Markets face pandemic that’s not under control

A second wave COVID-19 outbreak in Victoria and continued high rates of global transmission present problems for economies and risks for investors

4 July 2020 | Shane Oliver,  AMP Capital (Image: Shawn Ang)

The past week has seen more disappointing coronavirus news globally, with the daily number of new reported cases now running at over 200,000.

As has been the case for the last few weeks now this reflects emerging countries (notably Brazil, India, Mexico & South Africa) along with southern and western states in the US. Fortunately Europe, having taken a more cautious approach to reopening, is continuing to keep new cases down despite periodic outbreaks in various European countries.

In Australia, Victoria has seen a continued surge in new cases pushing up Australia’s new case count and leading to a new six week “stay at home” lockdown of Melbourne.

Clearly the coronavirus epidemic globally is still far from being controlled and even countries (like Australia and Israel) that had initial success in bringing it under control are at risk of renewed flares up if small outbreaks are not quickly contained. This remains first and foremost a human tragedy, but it poses a significant threat to the economic recovery and the outlook for investment markets.

A cloud over economic recovery

First, while Melbourne has returned to lockdown and several US states have paused or partially reversed the reopening, so far there has been no significant reversal of the reopening across the OECD as measured by lockdown stringency indexes, albeit reopening has stalled.

Second, while Victoria is clearly taking a tougher stance, the hurdle to return to a generalised lockdown in the US looks high given significant shutdown fatigue, a perception that the economic cost is too high and political pressure from Trump (who described 99% of cases as “totally harmless”!). The second wave is seeing a rise in hospitalisations and now deaths, but both are running proportionally well below what was seen in the first wave.  

Third, various Asian countries have shown that it is possible to manage outbreaks and keep new cases relatively low with a combination of tracing, quarantining and quickly applied targeted lockdowns (contrast how quickly China locked down parts of Beijing last month to Victoria which took weeks to do the same thing) and the culture of wearing masks.

The case for making masks compulsory in public seems obvious. They protect others from those with coronavirus, provide a reminder to be on guard and have been estimated to substitute for a lockdown that would otherwise knock 5% off GDP.

US states where they are mandatory are seeing substantially less new cases. Based on the March/April lockdown it will take about two weeks before Victoria sees new cases peak, but after that we should be able to learn from the Ruby Princess and hotel quarantine debacles and from various Asian countries and keep new cases low.

Australia has a much better chance of this than the US as our new case load of around 7 a day per million people is very low compared to the US which is running at 160 new cases a day per million people.

Fifth, the renewed Melbourne lockdown will slow the Australian economic recovery but should not derail it. Our rough estimate is that it will knock around $5bn off September quarter GDP. As a result, we have scaled back our September quarter GDP forecast to 1.5%. A risk though is a negative flow on to confidence in other states on the grounds that “if it can happen to Victoria it can happen here too” but this would probably require an escalation in cases in other states to be sustained.

A fiscal slope

Finally, forget about a fiscal cliff – it’s more likely to be a fiscal slope. The thought of various stimulus measures expiring in the months ahead causing some sort of fiscal cliff over which economies and share markets will plunge has caused much consternation amongst some.

US stimulus measures including increased unemployment benefits are likely to be extended with another stimulus soon of around $US1trn or more. And in Australia the Government has confirmed that “there’s going to be another phase of income support” with an extension of the JobKeeper program and various other measures including a likely bring forward of tax cuts along with more investment incentives. More industry support packages are also likely.

The Government will partly fund this by taking JobKeeper away from those who don’t need it, but the bulk will likely come from the $60 billion  saving already announced on JobKeeper, which we expect to be fully spent.

This will mean an additional fiscal stimulus of 3% of GDP. Our expected budget deficit for the 2019-20 financial year remains $100 billion, but that for 2020-21 is likely to be around $200 billion. The Government is also providing further relief on insolvent trading and banks are extending the bank payment holiday for viable customers. All of which will head off the much-feared crunch point at the end of September when support measures were originally scheduled to end.    

Are Chinese shares in another bubble?

Not yet – but they could be heading there. Chinese shares are up 14% month to date, have surged above their 2018 high and are now just 12% below their 2015 high. They are trading on a forward PE of 14 times which is hardly the stuff of bubbles. But the combination of a good track record in controlling the virus compared to many other countries, a solid economic recovery and ultra-easy monetary policy all point to more upside.

Investment markets and key developments over the past week

Global share markets mostly rose over the last week as investors were torn between rising coronavirus cases and US/China tensions on the one hand but positive news on virus treatment, indicators of recovery and policy stimulus on the other. US shares rose 1.8% helped by Gilead Sciences reporting that Remdesivir cut coronavirus mortality risk by 62%, Eurozone shares rose 0.2% and Chinese shares surged 7.5%. However, Japanese shares fell 0.1%.

Australian shares fell 2.3% on the back of fears about the economic impact of Melbourne’s return to lockdown with property, industrial, healthcare, retailers and utility stocks being the hardest hit. Bond yields fell. Oil prices fell but metal prices rose, and the iron ore price rose to its highest since August last year. The Australian dollar rose slightly as the $US fell. 

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

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