Investment markets & key developments

US shares made it to a new high in the past week helped by strong earnings results and good economic data, and Chinese shares rose but European and Japanese shares pulled back slightly. The positive US lead also saw Australian shares rise helped by reopening optimism led by gains from property, IT, retail and financial shares. Bond yields resumed their upswing with 10-year bond yields in the US, Germany and Australia now back to or near their highs of earlier this year. Oil prices were little changed, metal and iron ore prices pulled back a bit but the $A rose and briefly made it above $US0.75.

Still hard to see the Fed, ECB and RBA quickly following the BoE, BoC and RBNZ…well not just yet. Inflation risks remained the focus in the last week with more high readings in New Zealand, the UK and Canada adding to expectations for the removal of monetary stimulus or further tightening by their central banks. This followed very hawkish comments by Bank of England Governor Bailey. All of which pushed up bond yields and expectations for faster withdrawal of monetary stimulus. However, it’s not automatic the other more dovish central banks will follow: comments from key Fed and ECB officials remain dovish; they have seen a long period of inflation undershoot prior to the pandemic; and all worry that premature tightening could just lead to a return to weak inflation once pandemic distortions to inflation fade. The departure of Bundesbank President Weidmann may add to the ECB’s dovishness.

In Australia, inflation at least up until the June quarter has been weaker than in countries like the US and New Zealand, inflation expectations in Australia have been more contained, while some sectors have seen wage inflation lift for most it appears to remain weak and the RBA minutes (while dated) remained dovish on rates. That said, the supply constraints driving higher inflation look like being with us for a while yet and Australia’s reopening looks to be unfolding faster than expected which may bring forwards the next step in the process of unwinding the extraordinary pandemic related stimulus. After having commenced tapering, the RBA could be getting closer to ending Yield Curve Control, ie the 0.1% target for the April 2024 Government bond but the first rate hike is still unlikely until 2023. In any case, higher bond yields are likely to soon start pushing up fixed mortgage rates again.

Meanwhile, there does appear to be some progress towards resolving the fiscal issues in the US with Democrats moving towards a compromise $US2 trillion Build Back Better spending plan – which is down from the proposed $US3.5 trillion plan. If agreed, it could clear the way for a vote in the House on the $US550bn infrastructure package that has already passed the Senate and see moderates Democrats supporting an increase in the debt ceiling.

While the risk of a correction for shares remains – with issues around inflation and China’s slowdown likely to linger for a while – they seem to be climbing the proverbial wall of worry. US shares have made it to new highs and the relative strength of cyclical plays like copper, financials, credit spreads and the $A are a positive sign that the world is not about to plunge back into recession and augur well for a rising trend in shares over the next 6-12 months. And the period ahead is normally positive for shares into the Santa Claus rally.

Adele is back. When I first heard Adele’s Rolling In The Deep I thought she was amazing. And I reckon Skyfall is the best Bond song of recent years (although bond tunes these days struggle to match the John Barry music of the earlier Bond films and of course Live And Let Die…then again my generation might say that!). After six years Adele has a new album out the first single of which, Easy on Me, broke single day streaming records on Spotify. So “do yourself a favour” and check it out. Cassettes must be coming back as there is one in the video at 1.32 with a nice crackle suggesting it was taped off vinyl!

Coronavirus update

New global coronavirus cases are continuing to fall with most regions remaining in a downtrend, including the US although the UK and parts of Europe are trending up.

Key to watch in the UK and Europe will be hospitalisations and deaths. The UK (and maybe Europe) may be starting to see the feared rise in new cases following reopening, the start of cooler weather, a stalled vaccine program at 68% of the UK population, fading efficacy against new infection for those vaccinated earlier this year and a slow start to boosters. Key to watch will be whether vaccines remain successful in keeping hospitalisations manageable and deaths down as they have since mid-year. The US faces a similar risk. So far so good though. Deaths in the UK are continuing to run less than 20% below the level suggested by the December/January wave.

52% of people globally have now had one dose of vaccine and 38% have had two doses.

A risk remains that poor countries are lowly vaccinated which increases the risk of mutations. Singapore is perhaps the gold standard with 83% fully vaccinated and is rapidly ramping up booster shots. Following reopening its still seeing around 3000 new cases a day – but it appears to have stabilised helped by the return to some restrictions and booster shots may be helping as is the case in Israel.

Australia is continuing to vaccinate around 1% of the population a day with 74% of Australia’s whole population now having had at least one dose, and 59% having had two doses, which is now above the US. The ACT, NSW and Victoria are continuing to lead the charge helped by making vaccination a condition of participating in the initial recovery (and maybe even indefinitely in Victoria). 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 have surpassed the 80% of adults double vax target, and Victoria will do so in the next week. Tasmania has reached the 70% double vax target and other states should do so in mid-November. On current trends Australia will average 90% of the adult population fully vaccinated by the end of November. Booster shots are set to be available from mid-November in order to head off waning vaccine effectiveness, with Pfizer trials showing that their booster restores efficacy against infection to 95%.

Reflecting the achievement of vaccine targets, reopening is continuing in NSW, the ACT and Victoria, and Queensland has issued a plan to reopen its domestic border with key steps contingent on the achievement of vaccination targets. If anything, the reopening is so far proceeding faster than expected reflecting changes under NSW’s new premier and the faster achievement of vaccine targets.

Vaccination is helping keep serious illness down. Coronavirus case data for NSW shows the fully vaccinated make up a low proportion of cases (5%), hospitalisations and deaths in contrast to their majority share of the population and as in the UK the level of deaths is running 20% below the level predicted on the basis of the previous wave.

The main risk in Australia remains a resurgence in new cases in NSW, the ACT and Victoria after reopening – like the UK, Israel and now Singapore have seen – which threatens to overwhelm the hospital system necessitating some reversal in reopening to slow new cases down as seen in Singapore. This could particularly be a risk in the months ahead if vaccine efficacy for those vaccinated earlier this year starts to wear off before booster shots are fully rolled out. The speed of the reopening and the sharp narrowing in the gap between doses (which can reduce vaccine effectiveness) has arguably added to this risk. Key to watch will be new cases but particularly hospitalisations and deaths – in terms of whether the hospital system is coping. So far so good – with hospitalisations and deaths remaining subdued relative to new cases compared to past waves – but its only early days in the reopening process. Domestic border reopening in the other Australian states that have not been locked down may also be bumpy as they have a lower level of natural immunity and high numbers of cases could impact confidence as they are less used to it.

New Zealand’s move to a traffic light system to guide the transition to living with covid once 90% of those over 12 are vaccinated makes sense – because it targets a higher level of vaccination which better helps reduce the risk of coronavirus spreading and provides guidance and greater certainty in terms of what level of restrictions will be imposed depending on pressure on the hospital system from new cases.

Economic activity trackers

Our Australian Economic Activity Tracker rose sharply over the last week as reopening gathered pace. All components rose but particularly restaurant bookings, transactions and mobility. It’s likely to move higher as reopening continues.

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, this recovery may still prove more gradual in the months ahead than was the case after last year’s lockdowns but it’s likely to speed up next year as we learn to live with covid.

Our US and European Economic Activity Trackers were little changed but Europe remains stronger than the US.

Major global economic events and implications

US economic data was mostly strong. Industrial production and housing starts fell in September but both were impacted by poor weather, home sales rose solidly, the NAHB home builder conditions index for October was very strong, jobless claims are continuing to fall and while manufacturing conditions in the Philadelphia region fell, they remain strong with increases in the new orders and employment components. The Phily Fed survey saw price pressures fall but remain high. Continuing unemployment claims have almost fallen back to pre-pandemic levels which should mean an increase in labour supply.

US earnings reports continuing to surprise on the upside. 81% of June quarter earnings reports to date have exceeded expectations with an average beat of 13%. This is down from the blow out recovery numbers seen in the previous few quarters but still above the norm which has seen 76% beat. So far only 22% of S&P 500 companies have reported though.

Japanese business conditions PMIs rose in October as coronavirus cases fell. While headline inflation rose in September on higher food and energy prices core inflation was unchanged at -0.5%yoy.

Chinese growth slowed further in the September quarter with GDP growth slowing a bit more than expected to 4.9%yoy as earlier policy tightening, coronavirus restrictions and weather all weighed. September monthly data was mixed though with investment and industrial production down but retail sales accelerating as covid restrictions were eased. Average home prices fell for the first time since 2015 as property tightening measures hit. We expect some policy easing measures to boost consumer spending and investment.

Australian economic events and implications

Australian business conditions PMIs rose in October consistent with reopening and the recovery underway in our Australian Economic Activity Tracker. See previous chart.

Jobs market starting to recover. After falling for several months as a result of the lockdowns in south east Australia, payroll employment rose over the two weeks to 25 September with gains in NSW and the ACT and Victoria looking like its bottomed. A further recovery is likely in the months ahead as a result of reopening. Meanwhile ABS data for the year to August shows that manufacturing and health care have seen the biggest gains in jobs whereas agriculture, wholesale trade and constriction have seen the biggest losses with the surprise being that arts & recreation, retail and accommodation and food have been stronger than commonly perceived.

What to watch over the next week?

In the US, September quarter GDP growth (Thursday) is expected to slow sharply to 3% annualised after 6.7% in the June quarter reflecting the impact of the Delta outbreak through July and August and supply constraints. In other data expect strong gains in home prices and new home sales and a rise in consumer confidence (Tuesday), continued strength in underlying durable goods orders (Wednesday), a rise in pending home sales (Thursday), September quarter employment cost growth to pick up slightly to 0.8%qoq and core September private final consumption inflation to slow slightly to 0.2%mom but with annual inflation rising to 3.7%yoy (all Friday). The September quarter earnings reporting season will continue with the consensus being for 29% earnings growth on a year ago.

Various central bank meetings are expected to leave rates on hold in the week ahead. However, the Bank of Canada (Wednesday) is expected to be hawkish possibly announcing the end of QE and flagging rate hikes in first half next year, but the ECB and BoJ (Thursday) are expected to be dovish. The ECB will be watched for any guidance it provides regarding asset purchases post the end of its pandemic bond buying program early next year and whether it pushes back against rising bond yields.

Eurozone September quarter GDP (Friday) is expected to rise 2.3%qoq reflecting reopening and economic confidence data (Thursday) is expected to remain strong. CPI inflation for October (Friday) is expected to have increased further reflecting higher gas prices.

Japanese industrial production and jobs data is due Friday.

In Australia, the focus is expected to be on September quarter inflation data (Wednesday) which is expected to show a 0.8% rise in the quarter with annual inflation of 3.1%, compared to 0.8%qoq and 3.8%yoy in the June quarter. Key drivers are expected to be strong gains in prices for food, alcohol, clothing and furnishing, petrol prices (up around 6%) and a solid gain in rents but with the HomeBuilder subsidy keeping new dwelling purchase costs down and the underlying trimmed mean and median measures of inflation remaining at 0.5%qoq or 1.9%yoy. This would be only slight above RBA forecasts for underlying inflation so would be unlikely to have a significant impact on its forecasts. In other data, expect a 1.5% gain in September retail sales, a -5.1% fall in September quarter retail sales volumes and a further acceleration in housing credit growth (all due Friday).

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 further 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.