Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Global share markets were mixed over the last week with US shares up 0.6% helped by a solid but less than expected rise in employment, Eurozone shares up 0.6% as reopening continues, but Japanese and Chinese shares down -0.7%. Australian shares rose another 1.6% pushing them further into record territory helped along by strong economic growth data and ongoing RBA dovishness. The rise in the S&P/ASX 200 was led by energy stocks (on the back of the rising oil price), utilities, consumer staples, property and industrial shares. Bond yields fell in the US as softer than expected payrolls were seen as taking some pressure of the Fed despite ongoing taper talk and yields were flat to down elsewhere. Oil prices continued to rise, and the iron ore price rose, but metal prices fell. The A$ rose despite a slight rise in the US$.
Just as the rebound in shares has surprised many so has the rebound in GDP and in Australia both are now at record highs. The stronger than expected 1.8% March quarter GDP growth rate in Australia on top of nearly 7% growth in the second half of last year has delivered a Deep V economic recovery that has taken GDP above its pre pandemic level and Australia is one of only a few countries to have done so. It reflects a combination of better virus control and better government support measures. It also makes a nonsense of the claim that we should have just let the virus rip as countries that were far laxer in controlling it ended up with a bigger economic hit and a slower recovery. This quarter will likely see slower growth as the easy reopening gains are behind us and as the Victorian lockdown impacts. But the lockdown looks like being relatively short and as such is only likely to detract -0.3% or less from June quarter GDP (see below). More broadly there are strong grounds for optimism that the economic expansion in Australia will continue at a decent rate: increasing vaccination will underpin reopening and eventually put an end to lockdowns; global growth is strong; the outlook for consumer spending, home building and business investment is strong; and fiscal and monetary stimulus continue. The strong economic recovery is underpinning a strong rebound in profits which is being magnified by the impact of past corporate cost controls and combined with continuing low interest rates will drive a further rise in Australian shares. Just as well we revised our year end S&P/ASX 200 target from 7,200 to 7,400 last week but even that is now looking too cautious.
There were no surprises from the RBA with the key messages remaining that rate hikes are a long way off – as they are rightly determined to see 3% plus wages growth which is also a long way off, but they will review some of their other easing measures in July. With the stronger than expected recovery we expect the bond they buy to enforce their 0.1% yield target to remain the April 2024 bond which will mean that the period of the 0.1% target will decline over time and bond buying to be tapered (or cut back) to around $2.5bn a week from September. Consistent with the latter they even left a hint in their post meeting statement by removing a reference to being prepared to undertake more bond buying.
The drumbeat towards “thinking about talking about tapering” in the US continued over the last week with Fed speakers split between those remaining dovish (and seeing risks on both sides) and those repeating that the Fed should start thinking about tapering. The slightly softer than expected rise in US payroll employment in May probably won’t change the Fed’s thinking, but another pickup in CPI inflation likely to be reported on Thursday will further spur the taper talk. However, there is a long way to go yet – with the formal taper talk likely to start in the next few meetings and actual tapering not likely till later this year. By the time it starts it will be well and truly factored into markets so it may turn out to be a re-run of the December 2013 to September/October 2014 taper that saw US shares continue to rise. And of course, tapering is not monetary tightening, and it took two years from the start of tapering in December 2013 to the first Fed rate hike in December 2015.
On the fiscal policy front, the odds of a bipartisan infrastructure deal are looking shaky despite President Biden offering to substantially pull back his corporate tax hike proposals. If this fails, the Democrats will be forced down the path of budget reconciliation (which only requires a simple majority to pass in the Senate) but a ruling by the Senate Parliamentarian that they can only use one more reconciliation bill this year will also complicate things and may mean that the infrastructure and families packages will have to be merged which in turn could lead to some of the measures being dropped or watered down (including some of the tax hikes).
China pushing back against market forces – Renminbi appreciation and its slowing population – but will it work? Since its low in May last year the Renminbi has appreciated by 12% against the US$ which will reduce China’s trade competitiveness so to try and slow it down the PBOC has increased the amount of reserves Chinese banks have to put aside to hold foreign currency deposits. It’s doubtful it will have a lasting effect though given the main driver of its rise has been a falling US$ which in turn is being driven by global recovery reducing safe haven demand for US dollars and by a blow out in the “twin trade and budget deficits” in the US. Similarly, it’s doubtful whether China’s shift to a three-child policy will work any more than its move to a two-child policy did in 2016. The trend to lower birth rates is common to most countries as they develop (driving infant mortality down, more choices for consumer spending and better financial security for retirement). That said if any country can pull it off with carrot and stick inducements China can.
The good news on coronavirus is that the trend remains down in new global cases and deaths. The number of new cases has more than halved in India and developed countries are seeing a continuing sharp fall as vaccines do their job in Europe and the US. The bad news is that various countries continue to see upswings including many countries in South America, South Africa, Malaysia, Vietnam and South Korea. With the problems in South East Asia highlighting the risks for countries that have low immunity either from direct exposure of via vaccines. With covid tolerance low though in Asia several countries have announced new lockdowns and will likely control it pretty quickly.
In Australia, the bad news is that the snap lockdown in Melbourne was extended for another seven days. However, the good news is that the number of new daily cases has trended down since the lockdown began despite increased testing and is relatively low (as is the trend in new cases in Australia in total) suggesting that the lockdown is working. All of which adds to confidence that the lockdown will be short.
As a result, we retain our assessment that the economic impact from the snap lockdown in Victoria will be relatively “minor” (although still horrible for those directly impacted) as spending is temporarily hit but bounces back quickly once the lockdown ends as has been the case in response to other snap lockdowns across Australia since late last year. So, we continue to see an economic cost of around $1-2bn rather than the $15-20bn or more cost of last year’s July to October lockdown in Victoria. This would amount to a 0.3% hit to June quarter national GDP, but it would likely be less than this as economic activity bounces back once the lockdown ends. The announcement from the Federal Government that workers unable to earn an income due to lockdowns in hotspots would be eligible for weekly payments of up to $500 will help but it’s not clear how many will actually get it given the conditions it comes with. It may not be that relevant if the lockdown ends soon but if not support will have to be increased.
Vaccination continues to ramp up globally, but only 11% of the global population has received at least one dose of vaccine, with only 8% in emerging countries and 40% in developed countries. The UK is now at 60%, the US is at 52%, Europe is at 40% and Australia is at 18%. The success of the vaccines continues to be evident in Israel, the UK and the US which have seen a collapse in new cases, hospitalisations and deaths.
Our Australian Economic Activity Tracker fell sharply over the last week as a result of Victoria’s lockdown with most components falling – highlighting the threat to the recovery if the lockdown is long. The fall has been bigger than seen in response to the other snap lockdowns seen in Australia since November as the others affected less people and were arguably associated with less fear. However, if the lockdown is relaxed soon, we are likely to see the rising trend in economic activity quickly resume again as seen after the various other snap lockdowns ended.
Our US Economic Activity Tracker is almost back to its pre-coronavirus level, and our European Tracker is now rising rapidly as Europe reopens.
Sticking with the Beatles and love after last week with Ringo, if you put aside the silly Her Majesty the very last lines in The End which was the last serious song on the Beatles Abbey Road album which was their final recorded album (as Let It Be came out later but was recorded earlier) were “and in the end the love you take is equal to the love you make”. I always thought that it was really amazing that the closing statement from The Beatles were those thoughtful and inspiring words. Sure the philosophical concept is hardly original but that they had come to that realisation and were prepared to end what turned out to be their final album as a group with those words is pretty inspiring and got me to thinking about them earlier in life than I might otherwise have. Any way Paul McCartney continued on with the focus on love to the point that Wings had a monster hit with Silly Love Songs “inspired” by John Lennon.
Major global economic events and implications
US data was mostly strong with the ISM manufacturing and services conditions indexes rising even further, upwards revisions to already very strong PMIs, a further rise in construction spending, jobless claims falling further and payrolls rising albeit by less than expected. The Fed’s Beige Book also referred to an acceleration in growth along with rising price pressures and the ISM and PMI surveys reported ongoing very high price pressures.
US payrolls up but by less than expected still leaving plenty of slack in the US jobs market. May payrolls accelerated to a 559,000 gain and unemployment fell further to 5.8% from 6.1%, but the rise was less than the market expectation for a 675,000 gain and the decline in unemployment came with a fall in labour force participation. Participation should rise as schools reopen and enhanced unemployment benefits end in September – with many states already ending them. Looking beyond the distortions caused to participation by the pandemic there still appears to be plenty of slack left in the US jobs market – payroll employment is still 7.6 million below pre coronavirus levels and reflecting this the ratio of employment to population is still down by 3.3% and the combination of unemployment and underemployment remains high at 10.2%. All of which is likely to keep underlying wages pressures subdued beyond any near term burst and the Fed cautious although it’s still likely to start its taper talk soon.
Eurozone business conditions PMIs for May were revised with the composite PMI at a strong 57.1, but while unemployment fell in April it’s still very high at 8% and core inflation in May was still only 0.9%yoy. So, the ECB won’t be rushing into monetary tightening.
Japanese data was on the weak side with a smaller than expected rise in industrial production and falls in retail sales and consumer confidence not helped by the latest coronavirus state of emergency.
Chinese business conditions PMIs were mixed in May with the official composite PMI up slightly but the Caixin composite PMI down slightly, but they average out at a solid and little changed reading of 54 suggesting growth remains solid.
Australian economic events and implications
Strong economic news continues to dominate in Australia. The big one was the 1.8% rebound in March quarter GDP which was driven by a combination of consumer spending, housing and business investment and inventory rebuilding. More timely monthly data – for retail sales, business conditions PMIs, car sales and trade – point to continuing strength through the June quarter at least up until Victoria’s lockdown.
What’s more the current account surplus expanded further in the March quarter – meaning that Australia remains a capital exporter and that Paul Keating’s warning that we would become a banana republic are a distant memory – partly helped by Paul Keating’s reforms including mandatory super which has led to increased investment in global shares and an income stream back to Australia.
Housing finance commitments boomed to a new record high in April driven by existing owner occupiers and investors. First home buyer finance fell for the third month in a row and is likely to have peaked as demand was pulled forward by incentives debt and poor affordability is now really starting to bite. Meanwhile investors are piling back in and taking over from first home buyers which means the property market is becoming more speculative. The continuing surge in housing finance is consistent with ongoing strong growth in home prices. It also points to a continuing acceleration in housing credit growth which along with a deterioration in lending standards – which will follow from the booming property market and the more speculative nature of the market implied by the greater role now being played by investors – will likely drive the RBA and APRA to tighten lending standards in the next six months
What to watch over the next week?
In the US, the focus will be on May CPI data (Thursday) which is expected to show a further acceleration to 4.6% year on year with core inflation rising further to 3.4% year on year as the price falls from a year ago drop out, and the impact of higher commodity prices, production bottlenecks and reopening continue to impact. Small business optimism and job opening data will also be released on Tuesday.
The ECB on Thursday is expected to leave monetary policy on hold, but market interest is likely to focus on its intentions for its bond buying program.
The Bank of Canada also meets Wednesday and is expected to leave interest rates on hold.
Chinese trade data (Monday) is expected to show continued strength in exports and a further acceleration in imports. Inflation data (Wednesday) is expected to show a bounce to 1.6%yoy in the CPI with producer price inflation accelerating further to 8.4%yoy. Credit data will also be released.
In Australia, the NAB business survey (Tuesday) and the Westpac/MI consumer survey (Wednesday) are likely to show continuing high levels of confidence but both may show a bit of a dip on the back of the Victorian snap lockdown.
Outlook for investment markets
Shares remain vulnerable to a short-term correction with possible triggers being the inflation scare, US taper talk and rising bond yields, coronavirus related setbacks and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth and earnings helped by more stimulus, vaccines and still low interest rates augurs well for shares over the next 12 months.
Our year-end target for the Australian S&P/ASX 200 is now 7400 reflecting stronger than expected earnings growth, a faster than expected rebound in dividends and ongoing low interest rates keeping shares relatively attractive. The risk is probably on the upside.
Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.
Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield but the hit to space demand and hence rents from the virus will continue to weigh on near term returns.
Australian home prices are on track to rise around 18% this year before slowing to around 5% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
Although the A$ is vulnerable to bouts of uncertainty and RBA bond buying and China tensions will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by strong commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around US$0.85 by year end.