An improvement in Victoria’s COVID-19 numbers has been offset by higher concerns in New South Wales and perhaps an acceptance that the economic pain could outlive the pandemic by some considerable time
29 August 2020 | Shane Oliver, AMP Capital
Global share markets rose over the past week helped by continuing signs of economic recovery, positive coronavirus vaccine and treatment news and anticipation of the Fed’s shift to inflation average targeting.
Australian shares fell slightly though over the past week reflecting poor earnings results with weakness in utilities, energy, health, telco and material shares. Bond yields rose helped by the Fed’s more dovish approach to inflation targeting. The iron ore price fell slightly, but metal and oil prices rose as the $US fell and this also saw the $A rise to around $US0.73 its highest since December 2018.
The better news flow on coronavirus continues. New global coronavirus cases have been trending flat for a month now. Emerging countries may be rolling over with better trends in Brazil, South Africa (which has gone from 13,000 new cases a day down to around 2000), Pakistan, Mexico and Saudi Arabia.
New cases are continuing to trend down in developed countries led by a sharp decline in the US and to a lesser degree in Japan offsetting a still rising trend in Europe.
The really good news remains that the second wave of new coronavirus cases in developed countries has continued to be far less deadly than the first wave with deaths running well below their April high whereas new cases have been well above. This is helping to avoid a return to generalised lockdowns in most countries – in favour of targeted measures – and helping confidence hold up.
The latest downtrend in new coronavirus cases without a generalised hard lockdown adds to confidence that the economic recovery that has been seen in developed countries since April can continue. This is particularly notable in the US with our US Economic Activity Tracker resuming its upswing. The Atlanta Fed’s estimate of September quarter GDP growth based on already released data is now running around 7% quarter on quarter.
Uncertainty hits activity
The Victorian lockdown and bouts of uncertainty and negative headlines in NSW are continuing to weigh on economic activity in Australia with our Australian Economic Activity Tracker remaining well down from its July high.
Fortunately, it has now stabilised over the last two weeks, with improvements over the last week being seen in consumer confidence, mobility and hotel bookings. Weakness in Victoria is now being offset by strength in other states. If Victoria continues to come under control and the lockdown is eased later next month then the economic recovery should resume.
Finally, positive news on the medical front continues to flow regarding vaccines (including in relation to a vaccine being developed at the University of Queensland) and various treatments. There have also been documented cases of re-infection, but this does not necessarily mean that a vaccine won’t help and its also quite possible that the ultimate solution will involve a combination of vaccines and treatments.
On the policy front, Fed Chair Powell’s Jackson Hole speech has confirmed the Fed’s move to inflation average targeting. This is big stuff and very dovish. Since 2012 it has had a 2% inflation target – but the objective was just 2% regardless of what had happened in the past. So, in December 2015 rates were raised even though core inflation was just 1.5% and unemployment was at 5% because the Fed “expected” inflation to rise to 2%. Inflation average targeting basically means that the Fed will tolerate a period of “moderate” inflation overshooting after a period of undershooting to achieve an average of 2% inflation “over time”.
It is making this shift because the zero bound of interest rates is now closer and so binds monetary policy more frequently and because the relationship between unemployment and inflation looks to have weakened. In the current environment of undershooting this means that it will be a lot slower to raise rates which in turn is positive for the economic recovery and investment assets. We expect the Fed to back this up with a more dovish commitment not to raise rates until the US is at or near full employment and inflation is at least 2% and with more explicit guidance around QE. This is likely next month. Of course, it does shift the dial towards higher inflation risk longer term.
In other good news the US and China reaffirmed their commitment to the Phase One trade deal signed in January, after a formal review. Despite escalating tensions between the two countries it remains clear so far that Trump does not want to do anything that threatens the US recovery and hence his re-election chances. This may change of course if Biden widens his average 7-point poll lead dramatically.
While many have argued that shares have disconnected from the real economy and profits it should be remembered that this is common at this point in the economic cycle. Just as shares led on the way down, they invariably lead on the way up. Recession and a slump in profits has been talked about for nearly six months now so its more than fully factored in but share markets are now taking their lead from good news on the medical front regarding coronavirus, declining new cases, low interest rates and signs of economic recovery at a time when there is still plenty of cash on the sidelines.
Shares are still vulnerable to further volatility, with coronavirus and US/China tensions being the main risks. But the positives should keep any volatility to being a correction in a still rising trend. Expensive US tech and healthcare stocks could also come under pressure but if this occurs when growth is recovering then a rebound in cyclical and value stocks and non-US shares should provide an offset.
Earnings bad but could have been worse
The last financial year has seen the biggest earnings slump since the early 1990s recession, but it’s not been as bad as feared. The Australian June half profit reporting season is pretty much done with 92% of companies having reported accounting for 99% of market capitalisation. Company earnings and dividends have been hit hard by the coronavirus shock. Only 36% of companies have seen earnings rise from a year ago compared to a norm of 66% and a whopping 55% cut their dividends compared to a norm of just 16%, which attests to the severity of the hit to earnings and the uncertainty around the outlook.
Consensus earnings estimates for 2019-20 based on those companies that have reported with expectations for the remainder 2019-20 have fallen to -23.2% (from -21% four weeks ago) and this will make it the worst fall in earnings since the early 1990s recession. Financials have been hit the hardest with the consensus now expecting a -30.9% slump in their earnings led by insurers and the banks, followed by industrials with a -17.8% fall in earnings and resources with -14.7%. Consumer discretionary stocks are the only sector to have seen a rise in earnings (+10.4%) as they benefitted from “at home” spending on furnishings and office equipment.
But despite the huge hit to earnings & dividends, corporate results were not as bad as feared and most companies appear to be quite resilient. Only 32% of results beat expectations compared to a norm of 44%, but beats outnumbered the 28% of companies that missed. This in turn saw 55% of companies’ share prices outperform the market on the day they reported. And its also enabled the share market to rise through August so far. Earnings growth expectations for this financial year are little changed at +8.9% but they have been revised up for resources and financials and down for industrials, particularly media, general industrials and utilities.
Dr Shane Oliver is Head of Investment Strategy and Chief Economist, AMP Capital
