Investment markets and key developments over the past week

Global share markets started the past week off strongly with US shares breaking out to new recovery highs, but gains were partly reversed later in the week on worries about the economic recovery in the face of rising coronavirus cases and increasing US/China tensions albeit this still left US, Eurozone, Japanese and Chinese shares up. Despite strength early in the week, Australian shares fell on the back of worries about the growth outlook with telco, industrial, health and utility shares leading the decline. Bond yields generally fell but oil, metal and iron ore prices rose. The Australian dollar also rose above $US0.70 as the US dollar continued to fall.

It was the same old, same old on the coronavirus front over the last week with an ongoing rising trend in new cases, particularly in emerging countries. Various developed countries have also been seeing renewed spikes including Japan, Hong Kong, Spain, France, Canada and Israel – so Australia is not alone.

There has been a bit of good news in the US though with the growth in new cases slowing, particularly in the south – maybe the mandated masks are starting to help.

The US is also continuing to see reduced hospitalisation and fatality rates compared to April reflecting the greater skew in cases towards younger people, better protections for older people and better treatments. This is important in potentially heading off the government mandating a general lockdown and/or people behaving as if there is one.

Unfortunately, the trend in new cases in Victoria has remained up, but NSW so far has managed to keep new cases down. It is clearly taking longer for the lockdown to work this time in Victoria – which may reflect more community transmission (as opposed to returning travellers) and less people taking the rules seriously. So far so good in NSW (although the 7-day rolling average case count remains elevated compared to a month ago) and its worth noting that new cases per million are running at 15 in Australia compared to a far higher 205 in the US.

The surge in new cases, the reversal of reopenings and the associated negative headlines are continuing to impact our weekly Economic Activity Trackers for the US and Australia, but so far at least it seems to have caused a stalling in the recovery rather than a new collapse. These activity trackers are based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, hotel bookings, credit card data, mobility indexes & jobs data. Our Australian Economic Activity Tracker fell back again over the last week reflecting weakness in consumer confidence, restaurants, retail traffic and hotel bookings but credit card data rose and weakness in Victoria is being offset by strength in other states.

Meanwhile, the past week saw more good news on the policy front. The US is still edging towards a new stimulus package – partly to extend enhanced unemployment benefit payments beyond the end of July. They may not make it by the end of the week but I suspect they will by early August given the threats to the recovery and the desire to avoid being seen to block measures to protect the economy. The European Union finally agreed a €750bn recovery Fund. And in Australia JobKeeper and increased JobSeeker are being extended beyond September albeit at reduced rates.

While it came with lots of resistance from the Frugal Four (Sweden, the Netherlands, Austria and Denmark) the European Union made a big leap towards a common fiscal policy – albeit from a very low base – with agreement on the €750bn Recovery Fund – albeit with more loans (€360bn) and less grants (€390bn) than originally planned. The common issuance of debt by the EC will be a big step forward. While it all came with lots of resistance the outcome is consistent with each new crisis (the 2011-12 debt crisis and now coronavirus) driving a more integrated Europe, rather than breaking it apart. This is all positive for the Euro and European assets.

In Australia, the Government extended the JobKeeper and JobSeeker programs, albeit at reduced rates, which along with the apprentice subsidies and JobTrainer program have added $22bn to stimulus measures bringing total coronavirus related stimulus to $174bn and leaving Australia at the top end of comparable countries in terms of coronavirus stimulus measures relative to GDP for this year. These are “eye watering” numbers as was the $180bn projected budget deficit for 2020-21 unveiled by the Government. This is a record in terms of dollars and as a share of GDP at 9.7% is the highest since WWII. Ultimately, we expect it to be even higher at around $220bn as the Government unveils another $20bn in stimulus between now and the October budget and as revenue recovers more slowly than the Government expects. If the economy were strong and we didn’t have coronavirus to contend with this would not be smart but we do and supporting the economy through this tough period is absolutely the right thing to do. Moreover, the starting point level of public debt in Australia is low relative to comparable countries, borrowing costs are very low, the Government is borrowing in Australian dollars not foreign currency, we are not dependent on foreign capital and the support programs are not a permanent increase in spending. So I am not too fussed about the implied rise in debt.

The RBA through its latest minutes and a speech by Governor Lowe provided a good insight into it what is not on its list of possible additional monetary easing measures – negative interest rates, foreign exchange intervention and direct monetary financing of government spending – and what could still be possible – lower but still positive interest rates and the purchase of more government bonds. In relation to the latter though it concluded there was no need at present. But if it did conclude that it needed to do more a cut in the cash rate to 0.1% and more broad-based quantitative easing look like the paths it would go down.

What are the negatives and positives for shares? Here is a quick list. The negatives are that: new coronavirus cases are still rising; reopening is pausing or reversing in some cases; this is impacting confidence; at a time when unemployment is very high; earnings have taken a big hit; and US/China tensions are continuing to escalate (with the US closing China’s Houston consulate, China closing the US’ Chengdu consulate in retaliation) and Pompeo criticising China.

The positives are that: there have been favourable developments regarding coronavirus treatments and vaccines; the second wave so far in the US has been less deadly; several countries continue to contain the virus showing it can be done; China has traced out a Deep V recovery showing that it also can be done; the safe haven $US is falling which is normally a positive sign; monetary and fiscal policy remains ultra-easy; low interest rates and bond yields make shares look cheap; and there is a lot of cash on the sidelines

Our base case remains for the economic recovery to continue but for the Deep V rebound evident in much recent data to give way to a slower bumpier recovery going forward. Shares are still vulnerable to a further volatility, with renewed lockdowns and US/China tensions being the main risks. But the positives should keep any volatility to being a correction against a still rising trend.

Why is the Australian dollar so strong? The $A has broken above $US0.70 having bottomed out at the height of the coronavirus panic in March at around $US0.55. Its being driven higher by a combination of a falling US dollar as safe haven demand for it recedes; the Fed printing more US dollars than the RBA is printing Australian dollars; rising commodity prices with iron ore above $US100/tonne; and maybe optimism that Australia will recover faster than the badly coronavirus hit US. I expect it will continue to rise. At this point its still around fair value so not high enough to be an issue for the RBA but if it does rise so far that the RBA sees it as a threat to the recovery expect it to respond with more QE, not negative rates and foreign exchange intervention.

In times when it’s a bit depressing within and without its good to listen to a really upbeat song. That said I really only like to listen to upbeat songs – well at least in terms of the melody. Good head candy works a bit like meditation or a mantra in drowning out negative thoughts. One of the very best is The Archies’ Sugar Sugar from 1969 but an equally good lift can be had from Taylor Swift’s Me, my second favourite song from Lover. Speaking of which she has a new album (Folklore) out right now. So, do yourself a favour…

The Bachelor in Paradise certainly provided a nice distraction over the last week – particularly when Jamie briefly exited when he thought Timm had left.

Major global economic events and implications

The US housing market recovery continues. While home prices fell in May existing home sales surged 21% and mortgage applications to purchase property remain strong. However, signs that the reversal of reopenings is impacting economic activity are continuing to mount with initial jobless claims edging up again over the last week after many months of falling suggesting the labour market may be slowing again. It may just be seasonal, but the US Census Bureau’s weekly household survey also suggests a slowing in the labour market since mid-June. So far around 25% of US S&P 500 companies have reported and results have generally been quite a bit better than expected with 85% beating on earnings by an average 16% and 69% beating on sales. Its still early days though.

Japan’s composite business conditions PMI rose again in July to 42.6. It’s now well up from its April low of around 26 but still well down from its pre coronavirus level of around 50. Core inflation remained very low at 0.4%yoy in June.

Australian economic events and implications

Australian retail sales rose another 2.4% in June led by large increases in sales at cafes & restaurants and in clothing & footwear stores as reopening continued. Coming on the back of a 17% rise in May, retail sales are now well up a year ago. This tells us that there was a lot of pent up demand and people were keen to get out and spend again. However, retail sales still fell around 2% in the June quarter thanks to the April slump and consumer services are likely to have been a lot weaker so it’s still consistent with a large fall in June quarter consumer spending. The resurgence of coronavirus poses a threat going forward but based on credit card data this mainly seems to be an issue so far in Victoria. Meanwhile, preliminary goods trade data for June showed that exports continue to hold up well thanks to exports to China against weak imports holding out the prospect that net exports will be one source of support for June quarter GDP. Over the last year China took 39% of Australian good exports and accounted for 27% of Australian goods imports.

What to watch over the next week?

Trends in new coronavirus cases along with pressure on medical systems will continue to be watched closely, particularly in the US and Victoria.

In the US the Fed (Wednesday) is not expected to make any changes to monetary policy but is likely to remain very dovish and prepared to do more if needed. There is a chance of outcome based forward guidance and a fixed commitment on QE, but this is more likely in September. On the data front expect June quarter GDP (Thursday) to show a 34% annualised collapse (that’s -8.5%qoq) thanks to the shut down in late March and through April, but this is really old news with June durable goods orders (Monday) likely to rise another 7%, pending home sales (Wednesday) to rise 16% and personal spending (Friday) to show another strong gain. July consumer confidence (Tuesday) is likely to slip thanks to the latest surge in coronavirus. Core consumption deflator inflation (Friday) is likely to have remained weak as are June quarter employment costs (also Friday). The flow of June quarter earnings results will ramp up.

Eurozone June quarter GDP (Friday) is expected to show an 11% quarter on quarter plunge, but again this has been long anticipated now so as in the US its really old news. June unemployment data (Thursday) is expected to rise slightly to 7.6% and core inflation for July (Friday) is likely to have fallen to around 0.7%yoy.

Japanese labour market data for June is likely to be weak but industrial production (both due Friday) is likely to show a small rebound.

In Australia, June quarter CPI inflation is likely to fall -2% quarter on quarter reflecting “free childcare”, a 20% plunge in petrol prices and falling rents resulting in annual deflation of -0.5%yoy, its first fall since 1962. However, a rebound in petrol prices and the end of free childcare will see headline inflation bounce back this quarter so its best to focus on underlying inflation which is expected to fall to just 0.2%qoq and 1.5%yoy. On the economic activity front the ABS’ household impacts of covid survey (Monday) and payroll jobs (Tuesday) for early July will be watched to see how Melbourne’s shutdown may be impacting employment, building approvals (Thursday) for June are likely to rise slightly after a plunge in May, and credit growth (Friday) is likely to have remained weak.

Outlook for investment markets

After a strong rally from March lows shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery and US/China tensions. But on a 6 to 12-month horizon shares are expected to see good total returns helped by a pick-up in economic activity and policy stimulus.

Low starting point yields are likely to result in low returns from bonds once the dust settles from coronavirus.

Unlisted commercial property and infrastructure are ultimately likely to continue benefitting from a resumption of the search for yield but the hit to economic activity and hence rents from the virus will weigh heavily on near term returns.

Australian home prices are falling and higher unemployment, a stop to immigration and rent holidays will push prices lower into next year. Home prices are expected to fall by around 5 to 10% into next year from this year’s highs, with the risk of bigger falls if the renewed rise in coronavirus cases leads to a renewed generalised lockdown. Melbourne is particularly at risk on this front as its renewed lockdown pushes more businesses and households to the brink.

Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.25%.

Although the Australian dollar is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and US/China tensions, a continuing rising trend is likely. Particularly with the US expanding its money supply far more than Australia is via quantitative easing and with China’s earlier recovery supporting demand for Australian raw materials (assuming political tensions between Australia and China are kept to a minimum).