Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
After 30% plus falls from their highs earlier this year, share markets had a welcome rebound over the last week. While the number of coronavirus cases continues to soar and economic data beyond China is now showing the huge impact from the shutdowns, share markets managed to rebound as a lot of bad news had already been factored in and government and central bank stimulus measures are now reaching a critical mass in terms of limiting the economic impact of the shutdowns. Shares fell on Friday as the European Union (EU) didn’t reach agreement on a joint fiscal response to the virus and the US Federal Reserve (Fed) said it would scale back its bond buying a little (which looks more like fine tuning given bond yields have fallen, rather than the Fed reducing support). Despite this, US shares rose 10.3% for the week, which was their strongest week since March 2009, eurozone shares rose 6.5%, Japanese shares gained 17.1%, Chinese shares rose 1.6% and Australian shares gained 0.5%. Bond yields fell, helped by central banks’ bond buying programs, particularly in Italy. Oil and iron ore prices fell. The US$ fell back sharply on the back of unlimited Fed quantitative easing, which saw the A$ bounce back to around $US0.6150.
The news on the spread of coronavirus and the economic impact of shutdowns remains bleak:
- First, new cases outside China are continuing to surge, with Europe leading the rise (53% of coronavirus cases are in the European Union), but the US also likely to see a rapid rise in the weeks ahead, as the number of tests increases.
- Italy, Switzerland, Spain, Austria and Norway are looking bad after adjusting for population, but the US and Australia are continuing to climb to.
- Second, the mortality rate has continued to edge higher and is now 4.5%, thanks to a surge above 10% in Italy and to above 7% in Iran and Spain. The basic problem in Italy is that its hospitals have been overwhelmed, highlighting the need for aggressive social distancing elsewhere in order to avoid the same fate.
- Third, reflecting this, social distancing has intensified globally and in Australia. Nearly 60% of 41 major countries have severe restrictions on mobility in place compared to around 5% prior to 10th March. Even China has now closed its border to foreigners to stop importing coronavirus cases.
- Finally, the lockdowns are resulting in a huge hit to economic activity. This was already evident in China in February and over the last week has become clearly evident in developed countries, with business conditions PMIs falling to below levels seen in the Global Financial Crisis (GFC) and US jobless claims rising by a record 3.3 million. Similarly, sharp falls in business conditions PMIs occurred in Australia.
But there are some snippets of light at the end of the tunnel:
First, after circa 35% falls, share markets have already factored in a sharp contraction in economic activity and with everybody gloomy were able to have a decent bounce, despite horrible economic data.
Second, Italy has seen the number of new cases trend sideways to down slightly for six days, suggesting its lock down from 9 March may be working, albeit it’s too early to get too excited. Out of interest, it may be following a similar pattern to China with a rough lag of 10 to 20 days between the lockdown and the peak in new cases. Following the Chinese experience, some relaxation of the lockdown may be possible in a month or so. If Italy can get it under control, then it’s a positive sign for the rest of 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, Nike announced that 80% of its stores in China have reopened. Of course, China will be impacted by less demand for its goods from the rest of the world.
Fourth, policy stimulus has continued to ramp up dramatically, providing some offset to the economic shock from the virus and its impact on financial markets. Notably in the last week:
- The Fed has moved to open ended quantitative easing (QE) and expanded its array of lending programs to provide assistance to various borrowers including commercial real estate, consumers and businesses, corporate bonds and municipal finance.
- A US$454 billion federal guarantee of loans as part of the US spending package will enable the Fed to gear up to around 10 times that in Fed loans, representing a massive injection of cash into the US economy.
- The latest US spending package is now $US2 trillion or 9% of GDP and includes loans, loan guarantees, tax concessions, an extension and increase in unemployment benefits (by $600 a week), payments to business and payments to individuals. Taken with Fed action, it’s likely to help businesses hold off from laying workers off. The package has now passed Congress and has been signed into law.
- The European Central Bank (ECB) dropped its limits on how many and whose bonds it can buy under its QE program, filling the gap as the EU only slowly moves towards some sort of joint fiscal response to the virus (likely using the European Stability Mechanism or joint coronabonds). This, along with other measures, has seen Italian 10 year bond yields fall from 2.4% a week or so ago to around 1.3%, which is near pre crisis lows.
- The Reserve Bank of New Zealand (RBNZ) announced QE and the New Zealand Government ramped up its wage subsidy program. It’s also moving towards guaranteed lending to businesses and support for mortgage holders.
- Singapore boosted its stimulus package to around 11% of GDP.
- India announced a stimulus plan and cut interest rates by 0.75%.
- G20 leaders committed to doing “whatever it takes” to control the virus and limit its economic hit. This is mainly symbolic, given they were mostly doing that anyway… but still!
The hit to GDP (across Europe, the US and Australia, which could be as bad as 10% or so in the June quarter) and jobs may look like a depression, but the policy response is way different to what was seen in the last depression in the 1930s, where the initial response was policy tightening. There have now been more than 240 stimulus announcements around the world. Central banks and governments are clearly committed to doing “whatever it takes” to limit the economic impact on the economy and ensure a decent recovery. The next chart shows our estimate of global fiscal stimulus as a share of GDP over the year ahead. If currently proposed measures are allowed for, it will be over 3% of global GDP and far greater than that seen in the GFC.
These measures will help minimise the downside and boost the recovery, but we still need to see evidence that the virus and its economic impact will come under control before we can be confident that shares have bottomed. Shares have had a very strong bounce in the last week, but we saw similar rebounds in the GFC before shares ultimately bottomed.Key things to watch for in the short term for a sustained bottom in markets are: signs that the number of new cases outside China is peaking (countries to focus on now are Italy, where the news has improved a bit and the US, as it drives the direction of share markets); the successful deployment of anti-virals; 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 a lot); “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 seen in the past week 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
The slump in business conditions across the US, Europe and Japan and the surge in US jobless claims by a record 3.3 million clearly indicates that what happened in China is now happening in developed countries too. The surge in US jobless claims is consistent with a rise in unemployment to 5.5%, but it’s likely to go well beyond that. Other data was mostly lagging so I won’t bother running through it here.
Australian economic events and implications
Just as occurred in the G3, the CBA’s Australian business conditions PMIs plunged in March, led by the services sector. An Australian Bureau of Statistics (ABS) survey showed that 86% of Australian businesses expect to be adversely affected by the coronavirus (CV). Weekly consumer confidence also plunged by a record 28 points. Skilled vacancies fell in February, so were already somewhat soft before the CV-shutdown storm hit. Queues outside Centrelink offices point to a very sharp rise in unemployment ahead. It’s complicated, because many workers have simply been “stood down” as opposed to being dismissed, but unemployment is likely to spike to around 10-15%.
What to watch over the next week?
The focus in the week ahead is likely to remain on the number of new Covid-19 cases, lockdowns and their deepening economic impact and the global policy response to deal with it. Key to watch for in the weeks ahead will be a peak in the number of new cases in Italy and the US.
On the data front, in the US, expect to see a sharp fall in consumer confidence (Tuesday), a sharp fall in the ISM manufacturing conditions index (Wednesday), another big rise in jobless claims (Thursday), a sharp fall in March payroll employment, a rise in unemployment to around 5.5% and a slowing in wages growth (Friday).
In the Eurozone expect a sharp fall in March economic confidence indicators (Monday), core inflation to fall back to around 1.1%yoy (Tuesday) and unemployment to remain unchanged for February (Wednesday).
In Japan expect a sharp deterioration in the Tankan business conditions survey (Wednesday).
Chinese business conditions PMIs for March (Tuesday) are expected to show a sharp rebound to around 44 from 29 because conditions have improved since February…which of course is not the same as saying they are back to normal yet.
In Australia, expect credit growth (Tuesday) to remain modest, CoreLogic data to show a slowing in house price growth to around 0.7% for March and building approvals (both Wednesday) to show a 6% bounce after a 15% fall in January, job vacancies (Thursday) to fall and February retail sales (Friday) to show a 0.4% gain in line with preliminary data already released.
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 rebound 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 decline in retail property values and the hit to economic activity from the virus will weigh heavily on near term returns.
Australian house prices are now under threat given the recession in response to coronavirus disruption. Social distancing will mean a collapse in sales volumes and a sharp rise in unemployment poses a major threat to the property market. Prices are expected to fall up to 20%, but hopefully stimulus measures and bank mortgage payment deferrals will help limit falls.
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 risks pushing the A$ lower in the short term, possibly to a re-test of its 2001 low of $US 0.477. Expect a strong rebound once the threat from coronavirus recedes though.
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