Investment markets and key developments over the past week

Share markets generally fell over the last week with first worries about the resurgence in global coronavirus cases and then reports that President Biden will propose a doubling in capital gains tax for high income earners weighing on markets. Although Chinese shares managed to rise from a double bottom after sharp falls since February, US, European and Japanese shares fell. Despite the weak US lead Australian shares were little changed with sharp falls in energy, IT and property stocks being partly offset by gains in health, industrial and material shares. Bond yields fell slightly in the US, Japan and Australia but were flat in Europe. The Australian dollar was little changed despite a further fall in the US dollar.

Interestingly, Bitcoin had its third 25% plunge so far this year, but this time has broken down through its rising trend seen since December. Maybe the new investors necessary to keep it going up are getting harder to find? Maybe some are getting out ahead of another major fall following the four-year pattern of tops it has seen – 2013, 2017, 2021? Maybe competition from other crypto currencies is weighing on Bitcoin? Or maybe it’s just noise and its trip to the moon will once again resume?

Our assessment remains that share markets will head even higher this year as recovery continues and this boosts earnings. However, shares won’t go up in a straight line, investor sentiment is very bullish which is negative from a contrarian perspective and we are coming into a seasonally softer period of the year for shares as the old saying “sell in May and go away…” reminds us. A resumption of the bond tantrum, US tax hike concerns, coronavirus setbacks and geopolitical risks (around US/China tensions, Russia and Iran) could all provide a trigger for a correction. It would likely be just another correction though. Our ASX 200 forecast for year-end remains 7200 and we still see the risks as being to upside.

More tax hikes on the way in the US – and the share market is finally starting to notice. President Biden may unveil his American Families Plan on Wednesday in the week ahead with around $1.5 trillion to $2 trillion in funding over eight years for areas like childcare, medical leave, pre-kindergarten care and education but to be funded with proposed tax increases including for the top income tax rate and capital gains. While the US share market didn’t seem too concerned about the proposed increase in corporate taxes, the prospect of a proposed doubling in the capital gains tax rate for high income earners seem to be causing some concern. However, as with the corporate tax hike (which as it currently stands will cut around 8% of US earnings per shares) the increase in top personal and capital gains tax rates will likely be watered down by Congress and there is an offsetting boost to spending which given that it focussed on lower income earners should boost corporate revenue.

Geopolitical risk could make a comeback after a period of relative calm following President Trump’s demise with tension building in three key areas: around US and Russia with a risk being that Russia invades Ukraine again to shore up political support ahead of Russian parliamentary elections later this year; an increase in Middle East tensions ahead of a possible US return to the nuclear deal with Iran; and US/China tensions particularly in relation to Taiwan. The latter is probably the biggest risk – while the US/China trade war has not intensified under Biden, Trump’s tariffs have not been reduced either and the Biden Administration has maintained a hard line. Tensions are now heating up again as the US is preparing to sell weapons to Taiwan with China undertaking military exercises and some in China threatening to reunify Taiwan by force. I can’t see China undertaking a full-on invasion given the economic costs that would follow from trade sanctions, etc and it all sounds like a lot of posturing, but the risks have gone up and markets may start to focus on it more, particularly if there are any accidental military clashes in the area. As such it along with the issues around Russia and Iran could serve as the trigger for a correction in the months ahead. Trying to time geopolitical events though is not easy – they are often easier to respond too once they are fully factored into markets and they are assuming the worst, as the worst usually doesn’t happen.

Almost on que Australia/China tensions seem to be escalating again too with the Federal Government cancelling Victoria’s (yet to be used) Belt and Road Initiative with China which could result in a further escalation in bans and tariffs on Australian exports to China. So far these have not had a major macroeconomic impact because the value of the products affected is relatively small and the impact has been swamped by the strength in iron ore exports and prices. This is likely to remain the case for a while yet and there is insufficient iron ore supply from other countries for China to move away from Australia. It could become more of an issue over the longer term though if the tensions are not resolved.

Bank of Canada starts to taper its bond buying – is it leading the way for other central banks? Yes – but they will take longer. After upgrading its growth forecasts the Bank of Canada has cut its weekly bond purchases from $C4bn to $C3bn. This clearly begs the question as to whether other central banks may soon follow. Our assessment is that they will but not till later this year. The Canadian jobs market has been far stronger than in the US and Europe. Compared to Australia, property price growth and housing credit growth is running much stronger in Canada. And while the minutes from the last RBA meeting show it being more upbeat on the economy it still sees wages and inflation being subdued for several years and remains very dovish. We see the exit path from easy money in Australia as being: an end to cheap bank funding in June; the 0.1% bond yield target remaining focussed on the April 2024 bond which will enable it to time decay as that bond matures; bond buying to be halved from $5bn a week to $2.5bn a week from around September; and the first rate hike coming in 2023.

The Australian Budget is now just over two weeks away and is expected to see a faster than expected recovery and higher iron ore prices drive much lower deficits. Key elements are likely to include: an upgrade to growth forecasts; an extra $2.5bn a year in aged care spending; extra spending on mental health, skills and women’s’ economic security; a possible lifting of the home price caps for the First Home Loan Deposit Scheme; and an extension of the Low and Middle Income Tax Offset (LMITO). A failure to extend LMITO would see up to 10 million Australians miss out on income tax rebates of up to $1080 for the next financial year and this could slow the recovery. Since the rebates are not paid till the September quarter next year the Government could always delay the announcement of an extension till just before the next election if it wants too. While the Treasurer is unlikely to announce budget repair measures, the budget deficit this year is likely to be around $125bn (down from $214bn projected in the October Budget last year) and $50bn next financial year (down from $112bn in the last Budget) thanks to the revenue windfall from faster recovery and higher iron ore prices and reduced welfare payments.

Reported new global coronavirus cases broke out to a new record high over the last week. This is mainly being driven by emerging countries, particularly India (with only 8% vaccinated) which is accounting for more than a third of global new cases. New cases in the US remain well down from their recent high and Europe is trending down. New coronavirus cases in Australia remain very low and due to returned travellers – although there have been more concerns about returned travellers becoming infected while in quarantine with one testing positive in Victoria after having left quarantine.

So far around 7% of the global population has now received one dose of vaccine but this masks a huge divergence between developed countries at around 42% and emerging countries at around 5%. Within developed countries the UK is leading the charge at 50% and the US is at 41% with Australia well behind at around 7%. Europe is running at 20% but has been speeding up.

While issues keep popping up around the vaccines (eg, in terms of clotting risk with some vaccines, their rollout and take-up and the likely need for regular boosters) the evidence continues to suggest they are working. This is evident for example in the decline in hospitalisations in the UK, the US and Israel. While risks remain of a resurgence in new cases amongst the young in countries before herd immunity is reached the impact can be minimised by vaccinating older/at risk groups and the issue of take up can be resolved by “vaccine passports”. As production ramps up vaccination in laggard countries will accelerate – it’s just that it will take longer than first expected and there is a risk that the longer it takes the greater the risk new variants will develop. The bottom line for now though is that investment markets are right to look through the current resurgence in new global cases, to ongoing global recovery ahead.

Our Australian Economic Activity Tracker fell slightly over the last week but remains very strong suggesting that economic recovery remains on track. Our US Economic Activity Tracker also fell slightly but our European tracker rose a bit albeit it remains very weak not helped by ongoing lockdowns.

It’s sad to hear that the lead singer of the Bay City Rollers, Les McKeown, passed away. I wasn’t into wearing Tartan in 1975 and wasn’t a big fan (being more into ABBA and Wings at the time) but I kind of liked the Bay City Rollers’ version of Bye Bye Baby. Here’s the original version of Bye Bye Baby from The Four Seasons.

Major global economic events and implications

US existing home sales remained weak in March with storm impacts possibly continuing but initial jobless claims fell sharply again. Meanwhile, the US March quarter earnings reporting season is off to a good start, although it’s still early days with only around 25% of S&P 500 companies having reported. So far around 76% of US S&P 500 companies have beaten earnings and revenue expectations. Consensus earnings expectations for the quarter have now risen to 28% year on year, from 21% two weeks ago but are likely to ultimately come in at around +35% to 40%. While 76% of companies surprising on the upside is in line with the norm of around 75%, the average surprise is a very strong 34%.

As widely expected, the European Central Bank left monetary policy on hold with uncertainty about the near term but some optimism about vaccines underpinning recovery. President Lagarde described the Eurozone as being on “crutches” and sees it as “premature” to discuss any reduction in stimulus.

Japanese business conditions PMI’s rose slightly in April but remain softish with the composite PMI at 50.2 and core inflation edged up slightly in March but only to 0.3% year on year.

Australian economic events and implications

Australian data remained strong over the last week with retail sales up 1.4% in March after snap lockdowns depressed sales in February and business conditions PMIs for April rising again to very strong levels and new home sales down from recent highs but also remaining strong. With strong PMIs, companies are also reporting rising input and output prices consistent with rising inflation.

Australian retail sales compared to pre-pandemic levels have been far stronger than seen in most major countries – the exception being the US where stimulus checks totalling $2000 so far this year for most adults have provided a huge boost.

While real retail sales look to have fallen in the March quarter detracting from consumer spending this may partly reflect a rotation in spending back downwards services as a result of relaxing social restrictions and this is likely to continue. We expect consumer spending growth (which includes retail sales and other services) to remain strong this year reflecting the recovery in jobs, strong levels of consumer confidence, low interest rates, positive wealth effects from gains in house prices and shares and pent-up demand evident in high saving rates.

What to watch over the next week?

In the US, the focus will be back on the Fed (Wednesday) which is expected to reiterate that the economic outlook is stronger, but it remains too early to taper its bond buying and that the conditions for rate hikes are a long way from being met.

On the data front in the US the highlight is expected to be an acceleration in March quarter GDP growth (Thursday) to 7% annualised as consumer spending was boosted by stimulus checks. This will likely also be evident in a 20% gain in personal income for March (Friday) and a solid rise in personal spending. In terms of other data, expect a solid rise in March durable goods orders (Monday), gains in house prices and consumer confidence (Tuesday) and a rise in pending home sales (Thursday). Core private final consumption deflator inflation for March is expected to have picked up to 0.3% month on month or 1.8% year on year and the employment cost index for March is expected to show a 0.7%qoq rise (both Friday).

The US March quarter earnings reporting season will also ramp up in the week ahead.

In contrast to the US, March quarter Eurozone GDP (Friday) is expected to have fallen by another -0.5% quarter on quarter as lockdowns impacted. Meanwhile Eurozone unemployment for March is likely to have held around 8.3% and core CPI inflation for April is likely to have remained weak at around 1% year on year (both due Friday). April confidence data Thursday will be watched for any slippage after the improvement seen in March.

The Bank of Japan (Tuesday) is expected to leave monetary policy on hold but remain dovish and jobs and industrial production data will be released Friday.

Chinese business conditions PMIs (Friday) are likely to see the composite PMI remain solid at around 55.

In Australia, the focus will be on the March quarter CPI (Wednesday) which is expected to show a rise of 0.9% quarter on quarter or 1.4% year on year reflecting a 9% rise in petrol prices (which alone will contribute +0.3 percentage points to inflation), a strong increase in new dwelling costs along with modest rises in rents and seasonal increases in health and education costs. Underlying inflation measures are likely to be more subdued at 0.5% quarter on quarter or 1.2% year on year, but this would still be at a stronger pace than implied by the RBA’s forecasts back in February which forecast June quarter trimmed mean inflation of 1.25%yoy or an average of 0.25% in both the March and June quarters. March quarter producer price inflation will be released Friday and private credit growth for March (also Friday) is expected to show a slight acceleration in housing credit growth.

Outlook for investment markets

Shares remain at risk of further volatility with possible triggers being a resumption of rising bond yields, coronavirus related setbacks, US tax hikes and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and still low interest rates augurs well for growth shares over the next 12 months.

Global shares are expected to return around 8% over the next year 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 5% grossed up dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7200 although the risk is shifting to the upside.

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 are likely to rise another 15% or so over the next 18 months to 2 years being boosted by record low mortgage rates, economic recovery and FOMO, but expect a slowing in the pace of gains as 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%.

Although the $A is vulnerable to bouts of uncertainty and RBA bond buying will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar, probably taking the $A up to around $US0.85 by year end.