January 27, 2021

Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
(AMP Capital)

Source: Bloomberg, FXStreet, AMP Capital

Investment markets and key developments over the past week

Global share markets rose over the past week, with US shares hitting a record high, helped by good earnings news and optimism regarding President Biden’s stimulus plans. For the week, US shares rose 1.9%, eurozone shares gained 0.1%, Japanese shares rose 0.4% and Chinese shares rose 2.0%. Reflecting the positive global lead and good Australian economic data, the Australian share market rose to its highest since February and gained 1.3% through the week, led by strong gains in information technology, retail, health and telecommunications stocks. Bond yields generally rose slightly, as did metal prices, but oil and iron prices fell slightly. The A$ rose slightly & the US$ fell.

Global and Australian shares are vulnerable to a correction, but so far this has been limited to brief pauses, followed by more good news driving the market higher. The risk of a short term pull back remains though, with February often being a weak month in the first year of a new US President. Beyond short term uncertainties, we continue to see shares heading higher this year on the back of reopening, recovery and easy money, with the ASX 200 likely to hit 7,200 by year end. The Bitcoin rollercoaster also continued; over the last month it roughly doubled only to then fall 25%.

He’s gone!…and that’s the way some in America saw it. To be fair, Trump did some good things – he started no new wars and the share market liked his tax cuts and de-regulation. In fact, his four years in office saw the US share market return an annualised 17% pa. That said, it returned an impressive 15% pa under Obama and 19% pa under Clinton, with all periods benefitting from falling interest rates. Moreover, the positive boost to the economy from Trump’s tax cuts was partly offset by his trade war and erratic policy making that raised uncertainty. Trump also did a lot of harm in terms of fuelling division in the US, debasing standards of decent public discourse and in mismanaging the coronavirus pandemic to the point that the US saw deaths rise a depressing 15% last year, compared to a normal increase each year of around 1.5%. But as Comedian in Chief, he provided lots of laughs such that there was no need to watch Alec Baldwin doing Trump, as Trump as Trump was even funnier. I will miss that bit.

President Biden has now taken over, with a progressive and mostly share market friendly program. Fortunately, the transition occurred over the last week with minimal unrest, while his inauguration speech focussed on unity and healing divisions. A Biden presidency will likely see: more stimulus; a focus on reducing the drivers of social division – notably inequality; some reversal of Trump’s deregulation; modest corporate and top earner tax rate hikes; a greater reliance on experts, as evident in Biden’s cabinet appointments; a serious focus on dealing with coronavirus; the US to re-enter World Health Organization (WHO) and re-join the Paris Climate Accord; more spending on infrastructure, health and dealing with climate change; a strengthening of traditional US alliances; and the US remaining tough on China but seeking a more of diplomatic approach to dealing with differences. Biden’s Administration is moving quickly to implement much of this. On balance, this is likely to be positive for shares, with stimulus dominating tax hikes (albeit with bumps along the way). The combination of the Biden Administration providing more stimulus and the US Federal Reserve (Fed) reiterating that it will remain dovish is particularly positive for shares.

For Australia, the main implications from a Biden Presidency are likely to be: a stronger US economy which will benefit the Australian economy; a benefit to Australian companies with US exposure (such as wine and building material companies); a stronger more consistent relationship with the US; and a toning down of the trade war with China in favour of a more diplomatic and engaged approach to resolving issues which will be less negative for Australia. On balance, this should benefit Australian shares (which will be relatively more attractive if the US corporate tax rate goes up) and the Australian dollar.

Since October, there has been a rising trend in countries (notably in Europe) in adopting more stringent lockdowns.

Source: University of Oxford, AMP Capital

Maybe this is working, as we have now seen a slowing in new coronavirus cases. This is particularly the case in developed countries, with the US, Europe, the UK, Japan and Canada all seeing some decline in new cases, possibly suggesting that lockdowns are starting to impact. China has continued to see a pick-up in new cases, but it’s only running around 200 a day and is likely to be controlled by aggressive regional lockdowns without causing a major disruption to the Chinese economic expansion.

Source: ourworldindata.org, AMP Capital

Ultimately the pandemic appears unlikely to be fully resolved until vaccinations have seen 70% or more of populations achieve a degree of immunity. This could be achieved by July/August in the US and Europe, but it may take a bit longer in Australia given the lower proportion of the population that have been exposed to coronavirus. While in theory the new more contagious mutations of coronavirus should not affect vaccine efficacy, two lab studies found some reason for concern, with a South African study finding that the South African variant may reduce the immunity of those previously affected and a US study finding that the some of the mutations may reduce the effectiveness of the Moderna and Pfizer vaccines. Research is inconclusive at this stage though and it’s also possible that vaccines can be altered, if needed. So far 28% of Israel’s population, 7% of the UK’s population and 4% of the US population have received a vaccine dose.

Source: ourworldindata.org, AMP Capital

In Australia, the number of new coronavirus cases remains low – and mostly confined to returned travellers. The chart is so boring I am tempted to leave it out again…but the last time I did that we had the Avalon cluster and I got locked down!

Source: covid19data.com.au, AMP Capital

While our weekly Economic Activity Tracker for Australia fell from its high a few weeks back, as tougher coronavirus restrictions impact, it has stabilised in recent weeks at a high level and edged up slightly over the last week. With restrictions being eased, it’s likely to head higher in the weeks ahead. Our US Economic Activity Tracker also edged up over the last week but remains soft and down from its September high. Meanwhile our European Economic Activity Tracker fell slightly over the last week and remains very soft.

Source: AMP Capital

The last week saw the great record producer – but seriously flawed human, Phil Spector, pass away in jail. Like Brian Wilson, I have listened to The Ronettes’ Be My Baby Be My Baby over and over (well maybe not quite as much as Brian and I reckon Brian bettered it with Don’t Worry Baby). Phil however also produced The Beatles’ Let It Be album (not that Paul was so happy with the end product and decades later had it stripped naked) and produced the beautiful sound of George Harrison’s 1970 solo triple vinyl All Things Must Pass, where the best song would have to be Isn’t It A Pity.

Major global economic events and implications

In contrast to recent payrolls, jobless claims and retail sales data, US data releases over the last week were good with: a rise in business conditions PMIs for January to robust levels (see the next chart); strong home builder conditions, mortgage applications, existing home sales and housing starts; and a decline in jobless claims.

Source: Markit, AMP Capital

Its early days in the US December earnings reporting season, with just 14% of S&P 500 companies having reported, but so far it’s been strong, with 86% surprising on the upside by an average 28%. As a result, consensus earnings expectations are getting revised up to now only show a -6% year-on-year decline, but are likely to end up back at pre-COVID-19 levels.

The European Central Bank (ECB) left monetary policy on hold as expected. While its comment of symmetry around its Pandemic QE program (ie, it could be increased or decreased) was seen as hawkish by some, ECB President Lagarde emphasised that it is conditional, ie, it won’t purchase less bonds until financial conditions are strong enough to offset the deflationary shock of the pandemic. Right now, that looks a long way away, with Lagarde warning that the pandemic continues to pose a serious risk, so aggressive bond buying is on track to continue. The threat to the eurozone economy was highlighted by a further fall in business conditions PMIs for January. UK PMIs are particularly weak.

Meanwhile, Prime Minister Conte’s Italian coalition government survived a confidence vote in parliament and may hang in there for a while yet, as most parties fear losing seats in an early election. If the Government can survive till July, then an early election technically can’t happen until next year, so there’s a chance it will hang on for a while yet.

The Bank of Japan also left monetary policy on hold and continues to see the risks to growth and inflation as being on the downside. Meanwhile, Japan’s business conditions PMI softened again in January, reflecting the rise in coronavirus cases and tighter restrictions, while core CPI deflation intensified in December to -0.4% year-on-year.

China’s economic expansion remains on track – GDP rose another 2.6% in the December quarter to be up 6.5% on a year ago and activity indicators generally remained strong in March.

Australian economic events and implications

Australian economic data remained strong over the last week, with employment up another 50,000 in December, new home sales nearly doubling in December (pointing to a strong rebound in housing construction) and consumer sentiment and business conditions PMIs remaining strong (see the previous chart) despite the mini coronavirus scare over Christmas/New Year. The continuing rebound in employment is particularly impressive. Nearly 90% of jobs and hours worked that were lost into May have now been recovered, making for a very deep V rebound. This compares to only 56% of US payroll jobs that have been recovered. Further, both unemployment and underemployment have fallen sharply, taking the labour underutilisation rate down to 15%, from around 20% in April.

Source: ABS, AMP Capital

While retail sales fell 4.2% in December, this partly reflected payback after strong Black Friday sales and COVID-19 restrictions in NSW and Victoria in late December. Despite the pullback, retail sales remain way above trend, being up around 1.9% in the December quarter and on track to contribute to December quarter GDP growth. Expect some slowing in retail sales this year though, as pent up demand is exhausted and spending on services gradually recovers.

Source: ABS, AMP Capital

Will the continuing run of mostly strong Australian data shift the RBA from dovish to hawkish? Eventually – but it’s still a bit too early for that. While the jobs market has improved faster than expected, we are still a long way from full employment. Jobs growth is also likely to slow a bit in the months ahead, with some jobs (e.g., travel related) taking longer to return and some (e.g., in parts of retail) likely to never return again, the end of JobKeeper in late March will likely create a bit of apprehension (not that I expect much impact), coronavirus still has the potential to create upsets in the short term with uncertainty remaining how effective vaccines will be, the strong A$ is maintaining pressure on the RBA to extend Quantitative Easing (QE) and a shift to hawkishness now would be inconsistent with the RBA’s commitment to focus on the achievement of actual inflation sustainably at target. Therefore, we expect RBA Governor Lowe’s speech on The Year Ahead on 3rd February to welcome the good data seen lately, but signal the RBA will stay the course with a dovish bias. Given the passing of time, the RBA may however drop the expectation to not raise the cash rate for at least three years and perhaps replace it with a reference to say a “before 2023.”

What to watch over the next week?    

In the US, the Fed is expected to leave monetary policy on hold when it meets Wednesday and reiterate that rate hikes are not expected until full employment has been reached and inflation is at target (with expectations of a moderate overshoot) and that it will continue to buy bonds at the current pace until substantial further progress is made towards full employment and price stability. Fed Chair Powell is likely to remain very dovish, stressing that now is not the time to be talking tapering.

On the data front in the US, expect continued strength in home prices and flat consumer confidence (both Tuesday), continued strength in durable goods orders (Wednesday), a slowdown in GDP growth for the December quarter (Thursday) to +4.8% annualised (or +1.2% quarter-on-quarter) after the reopening rebound of +33.4% annualised in the September quarter. As new coronavirus cases surged through the quarter, expect a 1% rise in new home sales (also Thursday), a slowing in core personal consumption deflator inflation to 1.3% year-on-year and continuing soft growth in employment costs of just 0.5% quarter-on-quarter (both Friday).

The flow of US December quarter earnings reports will also ramp up. While consensus estimates have now improved to a 7% year-on-year decline, strong business conditions readings and results so far point to earnings being roughly flat or slightly up on a year ago.

Eurozone economic confidence is likely to remain softish for January (Thursday).

Japanese industrial production data for December is expected to rise, but jobs data may be a bit soft (both due Thursday).

Australia’s December quarter CPI due Wednesday is expected to rise by 0.7% quarter-on-quarter, reflecting the normalisation of child care costs (after the subsidy was removed on 12 July), higher tobacco taxes and a seasonal rise in travel costs but this will leave annual inflation at just 0.7% year-on-year. Underlying inflation is expected to remain weak, at just 0.4% quarter-on-quarter (or 1.1% year-on-year) reflecting weak food prices, lower clothing prices, falling rents and ongoing spare capacity in the economy. Business conditions in the December NAB survey (Wednesday) are likely to have remained solid and credit growth (Friday) is likely to show more signs of a bottoming.

Outlook for investment markets

Shares remain at risk of a short-term correction after running so hard recently and 2021 is likely to see a few rough patches along the way (much like we saw in 2010 after the recovery from the GFC). Though looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and low interest rates augurs well for growth assets generally in 2021.

We are likely to see a continuing shift in performance away from investments that benefitted from the pandemic and lockdowns, such as US shares, technology and health care stocks and bonds, to investments that will benefit from recovery, like resources, industrials, tourism stocks and financials.

Global shares are expected to return around 8%, but expect a rotation away from growth heavy US shares to more cyclical markets in Europe, Japan and emerging countries.

Australian shares are likely to be relative outperformers, helped by better virus control enabling a stronger recovery in the near term. Stronger stimulus will likely help, as will sectors such as resources, industrials and financials as they benefit from the rebound in growth. Further, investors continue to search for yield, which will likely benefit the share market as dividends are increased, resulting in a c.4.4% grossed up market dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7,200.

Ultra-low yields (and a capital loss from a 0.5-0.75% or so rise in yields) are likely to result in negative returns from bonds.

Unlisted commercial property and infrastructure are ultimately likely to benefit from a resumption of the search for yield, but the hit to space demand (and hence, rents) from the virus will continue to weigh on near term returns.

Australian home prices are likely to rise another 5% or so this year, boosted by record low mortgage rates, government home buyer incentives, income support measures and bank payment holidays. The stop to immigration however, combined with weak rental markets will likely weigh on inner city areas and units in Melbourne and Sydney. Outer suburbs, houses, smaller cities and regional areas may see relatively stronger gains in 2021.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.

While the A$ is vulnerable to bouts of uncertainty around coronavirus and China tensions, and RBA bond buying will keep it lower than otherwise, a rising trend is still likely to around $US0.80 over the next 12 months, helped by rising commodity prices and a cyclical decline in the US dollar.

Important notes
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.