Making sense of our ‘recovery’ markets

The performance of the ASX is not as closely linked to US markets as it once was. Picture: AAP

The US, China and Australia have begun modest and uneven recoveries from their deep economic slowdowns. That’s clear from tracking indicators in the three countries — and was confirmed in the US and Australia by retail sales in May increasing by about 17.5 per cent.

But the US and Australia will likely report big declines in GDP for the June quarter, though well below the 10 per cent falls predicted in February and March. For many people and businesses, economic conditions remain grim and uncertain.

Realisation that economies are doing better than was earlier feared has supported the recovery in share prices that began in late March; and, once again, sharemarkets turned bullish before any positive economic data were released.

In the three months to June 30, global and Australian share prices rose by 19 and 17 per cent respectively. Understandably, many investors worry markets are now overbought. They fear the economic recovery could be crushed by an acceleration in infections of COVID-19, or by the short-term fiscal boosts to jobs and spending running out of funding, or by the disruptions and inflation caused by massive budget deficits and negligible interest rates.

Let’s consider the negatives and positives in the outlook, and flag the indicators that investors might use in updating their investment decisions.

● COVID-19: A further surge in rates of infections or deaths, globally or in Australia, would dim expectations for economic recovery and might drive share prices lower. The other side of the coin is that, were a vaccine to be discovered and mass-produced, confidence would rebound strongly.

● US shares: Despite wide differences between the US and Australia in the shape and timing of their economic cycles and in the composition of their share price indexes (the US market is dominated by technology companies while ours has resources and finance), the local sharemarket mainly takes its direction from the US.

However, our share prices no longer seem to swing up and down by more than US shares do: our sharemarket isn’t the “high beta” market it once was.

That’s because, as Chris Richardson of Deloitte Access Economics points out, we’re managing things better. “Australia’s economy is held together by lots of sticky tape and that’s truly great news,” he wrote, “but a whole range of policies have swung into action to cushion our living standards.” Among them: the federal budget was about balanced and its net debt relatively low when the pandemic broke out; the virus was contained relatively quickly (his report was written before the recent spread of COVID-19 in Melbourne); government spending put “money into pockets faster than we did during the global financial crisis”; and the super-low interest rates mean there’s “little change in expected federal interest costs” from the fiscal stimulus. He also warns of the “big challenges, and there can be no ‘mission accomplished’ flags flown until unemployment is back where it was when the virus hit”.

● The September cliff: Australia’s green shoots of economic recovery owe a lot to programs, including JobKeeper and JobSeeker, which are funded only to late September. The government’s review of these jobs-supporting schemes will be released on July 23, along with an update of economic forecasts for the next two years. My guess is that, particularly with the new surge in infections in Victoria, JobKeeper will be continued through to June 2021 on a reduced scale, and targeted to industries most disrupted by the pandemic. And that JobSeeker payments will likely be reduced from the higher rates introduced temporarily in March but kept at levels above those at which unemployment benefits were paid pre-COVID-19.

● The budget deficit: The Australian government ran a budget deficit of about 5 per cent of GDP in the year to June. I can’t see how the deficit can be less that 7.5 per cent of GDP in 2020-21. But such large deficits needn’t be disruptive in the next year or two. There’s a lot of slack in the economy, interest rates are low, our government’s net debt is low relative to other countries, household saving is at a high level, and inflation isn’t likely to be an early concern.

● Interest rates: The Reserve Bank expects to hold its cash rate at 0.25 per cent (abundant liquidity means the rate is currently trading lower) until employment is much higher and inflation is back in the range of 2 to 3 per cent. The bank is also targeting a yield of 0.25 per cent on three-year government bonds, and is expected to maintain that form of “yield curve control” through to 2023.

The same rate of 0.25 per cent is charged when banks borrow from the Reserve Bank under the Term Financing Facility scheme. Until September, each bank can borrow from the central bank for up to for 3 per cent of its loan book and for three years. The scheme, which lowers the costs banks charge on loans to medium-sized and smaller businesses, is likely to be extended until mid-2021.

The loan deferral scheme announced by the banking regulator in March, through which banks have since paused repayments on 780,000 borrowings totalling $236bn to customers badly hurt by the pandemic, was also to expire in September; last week it was extended by four months.

● Sharemarket valuations: If average price-earnings ratios were all that mattered, the many investors saying Australian shares are trading at unrealistically high price-earnings ratios would be spot on. But prospective interest rates and the global liquidity created by central banks also affect share prices in a big way, and can’t be ignored by investors.

Don Stammer is an adviser to Stanford Brown Financial Advisers. The views expressed are his alone.

don.stammer@gmail