Weekly market update - 27th of July 2020
Written and accurate as at: Jul 27, 2020 Current Stats & Facts
Key takeaways
- Equity and bond markets were flat for the week.
- A weaker shift in the US dollar (EURUSD +2%) was the catalyst for a shift higher in gold (+5%) and prompted signs of rotation from growth to value.
- In the US there are early indications that case-load growth and hospitalisations are peaking in the worst-affected states.
- Domestically we saw extensions of the JobKeeper and JobSeeker packages; while the RBA has clearly signalled its intention to continue providing policy support
Australian outlook
So far the Victorian government has refrained from imposing Level 4 restrictions, but the growth in cases remains disappointing. There are signs restrictions in Melbourne are slowing economic activity, while voluntary behaviour is having the same effect in Sydney.
This in part prompted clear policy signals last week. The federal government extended its packages, however, comments from RBA Governor Phil Lowe were of most interest. Lowe emphasised the view that social costs and degradation from the recession and persistent unemployment were too high to allow the normal clearing mechanism of labour and capital markets. Instead, policymakers must do everything in their power to mitigate the effects of this crisis.
This shift in thinking away from a free-market approach may be driven by considerations around the social effects of income inequality. It could also be driven by a view that labour markets are too rigid to react in a timely fashion to a shock of this nature. Regardless, it suggests policymakers will continue to shore up growth, with Governor Lowe suggesting there are several more tools available if needed.
Global outlook
New daily US cases have levelled off over the past week and hospital occupancy rates remain stable in hotspot states such as Florida, Texas and Arizona. If the market starts to believe the health situation is moderating, it should be positive for sentiment.
Nevertheless, US economic data was softer. Jobless claims rose week-on-week for the first time since March. Real-time indicators such as restaurant bookings suggest momentum has stalled after an initial surge. However, the environment is uneven. Demand continues to grow in sectors such as housing.
The next tranche of policy support appears to have been delayed while the Republicans seek agreement on a package. We are now likely to see a gap of a week or two between the end of payments under the previous package and the start of the new.
Elsewhere, the speed and scale of a €750 billion package announced by the EU came as a pleasant surprise given the debate between the “Frugal Four” northern states and southern countries likely to be the main support beneficiaries.
Markets
The weaker US dollar was driven by a combination of factors:
- Worse COVID caseload in the US vs Europe, and its expected impact on economic recovery
- Positive policy surprise in Europe versus delays in the US
- Growing uncertainty about the upcoming US election
- The impression that ineffective fiscal policy in the US puts more pressure on the Fed to ease in various forms.
Weakness in the USD adds to the bull case for gold. It is increasingly evident that virus spread is hampering economic re-opening in the US and is becoming a limiting force on growth. Unlike places such as China, which have effectively eradicated the virus, it is making it harder to return to pre-COVID levels of economic capacity. However, policy-makers are baulking at allowing this to trigger a significant recession and are falling back to stimuli such as more debt and more money supply growth.
This has several important effects, including question marks over longer-term strength of the dollar. This is seeing strength in the value of real assets. In some ways, this is positive because it suggests expectations around policy-supported growth remain reasonable. A reversal in US dollar weakness would suggest a flight to safety on the increased concern.
Inflation expectations have been rising in recent weeks, but have only recovered to pre-crisis levels. Further increases in inflation expectations would require people to start factoring in tighter labour markets, which appears unlikely at this point. That said, inflation is showing up in areas such as real assets.
Value had a small bounce versus growth in equity markets last week. There is a case for further value outperformance if we see US cases plateau, more fiscal stimulus — and if US tech earnings don’t bring any further upside to already high expectations.
Stocks
There was little news as we head into reporting season. There was some movement in the insurance sector last week, with updates from IAG (IAG, -6.0%) and QBE (QBE, +11.0%).
IAG’s was disappointing. While it has benefited even more than expected from a drop in motor insurance claims during the COVID period, this has been more than offset by greater provisioning against a weaker economic backdrop and higher-than-expected costs.
QBE provided more detail around the scale of Covid-19 claims for a business interruption which, while large, were well short of the top of the range that management first indicated in April. A key difference between the two insurers is that QBE has been able to push through stronger pricing than IAG, despite the global insurance market is more fragmented than the domestic insurance sector. This divergence is probably at least partly driven by political considerations in Australia.
Evolution Mining (EVN, -4.3%) was one of the ASX 100’s weakest — alongside IAG — despite the rise in the gold price. The market reacted cautiously to EVN’s plans for further expansion at the Cowal mine. We expect confidence to grow as the economics of the development become more apparent.
The market was more positive on Downer’s (DOW, +4.0%) capital raising. While shoring up the balance sheet, it should also be earnings accretive as it bought out the minority stakes in its Spotless acquisition and will also fund a restructure.