Investment markets & key developments
Global share markets remained under pressure over the past week from concerns about rising US inflation and faster US interest rate hikes, with interest rate sensitive tech stocks leading the declines. Omicron related disruptions are not helping although markets don’t appear to be too concerned. While European shares rose slightly US, Japanese and Chinese shares fell. The weak global lead weighed on the Australian share market with declines in retailers, tech and property stocks more than offsetting gains in resources and utilities. Long term bond yields fell slightly after the previous week’s rise although they rose slightly in Australia. Oil, metal, gold and iron ore prices rose as did the $A as the $US fell. The relative strength of commodity prices, resources stocks and the $A are a positive sign from a cyclical perspective.
Unfortunately, this year has started off dominated by coronavirus yet again as new cases have ballooned driven by the more transmissible Omicron variant – although so far markets appear to be looking through it to some degree. This partly reflects that while Omicron is highly transmissible it is proving to be less harmful and governments are so far mostly avoiding hard lockdowns. However, the surge in cases is driving self-regulation and many having to isolate impacting both demand and supply making the situation akin to a lockdown in some countries (including parts of Australia), and this will hit first quarter economic activity both globally and in Australia, before another sharp rebound once the Omicron wave subsides. China is particularly at risk as its vaccines are reportedly less effective and its covid zero policy risks resulting in more lockdowns adding to global supply shortages.
US inflation rose to near a 40 year high in December of 7% and putting more pressure on the Fed. The Fed already took a hawkish turn late last year and this has been reinforced by recent comments from various Fed officials including Chair Powell. We expect inflation to ease a bit this year as production increases and spending rotates from goods back to services but the Omicron wave and associated further supply setbacks risks delaying this. And with a tight labour market and accelerating wages growth in the US there is a rising risk that high inflation will become entrenched. As a result, we now see the Fed raising rates in March, hiking 4 or 5 times this year and starting quantitative tightening in the second half. However, while this will contribute to a more volatile ride for US and hence global shares its unlikely to be enough to end the economic recovery and cyclical bull market as monetary policy will still be relatively easy and other major central banks including the RBA will lag the US, with China’s central bank actually easing monetary policy this year.
Over the last few weeks we have lost a few music greats from the 1960s – notably Mike Nesmith and Ronnie Spector. The Monkees were a made-up band for a TV show inspired by The Beatles’ A Hard Day’s Night and Help – but showed they had talent. Mike Nesmith was also a songwriter but one of his best songs, Different Drum, was recorded by Linda Ronstadt and the Stone Poneys. I got to the see The Monkees a few years ago but unfortunately Mike was not on the tour. Out of interest his mother invented Liquid Paper. Ronnie Spector of The Ronnettes was integral to some of Phil Spector’s best work. Like Brian Wilson I have listened to Be My Baby over and over and here she is with I Can Hear Music.
The Omicron variant, which has come to dominate globally, has seen global coronavirus cases surge, led in particular by Europe and the US. Australia has been no exception. The bad news – which was all known in mid-December before the global surge occurred – is that its far more transmissible than Delta and results in prior coronavirus infection and vaccines providing much less protection against infection.
The good news is that its far less harmful than Delta (maybe up to 20% less so), a booster shot from a mRNA vaccine (Pfizer or Moderna) appears to offer significant protection from infection and against severe disease and hospitalisation and new tweaked vaccines are on the way. That it is less harmful is evident in deaths and hospitalisations remaining far more subdued through this wave, even once lags are allowed for. This is evident in the chart above for deaths globally, but its also evident in Europe, the UK, the US, Canada and Israel. See the next charts for Europe and the UK – but they all show a similar pattern.
In Australia, the greater transmissibility of Delta combined with the further removal of restrictions from November not helped by the relatively low level of prior exposure and booster shots have seen cases explode relative to the levels seen through the Delta wave. (And given problems with testing, the case data is probably massively understated.) The good news is that, as has been the case globally, Omicron is proving less harmful and so hospitalisations and deaths remain subdued relative to the surge in cases compared to previous waves. See the next chart. Data from NSW Health – albeit only up to late December shows – that whereas 4% of Delta cases ended up in hospital around 1% of confirmed and probable Omicron cases do so. And while new deaths are at record levels they are running around 13% of the level suggested by the 2020 wave reflecting protection from vaccines and Omicron being less harmful. (Its similar in the UK.)
The problem of course is that the explosion in cases is still leading to a surge in hospital cases (even though a lower proportion are getting seriously ill) leading to significant stress in the health care system. This along with the sheer number of people having to isolate is impacting both demand and supply in the economy and hence a hit to economic activity without having a formal lockdown. All of which highlights the case to have at least tried to slow down the spread with mild restrictions back in December rather than continue removing restrictions which were having little economic impact and which we feared for NSW was like playing Russian Roulette with the economic recovery. At this stage we have revised down our March quarter GDP growth forecast to 0.6% from 1.6%, but this is a guesstimate and while we are confident of a strong post Omicron rebound in the economy resulting in growth of 4% or so through the year the risk is high that the March quarter sees GDP go backwards again given the extent of supply disruptions.
Beyond the near-term uncertainties there are two other positives. New Omicron cases may have peaked in South Africa, the UK (see chart above), Canada and New York – of course we have less natural immunity but it could be a pointer to a peak in Omicron cases in Australia sometime in the next month or so. Secondly there remains good reason to believe that this could be the worst of yet (yeah I know I may have said that before): if Omicron with its lower virulence but greater transmissibility comes to dominate the other variants then it along with increasing levels of natural immunity, protection from vaccines and new covid treatments could put Covid-19 on to a path to becoming endemic like the common cold or flu.
On the vaccine front 51% of the global population have had two vaccine doses, with only 10% having had a booster shot. The risk is in poor countries where only 20% have had two doses and just 2% have had a booster. It’s in the rich world’s interest to help vaccinate poor countries to reduce the risk of more mutations. Australia at 77% double vaccinated is at the high end of developed countries. Only 17% have had a booster shot but its now rising rapidly
Economic activity trackers
Our Australian Economic Activity Tracker fell further over the last week as the Omicron wave impacts with broad based declines since their high late last year in mobility, restaurant and hotel bookings and shopper traffic. So far its holding up relatively well compared to the Delta wave slump but its early days. Our European and US activity trackers also fell with tighter restrictions impacting in Europe and mainly self regulation and worker shortages impacting in the US. Both are now back below pre-covid levels.
Major global economic events and implications
US consumer price inflation again surprised on the upside in December, maintaining pressure on the Fed to start removing monetary stimulus. CPI inflation at 7%yoy is the highest since 1982 and core CPI inflation is the highest since 1991. While pandemic related distortions continue to play a huge role in boosting inflation the concern is that the rise in inflation has continued to broaden with the median inflation rate rising further to 3.8%yoy and the share of CPI components seeing a greater than 3%yoy increase running at around 75%. We continue to expect inflation to slow this year as goods inflation moderates as demand switches back to services and production picks up. Some slowing in business survey input and output price surveys and a slight slowing in annual producer price inflation in the US, China and Japan is a positive sign. However, Omicron disruptions to supply (due to workers not being able to work, lockdowns in China, etc) will likely now delay this and the longer high inflation persists the greater the risk will be of it becoming entrenched necessitating much tighter monetary policy from the Fed.
Stronger credit growth and lower inflation in China. Chinese money supply and credit growth picked up in December, helped by policy easing but only slightly. A further pick up is likely with further policy easing. Meanwhile, both consumer and producer price inflation slowed in December with core inflation running at just 1.2%yoy providing no constraint to further PBOC easing.
Australian economic events and implications
Australian economic data was mostly strong, but much of the past week’s releases were a bit dated given the Omicron wave impacting the economy since late December. Retail sales surged 7.3% in November continuing their reopening recovery from the Delta lockdowns, building approvals rose 3.6% with house approvals remaining high historically although well down from last year’s highs, housing finance commitments rose strongly and they remain near a record high, the trade surplus fell but remains high and job vacancies surged 18.5% over the 3 months to November to a record high. While this is all dated thanks to the Omicron wave disruption the strength in retail sales in November highlights the huge amount of pent-up demand and excess savings which will support spending once the Omicron wave subsides and the strong job vacancies data highlights the ongoing tight labour market with employers likely to be reluctant to let workers go through this wave just as they were through the Delta wave.
Meanwhile, the Melbourne Institute’s Inflation Gauge fell slightly in December to a 1.9%yoy increase in the Trimmed Mean but for the quarter it came in at 2.4%yoy and points to some further pickup in underlying inflation pressures in Australia. It’s worth noting though that the breadth of inflation pressures in Australia is far narrower than in the US with 75% of US CPI components rising more than 3%yoy in December but in Australia it’s only been 35%. Nevertheless, assuming the Omicron wave impact is relatively short we continue to see the RBA starting to raise interest rates from November. There is also the risk that supply chain disruptions flowing from the Omicron wave accelerate the rise in inflation in Australia much as they have been doing in other countries over the last year.
The continuing surge in housing finance commitments to investors in November indicates that the Australian property market is becoming more speculative and maintains pressure on APRA for further measures to slow housing lending.
What to watch over the next week?
In the US, expect January regional manufacturing conditions indexes for New York (Tuesday) and Philadelphia (Thursday) to remain strong but the focus is likely to be on whether price components show further signs of topping out. January home building conditions (Tuesday) are likely to remain strong, but housing starts (Wednesday) and existing home sales (Thursday) are likely to fall slightly after strong gains in November. US December quarter earnings results will start to be released with the consensus expecting earnings per share growth of 20%yoy, masking a decline in the quarter, although this is likely to be revised up as results are likely to surprise on the upside.
The Bank of Japan is expected to leave monetary policy on hold and ultra-easy (Tuesday) with December core inflation (Friday) likely to remain negative.
Chinese December quarter GDP (Monday) is expected to show a further slowing in annual growth to just 3.6%yoy (from 4.9%yoy in the September quarter) but this will likely mask an improvement in quarterly growth to 1.2%qoq (from 0.2%qoq in the September quarter). December activity data is likely to show growth remaining subdued with both industrial production and retail sales up just 3.8%yoy.
In Australia, the Westpac/MI consumer sentiment reading for January is likely to show a fall thanks to Omicron but based on the weekly ANZ/Roy Morgan index its likely to be modest. Employment data for December is likely to show a gain of around 40,000 jobs after the reopening surge in November with unemployment rising slightly to 4.7%. Of course, this will be rather dated given the explosion in Omicron cases in January which is likely to result in a renewed (but temporary) hit to employment.
Outlook for investment markets for 2022
Global shares are expected to return around 8% this year but expect to see the long-awaited rotation away from growth & tech heavy US shares to more cyclical markets in Europe, Japan & emerging countries. Inflation, the start of Fed rate hikes, the US mid-term elections & China/Russia/Iran tensions are likely to result in a more volatile ride than 2021. Mid-term election years normally see below average returns in US shares and since 1950, have seen an average top-to-bottom drawdown of 17%, usually followed by a stronger rebound.
Australian shares are likely to outperform (at last) helped by stronger economic growth than in other developed countries, leverage to the global cyclical recovery and as investors continue to search for yield in the face of near zero deposit rates but a grossed-up dividend yield of around 5%. Expect the ASX 200 to end 2022 around 7,800.
Still very low yields & a capital loss from a rise in yields are likely to again result in negative returns from bonds.
Unlisted commercial property may see some weakness in retail and office returns, but industrial is likely to be strong. Unlisted infrastructure is expected to see solid returns.
Australian home price gains are likely to slow with prices falling later in the year as poor affordability, rising fixed rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact.
Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.
Although the $A could fall further in response to coronavirus and Fed tightening, a rising trend is likely over the next 12 months helped by still strong commodity prices and a decline in the $US, probably taking it to around $US0.80.
Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist