Economic Update

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

Will COVID-19 vaccines and treatments deliver?

– Peer-reviewed clinical trial data for COVID-19 vaccines not yet published

– Lots of very strong growth data around the world for quarter three as it anticipates a rebound

– Similarly, Australian labour force data are strong pointing to a positive start to 2021

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 your Financial Adviser.

The Big Picture

Much of 2020 has been spent worrying about how the US elections might go and when coronavirus vaccines might be available. The light at the end of the tunnel is now visible but it’s flickering.

Except for Trump, the world acknowledges that Joe Biden will assume office at his inauguration in January. The handover got a bit nasty at times but Biden’s team is now getting access to White House briefings as is normal.

But the election is far from over. The lower house (house of Representatives) is certainly going to remain controlled by the Democrats. The Senate, however, has two undecided seats – both in Georgia. Each state allows for different election procedures and Georgia’s requires a minimum 50% count for the winner. As this figure was not achieved for either seat, partly because of the number of people standing, both seats are up for grabs on January 5th 2021 in so-called run-off elections.

Georgia is traditionally held by Republicans but nothing is normal these days. If both seats go to the Democrats, the Vice President gets the deciding vote in a 50-50 Senate. If either or both are retained by the Republicans, the Senate remains held by the Republicans and Congress is ‘split’, as it has been for some time.

Markets appeared to like the idea of a split Congress as it makes many of the more extreme Democratic policies unlikely to get through into law. In particular, it means the big tax hikes favoured by Biden-Harris won’t get through.

On the downside, a split Congress means that the much needed COVID stimulus package will struggle to get through in any meaningful size.

As in turns out, in the days and weeks following the announcement of a Biden presidency, three different companies announced (by press release) the efficacy rates of their vaccines. Normally people wait for peer-reviewed academic journals to release the results. So, are we jumping the gun?

In a combined election-vaccine euphoria, markets here and around the world charged up in November at a pace not seen since the aftermath of the 1987 stock market crash!

The clinical trials have been running for months with tens of thousands of participants. However, for any one vaccine, such as Moderna’s, the number of cases being used in the efficacy (or effectiveness) calculation is quite small.

There are always two groups of participants – one that gets the actual vaccine, and one that get a placebo (or sugar pill) as a control. Since no one knows who might contract the virus a wide net was cast with 15,000 in each group. It turns out that only 90 people in the placebo group contracted the virus. On the other hand, 5 in the ‘treatment’ group contracted the virus. The efficacy rate of 95% is calculated as (90-5)/90 being the relative gain over the base.

One of the things that causes us some concern is that the rate of infection (90/15,000 = 0.6%) in the placebo group is very much lower than around the 4% witnessed so far in the USA in the general population. Obvious factors potentially explaining the difference include the length of the trial compared to the period the virus has actually been circulating. Less obvious factors might be that the sample might have been accidentally skewed towards regions where lock-downs were effective.

Also, as participation is voluntary, what type of people signed up for the trials? Are they more likely to have socially distanced than the rest? It takes time and effort – not to mention some risk of side effects – to participate in any clinical trial. Participation might have been skewed towards more public-spirited individuals – the sort of people who are motivated to consider the welfare of others. The trials attempt to balance a study for gender, age and other pertinent factors but public spirit is not an easy variable for which to condition.

Another factor coming to light was that the AstraZeneca study included an accidentally-allocated dosage using only half a dose in the first of two shots. This group of less than 3,000 participants showed a 90% efficacy in a group of only under 55’s but 62% in the sample without the mistake – including older people who are thought to be more at risk. We have not seen splits by age in the samples from other companies.

Obviously, protecting someone who might be less affected is less important than saving the vulnerable. Another factor we are considering is that people, when vaccinated, might feel ‘safe’ and no longer socially distance, etc. Therefore, after the vaccines are distributed, infection rates might increase and efficacy rates could fall.

Dr Anthony Fauci, the main medical adviser in the US, stated on 29th November that he expected ‘wave upon wave’ of outbreaks following Thanksgiving (and presumably Christmas) because of families and friends getting together for the holidays.

Fauci also said there is unlikely to be enough vaccine to get even front-line health workers protected by the end of January. When will senior citizens get their turns? It is also largely unknown how long immunity from the vaccines will last.

Renewed lock-downs in the US, the UK and other places will have ramifications for growth in quarter four (Q4) and Q1. It appears from causal observation of news reports around the world that Australia is dealing with the virus better than in many regions.

So, while we join others in applauding the efforts of scientists and medics involved in this vital work, and we rejoice in the success found to date, we feel that the markets have priced in a best-case scenario. Perhaps exhaustion after dealing with markets over 2020 needed some respite.

We think that, although the world is winning the fight against COVID-19, we don’t think it will be plain sailing in 2021. There may well be second dips in economic growth and more volatility in markets.

So far, we have noted big bounce-backs in many economies after the relaxation of behaviours following the first lock-down. For Q3 the following quarter-on-quarter economic growth data have so far been released: US 7.4%; China 2.7%; Japan 5.0%; Singapore 9.2%, etc. These are massive numbers compared to historical averages because Q2 was so bad! Australia’s results will be posted in the first week of December.

Not all news has been good. The UK which didn’t handle the virus well at the start and is just about to come out of its second lock-down, is expected by the government to grow in 2020 by the worst growth in 300 years! JP Morgan, a leading US bank, is predicting US growth in Q1 will be negative.

At home, the Federal and State governments, together with the Reserve Bank of Australia (RBA), have dealt well with the situation at hand. Current Infection rates are very low by international standards and a sensible approach to balancing restrictions with growing the economy is in place.

Our latest labour force data witnessed the unemployment rate at 7.0% when 7.2% was expected and 178,800 jobs were created when a fall was expected. The RBA expects the unemployment rate to have fallen to 6% by the end of 2022 and growth for 2020/21 to be 6%.

In Australia, we do have additional headwinds facing us in 2021. The relations between China and Australia have worsened. Shiploads of coal imports are being held up in Chinese ports due to seemingly questionable objections. And China imposed tariffs on wine imports of around 200% as an anti-dumping measure. An industry spokesman stated margins on wine exports to China are high by comparison to other countries. It has been reported that copper and barley might be targeted next.

Our medium to long-run view of the economy and markets remains strong. We do find the ASX 200 and the S&P 500 to be a bit expensive in the short-term and this may in part have explained a weaker market in the last few days of November. Because of this view, and the health and political headwinds, we do not think that volatility will stay low throughout the first half of 2021. We expect some bumps but nothing too bad!

Australian Equities

The ASX 200 rose by 10% over November after the index had given up about 2% in the last three trading days. There were major gains in Energy (28%), Financials (15%), Telcos (13%), Property (13%) and Industrials (12%). The Consumer Staples sector (-1%) actually went backwards!

We had the market heavily over-priced on the last Wednesday of November but the slight sell-off in the next three days does not prove anything. Markets are always being bombarded by news and the AstraZeneca flaws in their data being exposed could have been the reason.

Foreign Equities

The S&P 500 (+11%) was on track to have the biggest capital gains in a month since the recovery from the 1987 crash – until there was a slight sell off in the last few days of November.

Most other major international indexes followed suit. Markets rose sharply after the lock-down impact in March of this year. However, at that time, it was easy to argue that, with incomplete information, markets had just sold off by too much. There is no widely accepted suggestion by commentators that markets were very cheap in October. So, from where did the 12-plus percentage rallies come?

We think a large part of November’s gain was due to a euphoric response to ‘Trump gone’ and ‘vaccines here’. While the former is actually true the latter is far from having been confirmed using standard due process. We think any negative news on the vaccine front could give back quite a bit from those gains.

Bonds and Interest Rates

The RBA cut its overnight interest rate to 0.10% from 0.25% in November. It also announced it will continue to attempt to anchor the three-year rate at 0.1% and will spend up to $100bn on keeping longer term rates lower.

The US Federal Reserve appears to be done on its conventional policy initiatives. But it is also talking about possibly doing more to flatten the yield curve to approximately where it was before the election fever started.

Other Assets

The prices of oil, copper and iron ore rose sharply in November. Gold prices fell.

Our dollar against the $US strengthened while the VIX volatility, or fear index, fell sharply to only just above normal levels.

Australia 

In an historic move, the RBA cut its overnight interest rate to 0.1% from 0.25% early in November. It is extremely doubtful that they will move it any lower but the RBA did announce a $100bn programme to keep rates lower at longer rates – with terms over 5 years.

With the December meeting too close to the November cut to expect more central bank activity and no RBA board meeting is to be held in January, we expect little news from the Bank before February at the earliest. Their work has largely been done – and done well.

The unemployment rate climbed by one notch in each of the last two months – from 6.8% to 7.0%. However, there were 178,800 new jobs created in October and the participation rate improved to 65.4% when only 64.7% was expected. This rate suggests workers are being encouraged to enter the workforce in the hope of finding work.

China

China economic data are just fine. The Purchasing Managers Index (PMI) for manufacturing came in at a very respectable 51.4 indicating expansion over contraction. Industrial output, at 6.9%, beat the expectation of 6.4% but retail sales were a miss at 4.3% against an expected 4.9%.

A potential new free-trade zone, RCEP, based in Asia has been signed by a number of nations including China, Japan and Australia but not the US or India. China has been flexing its trade muscles – possibly having been aggravated by the dealings with Trump’s tariffs over the last couple of years.

A number of ships carrying Australian coal are being held up in Chinese ports for what seem like flimsy reasons. At the end of November, China slapped on massive tariffs for Australian wine imports because it claims we were ‘dumping’ wine at artificially low prices. Copper and barley are apparently in the cross-hairs.

With Trump all but gone and Biden the new kid on the block, China might be starting a global confrontation over trade before Biden gets comfortable in the White House, we maintain a watching brief.

US

The presidential election was still being contested by Trump well after the media called Biden as the winner. There are reports that Trump might be considering a second term in office after Biden, as is allowed under US law.

Biden will probably be constrained by a split Congress so the actual changes in policy will be a lot less than that suggested by the election campaign.

Since Biden has stated that he will take action on the coronavirus from day one, he has to do something. But vaccine development has all but been done under Trump – even the planned distribution of the vaccines and the building of manufacturing plants.

It does seem that the World Health Organisation is disputing the clinical results of four treatments for very sick people rather than prevention of all by vaccines. The only difference Biden can try and make is a change in attitude towards the wearing of masks and social distancing. If he tries to shut down the US economy by too much at least the 48% of people who voted for Trump will have a lot to say.

The latest jobs data in the US were quite strong. There were 638,000 new jobs created with the unemployment rate falling to 6.9% from 7.9% over the month when 7.7% had been expected. The ISM index, which is similar to a PMI (a measure of the relative strength in business demand), jumped from a big 55.4 to a massive 59.1. However, retail sales did miss as 0.3% against an expected 0.5%.

Europe

According to the government, the UK is now facing the worst growth rate since George I was on the throne three hundred years ago! And Brexit is far from complete with the due date for the completion of a deal being New Year’s Eve 2020.

Various EU countries are flipping into and out of lock-downs. Europe does not look like a good story for growth in 2021.

Rest of the World

India has just announced a $US20bn stimulus package following on the heels of a $US27bn jobs and manufacturing package.

Singapore reported a good Q3 growth figure and growth is actually up 5.8% over the corresponding quarter in the year before. Japan has also bounced back with a 5% growth in Q3. Its industrial output was also up – by 3.8% against an expected 2.1%.

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.

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.

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.

US

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.

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.

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.

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

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.

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.

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.

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.

US

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.