Local shares end a five- month winning streak

Australian shares have broken a five-month winning streak with a 2.3 per cent drop, delivering the second worst quarter in nearly two years.

Australian shares have broken a five-month winning streak with a 2.3 per cent drop, delivering the second worst quarter in nearly two years.

With US President Donald Trump’s re-election chances fading further after a feisty showing by Democratic Party leader Joe Biden in the first of three presidential debates, the local bourse suffered its biggest one-day fall in almost four weeks amid expectations of another sell-off on Wall Street.

The benchmark S&P/ASX 200 share index fell 136 points or 2.3 per cent to a five-day low close of 5815.9 as Wall Street’s S&P 500 index futures fell more than 1 per cent amid a spike in betting odds which gave Mr Biden his biggest lead over Mr Trump since mid-August.

It’s been a wild ride for investors so far this year. The Australian benchmark plunged 39 per cent from a record high of 7197.2 in February to a 7.5-year low of 4402.5 in March as the coronavirus pandemic and associated restrictions on movement sparked fear of economic collapse.

Then the S&P/ASX 200 had bounced 41 per cent by late August as unprecedented monetary and fiscal policy stimulus globally sparked the fastest-ever bull market in shares.

But with the technology sector of the US share market becoming overheated by a phenomenal increase in single stock bets by retail investors as well as Japan’s Softbank, and the increasing prospect of a contested US election outcome and eventual Democratic Party victory leading to tax hikes, a correction on Wall Street last month pushed the local bourse down 7 per cent from its peak.

Despite a burst of optimism last week over improving coronavirus trends and the prospect of faster than expected reopening in Australia, as well as predictions of fresh macroeconomic stimulus in Australia, the local bourse was unable to sustain much of a recovery before month end.

A 4 per cent fall in the S&P/ASX 200 last month marked its first down month since a 21 per cent collapse at the height of the coronavirus pandemic in March, a sell-off which preceded a remarkable five straight months of gains during which the index rose 18 per cent.

Wednesday’s drop left the index with a 1.4 per cent loss for the September quarter.

It came after an impressive 16 per cent June quarter rise and a 24 per cent March quarter drop. Even so, after the March meltdown the fall represented the second-worst quarter since December 2018 when the quarterly drop of 9 per cent. Investors will start the month with an overwhelming focus on US politics and the economic implications of the global resurgence of coronavirus, particularly in the US and Europe.

However, with coronavirus once again coming under control in Australia, the nation’s good prospects for economic reopening are in stark contrast to the uncertainty in the US and Europe.

Also, while Australia’s relationship with China appeared to reach a low point last month, Australia’s biggest exports have been unaffected and the Chinese economy is bouncing back, as evidenced by a strong reading for the nation’s official purchasing managers’ indexes for September.

There are also strong expectations of significant fiscal policy stimulus in next week’s federal budget, and the chance of fresh monetary policy stimulus from the Reserve Bank – which could include a more significant bond buying program – either at next week’s meeting or in the coming months.

While Australia faces a so-called “fiscal cliff” this quarter – as do other nations where fiscal support programs are being tapered and loan holidays by banks will be extended only on a case-by-case basis – the nation’s AAA credit rating gives significant capacity to extend economic support in the budget.

“The government looks set to continue using its policy space in next week’s Budget, expanding the deficit to a record $230bn,” said Morgan Stanley Australia economist, Chris Read.

Tax cuts, infrastructure and regulation will be the focus and while the RBA is unlikely to move again just yet, it will be preparing to ease again through 2021 easing, according to Mr Read.

He argues that with such an important economic transition ahead, policy support will be a “sustained and important feature of the economic recovery”.

Indeed the next week marks an important point in the evolution of policy support for Australia.

To date the federal government has utilised its ample policy space to provide significant support and with Victoria’s lockdown easing and COVID-19 cases in other states low, he expects the focus to shift from crisis support measures to policy that supports a private sector recovery.

Treasurer Josh Frydenberg’s recent comment that a return to surplus won’t be planned until the unemployment rate is well below 6 per cent suggests a premature shift in focus to debt reduction is unlikely, and given the uncertain outlook, Mr Read thinks the government’s near-term spending profile will be critical.

He sees new spending measures in 2020-21 of $30bn, which would see the deficit increase to $230bn or 12 per cent of GDP. Tapering of crisis support measures – particularly JobKeeper – will continue as planned, with new measures more focused on stimulating private demand.

Mr Read expects a bring-forward of Stage 2 income tax cuts and an investment incentive, an acceleration of infrastructure spending and education support.

But while the RBA has repeatedly flagged potential further easing over the past month, leading to markets pricing in some chance of a move next week, Mr Read thinks it’s unlikely now given the importance of fiscal policy and the need for the RBA to assess the Budget, with recent commentary suggesting that supply-side restrictions would also be a barrier for further easing.

“An eventual move looks more likely though, and we update our forecast to expected easing in February, cutting target rates from 0.25 to 0.1 per cent, and adding a modest quantitative target for bond purchases,” he said.

“As we have explored previously, the majority of this impact on the economy is likely to be through the exchange rate.”

Still, UBS Australia chief economist George Tharenou said a co-ordinated “Team Australia” approach to macroeconomic policy – like that earlier this year – is needed and increasingly likely.

“The RBA is likely to ease, complementing $50bn fiscal stimulus and material regulator support,” he said. The RBA now expected to cut rates to 0.1 per cent in October and ‘proper QE’ is still plausible.”