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Weekly Wrap – Trade tensions adding fuel to the fire

Week ending 15 May: There’s been a lot of talk about what’s happened in markets, but what does the data tell us? Senior Investment Manager George Lin offers a quick overview as he recaps the last week.

       Written by George Lin
Senior Investment Manager | Colonial First State
 

 

 

Geopolitical tensions with China remained in headlines last week – this time including Australia, after restrictions were placed on what represents about 35% of Australian beef exports to China, the country’s largest trading partner. This is reportedly linked to China’s criticism of the Australian Government’s call for an independent probe into the origins of the Coronavirus. More broadly, cautious commentary from high-profile investors on over-valued stock markets and more warnings against a rapid reopening of world economies (particularly the US) were also headwinds for markets. By week’s end, the ASX was up 0.25%, while the Australian Dollar (AUD) eased to trade at 64.15 US cents.

Last week, share markets continued to fluctuate – albeit on a much smaller scale than previous weeks. While economic data was poor during this time, investors seemed hopeful about the falling number of new daily Coronavirus cases – including in Australia. By Thursday, the ASX 200 gained more than 6% for the week, while the Australian Dollar (AUD) traded at a high of 62.3 US cents.

Daily market play-by-play

MARKET ANALYSIS

There’s been a lot of talk about what’s happened in markets – but what does the data tell us? Below, we take a quick look at some of the key measurements.

How bad is economic data really?

The Citi Economic Surprise Index (see Figure 1 below) measures whether newly released economic data is better or worse than market expectations. Generally, a reading below zero indicates that the data is worse than anticipated. Since March, the reading has deteriorated significantly for main developed economies as a result of the slump in economic activity that occurred when lockdown restrictions were imposed. The sharp decline we have seen also suggests that market expectations have not yet caught up with the reality of deteriorating economic data.

What areas of economic activity have been impacted?

The global Purchasing Managers’ Index (PMI – see Figure 2 below) is a leading survey-based measure of various global economic activities. A reading below 50 generally suggests that an economy is contracting, while a reading above 50 suggests an economy is expanding. Since March, the global PMI has deteriorated sharply to an unprecedented level. In particular, the Service PMI has contracted more severely than the Manufacturing PMI – reflecting the negative impact of the social-distancing measures on the services sectors (namely, areas such as retail).

FIGURE 1

Source: Factset

Figure 2

Source: Factset

Health check – how are countries faring?

March quarter Gross Domestic Product (GDP) figures provide some forward guidance for June quarter GDP, when the full impact of lockdowns will be reflected in economic data for a number of developed economies. China shut down its economy from late January to March and saw a quarterly GDP decline of 9.8%. The US, which entered a shutdown in mid-March, recorded a 4.8% decline. Australia is yet to report March quarter GDP, but expectations are a comparatively modest 0.6% decline. However, June quarter GDP growth figures are expected to be significantly worse, followed by a recovery in the second half of 2020. On a global level, the International Monetary Fund expects the world economy to shrink by 3.0% in 2020 – a lower figure than during the Global Financial Crisis.

FIGURE 3

Source: Factset

How have central banks responded to developments?

Central have banks reacted to the Coronavirus by reducing policy rates close to zero and either increasing their quantitative easing program (in the case of the US and Europe) or implemented quantitative easing programs for the first time (in the case of Australia, Canada and New Zealand). Ten-year bond yields are close to historical lows (see Figure 4) and central banks seem determined to keep yields low until a sustainable economic recovery. This is crucial for financial markets, as low yields support valuations in a number of asset classes.

FIGURE 4

Source: Factset

What has the impact been on share markets?

So far, it seems share markets have recovered strongly from the savage sell-off in March (see Figure 5). The S&P 500 (which tracks the performance of the top 500 stocks on the US share market) has performed particularly well among the developed markets – reflecting both the US Federal Reserve’s aggressive monetary policy measures and the resilience of large technology stocks. But since mid-April, share markets have traded in a narrow range as investors try to digest and weigh up poor economic data against the reopening of economies.

 

As share prices recovered, markets have become more expensive from an historical perspective. For example, the S&P 500 has a current tailing 12-month price/earnings ratio (P/E) of 19.15 compared to a median of 16.72 since mid-2006. The All Ordinaries has a trailing P/E of 14.58, which is marginally lower than the median of 15.69 (see Figure 6). This robust valuation is supported by a low-interest rate environment (which makes shares more attractive) as well as expectations that the economy (and, in turn, corporate profits) will recover rapidly in second half of 2020.

FIGURE 5

Source: Factset

FIGURE 6

Source: Factset

So what does this all mean for the future?

What this data offers is a visual – an early look at how the Coronavirus has impacted economic activity and, in turn, financial markets. So far, the drops we see in data suggest the pandemic has had widespread effects on various parts of the world. But markets continue learning about the Coronavirus and its impacts on economies and investments every day. And as more data is released over time, we can gain more insight as to the impacts markets may have experienced as a direct or indirect result of the Coronavirus, as well as the potential path ahead.

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