Economic update and market commentary

Australia:

The Reserve Bank of Australia cut the official cash rate to a new historic low of 0.1%.

The Treasurer released Australia’s latest Federal Budget. This was essentially a ‘no-surprises’ package of measures designed for Covid-19 challenged times.

Given the scope of the challenge, the budget deficit for 2020/21 was unsurprisingly large, at $213.7 billion, or 11.0% of GDP.

Even more importantly, deficits were forecast all the way out to 2030-31, resulting in gross debt rising from $872 billion in 2020-21, or 44.8% of GDP, to above $1 trillion, or 55% of GDP.

The virus has blown away Australia’s previously favourable budget position, where surpluses had been forecast for the next few years.

Medium-term projections were based on the potentially optimistic assumption that economic activity levels return to their pre-virus levels by the second half of 2021.

S&P kept Australia’s AAA rating on a negative outlook (implying a one-in-three chance of a downgrade in the next two years).

The retention of this rating is mostly contingent on fiscal deficits narrowing from FY22 onwards, even with the announced tax reforms and new expenditure measures.

US:

The US was in the midst of election fever. There was drama in mid-month when President Trump was diagnosed with Covid-19, though he was back on the campaign trail later in the month.

Uncertainty over the result of the election, as well as potential policy changes under a Biden administration saw investors rein in their risk appetite over the month.

Control of the Senate is perceived to be almost as important as the presidency itself, given the requirement to have new laws passed.

The latest opinion polls suggest Biden could win both in a ‘clean sweep’, providing a mandate to make meaningful changes to US policy and government spending.

Virus cases ballooned, though the political focus somewhat overshadowed the sharp increase. Late in the month, new daily Covid cases exceeded 100,000; well above previous peaks from earlier in the year. This is a concern for the timing and extent of the anticipated recovery in the world’s largest economy.

The latest employment data indicated the economic rebound might already be losing momentum. 661,000 jobs were created in September, but this total was well below consensus forecasts.

New Zealand:

There were further indications that some ‘normality’ was returning in New Zealand – the latest data showed the country saw the busiest month of house sales for more than three years in September.

Credit card spending increased modestly in September too from the previous month, though remains around -10% below levels from a year ago.

Europe:

Unfortunately, rapidly rising numbers of new Covid cases saw national lockdowns reintroduced in key countries. France and the UK announced four-week lockdowns, while Germany has entered a two-week lockdown.

These moves will weigh on economic activity levels in the December quarter, potentially derailing the recovery that was underway. The new restrictions are particularly bad news for the retail and hospitality sectors, which were due to start gearing up for the critical pre-Christmas trading period.

GDP data for the September quarter were released in several countries, though these backward looking indicators were largely overlooked given the renewed focus on lockdown measures and potential implications going forward.

Asia/Emerging Markets:

Despite virus-related disruptions, the Chinese economy grew 4.9% in the year ending 30 September.

Chinese officials unveiled their latest ‘Five Year Plan’ for the country. The economic blueprint suggests there will be a focus on the development of semiconductors and other technologies.

In other news, the Chinese Government allegedly told power stations to stop buying Australian coal; part of a broader diplomatic stoush. This would be an even greater concern for Australian exports if the ban extended to metallurgical coal used in Chinese steel mills.

Nonetheless, geopolitical flashpoints like these are worthy of attention, as they can have important implications for individual companies.

Elsewhere in Asia, South Korean GDP growth in the September quarter exceeded expectations, reflecting higher-than-expected exports.

This was encouraging for other export-oriented economies in the region.

Australian dollar

‘Risk-off’ sentiment saw the AUD decline by around 2% against the US dollar and a trade-weighted basket of other currencies.

Australian equities

Australian equities reacted positively to the Federal budget and growing hopes for a new US stimulus package in the early stages of the month.

The S&P/ASX 100 Accumulation index had risen more than 7% by mid-October.

However, risk-off sentiment later saw these gains partially reverse given rising coronavirus cases in the US and Europe and uncertainty surrounding the US election.

As a result, the S&P/ASX 100 Accumulation Index closed the month 2.1% higher.

The Materials sector declined -1.2% given weakness in broader commodities. The S&P/ASX Small Ordinaries Accumulation Index (+0.5%) underperformed larger caps stocks in October.

Listed property

Property securities markets were weaker in October, with the FTSE EPRA/NAREIT Developed Index falling -1.3% in Australian dollar terms, trailing the returns of the broader share market.

All major global markets fell during the month. Other than Australia, the best performers were the UK (-0.9%) and Canada (-2.4%). Laggards included Sweden (-9.2%), France (-9.1%) and Singapore (-7.6%).

The ‘risk-off’ mood was driven by the rapidly rising caseload of Covid-19 infections across Europe and North America, which has seen restrictions introduced on businesses and citizens in some countries in order to control the spread of the virus.

These measures are particularly damaging for assets tied to non-essential communal interaction or travel, including shopping malls, hospitality assets and hotels.

Locally, A-REITs outperformed global peers as Australia’s Covid-19 situation bucked the trend.

Victoria’s strict lockdowns were eased during the month, enabling the State’s hospitality and retail sectors to re-open.

Global equities

Most major developed equity markets finished the month of October lower. European markets led the way downward and suffered their worst week since the crash in March, reflecting a resurgence in Covid-19 infections.

This prompted new lockdown measures, which have increased concern about the region’s recovery.

In local currency terms the German DAX fell the sharpest, by 9.4%, while the Euro Stoxx Index contracted by 7.4%. Emerging markets outperformed.

The MSCI Emerging Markets Index rose by 2.0%, while the MSCI World Index lowered by -3.1%; both in local currency terms.

In the UK, the FTSE 100 Index tumbled by -4.9%, influenced by the announcement of new lockdown measures. In the US, the S&P 500 Index shrunk by -2.7%.

The last week of the month saw a spike in volatility as large technology stocks saw falls after reporting lacklustre quarterly results.

Asia had mixed returns, with China’s CSI 300 and the Hong Kong Hang Seng Index rising by 2.4% and 2.8% respectively, in local currency. The Japanese Nikkei, however, dropped 0.9%.

Global and Australian Fixed Income

Australian bonds were little changed overall in October, though there were varying returns from bonds with different maturities. There were some interesting moves in major overseas government bond markets too.

The US curve also steepened, with yields on longer-dated securities rising quite sharply.

In Germany, Bund yields came under downward pressure as new lockdown restrictions suggested the anticipated recovery in Europe’s largest economy could be delayed.

The UK and Japanese government bond markets were more stable, with 10-year gilt and JGB yields both edging 3 bps higher.

Global credit

Credit markets are being pulled in different directions. On one hand, weaker economic activity levels are expected to weigh on corporate profitability and default rates are highly likely to rise.

On the other hand, central bank buying as part of enormous asset purchase programs are providing important support. Ultimately, investors appear confident that central banks will increase the scale of their buying if spreads widen substantially.

Source: Colonial First State