energy also lagged behind while utilities and materials bucked the trend and rose. There were signs over recent weeks of some rotation away from US tech shares towards more cyclical parts of the market and this trend could continue for the short-term but a big collapse in tech stocks, like in the 2000’s is unlikely for now. Tech shares benefit from low inflation and low interest rates which is here to stay for the next year at least. While valuations and growth outperformance of the “Awesome 8” (as coined by BCA research) – Amazon, Apple, Facebook, Alphabet, Microsoft, Netflix, Nvidia and Tesla look very expensive compared to the rest of the market, earnings of these companies have also risen significantly and the current Nasdaq price-to-earnings ratio of 32 of is well below the 65 at the peak of the Dotcom boom (see chart below).

The $US was up by 0.4% this week but is likely to continue its downtrend as global growth picks up and the US Federal Reserve does more quantitative easing compared to other central banks. The $US is at its lowest levels since May 2018. US 10 year bond yields fell this week to 0.63% after reaching 0.72% last week on higher inflation concerns. Bond yields will remain constrained while the US central bank pursues its aggressive stimulus program.

Across other sharemarkets, Australian shares had a big 2.4% fall over the week, European shares fell by a lesser 0.3%, Chinese equities are down by 1.9% while Japanese shares are up by 1.3% (higher from investments made by Warren Buffet). The $A weakened slightly to 0.72 US dollars. Across commodities, metals were generally weaker except for iron ore (which is $127/tonne!) and energy prices were also down.

Generally, COVID-19 cases continue to track around 265K/day, which is fairly stable on recent weeks. Developed economies cases have slowed (driven by lower US cases) while emerging market cases continue to rise (see chart below).

Eurozone cases are also on the rise (see chart below), especially in France and Spain and are starting to reach the same levels that were seen back in March.

All countries are grappling with the trade-off between reopening the economy and managing COVID-19 cases. The good news is that in most developed countries, the second-wave has been less deadly than the first (see chart below for the US experience) which shows greater protection of vulnerable groups (aged care facilities) and better knowledge of therapeutic treatments for symptoms.

Unfortunately, the same cannot be said for Australia which has had a more deadly second wave in Victoria (see chart below) which shows poor management of COVID-19 in aged care. But it is good to see daily cases back down to around 100 or so.

There was more excitement about vaccine developments this week as the US Centre for Disease Control and Prevention told states to prepare for “limited doses” of a COVID-19 vaccine by 1 November (coincidentally close to the Presidential Election…?). Given that there a few countries currently testing their vaccines in phase 3 trials. our view is by mid-2021 around 20-30% of the global population (the most vulnerable groups) will have access to a vaccine. There is a question about whether the vaccine would be taken by the population but most global surveys show that around 50% of people say “yes” to a vaccine and another 25% say “maybe”. I’m curious to see what my peers think about taking an Australian approved vaccine – would you take one if it was offered in the next 6 months? Email me with your thoughts!

Speaking of the US Presidential election , the probability of Trump winning the election has risen over recent weeks (see chart below) from a low of 38% (at the peak of the US COVID-19 crisis) to around 45% The better the COVID-19 case count, the better the chances for Trump in November, despite the fact that the US is in a recession.

Our US Weekly Activity Tracker (which includes high frequency economic indicators like credit card spending, mobility, job advertisements, foot traffic and confidence) continues to trend a little higher (see chart below) while the Australian Weekly Activity tracker has deteriorated again over the past week from falling foot traffic, lower credit card spending and a deterioration in confidence with Victoria probably leading the falls here.

Major global economic events and implications

Following the US Federal Reserve’s update to its monetary policy framework, there is now some market expectation that the US Fed will make a change to its forward guidance at the September meeting. Fed speeches this week offered little clarity about what this would look like unfortunately. Fed Vice Chair Clarida gave a speech about the new framework but just reiterated the average 2% inflation target and noted that yield curve control was not yet warranted, although didn’t totally rule it out. Fed Governor Brainard said there was a need to align Fed policy to its new strategic framework, which does indicate the need for more stimulus or very dovish forward guidance, but it’s not clear when this will come. Chicago Fed President Evans spoke about the need for more US fiscal policy.

The US Fed Beige Book showed that the various Fed districts optimism around the recovery may be waning although the data shows a different story. For now, the “V-shaped” recovery remains intact with factory orders up by 6.4% in July. Business conditions are positive, and the August manufacturing ISM index rose to 56, from 54.2 in the prior month although the alternative Markit manufacturing PMI reading was revised down to 53.1 in August. The components of the ISM are also very encouraging, with the employment sub-index erasing all COVID-19 losses which is good forward-looking sign for jobs. The services ISM was 56.9, a little below the 58.1 last month but still solid and in line with expectations.

Eurozone consumer prices fell by 0.4% in August, confirming the deflationary environment, with core consumer prices a very low 0.4% over the year. Eurozone retail sales showed some moderation and fell by 1.3% in July, after a huge surge in the post-lockdown months. Despite some rise in COVID-19 cases again in Europe, third quarter Eurozone GDP is expected to be very strong, at over 7% over the quarter.

Japan’s industrial production jumped by 8% in July, with demand for autos surging. But retail sales fell by 3.3% in July.

China’s gauge of business conditions remains good with the manufacturing PMI index at 51 although it is slightly lower than last month at 51.1. The heavy rain and flooding in some regions would have weighed on activity. In contrast, the Caixin (small business) manufacturing PMI increased more than expected in August to 53.1 its highest level since early 2011, so there a divergence between small and larger firm business confidence. The non-manufacturing PMI was much stronger at 55.2 in August versus 54.2 in July.

India’s GDP fell by 29.3% in the June quarter, one of the worst declines around the world. Unfortunately the continued rise in COVID-19 cases doesn’t bode well for near-term growth.

Australian economic events and implications

Australian GDP fell by 7% in the June quarter, which was worse than the latest market expectations but better than had been expected around April when many were forecasting a 10% or so decline. This is the worst quarterly decline on record (the quarterly data only goes back to 1959). But annual GDP growth has declined to 6.3% which looks to be the worst since 1930-31 which saw financial year GDP fall by 9.4%. Australia has fared relatively well in the June quarter downturn compared to other countries around the world (see chart below) which all had various levels of lockdowns or restrictions.

However, given the stricter lockdown in Melbourne since early August and the other restrictions across the rest of Victoria, the outlook for GDP growth in the September quarter is for another negative quarter of growth (albeit a much smaller decline than the June quarter) whereas growth in a lot of other global counterparts (like the US) looks to be in a cyclical upswing as low interest rates and government fiscal stimulus boost economic growth. After this low point in Australian GDP (which we think will be the September quarter), there will be a need to fill the growth pothole left by the COVID-19 pandemic, so the pressure will remain on the Reserve Bank and Federal and state governments to provide additional support to the economy. Federally this is likely to come in the form of a bring forward of tax cuts and tax incentives to boost consumption and investment possibly in next months budget. And we now see the RBA in the months ahead cutting the cash rate to 0.1%, increasing and broadening its bond buying program and adopting an even more dovish commitment to not raise rates until inflation is actually and sustainably back in the 2 to 3% target band.

The RBA unsurprisingly left the cash rate on hold at its meeting this week. But, it did extend its Term Funding Facility which is a form of low cost funding to the banks (at a rate of 0.25%) out to June 2021 (previous expiry was 30 September 2020) and increased the total amount in the facility available to $200bn (previously it was $84bn). Cheap funding facilities for the banks support the flow of funding to the rest of the economy (households and businesses). The RBA’s post-meeting statement was dovish and the central bank added the words that its “considering further monetary measures” which fits into our view of more monetary easing.

The Reserve Bank’s credit data showed another fall in credit, down by 0.1% in July with annual growth stepping down to 2.4%. Personal credit and business credit both fell. Housing credit only rose by 0.2% in July, with owner-occupied credit much stronger than investor credit, which declined again.

The AiG Performance of Manufacturing Index fell into contraction in August, to 49.3 from 53.5. But the CBA Manufacturing PMI is stronger at 53.6 in the final August reading. Monthly CoreLogic home price data showed a smaller fall in home prices, of 0.5%, rather than the 0.8% decline in the prior month. July building approvals surged by 12% in July, despite expectations for a fall. And retail sales rose by a strong 3.2% in July.

What to watch over the next week?

Australian July housing finance should show a bounce in lending, August ANZ job advertisements may weaken again from the Victorian lockdown, weekly payroll data for the week ending 22 August will show more impacts of the Victorian lockdown, August NAB business confidence is likely to be weak again because of the Victorian situation and September consumer confidence is likely to show a fall. Australia, Victorian Premier Dan Andrews is set to announce a roadmap for reopening the economy this weekend.

US non-farm payrolls should rise again in August, by around 1.4 million people and the unemployment rate should decline to 9.8% from just over 10%. Other data includes the NFIB August small business confidence reading and August consumer price data.

In China, the August trade balance is released along with August consumer prices.

The European Central Bank and Bank of Canada meet but no major change to policy is expected from either central bank.

Outlook for markets

After a strong rally from March lows shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. But on a 6 to 12-month view shares are expected to see good total returns helped by a pick-up in economic activity and 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.

Australian home prices at present are being protected by income support measures and bank payment holidays but higher unemployment, a stop to immigration and rent holidays will push prices lower into next year. Home prices are expected to fall by around 10%-15% from their April high. Melbourne is particularly at risk on this front as its Stage 4 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 $A is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and US/China tensions, a continuing rising trend is likely. Particularly with the US expanding its money supply far more than Australia is via quantitative easing and with China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).