Investment markets and key developments over the past week

While the US share market rose over the last week, other global share markets fell with concerns about a renewed rise in coronavirus cases. The latest coronavirus outbreak and new lockdowns also weighed on the Australian share market with gains in telcos, retail and energy stocks offset by weakness in utilities, IT and property shares. The risk off tone saw bond yields fall, metal and iron ore prices decline, and the US dollar rise which weighed on the $A. Oil prices rose though due to an OPEC dispute which threatens to derail an increase in oil output.

While some headlines have noted that Australian share prices saw their best financial year gain in 2020-21 since the euphoria of 1987, the comparison is a bit misleading in that while the share market (as measured by the All Ords) returned 30.2% in 2020-21 this followed a loss of -7.2% in 2019-20 whereas 1986-87 saw a 54% return after a 42.5% return in 1985-86.

While there has been much understandable angst (and waffle!) here in Australia about the latest coronavirus outbreak and associated lockdowns, there is also bad news globally on the coronavirus front with the downtrend in new daily cases starting to stall and head higher again.

This partly reflects an upswing, particularly of the new variants like Delta and Beta, in relatively lowly vaccinated countries like South Korea, South Africa, Indonesia, Bangladesh, Russia, Columbia and Mexico. But its also evident in some countries that are more advanced in terms of vaccination – notably the UK (which is now seeing new cases around 25,000 a day), parts of Europe, Israel, the Seychelles and in the US (with around 20 states seeing rising trends). While it’s mainly unvaccinated people that are being infected some vaccinated people are too. The latter is not necessarily a problem because while vaccines are not completely effective against infection particularly against the Delta variant (although Moderna released a study showing its vaccine produced protective antibodies against the Delta variant), they are highly effective in preventing hospitalisation and death which is what will be key in term of allowing a continuing reopening in vaccinated countries. And vulnerable older people have mostly been vaccinated. So far so good with deaths and hospitalisations remaining low in the UK and Israel despite the rise in new cases – and this remains the key to watch going forward.

The problem though is that even in the UK and Israel there is still a big part of the population that has not been fully vaccinated (around 50% in the UK and 40% in Israel) posing a threat to the recovery until higher levels of vaccination/herd immunity are reached. This is an even bigger risk in the US and Europe where the degree of vaccination is lower, particularly in some US states that are running well behind (with daily cases rising in around 21 states).

So far 24% of people globally and 50% in developed countries have had at least one dose of vaccine. Canada is now at 69%, the UK at 68%, the US at 55%, Europe at 51% and Australia is at 25%. The increased transmissibility of the Delta variant and its ability to impact young people suggests that the level of the population required to be vaccinated to achieve herd immunity may be higher than the 70-80% we have been assuming. A concern is that vaccination rates appear to be slowing in several countries (see the second chart below) including the US well ahead of herd immunity levels.

Australia’s daily vaccination rate remains low at 0.4% of the population. However, with global vaccine production ramping up and more Pfizer and then Moderna vaccines scheduled to arrive in Australia, it should accelerate in the months ahead.

Of course, Australia is still a relatively lowly vaccinated country and this has left it more vulnerable to the latest outbreaks starting in Sydney and then Brisbane which have spread to other states necessitating more lockdowns – with lockdowns in Sydney and surrounds, Brisbane and big parts of Queensland (although this has now been cut back to Brisbane), Perth and Peel and Darwin (although this has now ended).

The economic impact is already evident in our Australian Economic Activity Tracker which fell back again over the last week reflecting declines in restaurant and hotel bookings, mobility and retail foot traffic. This is after having just recovered from Victoria’s lockdown. Our rough estimate is that providing the latest lockdowns are relatively short they will cost the national economy around $2.5bn with the experience of past snap lockdowns since November pointing to a rapid bounce back in economic activity once they end as pent-up demand is unleashed. Of course, if they turn out to be longer the economic impact will be deeper – possible necessitating more government assistance. The good news is that the lockdowns started when the flow of new cases was relatively low (compared to say Victoria in July and August last year – see the chart above) providing confidence that they should be relatively short. And as noted some of the lockdowns are already ending or being wound back, but NSW is a bigger risk having started the lockdown a bit later than was ideal given the new Delta variant.

Our US Tracker is now just above its pre-coronavirus level, and our European Tracker is almost there following a strong reopening rebound since April.

I can relate to this guy!..Bo Burnham. He’s a great piano player too. Back to pop next week!

Major global economic events and implications

US data releases over the past week were strong with strong gains in consumer confidence and pending home sales, surging home prices, strong jobs data and the manufacturing conditions ISM remaining strong, albeit down slightly from its high. The ISM price components also continue to remain very strong suggesting continuing inflation pressures for now.

Eurozone economic sentiment rose to about as high as it ever gets in June helped by reopening with gains in consumer and business confidence and unemployment fell to 7.9% in May from 8.1%. Meanwhile headline inflation fell to 1.9%yoy (from 2%) with core inflation falling to 0.9% (from 1%) highlighting that there is no US style inflation spike here.

Japanese data was mixed with falls in industrial production and retail sales and a rise in unemployment but gains in consumer confidence and in business conditions as measured by the June quarter Tankan business conditions survey.

Chinese business conditions PMIs fell in June but remain at levels consistent with pre coronavirus economic growth. Coronavirus related lockdowns in Guangdong may have impacted the manufacturing PMI a bit.

Australian economic events and implications

The Australian residential property boom rolled on in June with CoreLogic data showing home prices up another 1.9%, led by a 2.6% gain in Sydney, as ultra-low rates, government incentives, economic recovery and FOMO continue to impact. Average capital city prices are now up 12.1% year to date and 12.4% from a year ago, and thanks to a 17.7%yoy rise in regional prices national average prices are up 13.5% from a year ago which is their strongest annual increase since 2004. The latest coronavirus lockdowns are a threat but providing they are short they are unlikely to derail the housing market upswing.

This is seeing an acceleration in housing related debt growth, and housing finance commitments rising to a new record high in May (see the next chart) point to a further acceleration in debt growth ahead. The surge in housing finance is increasingly being driven by investors – with investor finance up 13.3% in May alone and 116% on a year ago which has taken it back to 2014-15 levels. This makes the housing boom more speculative. With monthly housing credit growth now running at 7% which is around the level seen when APRA started to tighten lending standards in late 2014, the same is likely to occur again soon with some banks already moving in anticipation. Home prices are now expected to rise 20% this year, of which they have already done 12.1%. But tightening lending standards along with poor affordability, rising fixed mortgage rates and weak population driven housing demand due to the hit to immigration are likely to drive a slowdown in price growth to 5% next year ahead of a 5% or so decline in prices in 2023. Housing finance going to first home buyers has topped out and their share of total housing finance has now fallen from 25% in December to 21% as home buyer incentives had brought forward demand from this group but also as they are squeezed out by worsening affordability and surging investor demand.

Meanwhile the Federal Government’s latest Intergenerational Report suggests there may be some relief in prospect for housing affordability longer term. The main story from the IGR is the need for more productivity enhancing economic reforms otherwise long-term growth (and most importantly growth in living standards) will be weaker than its projecting. But from a housing perspective the IGR’s not unreasonable assumption that 10-year bond yields will rise to around 5% over the long term to be more in line with nominal economic growth along with the reality of the hit to immigration and hence a smaller population is that two of the tailwinds behind the boom in Australian house prices since the mid-1990s – ie, ever lower mortgage rates and chronic undersupply from the mid-2000s – may wane in the years ahead.

Finally, some really good news. The trade surplus blew out to a near record $9.7bn in May thanks to surging exports (particularly iron ore) and ABS job vacancies rose 23% over the three months to May and are up 57% from their pre coronavirus level consistent with strong job ads and hiring plans.

What to watch over the next week?

In the US, the minutes from the Fed’s last meeting (Wednesday) will be watched closely for more colour around the move in the Fed’s dot plot to show rate hikes in 2023, although Fed Chair Powell has already calmed market fears to some extent regarding this. Meanwhile on the data front the ISM services conditions index for June (Tuesday) is expected to remain strong at around 64 and job openings and hiring (Wednesday) are also expected to remain strong. June quarter company profit results will start to trickle in with the consensus looking for a 62% year on year rise boosted by base effects from last year’s slump but the rebound in various macro variables suggesting this could end up being +90% or so.

Chinese inflation data for June (Friday) is expected to see CPI inflation unchanged at 1.3%yoy and producer price inflation fall back slightly to 8.8%yoy as base effects from a year ago start to drop out. Credit data is also due to be released from Friday.

In Australia, the RBA’s July Board meeting on Tuesday is expected to see the Bank ease up on some of its emergency stimulus measures but remain pretty dovish in view of the threat posed by the latest coronavirus outbreaks and lockdowns. Specifically, the RBA is likely to retain the April 2024 bond for its “3 year” yield target because it’s likely to conclude that there is a reasonable prospect for the conditions being met for a rate hike in 2024 and we also expect the RBA to announce that it will reduce its bond buying program to $75bn over six months from September (from $100bn at present) but would not be surprised if it moves to more frequent reviews of its bond buying. But otherwise, the RBA is likely to remain pretty dovish given the coronavirus threat and a desire to not want to add to uncertainty by sounding hawkish. This is likely to see the Governor reiterate that the conditions for a rate hike are viewed as being “unlikely to be met until 2024 at the earliest” or replacing it will something that’s equally as dovish. A speech by RBA Governor Lowe on Thursday is also likely to be relatively dovish.

Meanwhile on the data front in Australia, expect ABS data on Monday to confirm a 0.1% rise in May retail sales and show flat building approvals after a sharp fall in April.

Outlook for investment markets

Shares remain vulnerable to a short-term correction with possible triggers being the inflation scare and US taper talk, coronavirus Delta variant related setbacks and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth and earnings helped by more fiscal stimulus, vaccines allowing reopening once herd immunity is reached and still low interest rates augurs well for shares over the next 12 months.

Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.

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 now look likely to rise 20% this year before slowing to around 5% 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, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%. We remain of the view that the RBA won’t start raising rates until 2023.

Although the $A is vulnerable to bouts of uncertainty and RBA bond buying and China tensions will keep it lower than otherwise, a rising trend is likely to remain 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 $US0.85 over the next 12 months.