Shares defy a wall of worry

Despite all the bad news there is some logic behind the 39% rally on global shares

6 June 2020 | Shane Oliver, AMP Capital 

Share markets continued to power up over the last week as developed countries saw further reopening along with more green shoots of recovery (including a much better than expected jobs report in the US) and as some countries unveiled more stimulus measures, all of which swamped concerns about protests in the US and ongoing tensions between the US and China.

US shares rose 4.9%, Eurozone shares gained 9.3%, Japanese shares rose 4.5% and Chinese shares rose 3.5%. Reflecting the strong global lead, the Australian share market rose 4.2% to its highest level since early March with very strong gains in banks, energy, retail, property and industrial stocks but with the defensive health, telco and utility sectors lagging.

Reflecting the strong “risk on” tone bond yields rose sharply (but continued to fall in Italy and Spain helped by ECB actions), and oil, metal and iron ore prices also rose. Oil prices are benefitting from rising demand and a tentative OPEC agreement to extend production cuts and the iron ore price is benefitting from threats to Brazilian iron ore production due to its coronavirus crisis.

The Australian dollar rose to just below $US0.70, its highest since early January with the US dollar falling.

Share markets defy the bad news

From their March lows global shares are now up 39%, US shares are up 43% and Australian shares are up 32%. Australian shares are still down 16% from their February high and US shares are only down 6%.

While the continuing rise in share markets in the face of bad news – such as US riots and the news that Australia is almost certainly in recession – may surprise many it’s not illogical.

Shares anticipated bad news (including recession) in March with a roughly 35% plunge but are now taking their lead from a combination of falling new coronavirus cases in developed countries, positive news on the medical front regarding the virus, the reopening of developed countries, massive stimulus measures, green shoots of recovery and pessimistic and underweight investors being forced to buy into the market as it rises.

Shares are very overbought technically signalling the risk of a short-term pause, but overbought conditions are of the extremes often seen coming out of major bear market lows that augur well for 6-12 month returns. If April proves to be the low point in economic activity as we expect then given the massive policy stimulus seen since March shares should be higher on a 12-month outlook.

The three big risks remain: a second wave of coronavirus cases (which is a big risk in the US); collateral damage from the shutdowns resulting in a delayed or very slow recovery as bankruptcies surge and unemployment goes higher; and a serious escalation in US/China tensions.

And historically protests have not had a big impact on shares possibly because they lead to policy measures to calm the problem and they don’t tend to last long (although a failure by the US to get unemployment back down is a clear risk here).

Trump’s problems grow

The list of things that are bad for President Trump ahead of the election in less than five months has now expanded with civil unrest adding to recession, still very high unemployment and a pandemic. These would normally all be bad for the incumbent, but they are even more so given Trump’s mishandling of the pandemic and the civil unrest as well.

Trump looks to have inflamed the situation with calls to put troops on the streets. While its aimed at his base the danger for him is that it motivates more to show up on polling day and vote against him.

Betting odds now favour Biden and Trump’s approval rating has dipped to 43%. But the latter is in his normal range so not bad enough yet for Trump to conclude that he has little chance of winning if the economy improves.

Ramping up China tensions

Should his election chances plunge, Trump may conclude he has nothing to lose by ratcheting up the conflict with China – by say ramping up tariffs again – with the hope of rallying Americans around the flag. This would hold bigger risks for the economy and shares.

Hopefully it occurs close to the election such that investors don’t take it so seriously. The US under Trump now also has the problem that its moral authority to question China’s handling of human rights issues and Hong Kong is seen as seriously dented.

Australian negative GDP no surprise

While much attention is on data showing how bad the hit to economic activity from the coronavirus lockdown is – such as the decline in Australian GDP in the March quarter that given an almost certain slump in June quarter GDP makes it almost certain that Australia has now fallen into a “recession” – this is really old news that was anticipated by investment markets back in February and March (when shares plunged around 35% over the course of a month).

It’s no surprise that when people are told to stay at home big chunks of economic activity shut down due to an inability to work or spend. So statistical measures like GDP and retail sales showing that this has happened are of no real surprise. More importantly as we have been noting for several weeks now, more timely high frequency data continues to indicate that economic activity likely hit bottom back in April.

This is confirmed by 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, hotel bookings, credit card data, mobility indexes & jobs data which hit bottom in mid-April. In Australia there has been a clear uptrend for seven weeks in a row.

HomeBuilder is not an economy builder

In Australia, the Government is now moving into industry-based assistance with the announcement of a HomeBuilder stimulus package for the housing construction sector. It’s small at just 0.03% of GDP but assistance also looks to be on the way for the arts sector and probably also the tourism sector.

As far as additional economic stimulus goes its trivial though with a total costing of just $688m or 0.03% of GDP, and although it does have the “benefit” of being geared up as homeowners borrow, it’s not big enough to change our economic forecasts.

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