Economic Update

Economic Update – November 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

US election and COVID-19 dominate market activity:

Lock-downs re-introduced in major European economies and the northern hemisphere winter approaches
US GDP growth at record level, markets similarly saw reported earnings beat expectations
China’s reported economic data remains resilient

The Big Picture

COVID-19 infection rates continue to ebb and flow in different parts of the world. At the end of October Victoria removed some significant lock-down restrictions. But, in Europe and the UK increased infection rates have caused the re-introduction of lockdowns. The US continues to struggle in deciding how best to manage the virus especially as the US presidential election came to a head.

The combined impact of the election and the virus elevated risk towards the end of October but our ASX 200 finished the month in strongly positive territory. The same was not true for the S&P 500.

Since the outsized falls in economic activity observed in the first two quarters of 2020 were caused by public health restrictions on business and consumers, lifting such restrictions was always going to cause seemingly strong growth during the recovery.

US GDP growth in quarter three, released at the very end of October, was a record +33.1% annualised rate. There are two major distortions in reporting this figure. Firstly, the US annualises its quarterly growth using the compound interest formula. This scaling up makes no sense when the quarterly data are volatile as they are at the moment. The ‘raw’ quarterly growth was a more modest, but still massive, +7.4%. The second distortion is due to the apparent amplification of growth rates stemming from recovering from a very low base.

Given that the US election was scheduled to occur five days after the growth data were released, the distorted data might have been able to be misused in the campaign. However, at that point in time more than 80 million postal votes had been received – which translates to about 60% of the total turnout in the 2016 election. Clearly the turnout of US voters this time around will be significantly greater based on the magnitude of the pre poll votes.

While Biden seems to be a clear front-runner we know from recent elections and referenda that the polls can be misleading. But what is unusual about this election is that it is generally agreed that there is a significant chance of the election results being contested. That means that we should reasonably expect market volatility might continue at least through to the mid-January when inauguration of the President takes place.

If Trump is elected and the Republicans hold the Senate, we might expect a continuation of the last four years’ policies. If Trump is elected but the Democrats win control of the Senate it might be very difficult for the US economy to move ahead smoothly as the Democrats use control of the senate to frustrate the policies of president Trump and the Republican congress.

If Biden wins without taking the Senate it might be difficult for him to put his ideas into action as it was for both Obama and Trump. A so-called ‘blue wave’ whereby Democrats keep the lower house, win the Senate and the White House could bring stability more quickly but what of the policies?
Biden has said he “will move to control COVID” on “day one”. He hasn’t given any insight into how he would achieve control other than he would “follow the science”. Given that the virus wreaked havoc across the world, science doesn’t seem to have produced economically and socially-acceptable outcomes in most places. A problem will occur if Biden tries to introduce lockdowns against the public will.

Biden is also likely to increase taxes on both individuals and corporations. That may help counteract income inequality but would probably dampen aggregate economic growth. As a result, he might delay his tax policy or water it down so as not to disturb an economy that hasn’t yet broken free from the impact of COVID-19. US retail sales and labour market data were strong in the latest month. All-in-all the US economy is looking to be almost out of the woods – other than the fact that they haven’t been able to agree on the next stimulus package to offset the impacts of the pandemic. If stimulus does not come soon, the US economy may weaken.

China, from where the coronavirus emanated, has an economy that is more or less back on track. Its September quarter economic growth was +4.9% over the year or +2.7% over the quarter (which would equate to +11.2% using the US-type calculation for an annualised figure).

China’s retails sales beat expectations at +3.3% (compared to +1.8% expected) as did industrial output (+6.9% compared to +5.8% expected}. The Purchasing Manager’s index was also comfortably above the 50-dividing line at 51.1.

In Australia, our unemployment rate went up one notch to 6.9%, 22,900 jobs were lost. Since, in the previous month, there was an impressive 111,000 new jobs created we view the trend in jobs growth to be quite solid.

Our inflation rate did pick up sharply after the childcare subsidy was removed. At 1.6% for the quarter but 0.7% for the year, inflation is still quite weak and will not be a trouble to Reserve Bank (RBA). Indeed, the RBA has cut its overnight interest rate from 0.25% to 0.10%. Despite this, which will be supportive, there is in fact little the RBA can do – it is all down to the fiscal policies the government produces.

The Federal Budget was brought down in October and produced an estimated budget deficit of $213.7 bn. Following a modest surplus in 2019/20, the current deficit flags a big attempt to stimulate the economy on a number of fronts. It also appears that the government may add more stimulus if it transpires that this tranche is not enough.

The government debt is predicted to exceed one trillion dollars during the following fiscal year. With interest rates so low, that is not a serious problem unless rates suddenly start to rise. It is important to try to regenerate economic growth and recoup some of the debt through the natural increase in taxation flowing from growing incomes and profits.

The European economy continues to struggle and the European Central Bank (ECB) is considering adding further stimulus. Brexit remains a problem and the UK sovereign credit rating was downgraded one notch by Moody’s to Aa3 from Aa2.

With the Chinese economy strong and the US economy moderately strong, albeit with heightened coronavirus risk, they provide a reasonable base for the Australian economy. With the co-ordinated monetary and fiscal policy at home, we are modestly optimistic for the medium-term economic future of Australia.

Asset Classes
Australian Equities

The ASX 200 rose during October in spite of elevated volatility sourced from the coronavirus and the impact of the US elections.
Much of this growth was buoyed by the resurgence in the share prices of the big four banks following the government’s relaxation of certain restrictions on lending standards.

Foreign Equities

The S&P 500 had the biggest one-day fall since June on the penultimate trading day of October. However, there was a sharp bounce back the following day. The VIX’ ‘fear’ index also jumped and we do not expect the market to settle down at least until after the US election is over.

There have been a number of spectacular ‘beats’ by companies of their forecast earnings so far in the September quarter reporting season. We believe this situation was caused by companies and analysts being overly pessimistic in write downs of earnings early in 2020. Importantly, December quarter expectations have been revised upwards but some big companies declined to give ‘guidance’ for earnings in 2021.

There has been a lot of focus on the mega-cap tech companies and many of these easily beat expectations. However, the share prices of Facebook and Twitter went in opposite directions on their news. Twitter beat earnings’ expectations but missed on the growth in the number of users, so its share price was hit hard in after-hours trading.

Bonds and Interest Rates

The RBA cut its overnight interest rate to 0.10% from 0.25%. It now has no more ammunition left on that front since negative rates have largely been ruled out. It can, however, attempt to influence longer term rates such as the three-year rate.

The US Federal Reserve is all but done on its policy initiatives. It is accommodating fiscal policy that is needed to combat coronavirus until effective vaccines and treatments are widely available.

Other Assets

The price of oil and our dollar against the US dollar fell in October. Gold prices fell a little as did the price of iron ore.

Regional Review
Australia

The Federal Budget was handed down in the first week of October. It was quite stimulatory with modifications and additions to the previously launched Jobseeker and Jobkeeper programmes. It also cut income taxes for some individuals and announced an increased spend on infrastructure.
The jobs data released in mid-October refer to the month before the budget. It showed that the unemployment rate climbed one notch to 6.9% and 29,500 jobs were lost. The government initiatives might help reverse that soft result and help the labour market continue to recover.
CoreLogic announced that capital city house prices reversed the previous falls, except in Melbourne, which had been in lock-down.
Consumer prices rose sharply in the recent quarter by 1.6% but this gain was largely due to the reversal from the previous quarter resulting from the childcare subsidy being granted and then removed. Over the year, CPI inflation stood at 0.7% which was well below the 2% to 3% target range of the RBA.

China

The economic recovery in China continues. The latest economic growth data was a slight miss at 4.9% compared to an expected 5.2% over the year however the quarterly growth was a very respectable 2.7% for the quarter.
Retail sales and industrial output both exceeded expectations but fixed asset investment met expectations at a very modest 0.8%. With there being excess capacity in China, renewed asset investment is not yet required.

US

The US election has dominated market attention in recent months. Both sides made all sorts of claims in the presidential and vice-presidential debates which might come back to haunt them.
Biden stated that he ‘will shut down the virus” and that this will be his mission “from day one”. While this is a laudable objective it is all but impossible without effective drugs to combat the virus. Trump continued his often-unsubstantiated claims.

It was reported that there were 661,000 new jobs created in the previous month. While this is about three times a typical strong month before the virus it shows substantial slowing down of growth during the rebound. Around 10 million jobs lost in the shut-down are yet to be replaced.

The future of the US economy is still up to how the virus impacts public health and policy – and the outcome of the election, particularly if the outcome is contested. But, thus far, the rebound in 2020 has been considerably stronger than most people predicted in the early months of the pandemic.

Europe

The UK government continues to struggle to resolve the Brexit deal before the end of the year, However, the dire predictions of a ‘hard Brexit’ a couple of years ago are largely gone. The ECB is considering further stimulus measures as France and Germany go back into lock-down.

Rest of the World

South Korea, swift to react to the pandemic, posted a September quarter economic growth figure of 1.9% beating expectations of 1.7%. For the year, growth was down at 1.3% but again better than expected at 1.9%.

Economic Update – October 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

Labour markets seemingly improve

– Australian unemployment rate fell to 6.8%, still high but better than expected due in part to JobKeeper

– RBA and government are expected to provide more economic stimulus

– US presidential election may cause elevated volatility in financial markets

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact us.

The Big Picture

Both Australian and US unemployment rates fell markedly in their September data releases. However, the data might not truly reflect job status as government programs are being used to retain employees through these difficult times – and those that have lost jobs have been getting some extra assistance.

It is far too soon to suggest that either economy is really healing and more needs to be done from a policy perspective. The prospect of a new wave of COVID-19 infections could seriously send unemployment rates higher again.

October is likely to be a big month for policy announcements in Australia. The federal budget will be announced on the same day (October 6th) as the RBA board meets to announce any monetary policy changes. Traditionally, the RBA does not act on the same day as a federal budget but these are different times.

The RBA had started September keeping its Official Cash rate on hold but it announced $200bn of ‘cheap money’ it was going to make available to the banks to lend to their customers.

It had previously been thought that the RBA would not cut the Cash rate by another 0.25% points to zero in October. Recently Governor Philip Lowe hinted at a ‘partial cut’ to 0.1% was a possibility. It wasn’t until Westpac’s chief economist, Bill Evans, called for such a cut at the October meeting that markets reacted strongly with our dollar depreciating against the US dollar.

The following day, the government announced that it was relaxing its restrictions on borrower credit checks by banks. The big four bank shares jumped sharply in price on the news and our dollar fell even further.

Our dollar reached a recent low of $US0.5571 earlier in the year before climbing to $US0.7412, largely on US dollar weakness. The double finance announcements took the dollar down to just above $US0.70 in only a matter of days!

It is now time for the government to step up to the plate again and see what it can do to keep the economy alive until a vaccine is available to help life return to normal – albeit a new normal.

As is traditional, the government is leaking thoughts to the media before the budget to test the voters’ reactions. Tax cuts and more stimulus along the lines of JobSeeker and JobKeeper are likely.

During September, our national accounts were released. They showed that the economy contracted by 7.0% in the June quarter. A large negative number had been expected because government shutdowns had forced many businesses to shut down or trade for limited hours and/or under strict social distancing rules.

Because it is important for the government to plug the gap resulting from its public health and safety initiatives, the size of the budget deficit this time around should not be compared to past deficits. Indeed, it is probably better for the government to err on the side of generosity.

Any problems caused by too much stimulus can easily be fixed when the economy is back to strength. However, if insufficient stimulus is provided there could then be widespread defaults on loans to consumers and businesses with serious long-lasting ‘genuine’ consequences.

The Westpac and NAB consumer and business sentiment surveys showed us to be less gloomy than in the previous month, but pessimists still outweigh optimists. However, retails sales climbed 3.2% in the month. House prices slipped 1.8% in the quarter.

We also noted from the national accounts that the household savings ratio jumped to 19.8% (or about twice as high as the high point during this millennium)! People are scared to spend in uncertain times. They need a lead from government.

The US unemployment rate surprised many by falling to 8.4% when 9.8% had been expected. The US Federal Reserve (the “Fed”) is expecting 7.6% at the end of 2020, 5.5% the following year and 4.0% (or full employment) at the end of 2022.

The Fed is less confident about getting the inflation rate back up to 2%, its target rate. It expects 1.2% for this year, 1.7% for next and 2% in 2023. Since the Fed is now targeting ‘average’ inflation, it can and will tolerate actual inflation above 2% for quite some time. This new target is widely interpreted as the Fed not considering hiking rates again until at least 2024! In other words, there is good support for share markets until that time – barring other shocks to the system.

With just over a month to go before the US presidential election, the race is hotting up. Trump has fuelled even more ire from the Democrats by announcing his nomination for the vacancy on the Supreme Court caused by the death of the legendary justice, Ruth Bader Ginsberg.

Since US Supreme Court justices have a position for life, it matters a lot which side of politics gets its nomination to sit on the bench. With big issues such as abortion and gun control always at the fore, the approval or otherwise of Trump’s nominee could spark a particularly divisive election campaign.

Biden has largely been standing on the sidelines as the Democrats hope for Trump to lose the election for them. While Biden was well ahead in the polls a few months ago, the gap is much smaller now and almost non-existent in certain key swing states. A recent Reuters poll had the two candidates polling neck and neck in Florida and Arizona.

From an investment perspective, it seems imprudent to ‘bet’ on which candidate will win and what policies would follow. Rather, we believe in managing the risks associated with the outcome rather than the returns. The elder stateman of academic finance research, Wharton Professor Jeremy Siegel, believes the US share market will do well in 2021 under either candidate. Our current analysis of broker forecasts of earnings supports this view.

Although there is much angst between China and the US over big tech and trade, the China economy is doing okay. Recent auto sales were up 12%, exports were up nearly 10% and retail sales posted their first positive month of 2020.

In Japan, Yoshihide Suga has succeeded Shinzo Abe as prime minister after the latter resigned owing to health issues. Suga has stated that he will endeavour to continue the so-called Abenomics policies so little disruption is anticipated.

The UK is struggling with Brexit and looks like trying to overturn its recent agreement. It is fruitless to try and guess how this will all play out. Although the UK is suffering renewed COVID-19 restrictions, its unemployment rate has only climbed to 4.1% from 3.9%.

In summary, the underlying share markets seem reasonably well supported given very accommodating monetary and fiscal policies in Australia, the US and elsewhere. However, the lack of a vaccine for COVID-19, the ferocity of the political campaign in the US and the continuing US-China confrontation over trade and technology mean that there is every chance of more volatility into November. If the US election results are contested, as they were in Bush vs Gore, the volatility could spill over into 2021. For long-term investors, having a well-balanced portfolio through a period of expected volatility remains a prudent strategy.

Asset Classes

Australian Equities

The ASX 200 ended its five-month rally of positive returns. If we look at that as the market taking a breather after a tremendous run, a small loss in September should not be a material concern. This is particularly so since the S&P 500, the World index and Emerging Markets all suffered a similar fate. All rallies come to an end so a ‘breather’ is better than a correction.

Our analysis indicates the market is slightly cheap compared to its fundamentals, though volatility remains elevated to its longer-term average.

Assuming the Federal Budget and the RBA board meeting on October 6th are both stimulatory for the economy, this may act to temporarily at least buoy the local share market. However, the US market is likely to remain a key driver as the US election draws near. It is rare that our market powers on when the US turns down.

Foreign Equities

The S&P 500 had some stronger days near the end of September but there does seem to be mood of caution among market commentators as they contemplate the looming election.

We do not think the US market is over-priced in a short to medium-term sense but these are not normal times. After five consecutive months of strong gains, September was slightly negative. Future trends depend not only on the long-term fundamentals but also in the shorter term, on the existence or otherwise of a broadly available COVID-19 vaccine.

The announcement of an approved vaccine is getting closer. There are at least nine competing vaccines with trials well advanced. In many cases there are (partially) government-funded stock-piles of vaccines being built. The vaccines will not change from the ones at the start of the trials specified many months ago. It is simply that one or another maybe approved for safe use and the other stock-piles will be destroyed. It will still take some time to vaccinate populations in a broad sense but even targeted vaccinations are expected to provide a boost for share markets.

Bonds and Interest Rates

Although most central banks have had their official rates just about as low as analysts thought they could go, there was a lot of action in September.

The RBA put $200bn of cheap money on offer to banks to help lending to consumers and business in these troubled times. They are expected to do even more at their meeting on October 6th.

The RBA continue to act in attempt to keep 3-year government bonds rates lower than they otherwise would be. The official rate might even go down to 0.1% on budget/RBA board day.

The Fed too has thought outside of the box. It changed its target inflation rate from 2% to ‘an average of 2%’. This is important as an odd 2%-plus read will not force the Fed to act, nor the market to anticipate actions.

But with monetary policy taking new, interesting directions, fiscal policy, while now more actively engaged as a result of COVID-19, is still playing catch up. The seemingly broken US Congress system is struggling to get agreement on the amount and structure of additional stimulus for the US economy. We cannot recall such divisive times.

The Australian government also needs to continue to step up to the plate. It seems likely that it will make amends on budget day. So, while central banks are almost universally independent of government, the central banks have gone first and it’s is up to fiscal policy to play catch up.

Other Assets

Most of the major asset prices (oil, iron ore, copper and the $A) fell by a few percent in September. This is not the stuff of sleepless nights. It feels like an organised pause in asset price inflation.

Regional Review

Austrailia

The August labour force data published last month stated that 111,000 jobs were created with many of them full-time positions. The participation rate, being the percentage of the relevant population in the workforce again rose meaning that the drop in the unemployment rate was meaningful. The latest unemployment rate is 6.8% and it was 7.5% in the previous month!

GDP growth was a dismal 7.0% for the June quarter. Since growth in the previous quarter was negative, the simplistic application of a definition of a recession confirms we experienced our first recession in nearly 30 years. However, the 1990 recession was arguably caused by a very high RBA official cash rate.

Because of the lags in monetary policy taking affect, the resultant recession in 1990 was deep and the unemployment rate soared into double figures. Since this current situation is due to a prudent set of public health initiatives, the impact was felt immediately and is anticipated to be less harmful to our medium-term economic prospects.

China

The China recovery continues. Exports again grew strongly at +9.5% but imports fell by 2.7%. Industrial output was up 5.6% and retails sales grew for the first time in 2020. While the Chinese economy has not reached its former glory in terms of its economic growth rate, it was the first major country to rescind pandemic restrictions and its policies are seemingly working.

The saga of intellectual property rights and social media continues. It is not an easy problem to solve and we expect no major resolutions anytime soon.

The US Congress has still not worked out its next stimulus package but it did pass a bill to avert a government shutdown.

While initial jobless claims and nonfarm jobs creation data have improved, there is still a very long way to go before the US gets back to work fully.

It is not clear that the ‘blue wave’ will sweep Democrats into the majority in the senate and there will likely be similar problems to now of passing bills through congress, regardless of who is elected president.

If the election is again close, as many are predicting, there is an increased chance of the victory being challenged. That would cause prolonged uncertainly possibly into 2021.

Europe

The UK government continues to struggle to resolve the Brexit deal. Fortunately for most of us it will not have a major impact on our investment strategies.

Rest of the World

Japan has now elected its new prime minister, Yoshihide Suga, who has vowed to continue Shinzo Abe’s economic reforms – the so-called three arrows. It is far too early to tell how successful the transition will be.

September Economic Update

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

New highs on Wall Street:

Earnings season in US beats expectations, noting that expectations were lower due to COVID-19
The US market buoyed by large Tech companies still leading the charge
Australian jobs data show some strength but not out of the woods yet

The Big Picture

Wall Street’s second quarter (Q2) earnings reporting season, held mainly in August, provided a stronger result than expected on bottom line i.e. profits. Companies usually set a ‘low bar’ but this quarter’s ‘beat’ was much bigger than normal.

Admittedly, the main strength was in the tech sector – and mega-caps at that – but there were plenty of other good results. The Nasdaq (tech dominated) index made new all-time highs. The broader based S&P 500 also hit new all-time highs in August but the Russell 2000, representing smaller companies, did not fare so well.

Wall Street is on a roll but is it sustainable? Many argue that its success is largely due the Fed’s loose monetary policy. That is certainly true in part but it’s not the whole story.

Low yields on bonds and low rates on cash – which both come from the Fed’s policy stance – mean that equities are about the only place to earn income. However, massive improvements in technology and their impact on companies’ efficiencies are also at work.

That US earnings were largely under-predicted goes to the notion that many analysts’ views on over-valuation were partially misguided.

At home, our first-half company reports have also thrown up many upside surprises but our ASX 200 index has struggled to keep pace with Wall Street. Perhaps if we had a few Amazons, Netflix and Facebooks, things would be different. But we haven’t (yet?)! However, that doesn’t mean we can’t maintain growth in equities – but not necessarily at the same pace as Wall Street.

Our analysis shows us that only now does Wall Street start to look a little bit “toppy” but that does not mean a correction, or worse, is necessarily on the horizon. But it might mean the big short-term gains are behind us. In the long haul, we fully expect decent returns on Wall Street and at home. We do not think it is a time to sell – particularly when capital gains tax is included in the mix – but pausing between market entries with any excess cash, or dollar cost averaging, might be the way to go.

A lot is being talked about sector rotation and portfolio styles. Value portfolios (which are usually characterised by being cheaply priced relative to current earnings) have gone nowhere in recent years.

Growth portfolios (which are usually characterised by low dividends because companies prefer to re-invest earnings within the company rather than distribute them as income to the investors) have done well in recent years.

Apart from the relative performance in the steep market decline last March and the steep ascent since then, growth has beaten value by a country mile. However, our analysis suggests that these two aggregated sectors might be more on level-pegging terms in the year to come.

Diversification means that prudent investors shouldn’t take big bets on any stocks, sectors or styles. But prudent portfolio managers who have the flexibility in their mandates should try to anticipate changes in performance – but glide to a new position rather than lurch.

We think it is fair to say that much of the macroeconomic data has been corrupted by the impact of the sharp – but necessary – virus-related shut-downs and the consequent rush back to re-opening.

However, there have been a number of bright lights among the sea of data deluges. The US has witnessed some particularly positive housing data. China looks resilient. Indeed, the CEO of BHP just stated that ‘China is in a V-shaped recovery and looking good’.

The Fed held its big annual international central bank conference virtually rather than actually this year in Jackson Hole, Wyoming at the end of August. Nobody seemed to expect any big announcements this year. It was only going to be lower rates for longer but Fed Chairman, Jerome Powel, came up with a headline!

The ’old’ target for inflation of 2% was replaced by an ‘average inflation’ target of 2%’. The Fed had already baked in some wiggle room over slight breaches of 2% but this new target gives them even more room such that they could take a marching band with them!

The Fed does not want to stunt economic or market growth with a quick rate move. More importantly, it doesn’t want the market to try to second guess them so they’ve put this extra barrier around themselves.

In a previous meeting the Fed said they were ‘not even thinking about thinking about thinking about raising rates.’ Now they are not even thinking about the previous statement.

We think we can reasonably conclude that the Fed will not upset the apple-cart again – as it did a few years ago when Powell hiked rates and then had to recant.

So, with rates low for a very long time, what should we fear? We think there is no reason to expect a pent-up inflation boom to build in the near term at least. The only big changes in inflation since WWII in the US followed the Korean war in the fifties and the OPEC oil prices hikes in the seventies.

And what if there is a boom in economic growth? We should applaud growth – unless it causes inflation. There seems to be reasonable evidence that low rates promote growth (greater than it would otherwise have been) but the link to inflation is tenuous.

Macroeconomics is an uncertain science at best – even compared to microeconomics and econometrics. The accepted linkage between growth and inflation is the so-called “Phillips curve”. In 1958, Kiwi Bill Phillips published a seminal academic paper on the relationship between unemployment and wages growth. He pushed the idea no further than that! But acolytes took this empirical study to the limits, even though new data did not support such a stable relationship.

In truth, academic economists and central bankers cannot find empirical evidence to support a stable relationship between unemployment and inflation and – by extension – between interest rates and inflation.

There has also been a growing following for Modern Monetary Theory (MMT). It didn’t exist a few years ago but the thesis of its proponents appears to be – grow the budget deficit with no consequences (unless inflation builds up). It’s interesting to note that academics who support this theory also seem to cover their tenure (i.e. a life-time job no matter what) which means that MMT proponents are safe from any come back if they are wrong!

So, where do we stand? We think we need a modicum of common sense when it comes to printing money and creating debt and that we are currently on a sensible path. Growth is building and is close to being sustainable without central banks.

We think it will be many years before any problems arising from Fed action surface – if at all – so we choose to think in terms of investing in a stable medium-term strategy.

Unlike in the US, our unemployment rate has not yet started to fall. But the last published increase was only from 7.4% to 7.5% and 114,700 jobs were created (of which 43,500 were full-time) in July. The participation rate continues to climb reflecting that people from outside the workforce are being encouraged to look for work.

James Bullard, president of the St Louis Fed, recently stated that the US growth for Q3 will likely come in at the biggest ever (largely because of the sharp fall in Q1/Q2) as we argued earlier in the year. If it does come in at around 20% (annualised) as Bullard suggests, that might be a big boost for Trump less than a week before the presidential election. Since most people probably don’t understand all of the important data and statistical issues it could be some ‘fake news’ that works in Trump’s favour!

Asset Classes

Australian Equities

The ASX 200 posted its fifth straight month of capital gains in August. However, our analysis does not suggest that it is significantly overvalued.

The Consumer Discretionary, Property and IT sectors were the strongest of the 11 sectors that make up the broader index during August. The Telco and Utilities sectors posted big capital losses in August.

The earnings reports for the first half of 2020 that have been posted so far have overall been better than many expected but there have been a number of quite poor results. This patchy success stresses the importance of appropriate diversification strategies.

Foreign Equities

The S&P 500 and the Nasdaq indexes broke all-time records on a number of days where new highs were reached during August. The S&P 500, like the ASX 200, posted its fifth consecutive month of gains but its August returns over-shadowed our (Australia’s) performance.

In contrast to our analysis of the ASX 200 we do find some evidence of the US market having run too fast. That does not mean that a correction is imminent, inevitable or even likely. Rather, the index might move sideways for a while until the fundamentals grow to catch up and erode any over-pricing.

There is increasing optimism on Wall Street that earnings in 2021 will be as big as, or even bigger than, those in 2019.

James Bullard, the St Louis Fed president, claims that the US recession only lasted two months and so its impact on earnings is likely much less than many anticipated at the start of the pandemic.

The world and emerging markets indexes have performed largely in line with the S&P 500 since the March lows.

Bonds and Interest Rates

The Fed’s contribution to the annual Jackson Hole meeting of central bankers was more interesting than normal – even if it was a virtual meeting. The Fed made it totally clear that it is not even worth thinking about when rates will go up. Indeed, they have even changed the definition of the inflation target to make the intent even clearer.

They are now targeting “average” inflation meaning that inflation above 2%, the current target, could be tolerated for an indeterminate period of time. Moreover, since the employment target will now focus on low and middle-income people, analysts are taking this to mean there is even more wiggle room for the Fed before it feels the need to raise rates.

The US 10-yr yield rose about 10 bps to around 0.65% and this caused the gap to the 2-yr yield (the so-called yield curve) to steepen.

Australia’s RBA is also ‘on hold’ and likely to be so for a similarly long time.

Other Assets

After some massive volatility in the prices of oil in the first half of 2020, there has been little change in either benchmark Brent or West Texas Intermediate (WTI) oil prices for several months.

The price of gold rose to above $US2,000 but then it retreated. The $A against the US dollar has continued its rise. Analysts are largely attributing this move to the weakness in the US dollar rather than in the strength of ours.

Importantly, iron ore and copper prices gained strength in August – possibly on the renewed strength of the China economy.

Regional Review

Australia

The June labour force data published in July stated that 210,800 new jobs were created but the number of full-time jobs was negative as COVID-19 restrictions changed the nature of business in Australia. In July, another 114,700 new jobs were announced but this time they included 43,500 full-time jobs. Perhaps solid economic recovery is underway. In normal times, only around 40,000 to 50,000 new jobs in a month (with half of that full-time) would be considered a big success.

The unemployment rate did go up one notch (0.1%) to 7.5%. Given that the participation rate – measuring the proportion of the relevant population actually in the workforce – was strongly up, an increase in unemployment from 7.4% to only 7.5% is particularly noteworthy. That is, people not either employed or classified as unemployed in the previous month were optimistic about joining the unemployment queue or got a job straight away.

The NAB and Westpac sentiment indexes painted a gloomy picture and the business indicators were sampled before the re-introduction of restrictions in Victoria. Nevertheless, retail sales were up 2.7% for the month of July.

We do not think the data are strong enough to conclude that the Australia economy has turned the corner and started to recover – but it does look that it might be in the process of recovering!

China

China exports grew at 7.2% in July and were much stronger than expected. The difference was largely explained by an unusual increase in medical supplies, no doubt related to COVID-19.

China auto sales were up 16.4% for the month which was the fourth consecutive month of growth.

The official China manufacturing purchasing managers’ index (PMI) came in as a slight miss at 51.0 – but that was well above the 50 mark that separates expansion from contraction. The services PMI at 55.2 was a big increase on the previous month’s 54.2.

Popular opinion among senior spokespeople for major financial institutions interviewed on business TV channels are calling a strong China recovery. In turn, that recovery has already helped Australia’s resources sector.

The US congress is struggling to find a solution to creating the next virus-related stimulus package. Both sides are in favour of a sizeable package but they cannot agree on how the money should be spent. The people who were getting the $600 supplements have received no more cash since the end of July.

If a solution is not found very soon, there will be no new payments until 2021. It is reasonable to conclude that much of the squabbling is due to politicking before the November election.

Trump was doing very badly in the polls a few months ago but he is coming back strongly – but he still has a long way to go. Democrats might well have fired all of their anti-Trump bullets but the Republicans seem to have some salvos in reserve. With a strong campaign and strong economic data (only because it was so bad before) Trump could make the election close.

It is not for us to take political sides or say which party would be better for the economy. One sage commentator on business TV pointed out that it is foolish to position one’s portfolio on the expectation of a particular candidate winning. Lots of proposed policies get lost after the election or defeated by the opposition. Punting on a candidate’s victory and subsequent policies is not a prudent investment strategy!

Non-farm payrolls were again up strongly in July – this time to 1.8m new jobs against an expectation of 1.6m. The unemployment rate fell from 11.1% to 10.2%.

The Citi surprise index – that measures the proportion of times consensus economic forecasts are beaten by the outcomes – continues to be very high. That is, forecasters in recent months were, in hindsight, far too pessimistic about the US economy.

Core inflation came in at 0.6% for July which is the largest number since 1991. However, as with our most recent CPI reads, there are possible statistical aberrations flowing from the impact of the virus (and the Fed need a lot more evidence of rising inflation to act on this reading anyway!)

Europe

News from Europe has largely been swamped by that from the US and Australia in our investing world. German exports did beat expectations but there were also many negative results – but not to the extent that they will impact in any major way on our market and Wall Street.

Rest of the World

Japan’s Prime Minister, Shinzo Abe, has resigned his office owing to health problems. He had brought stability to government after five years of instability during which five people had taken turns at the helm before his term.

Abe had built a policy, “Abenomics”, with three instruments – known as the three arrows. While it cannot be said that his policies have yet solved the problems of Japan’s economy, his presence on the global stage will no doubt be missed. We wish him well.

Economic Update – August 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The rally in equities continues

– The ASX 200 and S&P 500 both posted four months of positive returns

– COVID vaccines are under development and undergoing trials in many countries, expectations are that they may be available in early 2021

– China economic data are getting back to pre-COVID levels

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact us.

The Big Picture

Equities listed on the ASX 200, Wall Street (S&P 500), the world and emerging markets indices all posted a fourth successive month of positive returns in July – although the ASX 200 gave up much of its July gains on the last day.

The S&P 500 just posted its best July gains in 10 years – an impressive +5.5%. Much of the recent gains on this index can be attributed to the mega-cap tech stocks including Amazon and Facebook. Indeed, if the tech stocks are stripped out of the S&P 500, its performance has only been modest.

Reporting season, when companies reveal their latest balance sheets and outlooks for the future, is well under way in the US for the June quarter. Reporting season is just about to start in Australia for the half year.

There have been some blockbuster corporate earnings reports on Wall Street but also a number of big misses. Success and failure have been roughly aligned with the ‘stay-at-home’ stocks like Amazon and Netflix vs COVID shutdown economies such as Airlines and hospitality stocks. Facebook and other internet companies have largely done very well – as have a number of the drug companies. The obvious suspects for entertainment outside of the home continue to struggle.

With many regions re-introducing opening restrictions on restaurants and bars to counteract the second wave, the global economy will struggle to get back to normal anytime soon. However, there are some bright spots.

China posted a massive 11.5% for June quarter economic growth against an expectation of 9.6%. On an annual basis, the outcome was obviously more modest at 3.2%. China trade data beat expectations on both exports and imports. The purchasing managers indexes (PMI) a measure of input demand, for both manufacturing and services were also strong.

While the US posted a widely expected large negative growth figure for GDP, retail sales are almost back to where they were before the COVID virus spread to the US.

Australia created 210,800 new jobs for the latest month but all of these were part-time. Indeed, full-time jobs actually went backwards. The unemployment rate came in at the expected 7.4%. The Reserve Bank of Australia (RBA) stated that its general economic outlook had been too pessimistic earlier in the year. It still expects unemployment to be 9.3% at the end of 2020 which is well below the peak experienced in the last recession nearly 30 years ago.

Australian inflation was reported to be 1.9% for the latest quarter – the lowest result in over 70 years. However, there were very special circumstances to explain this fall in prices. Childcare had become free for many and oil prices plummeted which created a big fall in petrol prices. Since the price of both of these items will likely ‘return to normal’ in the current quarter, a very large positive inflation figure is likely next time around.

It is important to note that the RBA’s preferred measure of inflation, that removes wild fluctuations in some items, was a much more modest 0.1% for the latest quarter – almost flat.

The European Union (EU) announced a 750 bn euro stimulus package to support COVID-affected people and businesses. The US senate republicans laid out a $1 trillion package for a similar purpose. Given their system of government, the republicans must now negotiate with the democrats before it can become law. This will delay the outcome somewhat.

At home, our government is extending economic support under a modified JobKeeper and JobSeeker scheme. One problem that was identified here and overseas is that some people were financially better off by not working. Law makers are trying to address this issue so that people are incentivised to go back to work.

Interestingly, in Australia a large number of people entered the workforce as unemployed in the latest data. The opposite of this behaviour is often referred to as the ‘discouraged worker effect’ as recessions loom and people give up looking for work. Perhaps we should refer to recent moves in data as an ‘encouraged worker effect’!

Also, on the bright side, at least three companies in the US are building up a stockpile of COVID-19 vaccines in anticipation of their drugs being validated by current clinical trials for approval by the US authorities. A similar situation is occurring in Queensland and the highly publicised Oxford university project.

Usually, clinical trials are completed before production commences because of the risk of wasting money on the production of drugs that turn out to be unsuccessful. The current ‘parallel production processes’ have been made possible by government financing. No corners are being cut in developing vaccines. The stocks of ineffective or bad drugs will be destroyed if and when appropriate.

Therefore, the 12-18 months minimum lead-time for vaccines that we reported on a few months ago has been dramatically reduced by these public-private partnerships. Given the number of different vaccines being developed, we think it is quite reasonable to expect one or more vaccines to be on the market from the end of this year. If that happens, we also expect stocks markets to rally from wherever they are at the time.

In the interim, governments are only seeking partial lockdowns; stockpiles of masks and respirators are being built; and medics are better informed about tracking and treating those so infected. We are hopeful that further success in vaccine trials in conjunction with ongoing government support will see the second half of 2020 faring better economically than the experience of the first half.

Asset Classes

Australian Equities

The ASX 200 had a positive month in July (+0.5%) in spite of losing more than 2% on the last day! Normally companies ‘confess’ in the weeks before the reporting seasons of August and February so that they cannot be accused of misleading investors when adverse figures are expected.

Confession season has been relatively quite this time around as much of the ‘confessions’ were made earlier in the year as the lock-down came into force. Therefore, we do not expect as much short-term volatility from any poor results as we might normally expect. Weaker results have largely been priced in.

Growth stocks, as opposed to value stocks, continue to dominate ASX 200 returns. We think that this momentum will continue at least for a little while.

Foreign Equities

The S&P 500, the world index and emerging markets all performed well in July – for the fourth month in a row. Indeed, July’s +5.5% on the S&P 500 marked the best July result in 10 years! The tech sector continues to dominate Wall Street’s performance and this is likely to continue as most of the big tech companies beat expectations at the end of July.

Interestingly, at just over half way through the year and after a sharp sell-off in March, the S&P 500 index is already close to where the consensus expected the market to finish 2020.

Bonds and Interest Rates

The US Federal Reserve (Fed) concluded its major meeting at the end of July with interest rates on hold and a statement that policy will err on the side of expecting poor results. Markets liked this, and initially rallied. The shorter-term US interest rates are now quite depressed with maturities out to 3 years all about the same, close to zero. However, for 10-year government bonds the yelled is 0.55%.

The RBA was also on hold and stated that, in hindsight, it was too pessimistic about the economy earlier in the year. Rates continue to be expected to be lower for longer.

Other Assets

The major commodities did quite well in July. Gold prices rose to close to $2,000 largely on the back of a weaker US dollar. Copper, iron ore and oil prices firmed which bodes well for the Australian resources sector. The Australian dollar firmed against the US dollar but not against other key currencies such as the UK pound sterling.

Regional Review

Australia

210,800 new jobs were created when ‘only’ 112,500 were expected. All of the new jobs were part-time. Full-time jobs were lost in June. These data points are consistent with restaurants and bars re-opening at less than full-capacity.

93,600 more people were unemployed at the end of June compared to the beginning. This figure is not at odds with the 210,800 jobs created. The participation rate, being the percentage of the population in the workforce, jumped sharply. People are classified as unemployed either if they are employed people who lose their jobs or if they enter the workforce from outside in search of work. This increase in participation from the latter source is considered to be a positive for the economy.

The June quarter inflation figure came in at a more than 70-year low at 1.9%. The trimmed mean, preferred by the RBA because it strips out volatile items was less dramatic at 0.1%. As the price of oil and childcare comes back to previous levels, the next read should be strongly positive but of little concern on its own. December 2020 quarter inflation should be a better indicator of underlying demand.

Victoria has re-imposed strong lock-down restrictions on its residents. Queensland has instituted travel bans from most people outside of that state. Hot spots are emerging in parts of Greater Sydney.

China

China’s PMI for manufacturing came in at 51.1 against an expectation of 50.7 and the services PMI continued to be very strong at 54.2. These data, released at the end of July backed up the recent stronger GDP growth data.

China’s March quarter growth was 6.8% on an annualised basis and this jumped strongly to +3.2% in the June quarter against an expected 2.5%. The quarter-on-quarter growth in June was an impressive 11.5%. Both exports and imports beat expectations. It would appear that China is already coming out of its first quarter slowdown.

US June quarter growth came in at a massive 32.9% but some of this figure is due to a statistical aberration. In the US they calculate the quarter on quarter growth rate and scale it up to an annualised figure (using the compound interest formula). It does not mean that GDP is 32.9% less than it was a year before! Rather, Q2 was approximately -9.5% quarter-on-quarter growth. We fully expect a bounce back in the September quarter.

US Non-farm payrolls data reported 4.8 million new jobs created but that leaves a lot of US people who lost jobs in recent months still on the sidelines. The latest unemployment rate is 11.1% but this rate is less than the previous month’s rate of 13.1%.

Of great importance to us is the latest Citibank surprise index. This bank collates consensus forecasts and outcomes for many important economic data series. The surprise index measures the proportion of times the outcomes were better than the consensus forecasts. The index was close to 100% near the end of July indicating forecasters had been far too pessimistic.

We continue to believe that the US and other countries are coming out of the effect of the lock-down more quickly than many, including ourselves, however, there is a long way to go particularly as hot spots flare up and policy responses react accordingly.

Europe

The European Union has agreed on a 750 bn euro package to compensate members for the impact of COVID restrictions. There was an extensive debate because different member states wanted a bias towards loans over grants or vice versa.

Economic Update – July 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery is happening sooner than we expected!

– End of quarter market volatility might have blurred the underlying strength of markets

– There are strong signs that many investors were too pessimistic a few months ago

– The US Federal Reserve continues to support markets

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.

The Big Picture

The bumper rally in Australian equities starting from the March 23rd 2020 low appears to be pausing as we enter a new financial year. There are many unknowns – not least of which include how the COVID-19 pandemic will playout, and how the November 2020 US presidential election will influence markets.

The financial year just ending (FY20) did produce a moderate negative return of -7.7% for Australian shares even after including dividends being re-invested. But, to put that loss in perspective, it is only the second loss in the 11 financial years since the post-GFC rally started in mid-2009! Moreover, it does not appear to us that the longer run rally will end anytime soon as many central banks are still operating under very loose monetary conditions.

It is very difficult to predict how the COVID-19 pandemic will play out given there are no vaccines or cures yet available – and may not be for another 12 months. There are signs in some regions, and some of the southern US states, that a material second wave is taking hold. Australia has fared comparatively well, however the state of Victoria has placed 30 suburbs of Melbourne back into lockdown due to a rapid increase in localised infections.

Since we now have far more knowledge and available resources than when the virus first struck, we think it is reasonable to assume that authorities will be able to better manage the spread and impact of the virus from here without the almost global shut-down of economies witnessed in the second quarter of 2020.

As restrictions are being relaxed, there are signs that economic recoveries are under way. We argued that the sharp negative growth figures we saw earlier this year – and still in some regions – should not be overly dwelt upon. We take the same measured view about the magnitude of the recovery figures.

In June US retail sales grew by 17.7% for the month and house sales by 16.6%. Australian retail sales grew by 16.3%. And China posted a 6% monthly gain in industrial profits – the first positive results since November! These are, of course, historically very high numbers. Our take-away is not the magnitude of these data points, but the timing. The recovery has started a couple of months before we and most others thought likely. And that is very welcome news indeed.

If the pick-up is faster than most expected, it is no surprise that we infer the market sell-offs into March were likely over-done. Some commentators are saying that the June quarter (Q2) rally was too strong. That is only the case if the over-sold notion is not taken into account. Either way, a strong rally into the end of a quarter (and our financial year) tempts fund managers to lock in some gains for window dressing and tax management purposes.

Until our company reporting season starts in August (and the US second quarter results start soon) we do not have much insight as to what companies really think the future looks like.

It is true that the US has called that their economy went into recession in February of this year. With our 0.3% result for quarter one growth and a likely big negative number for quarter two, we can reasonably conclude that we are in recession too.

However, US and Australia unemployment numbers are lower than one might expect in a ‘normal’ recession. These shut-down induced recessions are very different from the traditional ‘standard’ recession. The IMF has predicted global growth for 2020 to be 4.9% but that needs to be analysed in conjunction with the possible speed of the recovery.

With two new relevant COVID-19 drugs announced from Oxford University in June, some sensible re-opening of economies, and the nascent signs of economic recovery, the future is brighter than most thought only a few months ago. The US Federal Reserve has ramped up monetary stimulus and our government has announced further fiscal stimulus. It is often considered unwise, in a market context at least, to ‘fight the Fed’! i.e. don’t bet against the central banks (US Federal Reserve mainly), such is the strength of their influence that their actions can have a material influence on direction or state of markets.

Asset Classes

Australian Equities

The ASX 200 had a strong June posting a capital gain of +2.5% which was in line with the world market. However, capital gains for the financial year (FY20) were down 10.9% or 7.7% when re-invested dividends are included.

While FY20 was poor for the Australian index, two sectors stood out as very strong pockets of growth. The health sector gains were +25.7% and the IT sector gains were +18.0%.

We judge the market to be modestly under-priced but that call must be considered in the light of company earnings forecasts and outlooks seemingly lagging behind actual events. This situation should become clearer as our August reporting season gets under way.

Foreign Equities

The S&P 500 gains in June slightly lagged behind the ASX 200 with a gain of +1.8%. However, the US Dow Jones Index had the best Q2 since 1987; the S&P 500 had the best Q2 for 22 years; the Nasdaq broke through 10,000 for the first time and recorded gains of 24.4% in the last 12 months (our FY20). Europe posted the best quarterly gains for five years. Of course, Q1 (the March quarter) was very bad for most indexes so Q2 should not be viewed in isolation.

Bonds and Interest Rates

There has been little movement in official rates because they are effectively at the floor (at zero or negative). However, central banks have been trying to influence longer rates with quantitative easing (QE).

From June, the Fed is now able to purchase individual corporate bonds and it is committed to at least $120bn purchases per month of Treasuries and Mortgage Backed Securities until the end of 2022. That is much bigger than the QE during the GFC. It has also stated that the reference rate will not be increased at least until after 2022.

The governor of the Reserve Bank of Australia (RBA) stated that the official rate will be low for years to come.

These actions by central banks make investing in equities more appealing than they otherwise would be. Some call it the equivalent to a ‘put option’ (or floor) on the market. Volatility will still persist but money has to find a home that will pay a yield. Equities currently have the best chance of producing a reasonable income stream out of the standard asset classes.

With global official rates in the short term almost locked into near 0% for the major economies and the middle durations (such as 3-year bonds) heavily influenced by QE, the yield curve looks stable and accommodating.

Other Assets

Although there is still price volatility in commodities, prices are far more stable than they were a month or two ago. There has been increased commitment to controlling the supply of oil helping those prices stay well away from the May lows.

Copper and oil prices had a very strong month in June – and iron ore prices were marginally up.

Regional Review

Austrailia

First quarter GDP growth came in at 0.3% signalling the probable start to (at least) two quarters of negative growth which would be enough to call a ‘recession’ using the simplistic rule of two consecutive quarters of negative growth.

However, it should be stressed that growth over the year was still positive at +1.4%! All is not yet lost.

However, the unemployment rate is still only 7.1% which is well below the levels of previous ‘standard’ recessions. With the economy starting to reopen, unemployment may not worsen much more.

With Prime Minister Morrison launching $1.5bn worth of ‘shovel ready’ infrastructure projects in June, and it seems likely that ‘Job-keeper’ and other such schemes in some form are likely to continue, the government fiscal policy is aimed at supporting economic recovery.

China

China is flexing its muscles over Hong Kong and the US is getting involved. While it might be laudable to come to Hong Kong’s assistance (even trying to bring in Europe) there could be some very bad consequences for trade and global growth should this situation escalate.

Industrial production up +6% bounced back in the latest China data – the first positive since November. Hong Kong re-opened its Disneyland facility – albeit with some restrictions.

Both the manufacturing and services PMIs (Purchasing Managers’ Index) beat expectations. The manufacturing sector expanded for a fourth straight month at 50.9. The services sector PMI was up one point at 54.4 over the previous month.

While the impact of COVID-19 on New York seems to have been managed reasonably well, many of the ‘holiday’ and oil producing states that relaxed restrictions are now experiencing a very strong second wave. There seems to be little appetite for a second lock-down so it is unclear how this situation will pan out.

President Trump has slipped well behind Democratic contender Biden in the early election polls. However, Trump leads in ‘dealing with the economy’ so it is hard to predict who will win the election when ‘the chips are down’. If Biden wins, tax increases are on the agenda to address the widening income and wealth inequalities. However, it is unlikely anyone would try to raise taxes while the economy is so fragile.

Europe

There is little doubt that the fortunes of Europe are not as important as they once were considered to be. The possible fallout from a Grexit or a Brexit are no longer major issues. The UK even seems to be in a position to do a trade deal with Europe in July – well before the December 31st 2020 deadline.

Europe’s economic data has been as bad as elsewhere. But Europe is not as key to US and Australian economic success as it was previously. When Europe looked likely to implode (in around 2001-2013), it mattered a lot more.

Rest of the World

Japan was forced to reconsider the re-opening of its economy. The latest industrial output data was 8.4% for the month. Japan has not yet turned the corner as possibly the US and Australia have economically.

China passed laws to control certain aspects of its security relationship with Hong Kong to take effect from July 1st. The US is unlikely to remain quiet on this point and an adverse trade response is quite possible.

Iran has issued an arrest warrant for President Trump and a large number of other US citizens! It is no more than a political statement and it does not reflect well on Iran.

Economic Update – June 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery continues

Equities continue to climb the wall of what appears to be ‘less worry’
Economies are starting to re-open which is providing further support for equities
Central banks and Governments continue to apply rescue measures as COVID-19 continues to see increased infections dampening social and economic activity.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

We started last month’s update with the thought that the worst could be behind us but that volatility might still spook markets for a while to come. A quick look at key equity markets tells a more positive story for May with the ASX 200 adding 4.2% to the 8.8% gained in April. The S&P 500 added 4.5% to the 12.7% gained in April.

We still think it’s too soon to assume normal reliance on macroeconomic data. We expected the numbers to remain volatile and we were not disappointed.

The big picture we are focusing on is the mood in the markets about re-opening economies. In one month, we have gone from dire predictions of nothing opening to what looks like an orderly opening in Australia, the US and Europe. Yes, there are pockets of confusion but the stock markets seem to have been buoyed by the fact that an orderly return to work is already beginning to happen.

So long as there is one person carrying the virus there is a chance for others to contract it. There is a very high probability of a second wave. The question is – what form will that wave take?

In Australia, the shut-downs seem to have been largely successful. When someone in a newly opened bar or café contracts the disease, quickly responding to those exposed can minimise the spread. If left unchecked we can easily get back to the problem we had a month or so ago.

Of course, the systems and equipment we now have in place are better to deal with a new outbreak. Australians, by and large, appear to be reasonably responsible. Contrast that with the situation in the USA. There seem to be large clusters of vocal groups claiming all sorts of rights regarding employment and social mobility. It does not matter whose philosophy is correct, viruses only react to people close at hand. We would not be surprised if the relaxing of containment measures proves to be premature and a fresh outbreak occurred in the US and it might be big enough to unsettle markets. In light of the recent social unrest the potential for further outbreaks has likely increased. This will weigh on investment decisions.

Governments and central banks are still applying fiscal and monetary support in amounts that should assist to avert a further escalation of the economic impacts of the COVID-19 crisis. However, at the individual level some groups might be relatively disadvantaged.

Going forward, we are naturally keeping an eye on fresh outbreaks of COVID-19, potential vaccines and cures. They are all potential games changers.

Given the speed of the re-opening of Australia and the US we might expect to see some meaningful data on unemployment from July (to be reported from August). Until then our focus is more on intuition as meaningful forward looking data remains scarce. As economic data releases and in particular corporate earnings estimates stabilise, we will again be able to produce a more informed outlook.

Asset Classes

Australian Equities

The ASX 200 posted a strong +4.2% gain over May with a few sectors standing out. IT (+14.5%), Materials (+8.0%), Property (+7.0%), Telcos (+6.0%) and Financials (+4.7%) were the strongest sectors.

Based on the growing belief that we at least appear to have COVID-19 contained, then the market from a relative value sense is somewhat attractive but with ongoing uncertainty volatility will remain elevated.

Foreign Equities

The S&P 500 posted a +4.5% gain in May which followed a +12.7% gain in April. However, the S&P 500 is down ?5.8% on the year-to-date.

Many analysts have been quick to point out that the gains in recent years have been mainly concentrated in about 6 or 7 big tech stocks. Without those stocks, they say Wall Street would have just moved sideways.

Index investors need not overly worry about the concentration of strength in stock returns. Others need to be more careful about how they construct portfolios as COVID-19 and the respective Government and Central Bank responses to it have increased the relative attractiveness of some stocks and in particular, some industry sectors over others.

Bonds and Interest Rates

With most national bond rates close to zero, there is not much room for rates to move. We do not expect any of the major countries will be raising official rates any time soon.

With rates low, investors still have to consider deriving some yield from equities.

Other Assets

April was clouded by wild gyrations in the price of oil. West Texas Intermediate (WTI) prices even went negative mid-month as people got caught with the ending of the May futures contract.

We flagged that a repeat situation might occur in mid-May but no such disruption happened. Indeed, WTI oil prices (the relevant US price) were up 88% over May while Brent (the world price) was up 39.8%.

The OPEC problems and shortage of world demand are still big issues but the issue with the futures contracts seems largely contained for now.

After big changes during May the prices of iron ore, copper and oil finished May close to their intra-month highs. It is important for global stability for these commodity prices to stabilise at reasonable levels. At last, that seems to be happening. The Australian dollar (against the US) also finished May at near the intra-month high.

COVID-19 Review

The chart below is the latest from Johns Hopkins University Coronavirus Resource Centre.

The message is quite clear, the reported cases of COVID-19 continues to rise globally while we here in Australia have fared better than most, if not all. The reporting of COVID-19 cases is now escalating in the emerging economies of Brazil, India, Russia and counties in the middle East. Notwithstanding the US has reported circa 1.8 million cases which is in excess of three times that of Brazil in second place at 514,000.

While we in Australia are beginning to see a relaxing of containment measures, the real challenge is that other countries are also heading down this path. Whilst they have achieved apparent containment (i.e. they have flattened the rate of increase in infections), they are still dealing with many actual cases. Consequently, the risk of a second wave is statistically higher for them. While we hope the relaxing of restrictions more generally is successful and does not lead to a second wave of the virus, it is too early to tell and the situation will remain dynamic, despite the more positive experience we are having in Australia.

Regional Review

Austrailia

Australia’s process of gradually returning to work is becoming politicised after several months of apparent bipartisanship. RBA Governor Philip Lowe highlighted that the September quarter proposed unwinding of Job Keeper and Job seeker payments may be premature. The market appears to be running ahead of the economy at this point.

China

China and the US are at it again but Trump’s end-of-month speech did not bring up the possibility of an escalation of the trade war.

China’s relationship with Hong Kong is still being thrashed out. COVID-19 did little to distract the protagonists.

Pockets of the US economy are aggressively re-opening. We are not filled with confidence that the whole process will go smoothly. US citizens seem fixated on their constitutional rights rather than what might be good for the economy at this point.

Europe

The EU has proposed another $1.2 billion recovery fund to assist member countries to weather the recession resulting from the Covid crisis as virtually all member countries have broken EU deficit limits as they support healthcare and businesses to try and sustain their economies.

Rest of the World

Perhaps by next month, news on the rest of the world will match the importance of news on a global pandemic. For now, we focus on how restrictions are relaxed and how lagging economies will be funded.

Economic Update

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