With the August reporting season is well and truly done and dusted, the broker forecasts of earnings and dividends have settled down to be consistent with an above average capital gain over the next 12 months. The forecast yield is just below 4% with franking credits, if applicable, to be added to the dividends and capital gain. Of course, from our position, we think that short-run volatility is far from over but the long-run does look reasonably solid.
The S&P 500 also broke its run of positive monthly gains with a short, sharp correction. This index also fell 5% from its recent peak.
Our broker-based forecasts of earnings put our forecast of capital gains for the S&P 500 to be slightly better than for the ASX 200. However, yield is expected to be less than half of that on the ASX 200 and the US does not distribute franking credits.
Bonds and Interest Rates
The US yield curve steepened (longer term interest rates rising more than shorter term interest rates) a lot over September and now more closely resembles the curve earlier in the year. The short-term rates remain locked, close to zero, but the longer end yields are back around 1.5% or near to where they reached at the end of the rally that started at the end of 2020 before dipping in to around 1.2% during mid-2021.
The Fed came out of its September meeting unusually tentative. Fed chair Powell was keen to distance the Fed’s actions from largely unknown outcomes of the Evergrande problems in China. The Fed still has time this year to start tapering its $120 bn / month bond purchases program and have it finished by mid-2022.
While QE was important in keeping the economy afloat through the worst of the COVID19 pandemic and no doubt supported equity markets, few are arguing it is still necessary. With bond yields so low, cash has little alternative but to remain in equities for yield over the foreseeable future.
While the Fed member ‘dot plots’ have shifted a fraction, it is almost certain that the Fed will not raise rates until well after it has ended so that the degree of financial stability or otherwise can be assessed before starting the rate hiking cycle.
The Reserve Bank of Australia (RBA) announced that it has no plans to raise rates until at least 2024 even though house prices are surging. The official house price increase for Q2 was 6.7% and 16.8% over the year. Clearly, forms of regulating house price growth – other than through the official interest rate – are needed. To raise rates to control house prices might destroy the growth prospects of the broader economy.
The price of iron ore continued its decline over September from $US157 / tonne to a low of $US104 but then it retracted some of the losses to close the month at $US118.
The prices of gold and copper recorded modest declines of around 3-4%. The price of oil was up firmly by around 8-10% in September while the $A sold off against the $US by nearly 2%.
The Australian dollar recovered from a low of US$ 0.7133 during August to a range in the mid-73 cents, possibly more a case of the $US weakening on the back of the Afghan withdrawal than economic fundamentals.
At first glance, the Australia Labour Force report in September seemed really good. The unemployment rate fell to 4.5% when 4.9% had been expected. However, 146,000 jobs were lost. This situation could only happen because there was a fall in the participation rate – reflecting a discouraged worker sentiment.
Indeed, 66 million hours of work were lost in the latest month or a fall in hours worked of 3.7%! The picture gets worse when one notes the reported ‘hundreds of thousands’ of workers who, in fact, recorded working zero hours while ‘employed’!
Covid support benefits to individuals are to be cut back when the vaccination rate reaches 70% and to be eliminated two weeks after the 80% target is met. While we are expecting many establishments to re-open at the same time, there will be strict social distancing conditions imposed. And there will be the time between businesses re-opening and people being in a position to take up work. We can reasonably expect the next couple of months of labour data to reflect these disconnects.
On the broader GDP growth front, the Q2 number came in at a reasonably impressive 0.7% when only 0.1% had been expected. Most commentators are expecting a negative number for Q3. The question is, will there be a bounce back in Q4?
They key to answering this question might be found by analysing the household savings ratio. In Q2 it was 9.7% after falling from 11.7% in Q1. When the lockdown first struck in 2020, this ratio rocketed to over 20%. In due course we might expect the ratio to settle down in a range of around 4% to 8%.
The savings ratio jumped up because there were less opportunities and needs to spend – plus the desire by some to save for a rainy day. 15 – 18 months ago there was no clear path forward. No vaccines had then been proven to shield us from Covid-19. The impact of a falling savings ratio will help buffer GDP growth from being too low – or negative.
What we do not yet know is how infection rates will track after Freedom Day. The experience from other countries is that our infection rates will rise substantially. How will the governments then react?
We already have reports of many diagnostic tests for cancer and other potentially severe conditions having been cut back – because people haven’t been going out for tests during lockdowns or there are backlogs in hospitals. Our hospitals are reportedly coping with the pandemic but only just. If Singapore went back to light restrictions on an 80% vaccination rate, we might have to follow suit.
The latest monthly retail sales figure was also disappointing at 1.7%. Without being health experts, the key to a quick bounce back from Q3 growth will depend on the responsibility of Australia’s residents to wear masks and socially distance. We are hopeful for a solid bounce back but we are far from certain.
As for international travel, the hopes of a year ago have been sadly dashed. There is disagreement over whether the unvaccinated should be allowed in or out of certain countries. Indeed, Australia is reportedly not going to accept people with the China ‘sino’ vaccines even with a certificate. Will countries like the US, Canada and France, that do not recommend AZ allow our residents to travel even if fully vaccinated with AZ?
The OECD, now headed by our former Australian finance minister, Mathias Cormann, has recommended our RBA be reviewed. There has been no such review since 1981 Campbell Inquiry. The OECD is also recommending that we broaden the base over which GST is charged. In short, once the worst of the pandemic is behind us, we and other countries will need to address the surge in debt caused by the pandemic.
China’s economy continued to slow in September. Indeed, retail sales came in at 2.5% for the month when 7% had been expected. Industrial output was less of a ‘miss’ at 5.3% against an expected 5.8%.
The official monthly manufacturing Purchasing Managers Index (PMI) had been hovering at just above 50 – that separates contraction from expansion – until the end of September when it dropped to 49.6, the first time below 50 since the first month of the lockdown and a long time before the previous sub 50 read!
Now that the Evergrande debt problem is out in the open, we can question how much of China’s slow-down was engineered and how much was due to reduced demand. It now appears that a slice of the slow-down was deliberate, meaning that it can more easily be turned around.
China is also having a problem with the risk of being marginalised by new alliances between other countries. We now have the ‘submarine’ alliance between Australia, the USA and the UK (AUSUK); the ‘Quad’ alliance of Japan, India, USA and Australia is working together on climate change and other matters.
In the past, China has used its economic size in trying to influence Australia through import bans over a number of goods. More restrictions might be expected. There is likely to be continued tension between China and Australia so it is important we have strong allies in ‘our corner’.
The US nonfarm payrolls reported 235,000 new jobs were created in the latest month but 720,000 had been expected. However, the unemployment rate fell to 5.2% and the wage growth was a creditable 4.3%. But, just as in Australia, these data points are heavily affected by those who had jobs and those who lost them. It is generally accepted that lower paid workers are suffering the most and so the wage growth increase is more due to them dropping out of the picture than wage increases being given to those remaining in employment.
Retail sales were unexpectedly up at 0.7% for the month when 0.8% had been expected. Indeed, if ‘auto sales’ were excluded, retail sales were up by 1.8% in just one month! Since we do not know what caused this aberration, we will be conservative in our interpretation.
CPI inflation marginally beat expectations at 5.3% for the year or 0.3% for the quarter. When volatile items are excluded, the monthly rate fell to 0.1%. The inflation blip hasn’t dissipated as quickly as most expected, but the Fed seems to be holding the line. However, if inflation does not come back to near 2% for the year, the Fed will have to be more aggressive in raising rates and slowing the economy sometime in 2022.
Of relatively minor importance, the ‘Debt ceiling’ negotiations are on again. Every so often, government borrowing comes up against some predetermined limit. If the ceiling is not raised, the government can’t spend. There is often a squabble between the two sides, Republicans and Democrats, and sometimes there is a temporary government shutdown. This time around seems no different. All will no doubt be resolved before any real damage is done. It appears the ‘can got kicked down the road’ for a few weeks at the end of September but a more lasting solution is necessary.
France was understandably upset with Australia after its cancelling the circa $90 bn submarine program in favour of the AUSUK deal that delivers the US designed nuclear powered alternative capability. Some are questioning our sovereignty in this alliance. Some are questioning our back-door entry into nuclear power. Of course, we might also get ‘pay back’ from France and the rest of the EU. France withdrew its ambassador to Australia on the news.
The UK has been experiencing massive shortages of petrol at the pumps. Some have tried to put this down to Brexit. There is a shortage of lorry (truck) drivers with the appropriate Heavy Goods licences. Some are suggesting that many such drivers came from poorer Eastern European countries and accepted lower wages to work in Britain. With Brexit and a fall in the UK Pound vs the Euro, that labour supply dried up.
There is sufficient fuel. It is just in the wrong place. It has been suggested that the army might help in the interim.
The 16-year term in office of German Chancellor Angela Merkel is coming to an end. It is yet to be seen what changes in policy might flow as a result, it will depend on which coalition of parties forms government.
It is reported that it might take a few months before Merkel actually steps aside and her successor and coalition cabinet is announced.
Rest of the World
Fumio Kishida has been voted in to replace Yoshihide Suga as prime minister of Japan. He is from the same political party.
Indonesia is reportedly unhappy with the new Australia deal to build a fleet of nuclear submarines with the US and the UK as it might lead to an arms race in the region.