Investment markets and key developments over the past week

Coronavirus concerns continued to create volatility in investment markets over the past week, but the good news is that it remains both up and down volatility on a day to day basis as opposed to straight down as was the case up until a couple of weeks ago. US, European and Japanese shares gave up some of their gains from the previous week, but Chinese and Australian shares rose, with the Australian share market playing a bit of catchup and getting a boost from the Australian Government’s massive wage subsidy program. Bond yields fell in the US, UK, Japan and Australia but they rose in Europe. Commodity prices were mixed with a surge in oil prices (albeit only to $US25/barrel) on President Trump’s talk of Saudi Arabia and Russia cutting production and copper prices rose but the iron ore price fell. The $A fell back towards $US0.60 as the $US headed higher again.

As I always like to start off with, here is the bad news:

• First, new coronavirus cases globally are continuing to rise, notably in the US with Europe showing signs of stabilising.
  

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• While China seems to have got the outbreak under control it continues to have some problems with a rise in imported cases (that led a week ago to a ban on foreign travellers) and it put a small county (Jia) back under lockdown after a transmission from an asymptomatic doctor highlighting the problem of infected people with no symptoms being able to spread the virus. China also started reporting asymptomatic cases of which there are around 1400.
• Spain and Switzerland now have more cases per head of population than Italy. Cases per million people are rising rapidly in Germany, France, the US and UK but Australia may be joining Korea, Singapore, China and Japan in being more successful in stabilising the number of cases.
  

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• Second, the reported death rate from coronavirus is still rising with some countries continuing to see their health system overwhelmed and not just by older people. As a result, the global mortality rate has now risen to 5.2%, with Italy’s rate now 12.1%, Spain’s now 9.2% and the UK 8.7%.
• Third, to control the virus and take pressure off hospitals social distancing measures are intensifying (including in Australia) and getting extended (in Germany and Italy).
• Finally, this is increasingly showing up in a huge hit to global economic activity as evident in sharp falls in consumer confidence, surging unemployment claims in the US and even plunging auction clearance rates in Australia (although admittedly that was rather distorted).

But there is some good news:

First, while share markets remain highly volatile the volatility is now both up and down rather than just down and they have had two better weeks despite very bad economic news. After circa 35% top to bottom falls a lot of bad news had been factored in which is partly why markets have been able to look through very poor economic data releases.

Second, Italy has now seen the number of new cases trend down for nearly two weeks adding to confidence that its lock down from 9th March may be working. Out of interest it may be following a similar pattern to China with a rough lag of 11 to 21 days between the lockdown and the peak in new cases (depending how the peak is defined). Following the Chinese experience some relaxation of the Italian lockdown may be possible later this month. Spain also appears to have stabilised the number of new cases over the last week. (Note that while some question the reliability of China’s CV case data – partly driven by political motives – directionally it looks roughly right and lines up with President Xi’s March 10 visit to Wuhan and the easing of its lockdown/restart of its economy).

Australia also seems to have achieved a decline in new cases following shutdowns.

Unfortunately, this is not the case for the US.

Third, the Chinese economy is gradually returning to normal with daily activity indicators for traffic congestion, subway use, coal demand at power stations and property sales continuing to trend up. Reflecting this China’s PMI’s rebounded to around normal levels in March although this just appears to show that conditions improved compared to February rather than indicating that activity is back to normal. A pick-up in Korean exports in March provides confirmation of China’s pick up as stronger exports to China largely drove it. Two risks for China remain a second wave from say imported cases or asymptomatic people and weak exports as the rest of the world slows. But the Chinese experience does indicate that there is light at the end of the tunnel if we are rigorous in implementing a shutdown and support businesses and people through it.

Fourth, policy stimulus continues to ramp up dramatically, which is helping tip the risks away from coronavirus shutdowns driving a long and extended recession/depression. Notably in the last week:

• Having signed off on one $US2 trillion package Trump and Congress are now talking of another similar sized package focused on jobs and infrastructure.
• China announced more monetary easing and looks set to do more fiscal stimulus amounting to around 5% of GDP.
• The Australian Government announced a third fiscal support package centred on a wage subsidy for around 6 million workers costing $130bn over six months bringing total fiscal stimulus to be pumped into the economy in the year ahead to just over $200bn or 10% of GDP (see the next chart). The wage subsidy program will help businesses, help workers and help keep unemployment down and so is a very good move. It also announced a support package for the childcare industry and Australia has moved to a rent relief program for individuals and business tenants.
  

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• Several central banks cut interest rates again including a 0.5% rate cut in Canada and the RBNZ announced a cheap funding program for its banks.

There have now been more than 270 stimulus announcements around the world. Central banks and governments appear to remain committed to doing “whatever it takes” to limit the economic impact on the economy and ensure a decent recovery (although a laggard remains the EU where a joint response to fiscal support is lacking leaving the ECB to fill the void). The next chart shows our estimate of global fiscal stimulus as a share of GDP for this year. If currently proposed measures are allowed for its going to be nearly 4% of global GDP and far greater than that seen in the GFC.

Policy support will help minimise the downside and boost the recovery, but we still need to see evidence the virus and its economic impact will come under control before we can be confident shares have bottomed. Shares have performed better over the last two weeks, but we saw periods of strength in the GFC before the ultimate bottom was in.

Key things to watch for in the short term for a sustained bottom in markets remain: signs that the number of new coronavirus cases is peaking – there has been good news in China, South Korea, Italy and maybe even here in Australia but the US still looks a few weeks away from peaking and it drives the direction of share markets; the successful deployment of anti-virals – there are positive signs but it still looks like a way to go; signs that corporate and household stress is being successfully kept to a minimum – too early to tell; signs that market liquidity is being maintained and supported as appropriate by authorities – this has improved; “blood in the streets” – investor panic is already evident but it can always get worse; technical signs of a market bottom like a loss of selling momentum and an inverse “head and shoulders” pattern – the strong rally in the last two weeks is reminiscent of rallies in October/November 2008 that signalled the start of a bottoming process albeit the market did not finally bottom until March 2009; and lots of policy stimulus to minimise the fall-out from shutdowns – this gets a tick albeit we may need more.

Major global economic events and implications

In the US, the manufacturing conditions ISM held up reasonably well in March but it’s hard to see this lasting with consumer confidence falling sharply, car sales falling 30% and jobless claims now up by 10 million in two weeks. The surge in claims points to unemployment surging above 10% this month. The US needs to follow Australia and refocus away from enhanced unemployment benefits towards wage subsidies as a way to keep people in jobs and to avoid a confidence zapping surge in unemployment.

Eurozone unemployment fell to 7.3% in February, but this might be the low for a while with economic confidence falling sharply in March (albeit by less than expected). Inflation fell sharply in March to just 0.7%yoy with core inflation falling to 1%yoy.

The Japanese Tankan business conditions survey fell sharply in the March pointing to weaker growth ahead.

Australian economic events and implications

Australian data releases over the last week were mostly a bit dated with February data showing a small lift in credit growth, reasonable growth in retail sales (helped by coronavirus stockpiling, but after two weak months) and a big bounce in building approvals with March data showing continued growth in house prices. Against this though ABS job vacancy data fell over the three months to February, the ANZ/Roy Morgan measure of consumer confidence plunged to a record low and NAB’s survey of business confidence fell to its lowest since 2009 on coronavirus concerns. So consistent with the plunge in confidence expect to see much weaker data for home prices, building approvals, credit growth and retail sales through the shutdown.

What to watch over the next week?

The number of new Covid-19 cases, lockdowns and their economic impact and the global policy response to deal with it will likely remain the focus in the week ahead. Key to watch for remains a continuing downtrend in new cases in Italy and a peak, hopefully in the next few weeks, in the number of new cases the US.

In the US the minutes from the Fed’s last meeting (Wednesday) are likely to indicate a preparedness to ease more if needed. On the data front, expect to see a decline in job openings for February (Tuesday), a further sharp rise in jobless claims (Thursday) and core CPI inflation (Friday) remaining around 2.3%yoy.

In China, import data for March (Tuesday) will help shed some light on China’s post lockdown recovery. CPI inflation for March is expected to fall to around 4.9%yoy with core inflation around 1.5%yoy. Credit data for February is also due.

In Australia, the RBA (Tuesday) is expected to leave rates on hold at 0.25% with the Minutes from the last RBA meeting noting that the cash rate “was now at its effective lower bound” and that “there was no appetite for negative rates”. However, the RBA could indicate a willingness to expand its low-cost funding facility for banks and should consider expanding its bond buying program to the corporate debt market. The RBA will also release its Financial Stability Review (Thursday) which will be interesting to the extent that it may provide some assessment as to how the Australian financial system is faring in the current difficult environment. On the data front expect to see a sharp fall in ANZ job ads for March (Monday), a fall in the trade surplus for February (Tuesday) and a rise in housing finance commitments for February (Wednesday).

Outlook for investment markets

Shares are vulnerable to further short-term falls given the uncertainty around the coronavirus both in terms of the outbreak’s duration and its economic impact. But on a 12-month horizon shares are expected to see good total returns helped by an eventual 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 likely to continue benefitting from the search for yield but the hit to economic activity from the virus will weigh heavily on near term returns.

The Australian housing market is now weakening rapidly in response to coronavirus. Social distancing will mean a collapse in sales volumes and a sharp rise in unemployment, a stop to immigration through the shutdown and rent holidays pose a major threat to property prices. Prices are expected to fall between 5% to 20%, but government support measures including wage subsidies along with bank mortgage payment deferrals along with a plunge in listings will help limit falls at least for the next six months.

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

The deepening hit to global growth from Covid-19 and its flow on to reduced demand for Australian exports and lower commodity prices still risks pushing the $A lower in the short term possibly to a re-test of its low two weeks ago of $US0.55 or even its 2001 low of $US 0.477 as a worst case. But expect a strong rebound once the threat from coronavirus recedes.