Investment markets and key developments over the past week

Global share markets pushed higher again over the last week as positive vaccine news helped offset fears about the short-term economic impact of lockdowns in the US and Europe. US shares made it to a new record high as President elect Biden’s nomination of Janet Yellen as Treasury Secretary was seen as positive. Reflecting the positive global lead Australian shares had a solid weak even pushing back to their starting point for the year earlier in the week with gains being led by resources, utilities, financials, property and retail stocks. Bond yields were little changed but metals, oil and iron ore rose as did the $A against a falling $US.

After a huge month as the US election set off a sharp break higher in share markets – with Australian and US shares up 11% in November, Japanese shares up 16% and Eurozone shares up 17% – share markets are overbought and at risk of a short term pause. However, more upside is likely as momentum is very strong, we are now in a seasonally strong time of year for share markets and investors are yet to fully discount the potential for a very strong recovery next year in growth and profits as stimulus combines with vaccines. Cyclical recovery shares like resources, industrials and financials are likely to be relative outperformers as they have been laggards through the pandemic, and this should benefit the Australian share market over US shares.

Bitcoin having rallied far harder than share markets – with signs that it was becoming a bit manic – was more vulnerable to a pull back so its sharp 15% or so fall in the last few days is not that surprising particularly when measured against its normal volatility. Profit taking was likely also triggered by its return to near its 2017 high. Given Bitcoin’s extreme volatility its doubtful that its fall tells us much about broader risk appetite on the part of investors. Bitcoin could still have lots more upside as the $US trends down and if it breaks decisively above its 2017 high (and doesn’t follow gold with a false break) but there are sounder ways to play global reflation. The $A50 in my wallet still strikes me as far more reliable currency. To the extent that global recovery heads off fears of money printing forever and debasement of traditional paper currencies it may also work against Bitcoin and other cryptos.

The vaccine news keeps getting better with now AstraZeneca-Oxford reporting results showing up to 90% effectiveness for its vaccine depending on the dose in late stage trials. As Auric Goldfinger said in relation to meeting James Bond: “Once is happenstance. Twice is coincidence. The third time is energy action.” Having now three vaccines – AstraZeneca, Pfizer and Moderna – showing high levels of effectiveness without serious side effects so far adds to confidence that other vaccines will be effective too and that there is a good chance based on current production plans along with those who have already had the virus of reaching herd immunity globally by the end of 2021 or early 2022, particularly with AstraZeneca-Oxford committing to selling their vaccine without profit across a large part of the developing world. Of course there is still a way to go – AstraZeneca is doing more tests to validate the finding of higher efficacy from a lower dosage, more results are still required regarding efficacy and safety, and distribution will take time – but the light at the end of tunnel is definitely getting brighter. This in turn is helping share markets look through the continuing problems with coronavirus at present.

New global coronavirus cases have stabilised helped by a continuing decline in new cases in Europe as a result of lockdowns.

Europe is now starting to see pressure coming off its hospital system and deaths may be peaking, but in the US there are only tentative signs of a slowing in new cases with deaths rising well above the August high which in turn is resulting in more areas tightening restrictions. Japan and Canada are also seeing a strongly rising trend in new cases.

Our European Economic Activity Trackers have stabilised after plunging following the return to lockdowns last month. With new cases now falling taking pressure of hospitals the next move is likely to be a renewed recovery once the lockdowns are eased but that may be a month or more away.

By contrast our US Economic Activity Tracker is continuing to edge down – with most components falling over the last week – reflecting the still rising number of new cases and a continuing tightening in restrictions. A slowing in the US recovery looks certain in the months ahead.

While the cluster in South Australia is continuing to cause some concern, new cases associated with it remain very low (maybe the 3 day severe lockdown short circuited it!) as have case levels across Australia with virtually all being amongst returned international travellers as opposed to local transmission. Victoria has now gone 28 days without a local case and NSW has gone 20 days.

Reflecting the ongoing reopening in Australia, our Australian Economic Activity Tracker edged higher over the last week and is continuing to trend up nicely in contrast to the weaker trends in the US and Europe. All things being equal this should be relatively positive for the Australian share market and the Australian dollar.

Squattergate continues to drag on in the US with Comedian in Chief Trump still seeing election fraud wherever anyone voted for Biden including in Georgia where he has called the Republican secretary of state an “enemy of the people.” Trump has so far had no success in overturning the result as court cases continue to fail, Republican state legislators don’t seem too open to overturning the results and states are moving to certify their results. At least his legal team seems to have concluded that it was a bit of a stretch to claim that the imagined fraud was orchestrated in Venezuela with some connection to the long deceased Hugo Chavez (and so have disowned their lawyer who was claiming that) and more fundamentally Trump is allowing a transition of power to Joe Biden even though he is yet to concede. And he has said he will leave the White House if the electoral college affirms Biden’s victory when its scheduled to vote on 14th December. Biden now has more than 80 million votes to Trump’s 73.9 million. Trump only has 54 days left.

President-elect Biden’s nomination of former Fed Chair Janet Yellen as Treasury Secretary is a good move. She is a centrist with bi-partisan credibility (which should mean a relatively easy confirmation), deep economic policy making expertise and believes that its essential to continue with fiscal and monetary policy stimulus to get unemployment down. She and Biden are likely to work very well with the Fed (in contrast to the tense at times relationship between the Fed and Trump). As a result, her appointment is a positive for the share market.

First NSW now Victoria – fiscal stimulus continues to ramp in Australia as states take on board the RBA’s advice to provide plenty of stimulus. The extra stimulus in Victoria – focussed around infrastructure, housing, regional Victoria and hospitals – will add another 1% to national fiscal stimulus in this financial year, which is similar to that from NSW.

More on The Beach Boys…purists might be dismissive of Kokomo because Brian Wilson was not involved, but it was their first number 1 hit in 22 years, had a catchy tune and featured outstanding vocals from all The Beach Boys (excluding Brian as he wasn’t given enough notice to attend the recording sessions) in their layered singing style. It was written by John Philips (of The Mamas and the Papas), Scott McKenzie (of “San Francisco – be sure to wear some flowers in your hair”), Mike Love (of The Beach Boys) and Terry Melcher (record producer, the possible target of Charles Manson and Doris Day’s son). That said, I reckon that Getcha Back from three years before and written by Love and Melcher is slightly better – it almost sounds more Beach Boys than even their 1960s classics. Gotta love the giant beach ball at the end.

Major global economic events and implications

US data was mixed with a surprisingly strong gain in business conditions PMIs (see the next chart), solid gains in durable goods orders, personal spending and home prices and continuing strength in new home sales but weak consumer confidence on the back of rising coronavirus cases and another rise in jobless claims suggesting the labour market may be slowing.

While the US household savings rate has fallen to 13.6% it remains very high and should support spending once confidence improves. Meanwhile, inflationary pressures weakened again in October with core private final consumption deflator inflation falling to 1.4%yoy. The minutes from the last Fed meeting point to stronger guidance for its quantitative easing program based on the achievement of macroeconomic goals at its December meeting.

Eurozone business conditions PMIs fell sharply in November reflecting the return to lockdowns. With new cases trending back down they should soon bottom at levels well above that seen at the lows earlier this year in the first lockdown. In fact given the relative trend in coronavirus cases its not hard to imagine a reversal in the months ahead with European PMIs on the rise again and US PMIs sliding – which would be positive for Eurozone shares and the Euro relative to US shares and the US dollar.

Australian economic events and implications

Australian construction and investment data for the September quarter was weak with a 2.6% quarter on quarter fall in construction (with falls in home building, non-residential building and engineering) and business investment down 3%qoq. The declines were biggest in Victoria, but other states were soft too. The good news is that investment plans for the financial year were revised up on three months ago but compared to a year ago were only revised up from a fall of around 12.5% to a fall of around 10%. See the next chart. Further reopening, the likely deployment of vaccines, rising business confidence, government tax breaks for investment and public infrastructure spending are likely to combine to drive an improvement in investment over the year ahead.

In terms of business confidence and conditions the news is positive with business conditions PMIs rising again in November with the composite PMI rising to a solid 54.7.

What to watch over the next week?

In the US, November jobs data due Friday will probably be the focus with a 500,000 gain in payrolls expected along with a further fall in unemployment to 6.8%. In other data expect a 1% gain in October pending home sales (Monday), a slight fall in the manufacturing and services ISM (due Tuesday and Thursday) to still solid readings of around 58 and 57 respectively.

Eurozone core inflation (Tuesday) is expected to have remained weak in November at around 0.2% year on year and unemployment (Wednesday) is expected to increase slightly to 8.4%.

Japanese industrial production data (Monday) will be watched for further recovery and jobs data will be released Tuesday.

Chinese business conditions PMIs for November (due Monday, Tuesday and Wednesday) are likely to have remained solid consistent with ongoing economic expansion.

In Australia, the RBA is expected to make no changes to monetary policy at its board meeting on Tuesday, given its rate cut and quantitative easing announcement in November. The RBA is now in wait and see mode again and focussed on the implementation of its $100bn six-month bond buying program. The post meeting statement and Governor Lowe’s parliamentary testimony on Wednesday may express more confidence regarding the outlook given recent positive vaccine news but is likely to remain dovish given the huge amount of spare capacity in the economy with the RBA still not expecting to meet its inflation and employment objectives over the next few years. Governor Lowe is likely to repeat that the RBA does not expect to raise rates for the next three years at least.

On the data front the key focus will be September quarter GDP (Wednesday) which is expected to show the economy exiting the recession with a 2% quarter on quarter rise on the back of reopening after the pandemic driven shutdown shrank the economy by 7.3% in the first half of the year. The rebound is likely to have been driven by a strong surge in consumer spending, a rise in public spending and a contribution from inventories offsetting falls in new home building, business investment and a -1.5% points detraction from net exports. Were it not for Victoria’s lockdown the rebound would probably have been around 4 to 5%. Even with a 2% rebound GDP will still be down 4.8% on a year ago. In other data, expect credit data to show a pick up in housing credit growth (Monday), CoreLogic home price data for November to show a 0.6% rise but building approvals to show a 1% decline after a huge surge in September (both Tuesday), housing finance for October to show a 1% gain and the trade surplus remaining large (both Thursday) and October retail sales (Friday) to show a 1.6% rise consistent with preliminary data already released. Payroll jobs data will be released Tuesday, but it hasn’t proven to be particularly reliable.

Outlook for investment markets

Shares could see a further short term pause after recent strong gains. But we are now into a seasonally strong period of the year for shares and on a 6 to 12-month view shares are expected to see good total returns on the back of ultra-low interest rates and a strong pick-up in economic activity helped by likely vaccines.

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

Unlisted commercial property and infrastructure are ultimately likely to benefit 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 at present are being boosted by ever lower interest rates, government home buyer incentives, income support measures and bank payment holidays but high unemployment, a stop to immigration and weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney into next year. Outer suburbs, houses, smaller cities and regional areas are in much better shape.

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

Although the $A is vulnerable to bouts of uncertainty about coronavirus, the economic recovery and China tensions and RBA bond buying will keep it lower than otherwise, a continuing rising trend is likely to around $US0.80 over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar.