Market Update 10 July 2020

Investment markets and key developments over the past week

Share markets were mixed over the last week as investors were torn between rising coronavirus cases and US/China tensions on the one hand but indicators of recovery and policy stimulus on the other. US shares rose but gave up some of their initial gains, Eurozone shares fell, Japanese shares rose and Chinese shares surged by 9% or so. Australian shares fell on the back of fears about the economic impact of Melbourne’s return to lockdown with property, healthcare, industrial, retailers and energy stocks being the hardest hit. Bond yields fell. Oil prices fell but metal prices rose, and the iron ore price rose to its highest since August last year. The Australian dollar was little changed.

The past week has seen more disappointing coronavirus news globally, with the daily number of new reported cases now running at over 200,000.

As has been the case for the last few weeks now this reflects emerging countries (notably Brazil, India, Mexico & South Africa) along with southern and western states in the US. Fortunately Europe, having taken a more cautious approach to reopening, is continuing to keep new cases down despite periodic outbreaks in various European countries.

In Australia, Victoria has seen a continued surge in new cases pushing up Australia’s new case count and leading to a new six week “stay at home” lockdown of Melbourne.

Clearly the coronavirus epidemic globally is still far from being controlled and even countries (like Australia and Israel) that had initial success in bringing it under control are at risk of renewed flares up if small outbreaks are not quickly contained. This remains first and foremost a human tragedy, but it poses a significant threat to the economic recovery and the outlook for investment markets. There are several points to note on this.

First, while Melbourne has returned to lockdown and several US states have paused or partially reversed the reopening, so far there has been no significant reversal of the reopening across the OECD as measured by lockdown stringency indexes, albeit reopening has stalled.

Second, while Victoria is clearly taking a tougher stance, the hurdle to return to a generalised lockdown in the US looks high given significant shutdown fatigue, a perception that the economic cost is too high and political pressure from Trump (who described 99% of cases as “totally harmless”!). The second wave is seeing a rise in hospitalisations and now deaths, but both are running proportionally well below what was seen in the first wave. For example, the fatality rate of new cases is now running around 1% compared to around 7% in April. See the next chart. 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 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. Of course, if medical systems are overwhelmed then it’s a different story and a return to more severe lockdowns may become inevitable, posing a big threat to economies and share markets. So how the medical system is coping and deaths are the key to watch in the US.

Third, various Asian countries have shown that its possible to manage outbreaks and keep new cases relatively low with a combination of tracing, quarantining and quickly applied targeted lockdowns (contrast how quickly China locked down parts of Beijing last month to Victoria which took weeks to do the same thing) and the culture of wearing masks. The case for making masks compulsory in public seems obvious. They protect others from those with coronavirus and provide a reminder to be on guard. US states where they are mandatory are seeing substantially less new cases. Based on the March/April lockdown it will take about two weeks before Victoria sees new cases peak, but after that we should be able to learn from the Ruby Princess and hotel quarantine debacles and from various Asian countries and keep new cases low. Australia has a much better chance of this than the US as our new case load of around 7 a day per million people is very low compared to the US which is running at 160 new cases a day per million people. Short of a renewed lockdown the best hope for the US is a vaccine (but that still looks to be a while away and if it works it may come with various issues, such as how long it lasts for).

Fourth, the renewed Melbourne lockdown will slow the Australian economic recovery but should not derail it. Our rough estimate is that it will knock around $5bn off September quarter GDP. There are two ways to estimate this. First, taking the Treasurer’s estimate that the national shutdown in April was costing $4bn a week, the Melbourne metro area is 20% of the Australian economy so that’s a cost of $800m a week or $4.8bn over the six-week shutdown. Second, the original shutdown saw something like a 10% hit to GDP. But Victoria probably only recovered half that at most which means only a 5% fall in this shutdown or a 1% hit nationally which again is around $5bn this quarter. Against this other states and borders are being reopened and so should offset this. As a result, we have scaled back our September quarter GDP forecast to 1.5%. A risk though is a negative flow on to confidence in other states on the grounds that “if it can happen to Victoria it can happen here too” but this would probably require an escalation in cases in other states to be sustained.

Finally, forget about a fiscal cliff – its more likely to be a fiscal slope. The thought of various stimulus measures expiring in the months ahead causing some sort of fiscal cliff over which economies and share markets will plunge has caused much consternation amongst some. But as with the original and biggest fiscal cliff of December 31, 2012 in the US, its likely to be tapered into a fiscal slope. US stimulus measures including increased unemployment benefits are likely to be extended with another stimulus soon of around $US1trn or more. And in Australia the Government has confirmed that “there’s going to be another phase of income support” with an extension of the JobKeeper program and various other measures including a likely bring forward of tax cuts along with more investment incentives. More industry support packages are also likely. The Government will partly fund this by taking JobKeeper away from those who need it, but the bulk will likely come from the $60bn saving already announced on JobKeeper, which we expect to be fully spend. This will mean an additional fiscal stimulus of 3% of GDP. Our expected budget deficit for the 2019-20 financial year remains $100bn, but that for 2020-21 is likely to be around $200bn. The Government is also providing further relief on insolvent trading and banks are extending the bank payment holiday for viable customers. All of which will head off the much-feared crunch point at the end of September when support measures were originally scheduled to end.

Meanwhile, its clear that the surge in coronavirus cases and the associated negative headlines is starting to impact economic activity with our weekly Economic Activity Trackers for the US and Australia faltering further over the last week. 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. Both the US and Australian Economic Activity Trackers fell over the last week, with Australia seeing weaker readings for consumer confidence, retail foot traffic, restaurants and mobility indexes.

Economic recoveries never go in a straight line, but its clear that this one will be very bumpy as coronavirus continues to rear its ugly head and as the reverberations on businesses, jobs and households continue well into the future. Expect the Deep V rebound in much recent data to give way to a slower bumpier recovery going forward.

Shares are still vulnerable to a further correction or consolidation, particularly if the renewed rise in coronavirus cases in the US and Australia leads to a renewed generalised lockdown and if the recovery in economic indicators continues to falter. The approaching US presidential election could also add to volatility. Against this, shares should ultimately be supported by record amounts of cash on the sidelines, cautious investor sentiment, further policy stimulus and ultra-easy monetary policy. So our base case remains that as long as a new generalised lockdown is avoided shares will remain in a correction for the next month or so which ultimately gives way to a resumption of the rising trend.

President Trump’s approval rating continues to trend down and his disapproval up heightening the risks that he concludes he has nothing to lose by ramping up tensions with China beyond the current (mostly) war of words in a way that threatens the economic outlook in order to shore up his base.

Has the $US peaked? Since its March coronavirus panic high the US dollar index has fallen 6% and for the technically minded its now registered a so-called death cross with the 50-day moving average falling below the 200-day moving average. A falling US dollar would be consistent with improving global growth relative to that in the US and the Fed’s aggressive QE which is increasing the supply of US dollars. If the $US has peaked then its positive for commodities including gold, good news for emerging countries (which often have US dollar debt) and consistent with a rising trend for the Australian dollar.

Are Chinese shares in another bubble? Not yet – but they could be heading there. Chinese shares are now up 16% month to date, have surged above their 2018 high and are now just 10% below their 2015 high. They are trading on a forward PE of 14 times which is hardly the stuff of bubbles. But the combination of a good track record in controlling the virus compared to many other countries, a solid economic recovery, ultra-easy monetary policy and signs the authorities want the share market up all point to more upside.

Some good news – The Batchelor is back in production. I hope they fix up the inequity with The Bachelorette if it’s made too!

Ringo is my favourite Beatle along with George, Paul and John and Photograph written with George is one of his best. Its kind of happy sad. It was produced by George and has a Phil Spector Wall of Sound feel to it.

Major global economic events and implications

The US non-manufacturing ISM index rose sharply in June, jobless claims continued to fall and job openings and hiring rose in May. The labour market is still very weak though and as noted earlier more timely economic data indicates some faltering lately with the resurgence in new coronavirus cases.

Eurozone retail sales rebounded by a stronger than expected 17.8% in May, but the recovery in German factory orders and industrial production was less than expected.

Japanese household spending and wages fell more than expected in May, but the Economy Watchers household and business sentiment indicators rose more than expected in June.

Chinese inflation remained weak in June indicating that there is no constraint here on further PBOC stimulus. CPI inflation edged up to 2.5%yoy due to higher food price inflation, but core inflation fell to just 0.9%.

Australian economic events and implications

There were no surprises from the RBA which left monetary policy on hold. While it seems more confident that the downturn will be less severe than initially feared and made no mention of the worsening outbreak in Victoria it noted that the nature and speed of the recovery is highly uncertain and dependent on containing the virus. Consistent with this uncertainty the RBA repeated its commitment to do “what it can” to support jobs, incomes and businesses. The risk is that the RBA will have to do more, but this is likely to focus on more quantitative easing as the RBA continues to see negative rates as being “extraordinarily unlikely” in Australia. The cash rate is likely to be stuck at 0.25% for the next three years at least.

On the data front, while ANZ job ads rebounded 42% in June they are still down 45% on a year ago and other data was soft with the AIG’s services PMI remaining weak at 31.5 in June (in contrast to the CBA measure which rebounded strongly to 53.1), the ANZ Roy Morgan consumer confidence showing another decline on the back of bad news in Victoria and housing finance plunging 12% in May pointing to ongoing weakness in the property market.

What to watch over the next week?

Trends in new coronavirus cases along with pressure on medical systems will continue to be watched closely, particularly in the US and also Victoria.

In the US, expect June data to show a further recovery in small business optimism (Tuesday), industrial production (Wednesday), retail sales (Thursday) and housing starts (Friday) with home builder conditions for July (Thursday) also likely to rise slightly. July manufacturing conditions indexes for the New York and Philadelphia regions are likely to give up some of June’s rebound though as a result of the new surge in coronavirus cases. While headline CPI inflation (Tuesday) is likely to rise slightly thanks to higher energy prices core inflation is likely to edge lower to around 1.1%yoy. June quarter earnings results will start to ramp up with the consensus expecting earnings to fall -44%yoy due to the lockdown.

The European Central Bank (Thursday) is unlikely to make any changes to monetary policy having substantially ramped up its pandemic quantitative easing program at its last meeting. The EU leaders meeting on Friday and Saturday will be watched in terms of progress on its recovery fund and the proposal for the common issuance of debt. Industrial production for May (Tuesday) is likely to show a solid rebound.

Similarly, the Bank of Japan is unlikely to make any changes to its ultra-easy monetary policy (Wednesday).

Chinese data is likely to confirm the ongoing recovery with June quarter GDP (Thursday) expected to rebound by 9.6% quarter on quarter after March quarters -9.8%qoq contraction. Activity indicators are also likely to show a further improvement with annual growth in industrial production rising to 4.8% (from 4.4%), retail sales improving to +0.4% (from -2.8%) & investment improving to -3.4% (from -6.3%).

In Australia, the main focus is likely to be on June jobs data (Thursday) which is expected to show a 100,000 rebound in jobs after the loss of 835,000 jobs over the prior two months. This is consistent with an improvement in payroll jobs already reported by the ABS between mid-May and mid-June. However, the unemployment rate may actually rise slightly to 7.5% as participation rises partly due to the return of the requirement to look for work in return for receiving JobSeeker. Meanwhile, the latest ABS household impacts of Covid survey (Monday) and payroll jobs data will be watched to see whether the jobs market continued its slow recovery through the second half of June. In other data expect to see a further improvement in business conditions and confidence in the June NAB business survey (Tuesday) but a decline the July reading of consumer confidence on the back of the resurgence of coronavirus in Australia and the lockdown of Melbourne.

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 pose a major threat to property prices into next year. Home prices are expected to fall by around 5 to 10% into next year, 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 China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).