Labour markets seemingly improve
- Australian unemployment rate fell to 6.8%, still high but better than expected due in part to JobKeeper
- RBA and government are expected to provide more economic stimulus
- US presidential election may cause elevated volatility in financial markets
The Big Picture
Both Australian and US unemployment rates fell markedly in their September data releases. However, the data might not truly reflect job status as government programs are being used to retain employees through these difficult times – and those that have lost jobs have been getting some extra assistance.
It is far too soon to suggest that either economy is really healing and more needs to be done from a policy perspective. The prospect of a new wave of COVID-19 infections could seriously send unemployment rates higher again.
October is likely to be a big month for policy announcements in Australia. The federal budget will be announced on the same day (October 6th) as the RBA board meets to announce any monetary policy changes. Traditionally, the RBA does not act on the same day as a federal budget but these are different times.
The RBA had started September keeping its Official Cash rate on hold but it announced $200bn of ‘cheap money’ it was going to make available to the banks to lend to their customers.
It had previously been thought that the RBA would not cut the Cash rate by another 0.25% points to zero in October. Recently Governor Philip Lowe hinted at a ‘partial cut’ to 0.1% was a possibility. It wasn’t until Westpac’s chief economist, Bill Evans, called for such a cut at the October meeting that markets reacted strongly with our dollar depreciating against the US dollar.
The following day, the government announced that it was relaxing its restrictions on borrower credit checks by banks. The big four bank shares jumped sharply in price on the news and our dollar fell even further.
Our dollar reached a recent low of $US0.5571 earlier in the year before climbing to $US0.7412, largely on US dollar weakness. The double finance announcements took the dollar down to just above $US0.70 in only a matter of days!It is now time for the government to step up to the plate again and see what it can do to keep the economy alive until a vaccine is available to help life return to normal – albeit a new normal. As is traditional, the government is leaking thoughts to the media before the budget to test the voters’ reactions. Tax cuts and more stimulus along the lines of JobSeeker and JobKeeper are likely.
During September, our national accounts were released. They showed that the economy contracted by 7.0% in the June quarter. A large negative number had been expected because government shutdowns had forced many businesses to shut down or trade for limited hours and/or under strict social distancing rules.
Because it is important for the government to plug the gap resulting from its public health and safety initiatives, the size of the budget deficit this time around should not be compared to past deficits. Indeed, it is probably better for the government to err on the side of generosity.
Any problems caused by too much stimulus can easily be fixed when the economy is back to strength. However, if insufficient stimulus is provided there could then be widespread defaults on loans to consumers and businesses with serious long-lasting ‘genuine’ consequences. The Westpac and NAB consumer and business sentiment surveys showed us to be less gloomy than in the previous month, but pessimists still outweigh optimists. However, retails sales climbed 3.2% in the month. House prices slipped 1.8% in the quarter. We also noted from the national accounts that the household savings ratio jumped to 19.8% (or about twice as high as the high point during this millennium)! People are scared to spend in uncertain times. They need a lead from government.
The US unemployment rate surprised many by falling to 8.4% when 9.8% had been expected. The US Federal Reserve (the “Fed”) is expecting 7.6% at the end of 2020, 5.5% the following year and 4.0% (or full employment) at the end of 2022. The Fed is less confident about getting the inflation rate back up to 2%, its target rate. It expects 1.2% for this year, 1.7% for next and 2% in 2023. Since the Fed is now targeting ‘average’ inflation, it can and will tolerate actual inflation above 2% for quite some time. This new target is widely interpreted as the Fed not considering hiking rates again until at least 2024! In other words, there is good support for share markets until that time – barring other shocks to the system.
With just over a month to go before the US presidential election, the race is hotting up. Trump has fuelled even more ire from the Democrats by announcing his nomination for the vacancy on the Supreme Court caused by the death of the legendary justice, Ruth Bader Ginsberg.
Since US Supreme Court justices have a position for life, it matters a lot which side of politics gets its nomination to sit on the bench. With big issues such as abortion and gun control always at the fore, the approval or otherwise of Trump’s nominee could spark a particularly divisive election campaign.
Biden has largely been standing on the sidelines as the Democrats hope for Trump to lose the election for them. While Biden was well ahead in the polls a few months ago, the gap is much smaller now and almost non-existent in certain key swing states. A recent Reuters poll had the two candidates polling neck and neck in Florida and Arizona.
From an investment perspective, it seems imprudent to ‘bet’ on which candidate will win and what policies would follow. Rather, we believe in managing the risks associated with the outcome rather than the returns. The elder stateman of academic finance research, Wharton Professor Jeremy Siegel, believes the US share market will do well in 2021 under either candidate. Our current analysis of broker forecasts of earnings supports this view.
Although there is much angst between China and the US over big tech and trade, the China economy is doing okay. Recent auto sales were up 12%, exports were up nearly 10% and retail sales posted their first positive month of 2020.
In Japan, Yoshihide Suga has succeeded Shinzo Abe as prime minister after the latter resigned owing to health issues. Suga has stated that he will endeavour to continue the so-called Abenomics policies so little disruption is anticipated.
The UK is struggling with Brexit and looks like trying to overturn its recent agreement. It is fruitless to try and guess how this will all play out. Although the UK is suffering renewed COVID-19 restrictions, its unemployment rate has only climbed to 4.1% from 3.9%.
In summary, the underlying share markets seem reasonably well supported given very accommodating monetary and fiscal policies in Australia, the US and elsewhere. However, the lack of a vaccine for COVID-19, the ferocity of the political campaign in the US and the continuing US-China confrontation over trade and technology mean that there is every chance of more volatility into November. If the US election results are contested, as they were in Bush vs Gore, the volatility could spill over into 2021. For long-term investors, having a well-balanced portfolio through a period of expected volatility remains a prudent strategy.
The ASX 200 ended its five-month rally of positive returns. If we look at that as the market taking a breather after a tremendous run, a small loss in September should not be a material concern. This is particularly so since the S&P 500, the World index and Emerging Markets all suffered a similar fate. All rallies come to an end so a ‘breather’ is better than a correction.
Our analysis indicates the market is slightly cheap compared to its fundamentals, though volatility remains elevated to its longer-term average.
Assuming the Federal Budget and the RBA board meeting on October 6th are both stimulatory for the economy, this may act to temporarily at least buoy the local share market. However, the US market is likely to remain a key driver as the US election draws near. It is rare that our market powers on when the US turns down.
The S&P 500 had some stronger days near the end of September but there does seem to be mood of caution among market commentators as they contemplate the looming election. We do not think the US market is over-priced in a short to medium-term sense but these are not normal times. After five consecutive months of strong gains, September was slightly negative. Future trends depend not only on the long-term fundamentals but also in the shorter term, on the existence or otherwise of a broadly available COVID-19 vaccine.
The announcement of an approved vaccine is getting closer. There are at least nine competing vaccines with trials well advanced. In many cases there are (partially) government-funded stock-piles of vaccines being built. The vaccines will not change from the ones at the start of the trials specified many months ago. It is simply that one or another maybe approved for safe use and the other stock-piles will be destroyed. It will still take some time to vaccinate populations in a broad sense but even targeted vaccinations are expected to provide a boost for share markets.
Bonds and Interest Rates
Although most central banks have had their official rates just about as low as analysts thought they could go, there was a lot of action in September. The RBA put $200bn of cheap money on offer to banks to help lending to consumers and business in these troubled times. They are expected to do even more at their meeting on October 6th. The RBA continue to act in attempt to keep 3-year government bonds rates lower than they otherwise would be. The official rate might even go down to 0.1% on budget/RBA board day.
The Fed too has thought outside of the box. It changed its target inflation rate from 2% to ‘an average of 2%’. This is important as an odd 2%-plus read will not force the Fed to act, nor the market to anticipate actions. But with monetary policy taking new, interesting directions, fiscal policy, while now more actively engaged as a result of COVID-19, is still playing catch up. The seemingly broken US Congress system is struggling to get agreement on the amount and structure of additional stimulus for the US economy. We cannot recall such divisive times.
The Australian government also needs to continue to step up to the plate. It seems likely that it will make amends on budget day. So, while central banks are almost universally independent of government, the central banks have gone first and it’s is up to fiscal policy to play catch up.
Most of the major asset prices (oil, iron ore, copper and the $A) fell by a few percent in September. This is not the stuff of sleepless nights. It feels like an organised pause in asset price inflation.
The August labour force data published last month stated that 111,000 jobs were created with many of them full-time positions. The participation rate, being the percentage of the relevant population in the workforce again rose meaning that the drop in the unemployment rate was meaningful. The latest unemployment rate is 6.8% and it was 7.5% in the previous month!
GDP growth was a dismal 7.0% for the June quarter. Since growth in the previous quarter was negative, the simplistic application of a definition of a recession confirms we experienced our first recession in nearly 30 years. However, the 1990 recession was arguably caused by a very high RBA official cash rate.
Because of the lags in monetary policy taking affect, the resultant recession in 1990 was deep and the unemployment rate soared into double figures. Since this current situation is due to a prudent set of public health initiatives, the impact was felt immediately and is anticipated to be less harmful to our medium-term economic prospects.
The China recovery continues. Exports again grew strongly at +9.5% but imports fell by 2.7%. Industrial output was up 5.6% and retails sales grew for the first time in 2020. While the Chinese economy has not reached its former glory in terms of its economic growth rate, it was the first major country to rescind pandemic restrictions and its policies are seemingly working.The saga of intellectual property rights and social media continues. It is not an easy problem to solve and we expect no major resolutions anytime soon.
The US Congress has still not worked out its next stimulus package but it did pass a bill to avert a government shutdown. While initial jobless claims and nonfarm jobs creation data have improved, there is still a very long way to go before the US gets back to work fully. It is not clear that the ‘blue wave’ will sweep Democrats into the majority in the senate and there will likely be similar problems to now of passing bills through congress, regardless of who is elected president.
If the election is again close, as many are predicting, there is an increased chance of the victory being challenged. That would cause prolonged uncertainly possibly into 2021.
The UK government continues to struggle to resolve the Brexit deal. Fortunately for most of us it will not have a major impact on our investment strategies.
Rest of the World
Japan has now elected its new prime minister, Yoshihide Suga, who has vowed to continue Shinzo Abe’s economic reforms – the so-called three arrows. It is far too early to tell how successful the transition will be.