Written by George Lin/Senior Investment Manager CFS
In July, markets focused on the latest Coronavirus variant, economic data, and the volatility that Chinese government intervention caused share markets.
Last month, the delta variant of Coronavirus caused an increase in new cases in a number of countries, especially those with low vaccination rates – for instance, Australia, where some cities experienced lockdowns. For a third consecutive month, US consumer price inflation was higher than anticipated, while at the same time, bond yields defied expectations and plunged again. And across the world, Chinese share markets experienced a massive sell-off – with billions of dollars wiped from the market as concerns about the nature of government regulation escalated. By month’s end, the ASX 300 was up 1.1%, while the Australian Dollar (AUD) ended July at 0.7351 US cents.
KEY ECONOMIC DEVELOPMENTS
In July, the pandemic reared its head once again with a surge of delta variant cases. Countries with low vaccination rates struggled to contain delta. From an economic perspective, Australia is one of the countries most impacted. The situation in developed economies with high vaccination rates was mixed. While some of these countries (such as the UK) have experienced sharp rises in the number of new cases, they’ve been primarily relying on vaccination as the main tool to control the pandemic and seem reluctant to adopt new restrictions except as a last resort.
The global economy continued its uneven recovery. Global manufacturing sectors have expanded at a healthy pace despite some weakness in Chinese data, which has become a concern for markets. This is partly due to China’s status as the first nation thought to have controlled the pandemic which, in turn, provides the rest of the world with somewhat of a roadmap to a post-pandemic environment. In addition, growth in retail sales peaked in March but has since slowed significantly. Part of this weakness in data could very well be part of the process of economic normalisation.
In the US, the Consumer Price Index (or CPI, which measures the price changes of goods and services) was higher for the third consecutive month. For example, headline CPI rose 0.9% month-on-month in June while the yearly price rise increased to 5.4%, which was the highest since 2008. The sharpest price increases occurred in the sectors with supply chain issues such as new and used cars, as well as in industries benefiting from the economic re-opening such as airlines, hotels and car rentals. Arguably, these price rises should be a temporary part of the transition to economic normalcy and should fade over time. However, there are other components to the CPI (for example, wage inflation) which have also risen and may become structural or more permanent.
While the US central bank – the Federal Reserve (the Fed) – did not announce any changes to monetary policy at its July meeting, it signalled that the US economic recovery is gathering momentum and is making progress towards the Fed’s goals. Currently, financial markets expect an announcement regarding a change to monetary policy before the end of 2021.
KEY MARKET DEVELOPMENTS
Over the month, US 10-year bond yields fell from 1.45% at the end of June to finish at 1.23% at the end of July. Australian 10-year bond yields fell even further, from 1.53% to 1.18% as the various lockdowns escalated concerns about the Australian economy. The unexpected fall in bond yields was driven by an unusual but powerful combination of drivers, including somewhat weaker economic data in the US and concerns about the negative economic impacts of the spread of the delta variant.
Share markets had a very mixed month. Major developed markets delivered significantly different returns, ranging from -9.94% for the Hang Seng to 2.27% for S&P 500. The Hang Seng was affected by a sell-off in Chinese companies towards the end of July. This was initially triggered by new regulations on the education sector – a large and profitable sector in China – which significantly impacted the current business model of education companies. This escalated investors’ concerns about regulatory risk and led to aggressive selling in other sectors, such as internet and property development, which have also been the subject of increased regulation in China over recent months. On the other end of the spectrum, falling bond yields and a positive company earnings season proved supportive to US stocks. Australian stocks were also remarkably resilient in July, given the continuing flows of poor news on the lockdowns – with the ASX 300 rising 1.1%. Another casualty of Coronavirus developments in Australia and concerns about the Chinese economy is the AUD, which started July at 75.1 US cents and ended the month at 73.5 US cents, compared to a high of around 77.9 US cents in early March.
SO, WHAT MIGHT WE EXPECT LOOKING AHEAD?
The main question for investors surrounds the possibility of higher inflation in the US and how the Fed will react to it. While US inflation is near its peak, there is a strong possibility that it will be more persistent and overshoot people’s expectations over the next year.
However, investors are also looking at the changes occurring within China. There are mixed views on Chinese economic and market developments. While the signs of a Chinese economic slowdown are real, the political cycle means that Chinese authorities will be desperate to maintain economic growth at a sufficiently high level. The Chinese Communist Party (CCP) will hold its 20th Party Congress and elect a new leadership team by the end of 2022. After successfully amending the Constitution to allow for a third term, President (and Chairman of the CCP) Xi will want to ensure a smooth transition to his new term, meaning there will be an even stronger-than-normal incentive to maintain social stability and economic growth. However, there are some longer-term trends which raise legitimate questions. The latest regulatory outlook, for example, is a sign that investors are slowly (and reluctantly) considering the costs and geopolitical risks of investing in China.
Closer to home, the delta variant of Coronavirus is a short-term concern for the Australian market due to the lockdown. However, the Reserve Bank of Australia’s recent note reminds us (based on past experience) that with sufficient financial support ‘the economy bounces back quickly once outbreaks are contained and restrictions eased’. The most likely outcome is disappointing economic growth in the September quarter, followed by a recovery. There is uncertainty and much will depend on the duration of the lockdowns across Australia – particularly in New South Wales. However, it seems that while Australian markets may be more volatile in the short term, they may look beyond the impacts of the economic slowdown.
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