Economic Update June 2020 – “An Economic Winter is Unfolding”

The good news continues to be our outstanding performance in containing the virus, the ongoing removal of restrictions and a clear pathway back to normality at least in the things that matter most.  While the size of gatherings allowed in private and public spaces varies from State to State we can now see family and friends and travel intrastate.  The long weekend in most States last weekend saw an uplift in spirits and enthusiasm as so many took to the road to celebrate the end of lockdown and support domestic tourism and regional Australia.

But this initial burst of enthusiasm and rise in consumer confidence must be tempered by the reality of the raft of official economic statistics and surveys released this month. We might be emerging from hibernation, but an economic winter is unfolding. Our national accounts for the March quarter released on June 3^rd confirmed what we already know.  Our outstanding record of 29 years without a recession is now over.  The March quarter was only slightly negative with economic growth declining by 0.3% but this data includes only the very early impacts of the lockdown. The June quarter is expected to see economic growth decline by a further 8% quarter on quarter with annualised growth down by 4-4.5% for calendar 2020.

Retail sales data released for the month of April on June 4^th fell by a record 17.7% as consumers reduced spending and many physical stores closed. Café, restaurant, and takeaway food sales fell aby 35.4%, clothing, footwear and personal retailing sales fell by 53.6% and department store sales fell by 14.9%. Food Retailing dominated by supermarkets and grocery stores fell by 17.4% following the panic buying and strong growth in March. The best performer was Household goods retailing down by a negligible 0.1%, with hardware, electronic goods, and garden suppliers the best performing subsets.  Online retailing and retailers were the big winners with sales up by 26.4% in April following a 23.5% rise in March.  Online sales increased from 13% of all non-food retailing in March to 25.5% of sales in April.

The Australian Bureau of Statistics is also conducting additional surveys to measure the impact of COVID-19 on businesses and households. A visual summary of the business impacts of COVID-19 from the survey conducted between the 13^th May and the 22^nd of May is provided below. Over 70% of businesses are experiencing revenue declines directly related to COVID-19. Many small businesses in the hardest hit sectors such as tourism and hospitality will not recover.  

Against this terrible economic backdrop major share markets across the globe, including our own, have rallied strongly since the lows in late March surprising even the most optimistic forecasters and respected market commentators.  The domestic and global economy may be in recession with the worst yet to come for company earnings in the June quarter, but markets are having none of it. Our market has rebounded by 40% from the March 23rd low to over 6,000 points (as at June 10^th) and is currently within 15% of its record high in February.  In the USA the technology focussed Nasdaq index surpassed its record high in February this week and the US S&P 500 is back to within 5% of its record high.

Credit markets have also recovered strongly after the late March stumble which saw credit spreads widen sharply as pandemic uncertainty escalated.  Central banks including our own Reserve Bank again came to the rescue supporting markets and maintaining liquidity.  Credit spreads have narrowed over the last month with most high-quality corporate debt back to trading at face value or higher, including the bank hybrids.

While it would appear markets are again getting ahead of themselves, macro factors supporting equities relative to other assets classes have strengthened in the wake of the pandemic. Additional monetary stimulus and escalating government debt have all but guaranteed very low, and lower for longer, interest rates and therefore lower returns from bonds and interest-bearing securities. Commercial property (particularly retail and office) is also taking a beating domestically and internationally in relative terms with both rents and capital values falling. House prices domestically and rental yields are also expected to fall by 7- 10% in 2020. We continue to maintain our overweight equities position.

The strength of the recovery in equity markets suggests any retesting of the March lows now seem unlikely.  That said quarterly earnings reports out of the USA for the June quarter in July/August and our reporting season is likely to see some pullback to the current V shaped market recovery. US data for the June quarter will be the first detailed read on the COVID-19 earnings impact and a 35-40% fall in earnings is forecast. Geopolitical tensions, rising economic instability in emerging markets and race riots in America are other factors suggesting equity markets may not currently be correctly pricing risk.  

Australia continues to perform well relative to our peers on both the health and economic front.  Reasons include the government stimulus and support measures and the continued strong performance of our export sector.  Minerals and energy exports have again been the standout delivering another strong trade surplus in March. Within minerals, iron ore remains the standout with further disruption to supplies out of Brazil due to the virus sending iron or prices back over $100 a tonne. Productivity also improved in the latest quarterly economic data.

The silver lining in any recession is usually a sharp increase in productivity. Productivity growth has been elusive in recent years despite the ‘working smarter’ mantra of the digital age. But turning the lights out has forced every business to think outside the box and come up with different ways of working and operating that would not have been considered only a few months ago.  In the short term this could exacerbate unemployment as most businesses adopt new systems and technologies, become more productive and do more with less.  For many this will be necessary just to survive. The shutdown has also accelerated major structural and productivity enhancing changes across the economy.  The accelerated demise of many traditional industries and business models such as bricks and mortar retailing and the rise of the more efficient, less labour and capital intensive 24-7 online model is the most obvious example. The same can be said for banking and the delivery of many other services. Permanent changes in the ‘where, when and how’ we work in many industries has put the spotlight firmly on labour market reform and archaic practices such as penalty rates that are no longer fit for purpose in the digital age.  Labour market reforms to improve flexibility and reduce costs will be critical if we are to avoid a period of prolonged high unemployment and underemployment. We continue to reposition the portfolio to ensure we are on the right side of these major structural trends reshaping the economy.

Perhaps it is a pandemic driven productivity burst that markets are pricing in. Markets are forward looking. But today the disconnect between the economy and share markets looks a little too wide for comfort.

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Sources:  Commbank Global Markets Research, RBA, Morningstar.