Investment markets & key developments

Global share markets rebounded over the past week on indications that Omicron may only be resulting in mild cases. The positive global lead along with continuing RBA dovishness on interest rates also pushed the Australian share market higher for the week led by utilities, retailers, property and energy stocks. Reflecting the risk on tone bond yields, metal prices, oil prices and the $A all rose.

The 5% or so pull back in share markets on the back of Omicron and the Fed becoming more hawkish just looks like it was a normal correction after markets had become overbought again. Historically share market seasonality turns more decisively positive from mid-December. Of 22 cases of negative Novembers in the US share market since 1950, 19 were followed by gains in December. Of course, much will depend on Omicron.

Omicron looking less threatening, but… The bad news is that Omicron is clearly looking more transmissible than Delta (possibly 4 times more) and its likely to weaken the protection provided by existing vaccines. But the good news is that its looking like it results in milder symptoms and the loss of vaccine efficacy may be countered by a booster dose. South African data shows a surge in new cases but a milder rise in hospitalisations with a lower share of patients in ICU & on ventilators and shorter hospital stays.

There is still more time required to be confident on Omicron and even if it results in a lower hospitalisation rate, hospitals could still be overwhelmed if its greater transmissibility results in many more getting it at the same time – hence there is a case to return to some restrictions (like we have seen in the UK with work from home and mask and vaccine mandates). But while this may slow the economic recovery, it would unlikely be enough to derail it. And if Omicron due to its greater transmissibility comes to dominate the other variants it could turn out to be a good thing as it could put Covid-19 on to a path to becoming like the common cold or flu.

Evergrande’s “restricted default” in relation to its $US19bn of US dollar debt is no Lehman’s moment. While investors in it’s US dollar debt will likely suffer losses its unlikely to cause major problems: it’s been anticipated for months; a default on $US19bn in debt is in line with other global corporate defaults in recent years and small compared to Lehman’s $US140bn default; Evergrande is on a path to restructuring rather than a disorderly default on its domestic Renminbi debt; its only 0.1% of Chinese bank debt; policy makers have moved to cushion the impact on the Chinese economy by moving towards a pro-growth stance, easing monetary policy and signalling an easing in property tightening measures. So Evergrande is unlikely to pose a major threat to Chinese, global or Australian growth.

US debt ceiling pushed out to after the mid terms. Basically, Senate Republicans and Democrats agreed a deal which allows the Democrats to raise the debt ceiling past the mid terms out to 2023 without the Republicans actually having to vote for it. So the Democrats can avoid a crisis on this front and go back to resolving the Build Back Better plan and the Republicans can then campaign against “profligate spending” under President Biden in the mid-terms. All good for now but it likely means a very rough time for the Biden Administration in raising the debt ceiling again in 2023 (as by then the GOP will likely control one or both houses of Congress) – think 2011 or 2013!

No surprises from the RBA – dovish on rates but it will be data dependent. While the timing of when the RBA will start to raise rates remains the subject of much debate – with the RBA presumably still leaning towards 2024, possibly 2023 but not 2022 – ultimately it will be dependent on “the latest data and forecasts”. Our view remains that the economy and jobs market will be a bit stronger than the RBA is allowing for next year – pushing the unemployment rate down to 4%, wages growth up to the 3% pace its looking for and with slightly higher inflation – thereby putting in place the conditions for rate hikes which we expect to start in November next year followed by another hike in December taking the cash rate to 0.5% by end 2022.

Get Back. When I started watching The Beatles: Get Back, which saw over 60 hours of film footage of The Beatles from January 1969 cut back to nearly 8 hours spread across 3 episodes, I thought this could be boring. But when seeing McCartney and the band work on songs such as Get Back, Another Day, The Long and Winding Road, Carry That Weight, She Came In Through The Bathroom Window and George Harrison with All Things Must Pass I found that it provides an amazing insight into The Beatles at that time and how their songs came together. The original film cut in Let It Be has not been available since the 1980s reportedly because Paul McCartney and Ringo Starr were concerned about its depiction of The Beatles not getting on. Get Back presents a wider perspective.

Coronavirus update

Global coronavirus cases continued to rise over the last week, but its still early days in the Omicron wave.

US cases have started to pick up sharply over the last week – but this partly reflects a catch up after a Thanksgiving lull in reporting (which partly also explains the spike in deaths in the previous chart). Cases in Germany, Austria and the Netherlands have slowed helped by various restrictions but are now rising rapidly in France, Italy and Spain. Cases in Africa are continuing to rise with Omicron.

The surge in new cases reflects a combination of the earlier almost complete removal of restrictions, the onset of cold weather in the northern hemisphere, insufficient vaccination rates, fading efficacy against new infection, a slow start to boosters and now the more transmissible Omicron variant. The key to the threat the latest wave poses to the economic outlook remains whether vaccinations are successful in keeping hospitalisations down such that hospital systems can cope without lockdowns. The risk in relation to the Omicron variant is that while it may result in milder cases its greater transmissibility could still pose a problem if too many people get ill at once overwhelming hospital systems. This explains why various countries including the UK have returned some restrictions (work from home, mask & vaccine mandates – some of which still apply in NSW & Victoria!) after virtually eliminating them all, in order to slow new cases and ensure hospitals can cope. So far hospitalisation and death rates in Europe remain subdued relative to the wave a year ago.

This is also the case in the UK where hospitalisations and deaths are actually trending down.

45% of the global population are now fully vaccinated – but poor countries are just 18%. Vaccine mandates (now in much of Europe and the UK) are likely to boost this in developed countries but there is a long way to go in poor countries. Increasingly the focus will shift to booster shots with studies indicating a booster shot may be necessary to offset the reduced efficacy from just two shots against Omicron.

Australia at 75% of the population fully vaccinated is at the high end of developed countries. Only WA is yet to hit 80% of adults fully vaccinated, but its close at 79%. New coronavirus scares and the approval of vaccines for 5 to 11 year olds should take the percentage of the population fully vaccinated well beyond 80% and the booster program is set to speed up on evidence it will shore up defence against Omicron.

New cases are now rebounding in Australia with a further rise likely as Omicron spreads. So far, hospitalisations and deaths remain subdued – but will be the key to watch.

The fully vaccinated remain a low share of those getting covid.

Economic activity trackers

Our Australian Economic Activity Tracker was little changed over the last week remaining around pre-Delta levels after its recent reopening driven surge. Its rebound since the low in August suggests a 3% or so rise in GDP this quarter. By contrast our European and US Economic Activity Trackers remain weak partly in response to rising cases and restrictions not helped by the spread of Omicron.

Major global economic events and implications

Strong US labour market data. Job openings remain high and well above unemployment, quits remain high and jobless claims fell to a 52-year low. 3% unemployment is possibly on the way.

Japanese household spending rose again in October and economic sentiment improved further in November.
China’s December Politburo meeting signalled a shift towards boosting growth and supporting the property sector. It was quickly followed by a 0.5% reduction in banks’ required reserve ratio and further policy easing measures are likely. On the data front CPI inflation rose but core inflation fell to just 1.2%yoy and producer price inflation slowed implying little constraint here to further policy easing. Meanwhile, export growth remains strong and import growth accelerated. Total credit was weaker than expected in November but credit growth has stabilised at around 10%yoy.

Australian economic events and implications

In Australia it was a quiet week on the data front. ABS September quarter house price data confirmed the strong gains long ago reported by private data providers, ANZ job ads surged another 7.4% in November to be up 52.5%yoy and payroll jobs are now above pre-Delta levels confirming that the jobs market is very strong and the Melbourne Institute’s Inflation Gauge rose again in November with its trimmed mean measure of underlying inflation rising to 2.6%yoy and pointing to a further rise in underlying inflation this quarter.

The Federal Government’s budget numbers for the first four months of the financial year show the deficit running $8bn smaller than expected, despite billions in covid disaster payments.

Another rise in high debt to income housing lending keeps further macro prudential measures on the agenda. APRA September quarter housing data showed a decline in the share of high loan to valuation ratio loans but a further rise in the share of high debt to income ratio loans which is a key concern of the RBA and APRA at present.

What to watch over the next week?

The focus in the week ahead will be on central banks with the Fed, ECB, BoE and Bank of Japan all meeting.

In the US, the Fed (Wednesday) is likely to announce a faster taper of its bond buying in response to stronger economic data & higher inflation risks – taking its monthly reduction in bond buying each month from $US15bn currently to around $US25bn. While Fed Chair Powell may try to separate this from when interest rates will start to rise it will clear the way for a first rate hike in the June quarter and the so-called median dot plot of Fed officials’ interest rate expectations is likely to move from one rate hike next year to three. Talk of quantitative tightening may also begin but is unlikely until 2023. On the data front in the US expect a solid increase in retail sales and strong readings for home building conditions (Wednesday) and a solid rise in industrial production, strong housing starts and the December composite business conditions PMI remaining strong at around 57 (Thursday).

The ECB (Thursday) is likely to remain dovish on rates but will be watched for what it plans regarding asset purchases after its pandemic emergency bond buying program ends early next year but the net impact will likely be to allow some reduction in bond buying. Eurozone PMIs (also Thursday) may slip a bit further from the level of 55.4 for the composite as the latest coronavirus wave continues to impact.

In the UK its 50/50 as to whether the Bank of England (Thursday) will raise its cash rate in response to inflation or wait till early next year given Omicron risks. There is a big difference between the Fed & ECB which are making decisions around tapering (ie still easing but at a slower rate) and the BoE which is considering rate hikes (ie monetary tightening).

The Bank of Japan (Friday) is likely to leave monetary policy on hold – with inflation being stuck around zero. The Tankan business survey (Monday) and PMIs for December (Thursday) are likely to see a further recovery.

Chinese data for November (Tuesday) is expected to be mixed with a rise in the growth rate of industrial production but a slight slowing in retail sales and investment growth.

In Australia, the Federal Government’s Mid Year Economic and Fiscal Outlook (Wednesday) is likely to see the projected budget deficit this year revised down to around $70bn (from $107bn projected in the May Budget) allowing for the improvement in the budget seen already reflecting lower unemployment and stronger corporate tax revenue. However, allowance for $20bn in pre-election fiscal stimulus is likely to see only a $10bn improvement in the deficit for 2022-23 to $89bn from the $99bn deficit projected in May. Meanwhile, expect strong readings for business confidence (Tuesday) and consumer confidence (Wednesday) and November jobs data (Thursday) to show employment up 180,000, the participation rate rising to 65.4% and unemployment falling back to 5%.

Outlook for investment markets

Shares remain vulnerable to further short-term weakness given the rebound in coronavirus cases globally and the new Omicron variant, the inflation scare, less dovish central banks and the slowing Chinese economy. But we are now coming into a stronger period seasonally for shares and the combination of solid global growth and earnings, vaccines allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months. However, inflation and interest rate concerns will likely result in rougher and more constrained gains than we’ve seen since March last year.

Expect the rising trend in bond yields to continue as it becomes clear the global recovery is continuing, resulting in capital losses and poor returns from bonds over the next 12 months.

Unlisted commercial property may still see some weakness in retail and office returns but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.

After rising by around 22% this year Australian home price gains are likely to slow to around 5% next year as poor affordability, rising fixed rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact. Ultimately giving way to a 5-10% price fall in 2023.

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

Although the $A could fall further in response to the latest coronavirus threats, tightening Fed policy and the weak iron ore price, a rising trend is likely over the next 12 months helped by still strong commodity prices and a cyclical decline in the $US, probably taking the $A up to around $US0.80.