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Monthly Wrap: October 2020

Senior Investment Manager George Lin shares the latest on global financial markets and economic developments in the month of October.

       Written by George Lin
Senior Investment Manager | Colonial First State
 

 

 

Financial markets had a turbulent October, as optimism on a global economic recovery was challenged by Europe’s second wave of Coronavirus and as investors became cautious in the lead up to the US presidential election. Despite a strong start to the month, some share markets posted declines at the end of October. However, the Australian market delivered a positive return – with the ASX 300 up 1.9%. By month’s end, the Australian Dollar (AUD) traded at 70.25 US cents.

Key developments in Australia

After underperforming many major world share markets since the recovery began in April, Australia’s ASX 300 rose 1.9% and was among the best-performing developed share markets in October. This was due partly to improving investor sentiment on Australia’s improving Coronavirus situation, which has allowed the market to catch up with its global peers.


However, the Australian economic data released in October disappointed – reflecting, in part, the negative impacts of the Melbourne lockdowns. Employment declined in September, with a 25,000 fall in full-time jobs after increases in the prior three months. As expected, the Victorian job market was particularly poor, with a 35,500 fall in employment for the month. After a strong recovery, retail trade fell by 4% in August. Business conditions also remained well below the long-term average despite some earlier improvements. According to the National Australia Bank (NAB) Business Survey, business confidence remained weak in September despite previously improving.

Source: Factset
Figure 1

On the Australian policy front, there were two announcements in October. The first was the 2020 Federal Budget, which contains a number of measures to support the economy over the next 12 months and help avoid a “fiscal cliff” during the pandemic. The main measures include bringing forward stage-two tax cuts (which will be backdated to July 2020 if passed by Parliament), as well as the temporary full expensing of depreciable assets for business with revenue below $5 billion. While there are some concerns that the budget forecasts a $213.7 billion fiscal deficit (or 11% of Gross Domestic Product (GDP)) for 2020-21, the volume of debt issuance could be digested by debt markets. Long-term fiscal sustainability is simply not high on financial markets’ list of priorities during the pandemic.

 

The other significant but less publicised policy announcement is the low-key revamping of the Reserve Bank of Australia’s (RBA) monetary policy framework. After coming under fire for not following up on initial easing measures at the height of volatility this year, the RBA is changing its monetary policy framework from targeting forecast inflation to targeting actual inflation. The motivations for changing the framework were not openly articulated. However, the change may be linked to actual inflation being persistently lower than forecasts, and could be reflective of a greater willingness to tolerate higher inflation in order to generate stronger economic growth and a higher level of employment. The October meeting minutes further indicated that the RBA still retains a firm easing bias and that it is considering an expansion in its quantitative easing program. As expected, the central bank announced a series of changes at its November meeting – among them, a 15 basis point cash rate cut to an all-time low of 0.10% and an expansion in its asset purchase program to include the purchase of $100 billion worth of government bonds with longer-dated maturities.

Source: Factset
Figure 2

Further, a noticeable market development is the persistent fall in the three-year bond yield, which the RBA has been targeting at 0.25% since September. Over the past two or so weeks, the three-year bond yield has been range-bounded between 13 and 17 basis points.

Key developments globally

Major share markets had a lacklustre October. In the US, the S&P 500 Index fell by 3.3%, while the technology-dominated NASDAQ underperformed the S&P 500 and fell by 3.7%. Elsewhere, European share markets were among the worst performers – with the collective Euro STOXX falling by 3.7%.


Market volatility was driven by an uptick in new Coronavirus cases, fears of more government-imposed lockdowns, as well as political developments in the US – particularly in the lead up to the election announcement. After intense negotiations in October, the major political parties in the US also failed to agree on new financial stimulus. Now, it’s possible that more stimulus may not be passed until January, when a new congress commences its term.

Source: Factset
Figure 3

Indeed, Europe experienced a sharp escalation in the number of new Coronavirus cases in October, resulting in several governments imposing fresh lockdowns and social-distancing measures. France, Germany and England imposed month-long nationwide restrictions targeting non-essential services. This began to negatively impact social mobility and sectors such as retail, restaurants and tourism. But it must be noted that these measures are comparatively milder and more localised in nature, and may have a lesser economic impact compared to the global lockdowns imposed in March. While Euro Area GDP may contract over the December quarter, it will likely not be a repeat of the double-digit decline seen in the March quarter.

Despite the rising number of new cases, global economic data continued its uneven but upward trend. For example, the Global Purchasing Managers’ Index (PMI), a leading indicator of global economic activity, stayed above 50 in both the manufacturing and services sectors for the third consecutive month – suggesting the economic recovery is intact and consolidating at the global level. The recovery is confirmed by stronger-than-expected growth in September quarter US GDP, which rose 7.4% over the last quarter but is still 2.9% lower than one year ago. Interestingly, global data masked considerable divergence at both the country and sector level. For example, in the services sector, both the US and China have staged solid recoveries, while the European recovery has been weaker and less consistent (see below). Given the full impacts of lockdowns in Europe are not yet reflected in data, we anticipate to see further weakness in the European services sector in future.

Source: Factset
Figure 4

Looking ahead

An important driver of financial markets will be investor reactions to the US presidential election, recently announced in favour of Joe Biden. But while the media largely focused on the presidential election, congressional elections – especially the control of the Senate – are also important. That’s because the control of the Senate is critical to the ability of any administration to implement policy.


In the meantime, while an uptick in new Coronavirus cases may be worrisome, the most likely outcomes of the second wave in Europe include regional economic weakness, some risk aversion among investors, as well as “technical” market corrections similar to the 8% decline the S&P 500 experienced in early September – not the total collapse markets experienced in March. Although financial markets are wary, we remain cautiously optimistic as to the outlook for world financial markets. Our base case scenario is that the global economic recovery will continue at an uneven pace with occasional episodes of weakness – supported by world governments and central banks.


Colonial First State remains in close communication with our skilled investment managers and is constantly monitoring market and economic developments. So no matter the state of markets, you can feel confident knowing our team is actively reviewing conditions and keeping you informed – each step of the way. Learn more about investments and get the latest updates on our website.

 

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