Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Despite ongoing concerns about coronavirus most major share markets saw solid gains over the last week helped by good economic data, positive vaccine news and policy stimulus. Japanese shares fell 0.9%, but US shares rose 4% in a holiday shortened week, Eurozone shares rose 2.8% and Chinese shares surged 6.8% taking them above their pre-coronavirus highs. The strong global lead also helped the Australian share market overcome concerns about rising coronavirus cases in Victoria to drive the ASX up 2.6% for the week led by IT, telco, consumer and energy stocks. Bond yields generally rose slightly, oil and metal prices rose but the iron ore price fell, and the Australian dollar rose as the $US fell.
From their April lows many global and Australian economic data releases have seen a Deep V rebound and this has helped support share markets including Australian shares, However, shares (except those in China) remain below their June highs and are still vulnerable to a further correction or consolidation, particularly if the renewed rise in coronavirus cases in the US and Australia leads to a renewed generalised lockdown and as the recovery in economic indicators falters or slows which it may be starting to do. The approaching US presidential election could also add to volatility. Against this, shares should ultimately be supported by record amounts of cash on the sidelines, cautious investor sentiment, further policy stimulus and ultra-easy monetary policy. So, our base case remains that as long as a new generalised lockdown is avoided shares will remain in a correction for the next month or so which ultimately gives way to a resumption of the rising trend.
The past week has seen the daily number of new coronavirus cases continuing to rise globally. This is partly being driven by a surge in new case in emerging countries.
But new cases in developed countries are also continuing to rise due to a surge in the US driven by non-northeastern states, particularly in Texas, Arizona, Florida and California.
In Australia, Victoria is struggling to contain renewed outbreaks with new cases in Australia rising to levels last seen in April.
This in turn has seen several states in the US and Victoria in Australia pause or partially reverse the recent reopening. For example, California has ordered many indoor businesses to shut again in 36 counties and Victoria has locked down 10 Melbourne post codes (covering about 300,000 people). Naturally this has led to fears of a return to a generalised lockdown and a renewed downturn in economic activity. So far there has been no significant reversal of the reopening as measured by lockdown stringency indexes, but progress towards further reopening has stalled.
The hurdle to a return to a generalised lockdown likely remains high as shutdown fatigue is significant and authorities may conclude that the economic cost of doing so is just too high. China and South Korea have also shown that renewed outbreaks can be managed without generalised lockdowns. And so far, the “second wave” seen in the US has been a bit different to the first wave with hospitalisations up but still well down from earlier this year and deaths continuing to trend down. This may partly reflect more young people being confirmed with coronavirus (due to a big increase in testing since March which is picking up more people with mild or no symptoms), better protections for older people (who have a much higher chance of dying) and better treatments. All of which may mean that the latest wave of new cases may not be as deadly as that seen in the first wave.
If hospital systems generally continue to cope (notwithstanding isolated problems in some US states) and deaths remain low then a return to a mandated lockdown or people behaving as if there is a generalised lockdown is unlikely and the focus will remain on only partial and targeted lockdowns, travel restrictions (like those between Australian states and between some US states) and rigorous testing, tracking and quarantining and a renewed emphasis on social distancing such as limits on gatherings and making masks compulsory while in public as the main way to deal with outbreaks. In the absence of a vaccine we may just have to learn to live with it and manage outbreaks as Korea, China and others have done over the last few months. Of course, if medical systems are overwhelmed then it’s a different story and a return to more severe lockdowns may become inevitable, posing a big threat to economies and share markets.
The case for making masks compulsory in public seems obvious. They to protect others from those with coronavirus and provide a reminder to be on guard. Being the national norm in much of Asia they partly explain why coronavirus is under better control there. US states where they are mandatory are seeing less new cases (next chart). And analysis by Goldman Sachs indicates they could substitute for a lockdown that would otherwise knock 5% off GDP. Even Texas and US Vice President Pence have now seen the light on this.
Fortunately, the news on coronavirus hasn’t been all bad over the last week. China appears to have been successful in containing its recent outbreak in Beijing. Germany also appears to have contained a recent outbreak and new cases in the Eurozone are still tracking sideways. And there has been more positive vaccine news with another vaccine shown to produce antibodies to coronavirus.
While Australia has seen a rise in new cases it continues to rank well amongst OECD countries. It’s now back to second behind New Zealand but a key thing to note about this table is that Australia with new cases a day running at about 2.3 people per million is in a far better position to control coronavirus than the US which is running at 133 new cases per million people. We have to do a lot better in managing quarantines and getting people to take tests though.
Economic data releases for June continued to show the positive impact of economies reopening globally. Deep V rebounds were evident over the last week in global manufacturing PMIs, Chinese business conditions, the US ISM index, US car sales, US pending home sales, German retail sales and Australian retail sales.
However, our more timely weekly economic activity trackers for the US and Australia faltered over the last week as re-openings stalled and consumers worried anew about the outlook. 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 activity tracker fell over the last week in response to weaker readings for consumer confidence, hotel bookings and retail foot traffic and highlights the vulnerability of the economy to the latest rise in coronavirus cases.
The recovery going forward will likely be slower than the “Deep V” rebound seen so far in some data as second wave fears will add to consumer caution, the easy gains from reopening may have mostly been seen and even if there is a vaccine soon the coronavirus shock has accelerated the shift to a digital world and cost cutting associated with automation will drive a long tail of unemployment which will constrain growth.
Major global economic events and implications
US economic data was mostly good with a much bigger than expected rebound in employment in June and strong gains in the manufacturing conditions ISM index, consumer confidence, pending home sales and car sales with continuing high levels for mortgage applications to purchase properties.
The 4.8 million rebound in June payrolls reflects the return of furloughed workers into jobs and has now seen about one third of jobs lost since February recovered. This in turn drove a sharp fall in unemployment for workers on temporary layoff. That said, unemployment still remains very high at 11.1% and its noteworthy that the unemployment rate for those not on temporary layoff is continuing to rise.
Going forward economic data is likely to be more mixed as the renewed surge in coronavirus cases adds to consumer caution and the risk of a further pause or reversal of the reopening. A slowing in the decline in jobless claims also suggests that there is a long tail of unemployment which will see a slowing in the decline in unemployment and the risk of a renewed rise. Given all this it’s unlikely that the better than expected June jobs data will weaken the prospects for more fiscal stimulus or lead to a less dovish Fed.
Fed Chair Powell welcomed the bounce back in activity but noted that the path forward is very uncertain, will depend on containing the virus and government policy support for as long as needed. The minutes from the last Fed meeting also confirmed that the next stage of Fed easing will focus on more clearly defined forward guidance and QE. Australian style yield curve control looks to be on the backburner for now. The Fed could also move to an average inflation target – meaning that any undershoot on inflation would have to be offset by an overshoot – which would be very dovish.
Eurozone economic confidence improved in June, but by less than expected, unemployment rose but only slightly to 7.4% and core inflation fell to 0.5% year on year. Meanwhile a broad group of parties in Germany’s lower house of parliament backed the ECB’s bond buying program ending a threat to the Bundesbank’s participation in it from the German Constitutional Court, basically signalling yet again that Germany wants more Europe not less.
Japanese jobs data and industrial production for May and the Tankan June quarter business survey were all weak. Fortunately, the timelier June business conditions PMIs and consumer confidence have hooked up.
China’s business conditions PMIs rose more than expected in June, particularly the Caixin services conditions PMI, and have staged a Deep V recovery from their February low. This is despite the partial lockdown in parts of Beijing. Actual economic activity will take a bit longer to fully recover.
Australian economic events and implications
Australian economic data was a mixed bag. On negative side, building approvals fell sharply in May, credit growth was weak and while ABS payroll jobs data shows almost a 30% recovery in jobs lost between early April and mid-May the improvement has slowed in the last two weeks. Against this retail sales were confirmed to have bounced back by an even stronger than first reported 16.9% in May, the AIG’s manufacturing conditions PMI rose strongly in June and the trade surplus remained high in May as exports have held up better than imports (thanks to the relatively strong Chinese economy).
The 16.9% rebound in May retail sales – which was led by apparel, department stores and cafes/restaurants – was particularly impressive and leaves retail sales above their pre coronavirus shutdown levels. It tells us that there was a lot of pent up demand and people were keen to get out and spend again. It also suggests upside to our forecast for June quarter GDP to contract by 8%. However, the going is likely to be a lot tougher in the months ahead as much pent up demand has likely been spent, apparel and café/restaurant sales are still way down from pre coronavirus levels and the renewed coronavirus threat will likely result in some renewal in consumer caution. This is already evident in consumer confidence which has slipped over the last two weeks.
Meanwhile, home prices fell another 0.8% in June according to CoreLogic. We expect more falls ahead, particularly in Sydney and Melbourne given high unemployment, reduced demand from immigration and the depressed rental market. Our base case is for a 10% fall in Sydney and Melbourne but a second wave of coronavirus cases necessitating a renewed generalised shutdown and/or a premature end to government support would risk a deeper fall.
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 US states which are seeing rising trends, but also in Victoria.
In the US, expect to see a further improvement in the non-manufacturing PMI for June (Monday) but job openings for May (Tuesday) are likely to show a further deterioration. June quarter earnings results will also start to flow with the consensus expecting earnings to fall -44%yoy due to the lockdown.
Chinese CPI inflation data for June (Thursday) is expected to show a slight rise to 2.5% year on year but with core measures remaining very low.
In Australia, the RBA is unlikely to make any changes to monetary policy. The RBA has repeatedly indicated that 0.25% is the effective lower bound on rates and that negative rates are “extraordinarily unlikely” so the RBA won’t be cutting rates and given the weakness in the economy, high unemployment and inflation way below target its way too early to think about raising rates. In fact, we see the cash rate stuck at 0.25% for the next three years at least, which is consistent with the recent message from RBA Deputy Governor Debelle. Basically, the RBA sees its policy easing measures as working as expected and that while uncertainty remains high regarding the future so far things have been better than expected. So, it remains in wait and see mode. That said, its likely to reiterate its dovish forward guidance on monetary policy and indicate that it stands ready to do more if needed.
Meanwhile on the data front in Australia, expect to see a rise in ANZ job ads for June (Monday) but another decline in housing finance for May (Thursday).
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 massive 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.
The Australian housing market has slowed in response to coronavirus. Home prices are falling and higher unemployment, a stop to immigration and rent holidays pose a major threat to property prices into next year. Home prices are expected to fall by around 5 to 10% into next year, with the risk of bigger falls if the renewed rise in coronavirus cases leads to a renewed generalised lockdown and/or government support measures are prematurely withdrawn.
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 the global recovery and US/China tensions, a continuing rising trend is likely if the threat from coronavirus recedes. 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).