Market Watch

Over the weekend in Australia, the federal government announced a second fiscal stimulus package to offset the hit to growth from COVID-19.

Below are some of the main take-aways:

• An additional $46bn worth of direct government spending for individuals and businesses impacted the coronavirus.

Along with the first round of stimulus announced recently ($17.6bn to individuals and businesses, $2.4bn to the healthcare sector and $5bn of stimulus by the states) total Australia fiscal stimulus in response to coronavirus is worth around 3.5% of GDP.

This is in-line with other countries who have recently announced fiscal packages (see the table below). Most of the stimulus in Australia is front-end loaded over the next year.

Source: UBS, Bloomberg, AMP Capital

• Other stimulus measures include cheap bank financing which is aimed to stimulate borrowing, part of this was announced by the Reserve Bank of Australia last week.

The government also announced a $20bn loan guarantee to help impacted small/medium-sized businesses meet cash flow requirements. If you include these total loan guarantees with the direct fiscal stimulus then total stimulus in the economy is worth around 10% of GDP.

Then there are also the RBA interest rate cuts and three-year government bond purchases to meet the 0.25% yield target. So there is a lot of stimulus being thrown around in Australia which is completely necessary at the moment.

• Details of the package announced yesterday also include: increase the payment of the Newstart allowance (an additional $550/fortnight) and expanded eligibility for income support (the Newstart allowance). It also includes a further $750 payment (on top of the $750 already announced) for those on welfare support (5.2 million Australians), early access to superannuation for those whose wages have been directly affected by the virus (draw up to $10K from superannuation this and next financial year) tax-free, more flexibility around retirees on drawing down on their superannuation and increasing cash payments to SMEs ($20K payment up to $100K).

• Total global stimulus to combat the economic risks from the coronavirus should equal around 2% of GDP (including measures that we expect to be announced from the US and China). This is more than during the GFC (see the chart below) as countries deal with the most disruptive global shock since WWII.

View larger image

Source: UBS, Bloomberg, AMP Capital

• The PM said that more stimulus is likely, expect more direct cash handouts to Australian households more broadly to be announced over the next few weeks.

• Increased government spending stimulus alongside the hit to economic growth means that Australian AAA credit rating by international ratings agencies will be at risk of being downgraded. But the rest of the world is (relatively) in the same boat as governments will stretch budgets to support the economy. In theory, a downgrade to the sovereign AAA credit rating will increase Australian bond yields and the cost of borrowing for the government. However, the evidence on this isn’t conclusive. The US downgrade in 2011 saw bond yields fall after its credit rating was downgraded.

• As we have said before we don’t think that fiscal stimulus will be enough to keep Australia out of recession over March/June quarter. The hit to GDP growth in the March quarter from lower Chinese tourist and education spending, along with the impact to the bushfires will be large. June quarter GDP growth will be impacted by the rest of world (ex China) dealing with coronavirus shutdowns and we see a Eurozone and US recession occurring this year which will be another negative impact to Australian export growth. On top of that, more local infections of the virus is leading to some lockdowns with more expected which will limit consumer spending. Our base case is now for a 3.5% contraction in the Australian economy but it could be larger.

• The fiscal stimulus package will help in limiting the depth of the Australian recession, it will help to keep companies afloat (and should provide some limit for keeping the unemployment rate from skyrocketing) and it is necessary to get a strong recovery after the virus has run its course. It is important to keep tracking how the daily change in new coronavirus infections is tracking globally (see the chart below), especially compared to the China experience. Unfortunately there are no signs yet of EU/US infections reaching a peak as lockdowns have only been imposed for a short time.

By Diana Mousina 
Economist – Investment Strategy & Dynamic Markets

Source: AMP Capital 23 March 2020

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.

The coronavirus is first and foremost a public health issue, but it is also having a very major impact on the economy and the financial system. As the virus has spread, countries have restricted the movement of people across borders and have implemented social distancing measures, including restricting movements within countries and within cities. The result has been major disruptions to economic activity across the world. This is likely to remain the case for some time yet as efforts continue to contain the virus.

Financial market volatility has been very high. Equity prices have experienced large declines. Government bond yields have declined to historic lows. However, the functioning of major government bond markets has been impaired, which has disrupted other markets given their important role as a financial benchmark. Funding markets are open to only the highest quality borrowers.

The primary response to the virus is to manage the health of the population, but other arms of policy, including monetary and fiscal policy, play an important role in reducing the economic and financial disruption resulting from the virus.

At some point, the virus will be contained and the Australian economy will recover. In the interim, a priority for the Reserve Bank is to support jobs, incomes and businesses, so that when the health crisis recedes, the country is well placed to recover strongly.

At a meeting yesterday, the Reserve Bank Board agreed to the following comprehensive package to support the Australian economy through this challenging period:

1. A reduction in the cash rate target to 0.25 per cent.

   The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band.

2. A target for the yield on 3-year Australian Government bonds of around 0.25 per cent.

   This will be achieved through purchases of Government bonds in the secondary market. Purchases of Government bonds and semi-government securities across the yield curve will be conducted to help achieve this target as well as to address market dislocations. These purchases will commence tomorrow. The Bank will work closely with the Australian Office of Financial Management (AOFM) and state government borrowing authorities to ensure the efficacy of its actions. Further details about the implementation of this are provided in the accompanying notice.

3. A term funding facility for the banking system, with particular support for credit to small and medium-sized businesses.

   The Reserve Bank will provide a three-year funding facility to authorised deposit-taking institutions (ADIs) at a fixed rate of 0.25 per cent. ADIs will be able to obtain initial funding of up to 3 per cent of their existing outstanding credit. They will have access to additional funding if they increase lending to business, especially to small and medium-sized businesses. This facility is for at least $90 billion. Further details are available in the accompanying notice.

   The Australian Government has also developed a complementary program of support for the non-bank financial sector, small lenders and the securitisation market, which will be implemented by the AOFM.

4. Exchange settlement balances at the Reserve Bank will be remunerated at 10 basis points, rather than zero as would have been the case under the previous arrangements.

   This will mitigate the cost to the banking system associated with the large increase in banks’ settlement balances at the Reserve Bank that will occur following these policy actions.

The Reserve Bank will also continue to provide liquidity to Australian financial markets by conducting one-month and three-month repo operations in its daily market operations until further notice. In addition, the Bank will conduct longer-term repo operations of six-month maturity or longer at least weekly, as long as market conditions warrant.

The various elements of this package reinforce one another and will help to lower funding costs across the economy and support the provision of credit, especially to small and medium-sized businesses.

Australia’s financial system is resilient and well placed to deal with the effects of the coronavirus. The banking system is well capitalised and is in a strong liquidity position. Substantial financial buffers are available to be drawn down if required to support the economy. The Reserve Bank is working closely with the other financial regulators and the Australian Government to help ensure that Australia’s financial markets continue to operate effectively and that credit is available to households and businesses.

Today’s policy package from the Reserve Bank complements the welcome fiscal response from governments in Australia. Together, these measures will support jobs, incomes and businesses through this difficult period and they will also assist the Australian economy in the recovery.

Source: Reserve Bank of Australia, March 19th, 2020

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Email: rbainfo@rba.gov.au

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.50 per cent. The Board took this decision to support the economy as it responds to the global coronavirus outbreak.

The coronavirus has clouded the near-term outlook for the global economy and means that global growth in the first half of 2020 will be lower than earlier expected. Prior to the outbreak, there were signs that the slowdown in the global economy that started in 2018 was coming to an end. It is too early to tell how persistent the effects of the coronavirus will be and at what point the global economy will return to an improving path. Policy measures have been announced in several countries, including China, which will help support growth. Inflation remains low almost everywhere and unemployment rates are at multi-decade lows in many countries.

Long-term government bond yields have fallen to record lows in many countries, including Australia. The Australian dollar has also depreciated further recently and is at its lowest level for many years. In most economies, including the United States, there is an expectation of further monetary stimulus over coming months. Financial markets have been volatile as market participants assess the risks associated with the coronavirus. Australia’s financial markets are operating effectively and the Bank will ensure that the Australian financial system has sufficient liquidity.

The coronavirus outbreak overseas is having a significant effect on the Australian economy at present, particularly in the education and travel sectors. The uncertainty that it is creating is also likely to affect domestic spending. As a result, GDP growth in the March quarter is likely to be noticeably weaker than earlier expected. Given the evolving situation, it is difficult to predict how large and long-lasting the effect will be. Once the coronavirus is contained, the Australian economy is expected to return to an improving trend. This outlook is supported by the low level of interest rates, high levels of spending on infrastructure, the lower exchange rate, a positive outlook for the resources sector and expected recoveries in residential construction and household consumption. The Australian Government has also indicated that it will assist areas of the economy most affected by the coronavirus.

The unemployment rate increased in January to 5.3 per cent and has been around 5¼ per cent since April last year. Wages growth remains subdued and is not expected to pick up for some time. A gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range.

There are further signs of a pick-up in established housing markets, with prices rising in most markets, in some cases quite strongly. Mortgage loan commitments have also picked up, although demand for credit by investors remains subdued. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality. Credit conditions for small and medium-sized businesses remain tight.

The global outbreak of the coronavirus is expected to delay progress in Australia towards full employment and the inflation target. The Board therefore judged that it was appropriate to ease monetary policy further to provide additional support to employment and economic activity. It will continue to monitor developments closely and to assess the implications of the coronavirus for the economy. The Board is prepared to ease monetary policy further to support the Australian economy.

Source: Reserve Bank of Australia, March 3rd, 2020

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Email: rbainfo@rba.gov.au

Epidemics can rattle markets, and as fund managers we need to know what is worth reacting to and what is a product of the 24-hour news cycle. Here, we share some learnings for advisers and investors facing information overload.

In the age of information, it can be easy for investors and advisers alike to be swayed or distracted by articles, statements and opinions which lack evidence, rigour and analysis. Certain headlines can be frightening and foster an air of anxiety.

Our role as guardians of clients’ capital means we apply refined filters to assess incoming information and guide our investment decisions. We have models to help us separate signal from noise during the regular flow of economic data, however navigating ad hoc events for which there may not be a ready-made model, is another critical aspect of portfolio management.

The situation unfolding with the Coronavirus is, above all, a human tragedy. For investment managers, who have a responsibility to be a steady hand during this time, it represents an ad hoc event to interpret and manage with caution. We share some of our thinking on the Coronavirus below, with insight to our thinking and processes during events of this nature.

1. Monitoring scale and severity

The scale of an epidemic is an important factor in analysing market impact, but you first need to determine what to measure. In the case of an epidemic, mortality rates hit our fear impulse hardest. However for financial markets the significance of an event like this boils down to the level of disruption caused to regular flow of goods and people.

By way of example, over 11,000 people died from the Ebola outbreak in West Africa in 2014.However the disruption caused to the global economy was much less than we’ve seen with the Coronavirus that originated in Wuhan, because of the differences in population density and the impact to global supply chains.

The media has placed a high value on the mortality rate, and the undeniable human tragedy this situation entails. As investment managers, our lens includes various other factors. Our focus has also been on the level of disruption caused to the economy, a function of the scale of the response required to contain the epidemic (e.g. flight cancellations) and the likely time to containment. In that respect, coronavirus has already exceeded both Ebola and the SARS outbreak in 2003.

Sources: PRC National Health Comm, Johns Hopkins CSSE, WHO, AMP Capital

2. Understanding context and the knock-on effect

The economic context also sets the scene for how harshly an event can impact markets. Further, it has large bearing on how lengthy the recovery phase will be.

In the case of SARS, GDP in China fell by over 2% in the June quarter of 2003¹. The economic backdrop wasn’t particularly helpful at the time – the global economy was still feeling the effects of early 2000s recession which saw the collapse of Enron, bursting of the Tech bubble and the September 11 terrorist attacks.

While the situation isn’t quite as dire this time around, the virus has arrived at a time where great hope has been placed on emerging markets’ ability to rebound from an 18-month long US-China trade war. China was set to play an important role in this rebound story and, critically, it’s share of global GDP has increased nearly three-fold since the 2003 SARS outbreak².

Equity market watchers will also be acutely aware of the markets sensitivity to US-China trade relations, and the coronavirus raises new questions about China’s ability to meet its obligations under the recently signed Phase One trade deal when it agreed to buy large quantities of US goods in exchange for tariff relief. Compounding the issue is the looming US Presidential election where Trump may not be in the position or mood to offer the type of leniency China requires to avert a more dramatic slowdown.

3. Adding a grain of salt

There have been some fairly wild conspiracy theories circulating since the onset of the Coronavirus, which the World Health Organisation (WHO) has called out³ as damaging and unnecessarily fear provoking.

The WHO has also been compelled to address some specific myths in an online fact sheet – including that eating garlic or covering your body in sesame oil helps prevent the Coronavirus.

There are also a number of more sinister headlines and theories in circulation, including that the virus was a biological warfare experiment gone wrong and the passing of the doctor that discovered the virus was part of an elaborate cover up. Absurd as some of these stories may seem, they do have the ability to impact an investors mindset and undermine the level of trust in the official reporting.

Here, a little situational awareness and rational thought can provide a timely filter. This is critically important when making investment decisions and analysis.

Over the past 16 months, China’s hog population has decreased by approximately one-third as a result of African Swine Flu, resulting in an 110% increase in the price of pork⁴. Under these circumstances it is reasonable to assume some behavioural shifts by the Chinese consumer, i.e. an increase in demand for substitute meats which may have unintentionally created the conditions for a coronavirus. It is also reasonable to assume that the doctor that sadly passed away was working tirelessly to help contain the virus, which compromised his immune system.

A portfolio manager deals in probabilities and thinking along these lines can be a vital debunking tool which allow you move on quickly to other things.

“At the WHO we’re not just battling the virus, we’re also battling the trolls and conspiracy theories that undermine our response,” WHO Director General Dr Tedros Adhanom Ghebreyesus said. In that statement, he endorsed a headline from The Guardian⁵ reading “Misinformation on the Coronavirus might be the most contagious thing about it.”

By and large we are closely monitoring sources like the WHO, while taking note of studies from other credible institutions, such as the London School of Hygiene and Tropical Medicine and the Imperial College London as they become available.

4. Keeping calm

As our chief economist, Dr Shane Oliver, often reminds us: our worst-case fears are just that – worst-case fears, and experience in recent history confirms this. Our senior economist, Diana Mousina, has also pointed out how fears of a Spanish flu type of situation – which was in 1918 and killed about 50 million people – have not yet come to pass here.

So while there is no doubting the severity of the Coronavirus; the disruption it has already caused and could cause were it to morph into a pandemic, an investment manager must remain grounded by probabilities because a steady hand is imperative during times of crisis.

With the benefit of a tried and true investment process and an ability to identify the facts that matter, we can get on with doing what we do best: growing and guarding our client’s capital.

¹ National Bureau of Statistics China, Bloomberg 2020
² https://www.imf.org/external/datamapper/PPPSH@WEO/OEMDC/ADVEC/WEOWORLD
³ https://www.bbc.com/news/world-51429400
⁴ https://www.forbes.com/sites/siminamistreanu/2019/12/28/chinas-swine-fever-crisis-will-impact-global-trade-well-into-2020/#57a3ba1531ae
⁵ https://www.theguardian.com/commentisfree/2020/feb/08/misinformation-coronavirus-contagious-infections

Author:  Brad Creighton, Portfolio Strategist – Dynamic Markets Sydney, Australia

Source: AMP Capital 18 Feb 2020

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.

Lessons from 2019

Economic growth is slowing, but still growing

Following the Australian federal election in 2019, those of us who were optimistic about the outlook for Australian GDP growth were surprised at the extent to which the Reserve Bank of Australia (RBA) cut interest rates. However, these cuts were also in the context of weak consumer confidence, housing price instability and low wage growth which led to a generally flatter mood, driving growth lower. From a real estate perspective this has yielded mixed results.

On the one hand, slowing economic growth has had an impact on demand and rental growth as businesses and consumers choose to save rather than take on new space. But on the plus side, falling interest rates typically coincide with rising real estate values, which we saw in 2019 as investors exploit the gap between lower interest rates and their rental yield.

With returns for fixed income products falling to record lows, investors have favoured real estate’s average return of 9.8% for the year to December 2019 (MSCI/IPD Total Return Index), in order to generate the higher, more attractive returns for their portfolios.

Lower for longer and longer is the new normal

Falling interest rates and slowing economic growth have cemented this lower for longer and longer period of minimalist expansion which will arguably be the new “norm” going forward.

Prior to 2019, economic growth levels were pointing to renewed momentum, finally breaking free of the quantitative easing period that prevailed post the Global Financial Crisis. However, with growth levels so anaemic, quantitative easing – where the Reserve Bank becomes an active buyer of government and corporate bonds to inject liquidity into the economy – now looks like the most likely outcome.

This has driven returns on traditional savings products like term deposits and government bonds to new lows, forcing investors to move into other asset classes to generate income streams that can sustain their retirement lifestyle, or boost their savings.

Real estate investment cycle extended… but not all sectors benefited

Commercial real estate yields, which reflect the value of rent against the asset price, have been compressing consecutively since 2009, marking the longest growth cycle ever recorded (JLL REIS Data). We expect to see this cycle prolonged as investors chasing more attractive returns move into real estate and out of more liquid asset classes like equities and bonds.

The one exception to this rule in 2019 was the retail sector, which saw mixed results. There are multiple global forces driving down retail values – rising competition from e-commerce, shrinking investor appetite for exposure to the sector and changing consumer habits favouring less “shopping for stuff” in favour of experiences and convenience-based offerings.

While last year marked a turning point for retail, on a global basis, Australian retail still remains more competitively priced due to its scarcity and our robust population growth compared to the US and UK where retail valuations have been falling by as much as 40% (CBRE Research).

On balance, 2019 was a positive year for real estate investors. The risks and rewards became clearer as central banks responded to sluggish growth and improving capital values benefitted from low interest rates. We also saw risks on the demand side rising as consumer and business confidence hit record lows. With this in mind, where next for 2020?

Investment strategies for 2020

Residential

Residential is benefitting more than most real estate asset classes from the immediate effects of falling interest rates. With mortgages now priced below 3% in some cases, home buyers have plunged back into the market, reversing the pricing downturn of 2017-18.

With the prospect of more rate cuts in 2020, house values are anticipated to remain in positive growth territory for at least another one to two years.

Populous markets like Sydney and Melbourne remain the firm favourites to deliver the most stable growth over the medium term, however recovery markets such as Perth and Brisbane will offer investors more affordable entry points, with higher growth upside as these markets enter a sustained upswing beyond 2021.

Office

While office was the market leader for total returns, 2019 saw returns across most major markets decelerate as the impact of slowing economic growth created a drag on rental growth, particularly in Sydney and Melbourne.

While demand from tenants is expected to slow in 2020, rents should remain solid as there are no signs of a supply breakout before 2022.

Pricing in all office markets is also expected to rise this year, as global investor demand for Australian office product remains very strong.

Beyond the core markets of Sydney and Melbourne, which will still deliver strong, but slowing returns, the resource states of Brisbane and Perth remain on track for recovery led growth in the short to medium term.

Value add strategies, such as retrofitting older office stock and upgrading facilities in prime locations which remain highly prized by tenants for their amenity and offer good core fundamentals, are worth considering to generate higher returns and long term rental income.

Industrial and logistics

Logistics is expected to outperform all commercial real estate sectors in 2020, providing investors with the highest total returns in both capital and income growth. This is predicated on three key drivers:

• Global demand for logistics assets from investors is already at record levels (refer to first chart below), as portfolios are re-weighted away from retail, which will provide short and long-term support to pricing; 

• Rental growth will benefit from an increasing sophistication of the tenant pool as it transitions from blue collar sectors to more technology enabled, consumer led products; and

• The average price of an industrial asset is typically 80-90% lower than a retail or office asset, making it a highly liquid market. But with such strong competition for product, accessibility will be difficult.

In order to acquire logistics assets, investors can consider infill sites – older facilities with shorter lease terms in highly sought-after markets with rising land values or development sites in larger greenfield locations with longer lease terms and newer generation assets.

Another strategy gathering momentum is the repurposing of other property types for logistics use. Bulky goods retail or smaller shopping centres in strategic locations can make good conversion opportunities whilst delivering rental income over the medium term.

While 2020 is set to be logistics’ year to come out on top, not all logistics and industrial assets are created equal, so careful site selection and tenant vetting will be critical to minimise risk.

Retail

Turning to the retail sector, the new war for consumers is being spread between two distinct camps – convenience and experience.

The convenience end of the bell curve favours supermarkets, food services and other essential household services. This is why we have seen smaller format neighbourhood centres continue to show positive capital growth as investors seek low volatility, smaller more liquid assets.

On the experience side, this is where the super regionals dominate the market as they have the largest footprint and an array of offerings such as cinemas, restaurants, car parking and global fashion brands. Consumers will go here to have a social experience with their friends and also access their convenience services.

While pricing for retail on the whole will show some softening in 2020, it won’t be as much as we previously anticipated. Online sales, which currently account for 7% of all retail spend (ABS), will continue to challenge the bricks and mortar sector, but with 93% of our spend still in store, the overwhelming majority of our retail spending will remain in shopping centres for the foreseeable future.

Final thoughts

Overall the outlook for real estate is bifurcating – on the one hand, pricing growth will accelerate across most sectors in 2020, as the benefits of cheap debt and attractive returns keep investor demand levels high.

However, this optimism needs to be measured with a sober reflection on the weak fundamentals of the Australian economy, which continue to amplify the risks on the demand side.

The good news is, the picture emerging is a lot clearer than in 2019, and despite a record growth cycle, the evidence suggests there is still more upside for real estate investors in 2020 and plenty of opportunities across sectors to find solid returns (refer second chart below).

Author:  Luke Dixon, Head of Real Estate Research – Real Estate Sydney, Australia

Source: AMP Capital 18 Feb 2020

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.

At home and abroad, major events have rattled global markets in the first quarter and are set to have an ongoing impact. However, it’s not all bad news, and as always – it’s a good idea to turn down the noise.

The United States and Europe

You might not know it from the headlines, but there has been some positive data coming out of the US this month.

This includes:

• The ISM (Institute for Supply Management) manufacturing conditions index rebounded into positive territory in January.

• The non-manufacturing ISM conditions index also rose and it remains solid.

• Small business optimism remains high.

• Jobs growth remained strong in January with unemployment remaining ultra-low

• Earnings seasons results have been generally good: Taking a look at data up to February 7, 64% of US S&P 500 companies had reported, with 76% beating on earnings expectations by an average of 5%. Further, 67% had beaten sales expectations. Earnings growth looks to be up by about 2.5% year-on-year, compared to market expectations a few weeks ago for a 2% decline.

Brexit is (finally) here

The United Kingdom officially left the European Union on January 31, after years of negotiations.

In good news for markets, so far, it appears the UK parliament is leaning towards wanting free trade to continue between the UK and the EU. Time will tell whether a deal is agreed by year end or not. But the key point is that Brexit has not contributed to the domino effect of countries wanting to leave the Eurozone that had been feared a few years ago. If anything, the Eurozone looks more determined to stay together.

Also:

• In January, Eurozone business conditions PMIs (Purchasing Managers Index) were revised up and are continuing to recover from the lows experienced last year.

• Likewise, global business conditions indicators also continued to recover in January

News from Australia

For some time, Australia will be dealing with the implications of the bushfires which ravaged the east coast. The mega-blazes which formed over the Christmas and early 2020 periods were largely extinguished after a deluge of rain in recent weeks, but we can expect a hit to GDP, especially in the March quarter.

In saying that, there has been some positive economic data recently.

• House prices were up solidly again in January. 

• Building approvals fell just 0.2% in December, but this followed an 11% gain in November, and they are up slightly on a year ago.

• Job ads also rose in January. 

• Retail sales were soft in December, but real retail sales managed an okay rise in the December quarter as a whole.

• The trade surplus remained high in December

The Coronavirus, China and global markets

The 2019 novel coronavirus, commonly referred to as the Coronavirus, was declared an international public health emergency by the World Health Organisation (WHO) on January 30 this year. This is, first and foremost, a human crisis.

There has been understandable concern about the knock-on impact to markets. At the moment, share markets have seen falls, with the Chinese market taking the biggest hit at about 12% followed by Asian shares. For global and Australian shares there have been falls at around 3%, although some or all of this has been reversed depending on the market.

No doubt, the Coronavirus will have an impact on markets for a while yet, particularly for China. Trade, people movement and confidence has been restricted, so it follows that we can expect the global and local Asian economies to take a short-term hit.

Keeping an eye on context

There are some points about this situation that are being lost in the noise, including:

• Fear can be louder than reality  

The current situation regarding the Coronavirus is highly uncertain. However, the experience with SARS, bird flu, swine flu and Ebola in recent history highlight worst-case pandemic fears don’t usually eventuate. 

In the last century, there were three influenza pandemics. The 1918 Spanish flu pandemic was most severe, killing about 50 million people worldwide. Economic activity was severely disrupted as people stayed in their homes, compounded by the end of World War I. Nothing has surpassed this since, which was 102 years ago.

A more relative case is the SARS outbreak in 2003. SARS infected about 8000 people, mostly in Asia, after an initial outbreak in China. SARS had a big negative impact on the countries most affected as people stayed home for fear of catching it. GDP in China, Hong Kong and Singapore slumped by over 2% in the June quarter of 2003. Growth then subsequently rebounded.

• Containment measures are aggressive

When compared to SARS, the containment measures from China in particular have been more aggressive and started earlier. Airlines and nations worldwide have imposed tight travel bans in and out of China and the Wuhan’s Xubei province, where the outbreak started. This may partly explain why 99% of cases have still been confined to China with about two thirds in Xubei province.

With measures such as these in mind, our base case scenario (with 75% probability) is one of containment over the next month or two. In this case, GDP in China and parts of Asia would likely take a 2 to 3% hit or maybe even deeper. Australian GDP could also take a significant hit in the current quarter as resource exports, tourism and education are impacted and this could see GDP go negative. But growth would then rebound in the June quarter. If this occurs shares, commodity prices and the Aussie dollar could see more volatility and downside in the near term but will largely be able to look through the short term economic and profit disruption to the eventual rebound.

A cool head

As I’ve long said – keeping your head calm in extreme times is critical. This includes when the crowd is convinced that disaster is upon us. These periods present temptation to make fear-based investment decisions, which seldom reaps results. So, in the interest of your investments long term best health keep calm, and carry on.

Author:  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia

Source: AMP Capital 17 Feb 2020

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