Investment markets & key developments

Global share markets mostly rose over the last week helped by a good start to the US earnings reporting season, solid economic data and US inflation data not being as bad as feared. The positive global lead also saw Australian shares rise led by materials, IT, health and property stocks. Bond yields pulled back a bit after their recent rise but oil, metal and iron prices rose with copper rising to its highest since early June. The strength in commodity prices contributed to a rise in the $A back above $0.74.

Correction risks remain – but cyclical indicators are still positive. While shares have risen over the last two weeks the risk of further correction remains – as issues around the debt ceiling, US fiscal policy and tax hikes, China’s slowdown, the energy crisis and supply constraints and inflation remain. However, we remain of the view that the issues will largely be resolved in a way that does not severely threaten global growth: a US default is most unlikely; China won’t bail out Evergrande but will restructure it to limit damage to the rest of the economy and will provide economic stimulus; and supply constraints will ultimately be resolved as the pandemic recedes, workers return and spending rotates back to services from goods. The relative resilience of cyclical plays like copper, financials and the $A through the recent correction are a positive sign that the world is not about to plunge back into recession and augur well for the rising trend in shares continuing over the next 6-12 months.

IMF forecasts still upbeat. While the IMF expressed concerns about coronavirus, supply constraints and inflation it only revised its global growth forecast this year down to 5.9% and sees 4.9% growth next year. Which is similar to our own view.

La Nina continues. Two years ago the world was into an El Nino weather phenomenon and for Australia that meant hot dry conditions down the east coast, severe bushfires and falling farm production. Fortunately, the Southern Oscillation Index which tracks surface air pressure across the Pacific tipped into La Nina last year and remains there and that suggests cooler wetter conditions down the east coast. While La Nina has recently copped a bit of flack as a driver of the surge in energy prices in Europe (as utilities stock up on gas ahead of a cold winter – although it could go the other way if La Nina drives more hydro and wind) for Australia its usually positive for farm production and helping keep bushfires mild. Getting coronavirus under control only to go straight back into a severe bushfire season would not have been nice!

Epic songs. A typical radio song runs around 2 or 3 minutes but in the late 1960s The Beatles had tested this with Hey Jude which ran at 7.11 minutes. But just before Jimmy Webb had composed a song called MacArthur Park which was about everything he observed in the park of the same name in LA while catching up with his girlfriend. The song was ultimately recorded by actor Richard Harris, had different movements and time signatures and at 7.21 minutes broke all the rules but made it to #2 in the US and #1 in Australia. It in turn inspired Paul Ryan to write Eloise for his brother Barry Ryan (who unfortunately passed away last month) and it ran 5.5 minutes. Queen’s Bohemian Rhapsody at 5.55 minutes is similar.

Coronavirus update

Lots of reason for optimism. New global coronavirus cases are continuing to fall with most regions remaining in a downtrend, except Europe which is mainly due to the UK.

More importantly, new deaths remain subdued relative to past waves. This is particularly evident in developed countries as vaccines have helped prevent serious illness. Deaths in the UK (the red line in the next chart) are running less than 20% below the level suggested by the December/January wave (the dashed line). While Israel saw a Delta spike in new cases in August and September – likely reflecting waning efficacy for Pfizer vaccinations from earlier this year the level of hospitalisations and deaths remained subdued compared to the previous wave and all are trending down again helped by the administration of booster shots to 42% of the population.

Another coronavirus treatment. Hot on the heals from favourable results Merck’s covid treatment pill, results from trials of AstraZeneca’s antibody cocktail show a similar halving in the risk of severe illness or death. So there’s now more ways to treat patients. These are very useful for high-risk groups for whom vaccines are less effective and the unvaccinated.

Vaccination rates are continuing to rise, albeit slowly. 50% of people globally and 73% in developed countries have now had at least one dose of vaccine.

Key risks to watch include: a possible resurgence in cases in the northern winter particularly as vaccine efficacy starts to wear off in some countries in the absence of rapid booster programs; the low level of vaccination in poor countries; and the possibility of more transmissible/more deadly mutations. But so far good.

In Australia, new cases spiked have a new high in Victoria, but if NSW, which led by a month and is continuing to see falling cases, is any guide, Victoria should peak soon.

Australia is continuing to vaccinate around 1% or more of the population a day with 72% of Australia’s whole population now having had at least one dose, which is well above the US. For first doses for adults, the ACT is now at 98%, NSW is at 91%, Victoria will reach 90% in less than a week and Australia will reach 90% in about two weeks. Making vaccination a condition of participating in the reopening from locked down states has put a rocket under vax rates. Allowing for current trends and the average gap between 1st and 2nd doses the following chart and table shows approximately when key vaccine targets will be met.

NSW and the ACT will likely hit the 80% of adults double vax target in the next few days, Victoria and Australia (on average) on average will reach 70% of adults in a week or so.

So based on reaching vaccination targets, the ACT’s lockdown has now ended and NSW will move to the second stage of reopening on Monday. NSW has also announced the removal of quarantine requirements for overseas arrivals who are vaccinated and have a negative covid test. Victoria will start reopening in about a week (cases permitting). Other states and territories will hit the 70% target in mid-November.

The main risk in Australia is that too rapid a reopening in NSW and/or Victoria leads to a resurgence in cases – like Singapore has seen with new cases running around 3000 new cases a day – which overwhelms the hospital system necessitating some reversal in reopening to slow new cases down as seen in Singapore. Note that NSW is still only at 64% of the whole population fully vaccinated compared to 82% in Singapore. A reversal in reopening would set back the economic recovery again. This could particularly be a risk in the months ahead if vaccine efficacy for those vaccinated earlier this year starts to wear off. A big decline in the lag between vaccine doses in Australia also runs the risk of them being less effective. A less risky approach than just tying reopening steps to vaccine levels may be to allow three weeks or so between each reopening stage in order to ensure that new cases and most importantly hospitalisations are not surging and overwhelming the hospital system.

Meanwhile, vaccination is continuing to help keep serious illness down. Coronavirus case data for NSW shows that the fully vaccinated continue to make up a low proportion of cases, hospitalisations and deaths.

The level of deaths (the red line in the next chart) is running at around 20% of the level predicted on the basis of the previous wave (dashed line). On this basis the vaccines are helping save roughly 52 lives a day at present.

Economic activity trackers

Our Australian Economic Activity Tracker rose further over the last week, helped by the start of reopening. It’s likely to move higher in the months ahead as the NSW reopening gathers pace and Victoria reopens. As such its increasingly certain that GDP will be up this quarter after what we estimate to have been a -4% hit in the September quarter. So, recession averted. However, given the high coronavirus numbers present in the community, which may result in a degree of consumer and business caution and the risk of a setback, along with only the vaccinated being able to initially participate in the reopening, this recovery will likely be more gradual at first than was the case after last year’s lockdowns.

Our European Economic Activity Tracker edged higher over the last week but our US Tracker remains stalled suggesting some loss of momentum in the US recovery.

Major global economic events and implications

Fed to taper at $US15bn a month. The minutes from the Fed’s last meeting provided no real surprises – it looks to be planning a $US15bn reduction a month in bond buying starting in the next couple of months and ending mid next year. Of course, tapering is not tightening, and while rate hikes are getting closer, they still look at least a year off.

US economic data was mostly strong, but the focus remains on supply constraints. Job openings fell in August but remain high and along with a record quits rate and falling jobless claims indicate a continuing strong labour market. 77% of June earnings reports to date have exceeded expectations but so far only 35 S&P 500 companies have reported.

US inflation pressures broadening. While core US inflation in September was in line with market expectations at 0.2%mom and 4%yoy, price increases have been broadening with median inflation rising to 2.8%yoy as supply constraints along with the recovery in rents impact. And producer price inflation accelerated further to 8.6%yoy. Ultimately, we see this settling down as the pandemic recedes, more workers return to work and consumer spending rotates back to services from goods but that may still take another 6-12 months.

Japanese producer price inflation accelerated further to 6.3%yoy in September reflecting global pressures although so far there is not much pass through to Japanese consumers.

Similarly, in China where producer price inflation rose to 10.5%yoy in September, but CPI inflation fell to 0.7%yoy and core inflation was unchanged at 1.2%yoy, posing no major constraint for the PBOC in reinvigorating Chinese growth. Although Chinese exports surprise on the upside in September imports slowed more than expected and credit growth was weaker than expected consistent with an ongoing slowing in growth. Of interest to Australia: while iron ore import volumes are down -12%yoy, coal import volumes are up 76%yoy.

Australian economic events and implications

Jobs down, but its history. There were no surprises with employment down another 138,000 in September reflecting the lockdowns in Victoria, NSW and the ACT. From its June pre lockdown high, employment has fallen by -330,000 but thanks to a plunge in participation the workforce has fallen by -281,000 such that unemployment has actually fallen to 4.6% from 4.9%. Allowing for those working zero hours and the decline in participation “effective unemployment” has actually risen to around 7.6%. The good news though is that with NSW now reopening and Victoria set to follow employment is likely to start recovering (although the ABS jobs survey may not pick this up till November). The relative resilience in job vacancies through these lockdowns compared to last year as reflected in our Jobs Leading Indicator is a positive sign in this regard. The bad news of course is that with reopening, labour force participation will rebound probably back to where it was in June which will probably see unemployment move up to around 5% by year end before it resumes its downtrend through next year.

Solid confidence, home building strong. While confidence readings were mixed in the last week – with business confidence up according to the NAB survey and consumer confidence up according to the ANZ/Roy Morgan survey but down according to the Westpac/MI survey – all are around reasonable levels and well above last year’s lows which augurs well for recovery. After the adjustment from the HomeBuilder boost new home sales for the six months to September were up 9.3% on the same period in 2019 and a 23% jump in dwelling commencements in the June quarter points to a big pipeline of dwelling construction (albeit construction shutdowns in the last few months in NSW and then Victoria will delay some of this).

What to watch over the next week?

In the US, expect a small rise in industrial production and continuing strength in home building conditions (Monday), flat September housing starts (Tuesday) after a solid rise in August, a rise in existing home sales (Thursday) and a continuing solid reading for the October composite PMI (Friday) with the focus likely to be on supply constraints and price pressures. The September quarter earnings reporting season will start to ramp up with the consensus being for 28% earnings growth on a year ago.

European business conditions PMIs for October (Friday) are also likely to remain solid, albeit with the focus on supply constraints.

Chinese September quarter GDP data is likely to confirm its growth slowdown with growth of 0.4%qoq or 5%yoy reflecting earlier monetary tightening and coronavirus restrictions in August. September data for industrial production and investment is also likely to show some further loss of momentum but retail sales growth is expected to pick up following the relaxation of covid controls.

Japanese business conditions PMIs for October are likely to improve following the decline in coronavirus cases but core inflation for September is likely to have remained around -0.5%yoy with both due Friday.

Australian business conditions PMIs for October (Friday) are likely to bounce as reopening in NSW and the prospect of reopening in Victoria boosts confidence.

Outlook for investment markets

Shares remain vulnerable to short-term volatility with possible triggers being coronavirus, global supply constraints & the inflation scare, less dovish central banks, the US debt ceiling and spending and tax plans and the slowing Chinese economy. But looking through the short-term noise, the combination of improving global growth and earnings, vaccines ultimately allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months.

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.

Australian home prices look likely to rise by around 21% this year before slowing to around 7% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as poor affordability impacts, government home buyer incentives are cut back, listings return to more normal levels, fixed mortgage rates rise, macro prudential tightening slows lending and immigration remains down relative to normal.

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

Although the $A could pull back further in response to the latest threats to global and Australian growth and weak iron ore prices, a rising trend is likely over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the $A up to around $US0.80.

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