Investment markets and key developments over the past week

Global share markets rose again over the last week helped by good US earnings, declining new coronavirus cases and ongoing assurance of easy monetary policy and US fiscal stimulus. Australian shares fell slightly for the week though led by declines in energy, industrial, material and utility stocks not helped by Friday’s news of yet another snap lockdown – this time in Victoria. Bond yields were mixed with slight falls in the US and Europe but slight increases in Japan and Australia. Commodity prices and the $A rose, as the $US fell.

Bitcoin resumed its melt-up over the last week, after a brief but sharp correction. While digital currencies likely have a future, it remains unclear whether it will be Bitcoin as opposed to something else or government provided currencies and what the level of demand will be given that digital transactions are common anyway and Bitcoin remains highly unstable making it an unreliable store of value. All of which makes it very hard to attach a fundamental value to it. But as with Dutch Tulip bulbs and other bubbles through history it could still go a lot higher as the $US trends down and more jump on to the speculative bandwagon.

The downtrend in new global coronavirus cases continued over the last week with most regions seeing a fall and deaths now moving decisively lower too.

Confidence about vaccines is on the rise again with production concerns declining now that there are seven vaccines globally and the realisation that while the current vaccines may not be as effective in preventing infection from the new mutations (around 60% effective with the new mutations versus around 90% for the original) they appear highly effective in preventing severe cases and the need for hospitalisation and deaths. And if the latter remains the case then the new mutations won’t be a barrier to reopening once sufficient people have been vaccinated. Rough estimates suggest herd immunity can be reached in developed countries by the December quarter, with the US around mid-year, and in first half next year in most emerging countries. 40% of Israel’s population has now received one dose of vaccine, 20% in the UK and 10% in the US. (Note that this is not the same as total vaccine doses divided by the population which exaggerates the proportion of the population that has been vaccinated.) Declining new cases and the spread of vaccines add to confidence about a sustained reopening this year.

It’s the same old in Australia – while new cases remain low the returned traveller quarantine program continues to cause problems, with the latest being in Victoria where quarantine workers and their close contacts being infected with the UK variant has triggered another snap stay at home lockdown like those seen recently in SA, Queensland and WA for five days.

With new coronavirus cases remaining low in Australia despite regular scares and brief targeted lockdowns, our weekly Economic Activity Tracker for Australia pushed higher again over the last week. The snap five day hard lockdown in Victoria may cause a few bumps in the recovery but as we have seen lately with snap lockdowns in SA, NSW, Queensland and WA their economic impact has been relatively minor and short lived – as they have been well timed and brief and Australians have adapted to them in ways that are less economically disruptive. So, providing any new lockdown in Victoria is brief then the economic impact is likely to be minor, albeit it’s very tough for those directly impacted.

Our US Economic Activity Tracker edged up fractionally but remains soft & down from its September high. And our European Economic Activity Tracker rose slightly again over the last week but remains very weak.

US fiscal stimulus looking bigger. Our expectation has been that President Biden’s $1.9bn coronavirus stimulus would be wound back by Congressional negotiations to around $1.5bn or less. But it’s increasingly looking like it could end up around $1.9bn: Congress has already passed a budget via reconciliation including the full $1.9bn with no push back by Republicans; moderate Democrats aren’t offering much opposition; the package is claimed to pay for itself as required under reconciliation because of the boost to the economy it provides (much like Trump justified his tax cuts). Democrats seem to be trying to make up for not going hard enough in President Obama’s first year. This could also be followed up by a big infrastructure spending program which taken with the $0.9trn stimulus now being paid out could take total stimulus up to a whopping $3.8bn or 17% of US GDP albeit with some spread over into the next few years with a risk that it overheats the US economy.

That said there is a long way to go yet, but massive fiscal stimulus taken together with ongoing ultra-easy monetary policy could be the straw that breaks the camel’s back of disinflation. This is clearly something central bankers would welcome as evident in comments from Powell and Lagarde in the past week and Lowe the week before. Having battled falling inflation expectations for a decade now they are clearly intent on pushing it back up knowing that without higher inflation expectations leading to higher wages growth any pickup in inflation due to a spike in say commodity prices and temporary bottle necks in goods production simply won’t be sustained.

The debate continues in Australia about what will happen when JobKeeper and other stimulus measures end, particularly after March. We are not concerned because we already saw a far bigger wind down in stimulus last October – which saw jobs protected by JobKeeper plunge from 3.6 million to 1.5 million – with little impact on the economy or the jobs market that has since seen a further recovery and decline in unemployment. The reason was that the economy was recovering and so less government support was needed and the same is likely to be the case after March.

Last week I referred to Andy Williams…it was his 1967 Music to Watch Girls Go By that I discovered many years later that turned me on to his music. His TV show can be credited with helping Elton John break into the US. In fact Andy recorded his own version of Elton’s Your Song and his version of George Harrison’s Something really impresses me.

Major global economic events and implications

US data releases were mixed over the last week – small business optimism fell slightly, job openings rose but hiring fell, initial jobless claims fell but continuing claims rose and new mortgage applications remain strong. Meanwhile, January CPI inflation was a bit softer than expected with core inflation falling back to 1.4%yoy. Annual inflation readings are set to accelerate in the months ahead as last year’s lockdown driven slump drops out of annual calculations and due to bottlenecks in goods supply, but with the jobs market being a long way from full employment the Fed is likely to look through this as being transitory.

Consistent with this Fed Chair Powell remains dovish – noting that the effective unemployment rate is closer to 10% (only 56% of last jobs have been recovered and participation remains well below pre pandemic levels), “our national goal” is full employment, the US is a long way from that and so its appropriate for policy to remain “patiently accommodative.” So, despite all the talk about inflation hotting up the Fed (like the RBA) is sticking to its guns and won’t be jumping prematurely at shadows (like it arguably did last decade).

US earnings are back above pre coronavirus levels. The US December quarter earnings reporting season is now about 75% complete, with results remaining strong. 79% of companies have surprised on the upside (compared to a norm of 75%) by an average 19% and 72% have beaten on revenue. As a result, consensus earnings expectations have been revised up to +2% year on year. This means that earnings are about 11% higher than expected a month ago and are back above pre coronavirus levels.

ECB President Christine Lagarde was also dovish noting that it “will be a while until we worry about inflation” and that if necessary, it will do more QE.

Japanese economic sentiment remained weak and wages growth remained negative.

Chinese credit growth was stronger than expected in January, but annual growth slowed further. CPI inflation went negative in January, but this was due to a fall in non-food prices due to holiday travel restrictions so may prove transitory and producer price inflation turned positive for the first time since early last year.

Australian economic events and implications

While Australian business conditions moderated a bit in January according to the NAB business survey, business confidence rose as did consumer confidence and both remain strong and well above pre coronavirus levels.

New home sales plunged in January according to the HIA after the original HomeBuilder deadline but expect a surge and another plunge around the extended March deadline. Two implications: there is a big surge in housing construction to come but there could be an air pocket as first home buyer demand which has been brought forward drops back and if immigration remains down although investors may fill any gap in home buying demand.

Meanwhile the RBNZ’s return to tighter lending standards (via loan to valuation rules particularly for investors) on signs of property speculation and rising leverage may be a sign of things to come in Australia. Australia is not there yet with average house prices only just getting back to previous highs, the investment share of housing finance being low at 23% and not much evidence so far of easing lending standards but government home buyers incentives are likely to be cut this year and a tightening in lending standards may be necessary later this year or next if the market continues to hot up and conditions in the broader economy preclude a rise in interest rates.

It’s still early days in the December half earnings reporting season with only around 19% of companies having reported so far. While there have been some notable disappointments there has been a big turnaround from the lockdown impacted June half. So far 61% of companies have seen profits rise which is up from just 36% six months ago, 46% have beaten expectations compared to just 32% six months ago and 54% have increased dividends compared to 55% cutting dividends six months ago. Retailers and miners are doing well, and banks are boosting dividends, but insurers and utilities have been weak.

What to watch over the next week?

In the US, the key focus is likely to be on January retail sales (Wednesday) which are expected to show a decent rebound and various February business conditions surveys which are likely to remain strong helped by the decline in new coronavirus cases. PMIs and the Philadelphia manufacturing conditions index (Friday) are expected to remain strong and the New York manufacturing index (Tuesday) is expected to rise. In other data expect a decent rise in industrial production and continued strength in homebuilder conditions (Wednesday) and a slight pull back in housing starts (Thursday) and existing home sales (Friday). Meanwhile, the minutes from the Fed’s last meeting (Wednesday) are likely to confirm the Fed’s dovish stance but will be watched for guidance as to its reaction function regarding tapering. The December quarter earnings reporting season will start to wind down.

European business conditions PMIs (Friday) are expected to show some improvement following the decline in new coronavirus cases.

Likewise, Japan’s PMIs (Friday) are also likely to improve reflecting the decline in new coronavirus cases there. Meanwhile December quarter GDP is expected to show a 2.5%qoq gain (Monday) and core CPI inflation (Friday) is expected to bounce to flat year on year from -0.4% due to the suspension of the Go To Travel campaign.

In Australia, expect January jobs data (Thursday) to show a 20,000 rise in employment with unemployment falling to 6.5%. Preliminary January retail sales data are expected to show a 2% rise and February PMIs are expected to remain strong (both Friday). The ABS will also release payroll jobs data and the minutes from the last RBA meeting (both Tuesday) will most likely confirm the RBA’s dovish stance.

The December half earnings reporting season will hot up with 64 major companies reporting including: GPT, JB HiFi and Bendigo & Adelaide Bank (Monday); BHP, Breville, Domain and Scentre (Wednesday); Charter Hall, Coles, Whitehaven and Treasury Wine Estates (Wednesday); Coca-Cola Amatil, South32, Woodside and Wesfarmers (Thursday); and Cochlear and QBE (Friday). Earnings are expected to rebound in 2020-21 by 25% after the pandemic driven -24% plunge last financial year. In terms of sectors, earnings for resources are expected to rise by 47%, banks by 31% and IT stocks by 109%. Healthcare, media and gaming stocks are likely to see around 17% earnings growth and retailers are likely to surprise on the upside. Key themes are likely to be a rebound in dividends, stocks benefiting from a surge in housing activity and a likely outperformance of value and cyclicals over growth stocks, and small caps outperforming large caps.

Outlook for investment markets

Shares remain at risk of a short-term correction after having run up so hard recently and 2021 is likely to see a few rough patches along the way. But timing such moves will be hard and looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and low interest rates augurs well for growth assets generally in 2021.

We are likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns – like US shares, 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% 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 4.5% grossed up dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7200.

Ultra-low yields and a capital loss from a 0.5-0.75% or so rise in yields are likely to result in negative returns from bonds.

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 5% or so this year being boosted by record low mortgage rates, government home buyer incentives, income support measures and bank payment holidays but the stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney. Outer suburbs, houses, smaller cities and regional areas will see relatively stronger gains in 2021.

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