April 14, 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

While Japanese fell -0.3% over the last week and Chinese shares fell -1.0%, US shares rose 2.7% to a new record high helped by strong data, stimulus optimism and dovish comments from the Fed and Eurozone shares also rose 0.7%. Reflecting the strong US lead, RBA dovishness and playing catch up after underperforming the previous week the Australian share market rose 2.4% to a new bull market high with particularly strong gains in IT, material, retail, property and telco shares. Bond yields fell in the US and Australia but rose slightly in Europe. Commodity prices were also mixed with oil down but metals, gold and iron ore up. The A$ rose slightly as the US$ fell.

Seven reasons why shares have broken higher recently – with US shares reaching a new record, Eurozone shares rising well above pre-covid levels and getting close to breaking above tech boom highs, Japanese shares around their highest since the early 1990s, and Australian shares at their highest since February last year. The break higher has been driven by a combination of things:

• evidence that vaccines are working;

• optimism about reopening now or in the months ahead;

• extra US stimulus;

• mostly good economic data;

• ongoing earnings upgrades;

• a pause in the rebound in bond yields; and

• central banks remaining patient and dovish with the Fed and RBA focussed on meeting outcomes for their goals as opposed to forecasts for them to be met.

European shares have already outperformed the tech heavy US share market this year and notwithstanding vaccination delays the Australian share market may be starting to play catch up with the pre-Easter Brisbane coronavirus lockdown scare quickly resolved, earnings forecasts continuing to be revised up with earnings growth this financial year now expected to be 37% (compared to +21% in mid-January) and the RBA remaining very dovish. Bond tantrums are likely to return – with higher than expected US and Chinese producer price inflation over the last week reminding that higher inflation is on the way in the months ahead – and coronavirus scares could still cause volatility but the rising bull market trend in shares remains on track. Our ASX 200 forecast for year-end remains 7200 but the risk is that this is exceeded.

The global recovery is continuing to gather momentum with the IMF revising up again its 2021 global growth forecast to 6%, with 2022 revised up to 4.4%. Most countries/regions saw an upgrade although the US was a standout. While the recovery is uneven across countries and sectors with vaccine access being a clear short-term issue, the global recovery is a positive for share markets for now which benefit from rising earnings and still low interest rates. Things will eventually become “so good that they are bad” – once underemployed labour and capital are used up but that’s still some way off yet.

Source: IMF, AMP Capital

Positive signs for the passage of President Biden’s infrastructure plan and American Families Plan (which is yet to be detailed but which will include help for lower income households and tax hikes for high income earners) but expect the corporate tax rate hike to be scaled back from the proposed 28%. First, public support for more infrastructure spending is strong. Second, the Senate Parliamentarian has ruled that budget reconciliation can be used a second time to pass another bill. Not everything in Biden’s infrastructure plan will meeting the reconciliation rules but it does provide additional flexibility to pass the bulk of what the Administration wants through the Senate. Finally, the Republicans won’t support tax hikes which will likely force this down the reconciliation path requiring a simple Senate majority, but Democrat Senator Joe Manchin has indicated he will only agree to a 25% rate, his vote is needed to get to the simple majority and Biden has indicated a willingness to compromise. So, the corporate tax rate hike will likely be watered down as will the increased taxation on multinational income once lobbying gets underway. Of course, it’s all spread over many years, but the combination of more infrastructure spending and a smaller corporate tax rate hike seems acceptable to the US share market.

Renewed progress towards a global minimum corporate tax rate. This has been an issue for years given the ability of companies to arrange their affairs to report more earnings in lower taxing countries and so minimise their taxes. But it’s now getting a push along by the US which is seeking to minimise any capital outflow if it raises its corporate tax rate and has proposed a global minimum corporate tax rate of 21% and in return allow countries to tax US tech giants. The latter potentially removes a key blockage to progress, G20 finance ministers have pledged to reach consensus by mid-year and if so, it would all augur well for the 135 country tax negotiation at the OECD to reach a deal. Of course, there is a long way to go yet, but if successful it could mean higher corporate tax rates overall – but this would mainly be an issue for companies in countries with currently low tax rates, multinationals and giant tech companies. Australia’s corporate tax rate is above average so a globally agreed minimum tax rate would actually be relatively positive for Australian companies.

New coronavirus cases globally continued to rise over the last week with a slowing in Europe and Brazil being more than offset by increases in other emerging countries notably India but also in Japan and Canada. US new cases are relatively stable and well down from their highs, but deaths continue to fall. While the US is rapidly vaccinating (with production schedules indicating it will be awash in vaccines by the September quarter) it still has several months to go to reach herd immunity so new covid upswings there still can’t be ruled out as distancing is relaxed in the interim.

Source: ourworldindata.org, AMP Capital

Source: ourworldindata.org, AMP Capital

New coronavirus cases in Australia remain very low with the snap lockdown in Brisbane succeeding in snuffing out new local cases.

Vaccine rollout continues with all the evidence indicating that they are highly effective, but the rollout remains very uneven across countries and rare blood clotting has become more of an issue with the AstraZeneca vaccine for under 50s. Around 5% of the global population has now received one dose of vaccine but this masks a huge divergence between developed countries at around 33% and emerging countries at around 4%. Within developed countries the UK is leading the charge at nearly 50% and the US is at 34% (and running at over 3 million a day) with Australia well behind at around 4%. Interestingly Israel seems to have stalled at 58% and the UK could be as well possibly reflecting less people showing up for vaccines – which could become an issue as they are well below herd immunity (which is probably 70% or more) which in turn will increase the odds of “vaccine passports” being introduced. While the clotting risk with the Astra Zeneca vaccine is seen as very low (at around 4 per million), various countries have imposed age restrictions or recommendations on its use and Australia has announced that the Pfizer vaccine is preferred for under 50-year-olds.

Source: ourworldindata.org, AMP Capital

A switch away from AstraZeneca to other vaccines, along with the risk that the clotting issue leads to reduced public confidence in the vaccines generally risks slowing progress towards herd immunity but it’s probably not enough to threaten the economic recovery. There are several other effective vaccines, production is ramping up and “vaccine passports” could be used to encourage the achievement of sufficient vaccination rates.

The move away from the AstraZeneca vaccine in Australia will further slow the vaccine rollout in Australia, particularly given the heavy reliance on it which in turn poses a downside risk to Australia’s economic recovery but overall, we see the risk as small and not enough to justify any changes to economic forecasts. First, production of the other vaccines is ramping up with the US and UK looking to be heading towards oversupply in the third quarter, so once it’s time for under 50-year-olds to get vaccinated in Australia (after front line and at-risk people are vaccinated) there is likely to be plenty of the other vaccines available. Second, most of Australia has already reopened and has minimal restrictions. Third, there is negligible coronavirus infection in the Australian population. Finally, the vaccination delay is unlikely to impact the timing of the opening of international borders which we had assumed was at least a year away anyway (and don’t forget that international tourism is actually a net negative for Australia). While a further delay in vaccine rollout in Australia risks more local coronavirus outbreaks from the hotel quarantine system particularly as winter approaches this risk should be minimised by vaccinating all quarantine workers and returning Australians, and Australia has been successfully containing outbreaks with snap lockdowns anyway. So, while all these vaccines issues are a concern, they are unlikely to be enough to derail the recovery which is why share markets don’t seem too fussed.

The Australia/New Zealand travel bubble is good news for the travel industry and those looking to travel between the two countries (assuming plans aren’t disrupted again by more snap lockdowns) but it’s unlikely to change the economic outlook for Australia. Don’t forget that pre covid Australia ran a trade deficit in tourism as we lost more from Australians travelling overseas than we gained from foreigners coming here.

Our Australian Economic Activity Tracker fell slightly over last week and was probably impacted by the snap Brisbane lockdown, but it remains strong. Our US Economic Activity Tracker was little changed and remains down on a year ago and our European tracker softened a bit not helped by ongoing lockdowns.

Based on weekly data for eg job ads, restaurant bookings, confidence, mobility, credit & debt card transactions, retail foot traffic, hotel bookings. Source: AMP Capital

Back in the mid-1970s when glam rock was big the Ted Mulry Gang had a bunch of hits like Jump In My Car and Darktown Strutters Ball. Only years later did I discover that Ted Mulry used to do ballads back in the early 70s including Falling in Love Again which was written by the classic Australian song writing team of Harry Vanda and George Young.

Major global economic events and implications

US economic data releases remained strong over the last week with the ISM services conditions index rising to a record high in March and February job openings at a two-year high but the trade deficit widening and pointing to trade detracting from March quarter GDP growth. Producer price inflation accelerated far more than expected in March reflecting the rebound in raw material demand from last year’s lows and some supply bottle necks. In the absence of much higher wages growth though the pickup in inflation is likely to prove transitory. Meanwhile, the minutes from the last Fed meeting provided nothing new with the Fed more optimistic on the outlook but remaining dovish as it awaits actual data showing the achievement of its goals. Comments by Fed Chair Powell remained dovish too.

Eurozone unemployment was unchanged at 8.3% in February, but its composite business conditions PMI for March was revised up to a reasonable reading of 53.2. Renewed lockdowns suggest it may fall again in April though.

Japan also saw its composite business conditions PMI revised up in March but to a still soft reading of 49.9 and consumer and business confidence readings also improved in March. February data showed a rise in household spending and a slight rise in wages growth although it’s still around zero.

Chinese CPI inflation rose slightly more than expected in March to 0.4%yoy with a rise in core inflation offsetting a fall in food inflation and producer price inflation rose more than expected to 4.4%yoy. This increases the risk of tighter monetary policy in China, although I doubt it will get too tight.

India’s central bank left rates on hold but surprised by announcing a target for bond buying in response to the threat to the economic outlook flowing from a resurgence in coronavirus infections.

Australian economic events and implications

As expected, the RBA made no changes to monetary policy and remains ultra-dovish. While the economy is recovering faster than expected the conditions for a rate hike – actual inflation sustainably in the 2-3% target zone and wages growth well above 3% – are unlikely to be met for several years. Some slowing in quantitative easing is to be expected this year though with an end to the Term Funding Facility in June, a likely decision to leave the 0.1% bond yield target focussed on the April 2024 bond and a possible tapering in its longer dated bond buying program later this year

The RBA’s Financial Stability Review highlighted that it’s keeping a close eye on the property market but is still not particularly concerned as there has not been a significant increase in the growth of debt, investor credit growth remains low and lending standards “remain robust”. Our view remains that booming prices are invariably a precursor to a loosening in lending standards and investor finance is now hotting up again telling us that the market is becoming more speculative and as such it would make sense for APRA and the RBA to start tapping the macro prudential brake soon. But at this stage it’s still looks like any move is several months away.

Meanwhile, it was pretty quiet on the data front in Australia over the last week. But car sales rose slightly in March and are up 22% on a year ago, ANZ Job Ads rose 7% in March and are up nearly 40% on a year ago telling us the jobs market is strong and the AIG’s construction and services conditions PMIs rose to very strong levels. The Melbourne Institute’s March Inflation Gauge showed that while underlying inflation pressures may have bottomed, they remain pretty soft.

Source: ABS, Melbourne Institute, AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on CPI inflation data (Tuesday) which is likely to show a sharp rise to 2.5%yoy from 1.7% as year ago price falls drop out and higher energy prices impact with core CPI inflation rising to 1.6%yoy from 1.3%. Meanwhile, expect March data for industrial production and retail sales (Thursday) and housing starts (Friday) to show very strong gains after the storms depressed February data and the latest stimulus checks boost March spending. Small business confidence (Tuesday) is expected to rise, and home builder conditions (Thursday) are likely to be strong. Regional manufacturing conditions indicators will also be released on Thursday.

The March quarter earnings reporting season will start to kick off in the US with the current consensus being for a 23% rise in earnings on a year ago, but likely to be exceeded by a wide margin.

Chinese March quarter GDP growth (Friday) is expected to have surged to 18% year on year reflecting the recovery from the -9.7%qoq pandemic related slump a year ago, but this will likely mask a slowing in quarterly growth to 1%qoq due to coronavirus restrictions early in the year. Similarly, annual growth for retail sales, industrial production and investment are also expected to be strong reflecting the easy comparisons to a year ago, but to slow down from their January/February pace. Export and import data will be released Tuesday and are expected to remain very strong.

In Australia, the NAB business survey (Tuesday) and Westpac/MI consumer survey (Wednesday) are expected to show continuing strength in business and consumer confidence. Jobs data (Thursday) is expected to show employment rose by another 30,000 in March with unemployment falling to 5.7%.

Outlook for investment markets

Shares remain at risk of further volatility from rising bond yields and coronavirus related lockdowns. But looking through the inevitable short-term noise, the combination of improving global growth helped by more stimulus, vaccines and still low interest rates augurs well for growth assets generally over the next 12 months.

Global shares are expected to return around 8% over the next year 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; sectors like resources, industrials and financials benefitting from the rebound in growth; and as investors continue to drive a search for yield benefitting the share market as dividends are increased resulting in a 5% grossed up dividend yield. Expect the ASX 200 to end 2021 at a record high of around 7200.

Still ultra-low yields and a capital loss from rising bond yields are likely to result in negative returns from bonds over the next 12 months.

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 15% or so over the next 18 months to 2 years being boosted by record low mortgage rates, economic recovery and FOMO, but expect a slowing in the pace of gains as government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal.

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

Although the A$ is vulnerable to bouts of uncertainty and RBA bond buying will keep it lower than otherwise, a rising trend is likely to remain over the next 12 months helped by rising commodity prices and a cyclical decline in the US dollar, probably taking the A$ up to around US$0.85 by year end.