Essentially still bad news for the markets

While shares rose strongly early in the past week, they then fell sharply on the back of bad economic data, profit warnings, China-US tensions and profit taking after very strong gains in April

3 May 2020 | Shane Oliver, AMP Capital

The past week saw more bad economic data globally with sharp contractions in US and Eurozone GDP in the March quarter and this will be a lot worse in the current quarter as the full brunt of the shutdowns impact June quarter economic data.

We anticipate June GDP to contract by around 10% in the US, Europe, Japan and Australia. Consistent with this our weekly economic activity trackers for the US and Australia based on high frequency data for things like restaurant bookings, confidence, retail foot traffic, box office takings, credit card data, mobility indexes and jobs indicators are well down, although there is some sign of stabilisation in both countries.

US shares fell 0.2% for the week due to a 2.8% decline on Friday. Eurozone shares were closed Friday so still managed a 4.2% gain for the week. Japanese shares rose 1.9% for the week and Chinese shares rose 3%.

While the Australian share market fell a sharp 5% on Friday it still managed to eke out a 0.1% gain for the week. Bond yields fell in Europe, Japan and Australia but they rose slightly in the US. Oil prices rose on signs of improving demand, copper prices fell and the iron ore prices rose slightly. The $A rose as the $US fell.

Corporate profits hit

This will clearly weigh on company profits which will take a 30% or so hit in the near term. The March quarter earnings reporting season in the US which is now more than half way through is seeing only 49% of companies reporting profit growth on a year ago and profits are running down around 14% from a year ago (helped a bit by better than expected results from big tech companies) and consensus expectations for second quarter earnings are down 36% from the 2019 high. The hit to profits was highlighted in Australia with banks announcing a hit to earnings, capital raisings and cuts to dividends.

But while economic statistics and profits will likely get even worse before they get better leaving share markets vulnerable to a pullback after the sharp rise since 23rd March, as long as investors remain confident growth will return in the second half of the year then any share market pullback will be limited. There are several points to note here.

Curve flattening

First, the news on coronavirus curve flattening remains positive. New global coronavirus cases have been trending sideways to slightly down for the last four weeks now.

While various poorer countries are becoming more of a concern, Europe remains in a clear downtrend and the US looks to have peaked.

And Australia is continuing to see a very low number of new cases. Comparing OECD countries in terms of how they are performing in controlling the coronavirus outbreak (based around recovery rates, cases and testing) Australia ranks first, with New Zealand 2nd (guess where your next overseas holiday might be!) compared to the UK at 31st, Sweden at 36th and the US the worst performer in the OECD at 37th.

Easing lockdowns

Second, consistent with this the movement towards an easing of lockdowns is continuing to gather pace across Europe and the US, and Australia is cautiously heading down the same path with several states announcing minor easing in rules around social gatherings.

Providing any easing is gradual and based on criteria around widespread testing, falling new cases and better containment and tracking then the risk of a “second wave” should be able to be managed. The approaching winter in Australia also points to the need for caution but providing these criteria are met and foreign travel remains banned (except to NZ) then Australia should be able to see a gradual easing of restrictions weighing on economic activity from mid-May.

This looks to be on track with the prime minister indicating national cabinet will meet on 8th May to discuss the relaxation of restrictions. If this is the case, then we remain of the view that April or maybe May will be the low point in economic data with a gradual recovery underway through the second half.

Possible treatments

Thirdly, reports that a clinical trial of the anti-viral drug Remdesivir showed that it helped patients recover in 11 days on average as opposed to 15 adds to confidence that a pharmaceutical solution will be found.

The US FDA also cleared Remdesivir for emergency use with Covid 19 patients. (That said there is still a way to go on all this, the 30% faster recovery rate with Remdesivir may not make a big enough difference and it’s not clear that President Trump’s Operation Warp Speed plan to speed up a virus will have much impact.)

Not as bad as first feared

Finally, don’t forget this has so far turned out a lot better than feared in March when share markets had fallen around 35% and the worry was off a much longer lock downturn which would have had a far bigger impact on economic activity.

In Australia the official talk was a of a lockdown or hibernation of at least six months. Now the last time Australia’s prime minister  referred to a six-month hibernation was back on 7th April.

If the lockdown starts to ease through May as appears likely then it will have lasted two to three months depending on when measures are completely relaxed implying a smaller hit to the economy than originally feared. Note also that if international travel does not return it will be a drag on Australia, but the travel ban has only accounted for a small part of the likely full hit to GDP from the shutdown.

The trade surplus in tourism and education for Australia – which would be “lost” if global travel does not return – is 1% of GDP which is small compared to the estimated 10 to 15% hit to GDP from the shutdown as most of the hit is coming from reduced domestic demand.

The bottom line remains that after the strong run up in global and Australian shares since the low around 23rd March they are vulnerable to a pullback on the back of the very poor economic and profit data we will see over the next few months. Increased tensions between the US and China may add to this and a retest of the March low still can’t be ruled out.

But providing we are right and shutdowns ease in the months ahead resulting in April or May proving to be the low point in economic data then given the massive policy stimulus shares should be able to resume their rising trend and so we retain a positive 12 month outlook.

Three big risks

First – a second wave of coronavirus cases. This should be manageable with ramped up testing, quarantining and contact tracing (as per the App Australia is deploying), but the US is perhaps most at risk on this front.

Second – collateral damage from the shutdowns in the form of permanent company closures and rising defaults. So far so good but its early days and this will be critically important in terms of the speed of the recovery.

Third – an escalation in US/China tensions. Given the hit to the US economy and its very poor performance in managing coronavirus, Trump will find it hard to get re-elected and will be tempted to “wag the dog” in order to rally around the flag and distract voters.

A fight with China over the source of the virus may be part of this and looks to be starting to escalate already. Trump is limited in terms of what he can do without further damaging the US economy though, but it could still cause bouts of weakness in share markets.

Dr Shane Oliver is Head of Investment Strategy and Chief Economist, AMP Capital