Weekly Market Update – 21st August 2020

Investment markets and key developments over the past week

• Major global share markets, with the exception of Chinese shares, rose over the last week as US new coronavirus cases trended down and on optimism regarding a vaccine and the economic outlook, with the US share market briefly surpassing its February closing high. The positive global lead along with a fall in new Victorian cases saw Australian shares rise to the top end of the range they’ve been in since June with strong gains in consumer staple, financial, real estate and retail stocks leading the gains. Bond yields rose sharply on the back of rising inflation expectations. Oil, copper and iron ore prices rose but the gold price corrected as bond yields rose. The $A was little changed even though the $US fell slightly.

• The global news on coronavirus has been a bit more positive on three fronts recently. First, progress continues towards a vaccine with several now in final trials to hopefully show that they work and some of the producers already manufacturing doses. While news that Russia had approved its own vaccine for use added to the excitement, it’s yet to undergo final trials.

• Second, the number of new cases globally has been flat over the last two weeks, after rising since mid-April.

Source: ourworldindata.org, AMP Capital

• The improvement basically reflects a decline in developed countries with falling new US cases more than offsetting a still rising trend in Europe. New cases in Japan may also be slowing again.

• Finally, the second wave of new coronavirus cases in developed countries has continued to be far less deadly than the first wave with deaths running well below their April high whereas new cases have been well above. This continues to be evident in the US – where hospitalisations are now falling too – but is also evident in Europe and Japan. This adds to confidence that a generalised lockdown will be avoided in most countries – in favour of more surgical measures.

Source: ourworldindata.org, AMP Capital

• This in turn adds to confidence that the economic recovery that has been seen in developed countries since April can continue. With cases falling, deaths remaining relatively low and a return to a lockdown averted (at least for now) the US Economic Activity Tracker looks to be resuming it upswing, albeit gradually. Key components for consumer confidence, retail sales, mobility and job ads have turned up again.

Source: AMP Capital

• Of course, Victoria has taken a much tougher stance with a lockdown despite far less new cases than seen in other countries (and New Zealand has also gone down the same path after a rise in cases), but we have also seen some better news on coronavirus over the last week with new cases in Victoria trending down – highlighting yet again that lockdowns work. Its still a horrible depressing situation in Victoria, but at least there is a bit of light at the end of the tunnel (fingers crossed).

Sources: Covid19data.com.au, AMP Capital

• Reflecting the Victorian lockdown and some impact on confidence in NSW the Australian Economic Activity Tracker fell further over the last week with weakness pretty much across the board – in restaurant and hotel bookings, consumer confidence, shopper traffic and mobility indicators. However, if Victoria continues to come under control and NSW remains under control then hopefully the recovery should resume sometime in the next month.

Source: AMP Capital

• Our view remains that the delay in the Australian GDP recovery out to the December quarter along with the gradual and uncertain nature of the pace of recovery thereafter will necessitate more policy stimulus in Australia. The bulk of this will fall to fiscal policy and this is where the biggest impact will come but the RBA will likely also have to ease further. While RBA Governor Lowe’s Parliamentary Testimony expressed a reluctance to do more on the grounds that it “wouldn’t get much traction” and “there are limits to what more we can do and the main instrument we have now is fiscal policy”, with full employment and achievement of the inflation target on a sustainable basis likely to be years away more RBA easing remains likely. Governor Lowe repeated again that monetary financing of the budget is not on the agenda and negative rates remain “extraordinarily unlikely”, but noted an openness to further reducing the cash rate to 0.1% and expanding bond purchases if needed and its down these paths that the RBA is ultimately likely to go.

• One central bank that is a lot less hesitant than the RBA is the Reserve Bank of New Zealand. In the past week it increased its QE/asset purchase program from $NZ40bn to $NZ100bn (which given that the NZ economy is one sixth the size of Australia’s makes the RBA’s bond buying so far of $55bn look puny) and left negative interest rates well and truly on the table. This was despite upgrading its growth forecasts to the point that it now sees a stronger performance for the NZ economy than the RBA expects for Australia. The RBNZ is perhaps giving a greater weight to the downside risks than the RBA is and is clearly more comfortable in deploying alternative monetary policy measures and their efficacy than the RBA is.

• Is inflation about to take off? Recent inflation readings in the US and elsewhere have surprised on the upside and market inflation expectations have surged higher. The latter may reflect a bet that policy reflation globally will ultimately work. And the pickup in some inflation readings seems to reflect payback after very weak inflation/deflation over the March to May period (particularly in petrol prices) but also a bounce in goods prices as supply is constrained but demand for household goods has gone up as people have been spending more time at home. The latter may have further to go in the next few months and on a medium-term view massive monetary easing combined with fiscal stimulus likely do point to higher inflation. But on a 1-2 year view its hard to see a lot of inflation as goods production picks up (assuming shutdowns ease) and spare capacity remains intense as evident in very high unemployment after adjusting for wage subsidies. That said it’s hard to see much value in nominal bonds at these levels unless there is a renewed downturn in global growth.

• For share markets it’s the same story. The negatives remain the uncertainty around coronavirus, the pausing or reversal of reopening, very high unemployment, the hit to earnings, the US election, US/China tensions and the seasonally weak period of the year for shares that we have now entered. But these are arguably more than offset by a long list of positives including continuing good news on coronavirus treatments and vaccines, the second wave in developed countries being less deadly than the first, several countries showing that it is possible to contain the virus, China tracing out a Deep V recovery, the safe haven $US falling which is normally a positive sign, monetary and fiscal policy remaining ultra-easy, low interest rates and bond yields making shares look cheap and there is still a lot of cash on the sidelines. Shares are still vulnerable to further volatility, with coronavirus and US/China tensions being the main risks. But the positives should keep any volatility to being a correction in a still rising trend.

Major global economic events and implications

• US data was upbeat over the last week. Housing starts and permits surged in July with the August NAHB rising to its equal highest on record pointing to further strength in housing construction ahead. US housing is looking like a clear Deep V. While manufacturing conditions fell back in August in the New York and Philadelphia regions, the falls were modest given the second wave of coronavirus cases and both are around reasonable levels. Meanwhile, jobless claims continue to decline.

• A surge in US mortgage delinquencies is currently being managed by lender forbearance and as a result foreclosures remain low enabling the US housing market to strengthen. Of course, this highlights the need for jobs to come back big time over the next six months otherwise it could cause a problem.

Source: Bloomberg, AMP Capital

• Although the market reacted negatively to the minutes from the last Fed meeting it should be recalled that Fed Chair Powell’s post meeting press conference was very dovish and the Fed still looks on track to move to inflation averaging, more dovish guidance & more definitive QE guidance soon.

• Japanese June quarter GDP data confirmed a roughly as expected -7.8% quarter on quarter slump. This was at the low end of developed countries with US GDP -9.5%qoq, the Eurozone at -12.1% and the UK at -20.5%. September quarter GDP should show some recovery although Japan’s composite business conditions PMI was unchanged at 44.9 in August not helped by a second wave of coronavirus cases there. Core CPI inflation was unchanged at a low 0.4%yoy in July.

Australian economic events and implications

• Australian retail sales rose another 3.3% in July led by large increases in household goods – reflecting people being at home, not going away on holidays and so spending on refurbishment – along with a continuing recovery in clothing and café/restaurant sales. Victoria was the only state to see a fall (-2% mom). With retail sales up 12% on a year ago and running well above pre-covid levels some pullback is to be expected in the months ahead as demand looks to have been pulled forward and as government income support measures are reduced. Melbourne’s stage 4 lockdown will also likely depress August retail sales. However, the continued strength in July does tell us that people are still keen to get out and spend and that there is still some chance of overall positive GDP growth this quarter despite the setback in Victoria. The problems in Victoria saw the CBA’s composite PMI fall back sharply driven by a slump in the services sector with the manufacturing index little changed.

Source: ABS

• The minutes from the last RBA meeting provided no surprises and have been superseded by the SOMP and Governor Lowe’s testimony. The RBA remains dovish and is not ruling out further easing. With negative rates, monetary financing of the government and foreign exchange intervention basically ruled, further easing is likely to come in the form of a rate cut to 0.1% and more QE.

• The Australian June half profit reporting season is now 70% complete by companies and 80% complete by market capitalisation. While its clear that company earnings and dividends have been hit hard by the coronavirus shock, the hit has not been as bad as feared and most companies appear quite resilient and this in turn has enabled a majority (or 59%) of companies share prices to outperform the market on the day they reported and for the market as a whole to rise so far through August. In this sense its been similar to the US June quarter earnings reporting season. So far only 28% of results have exceeded expectations compared to a norm of around 44% but at least misses have only been 27% so beats have roughly matched misses. Only 33% of results have seen earnings rise from a year earlier (compared to a norm of 66%) and 55% have cut dividends (compared to a norm of just 16%). So far consensus earnings expectations for 2019-20 have fallen slightly to -21.6% (from -21% two weeks ago) and this will be worse fall since the early 1990s recession. Financials are being the hardest hit with the consensus expecting a -29% slump in earnings led by insurers and the banks, followed by industrials with a -15% fall in earnings and resources with -12%.

Source: AMP Capital

Source: AMP Capital

• In the US, the annual Jackson Hole central bank Economic Policy Symposium on Thursday and Friday will go virtual with the rather vague theme: “Navigating the Decade Ahead: Implications for Monetary Policy.” It’s hard to see any near-term clues for monetary policy moves but there may be some focus on the Fed’s likely impending shift to inflation average targeting under which a period of inflation overshooting will be tolerated providing an additional tail wind for investment markets. On the data front in the US expect to see a rise in August consumer confidence and continued strength in July new home sales (both due Tuesday), a continued recovery in durable goods sales (Wednesday), a rise in pending home sales (Thursday) and a further recovery in pending home sales and core PCE inflation (Friday).

• The German IFO (Tuesday) and French (Thursday) business conditions/confidence surveys along with Eurozone confidence data (Friday) for August will be watched to see how confidence has been impacted by the resurgence in coronavirus.

• In Australia, the ABS’s weekly payroll jobs data (Tuesday) will likely have been dragged down by the Victorian lockdown, June quarter construction data (Wednesday) is likely to have fallen 7% with business investment (Thursday) showing a similar fall reflecting the shutdown from late March. Preliminary July goods trade data (Tuesday) is likely to point to a continuing strong trade surplus.

• The Australian June half profit reporting season will basically wrap up with 41 major companies reporting including Fortescue and Super Retail Group (Monday), Ansell, Oil Search, Scentre and Stockland (Tuesday), Adelaide Brighton and Worley Parsons (Wednesday), Flight Centre and Nine (Thursday) and Woolworths (Friday).

• After a strong rally from March lows shares remain vulnerable to short term setbacks given uncertainties around coronavirus, economic recovery, the US election and US/China tensions. But on a 6 to 12-month view shares are expected to see good total returns helped by a pick-up in economic activity and 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 at present are being protected to some degree by income support measures and bank payment holidays but higher unemployment, a stop to immigration and rent holidays will push prices lower into next year. Home prices are expected to fall by around 10%-15% from their April high. Melbourne is particularly at risk on this front as its Stage 4 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 $A 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).

Source: AMP CAPITAL ‘Weekly Market Update’

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