06/11/2020

Key points

  • Globally, the pace of economic recovery from COVID-19 is uneven, with the US tracking at the optimistic end-of-expectations but economies such as the UK lagging behind fund manager mid-year forecasts.
  • Economic growth in the US has returned at a quicker-than-expected rate partly as a result of less-stringent lockdowns helping to boost the near-term economic outlook. Longer-term, many market commentators continue to expect US economic growth won’t return to pre-COVID levels until the end of 2021.
  • There are signs international trade is picking-up after the lows of May and June with China as a stand-out in global trade. China’s export position has benefited from its dominance in the global production for COVID-related products such as protective gear, pharmaceuticals and office equipment.
  • Global monetary policy is expected to remain loose throughout 2020 and well into 2021, with the risks skewed towards further easing.

Share Market Valuations

Whilst it can be argued that share market valuations are ‘high’ (current PE ratios are at near dotcom levels) relative to Bonds, which have seen officials rates fall significantly, they provide a healthy equities risk premium (the difference between earnings yield and bond yield).  So long as this continues it will underpin the support for shares.

TABLE One: US Share market Equity Premium

Value and Small tilts

The September quarter continued to see the Value (cheap companies) and Size premia under pressure globally as the following table of return (in AUD) attests.  This is largely (but not exclusively) a function of continued low interest rates which supports the current valuation of future cash flows.

TABLE Two: Global Value and Size Premia

Economic growth

Australia

The consensus foresees a return to modest growth in the third and fourth quarters following on from a second quarter which saw the country enter its first recession in 29 years. A sharp pullback in GDP of –7.0% in second quarter was the largest fall in quarterly Australian GDP since records were first kept in 1959. Most commentators continue to forecast a contraction in full-year GDP of around –4% with the possibility of regional lockdowns factored into the baseline scenario.

China

A relatively upbeat growth picture for China was affirmed in August with a monthly gain in retail sales—the first such gain this year. High-frequency data indicators for August paint a relatively upbeat picture for growth in China, making it less likely that policymakers will choose to stimulate the economy, especially as equity and housing prices rise. Retail sales rose by 0.5% in August compared with a year earlier, the first such gain this year, though they’re down by 8.6% for the first eight months of the year. Exports remained resilient, up 9.5% compared with August 2019. A broadening in China’s export goods is expected after a period where exports were concentrated in protective equipment, medical instruments, and work-from-home technology. We’ll watch for whether subdued spending in the developed world may weigh on China’s exports in the months ahead.

United States

A shift-forward in growth expectations is noted for the U.S. economy in 2020 although the longer-term picture hasn’t changed. Despite a second-quarter GDP forecast signalling an economy-wide collapse in activity, areas of the country with less-stringent lockdowns have supported economic activity even as infection trends have worsened in other areas. The overall picture is one of an improved economic growth outlook in 2020, though the long-term picture for U.S. economic growth remains unchanged. GDP returning to pre- COVID levels is not expected until the end of 2021, with the caveat that those forecasts would be subject to change without the fiscal stimulus of around $1 trillion currently forecast.

Japan

Japan’s full-year GDP is expected to contract to a range around –3% to –5% with little near-term economic impact from the resignation of Prime Minister Shinzo Abe. A moderate economic rebound is expected in the neighbourhood of 5%, above consensus, in both the third and fourth quarters as industrial indicators point to a manufacturing recovery.

United Kingdom

The early stages of economic recovery in the United Kingdom were weaker than in the euro area as the trajectory of new virus cases continued high for longer. Only a gradual recovery is expected for the rest of the year. Although most supply is back online, demand is likely to return more slowly as households remain reluctant to engage in highly social activities, especially amid a recent uptick in new cases in some areas. U.K. GDP is expected to be around −11% for the full-year, or somewhere between most baseline and downside cases set out in various mid-year updates available.

Emerging Markets

The International Monetary Fund (IMF) lowered its forecast for growth in emerging markets for both 2020 and 2021 on June 24, owing to a rapid intensification of COVID-19 infection rates in many countries. The IMF foresees emerging markets contracting by 3.0% before rebounding with positive growth of 5.9% in 2021. The IMF outlook for Latin America is particularly pessimistic with an expected contraction of 9.4% for all of 2020, before rebounding to 3.7% in 2021.

Monetary policy

Given our expectations for a slow recovery in demand, monetary policy is expected to remain loose into 2021, with risks skewed toward further easing.

The US Federal Reserve left its key federal funds rate unchanged at 0%–0.25% on September 16. Policymakers also broadly expect the rate to stay at this level through 2023. The European Central Bank left its main deposit rate unchanged at –0.5% on September 10 and said it would keep rates at current negative levels, or lower them further, until it sees the inflation outlook “robustly converge to a level sufficiently close to, but below, 2%.” The Reserve Bank of Australia (RBA) maintained its cash rate and three-year government bond target at 0.25% on September 1, and extended its Term Funding Facility through June 2021.

TABLE Three: G-6 Central Bank balance sheet size

Trade

Leading indices suggest global trade has swung back to an upward trajectory following the steep drops of May and June, with China leading the way thanks to healthy demand for products during COVID lockdowns. China is supported by its position at the centre of global goods products, particularly for those products in demand during COVID lockdowns, and by lower prices for commodity inputs.

Inflation

Inflation in the United States is expected to remain below 2% by the end of 2021. Potential upside risks to forecasts include virus-related supply shocks, fiscal support and/or monetary stimulus and the willingness of the Federal Reserve to tolerate above-target inflation.

The consumer price index in the United States rose by 0.4% in August compared with July on a seasonally adjusted basis, having risen by 0.6% in July. Compared with a year earlier, inflation rose by 1.3%, while core inflation—which excludes volatile food and energy prices—rose by 1.7%.

Headline inflation was –0.2% in the euro area on an annual basis in August, according to preliminary estimates—the first slide below zero in four years. Core inflation—which excludes energy, food, alcohol and tobacco—rose just 0.4% on an annual basis, which is down from 1.2% in July and is an all-time low. The euro’s recent appreciation against other major currencies is expected to continue to exert further disinflationary pressure as less expensive imports and more expensive exports weigh on GDP. Core rate of inflation to not expected to rise close to the European Central Bank’s 2% target over the next 12 months.

In Australia, consumer prices fell 1.9% in the June 2020 quarter compared with the March 2020 quarter, and by 0.3% compared with a year earlier—the first such contraction since 1997. An update on third-quarter inflation data is expected on October 28.

Employment

The unemployment rate in the United States fell for a fourth straight month in August, to 8.4%. Although the pace of job gains has slowed in the last two months, the labour market has surpassed expectations. With growth in the US expected to accelerate over the rest of the year, we believe it will finish 2020 with an unemployment rate of about 7% to 9%, compared with the 8% to 10% previously expected.

Unemployment in the euro area rose to 7.9% in July from a revised 7.7% in June, with the number of unemployed people rising by 344,000. Furlough and other job support schemes have been successful in limiting unemployment rates so far. The recent extension of furlough programmes in Germany and France has been encouraging.

In Australia, unemployment fell for the first time since the start of the pandemic—falling to 6.8% in August from 7.5% in July. An extended virus lockdown in the State of Victoria is expected to result in further job losses in September.

COVID

Whilst infection rates are on the increase globally, it is encouraging that death rates are falling.  Of course various vaccines are also in late stage human trials which is encouraging news and sets the state for 2021 to be about ‘getting on top of’ the virus allowing the global economy to start the recovery in earnest!

TABLE Four: Global COVID-19 infection and death rates