Macro: Sandcastle economics
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Risk Consolidates, PMIs in focus
Eleanor Creagh
Australian Market Strategist
Summary: Overnight risk assets recuperate as oil steadies, US equities posting gains across the board off the back of stronger oil prices.
Risk began on a solid footing in the Asia trade but has since faltered as attention turns to weaker PMIs in Australia and Japan and the raft of PMIs to be released later today as well as the high stakes EUCO meeting. Aussie stocks again lagging Asian counterparts, at the time of writing Nikkei +1.36%, KOSPI +0.83%, Hang Seng +0.39%, ASX200 -0.46%.
Weakness presenting in higher beta Aussie stocks that have bounced back strongly, ahead of reporting season. The price action in oil markets this week, a market with true price discovery that has not been altered by the “unlimited” liquidity from Central Banks, warning the rapid rebound in risk assets has perhaps run its course against the real economy backdrop. The ongoing sharp contraction in both the real economy and corporate earnings leaves little margin for error at current above average valuations, which are based on likely overstated earnings estimates. As it becomes more apparent that the road to recovery and widespread testing/vaccination is long and winding, the pipedream of a mean reverting snapback in activity in the 2H becomes more distant. This calls into question the sustainability of the bounce and continues to cap sentiment. The Aussie banks continue to weigh on the index, another headwind holding back the ASX200. As we wrote earlier this week, as the outlook for the banks and their traditionally juicy dividend payments becomes cloudier, the opportunity cost of these holdings grows. Headwinds include rising consumer credit defaults and bad debts across residential mortgage books and higher impairment charges denting profits. The share prices have already corrected significantly, but there is capacity for ongoing pressure particularly as we expect dividends will likely be deferred to 0 for the first half of 2020. The panic deleveraging of Q1 may be past, but dividend cuts remain a prompt for retail selling, particularly for pensioners reliant on dividends for income. Until this uncertainty is resolved when the big four (CBA, WBC, ANZ, NAB) update the market in May, it will be hard for Aussie stocks to push much higher from these levels.
The Australia Services PMI collapsed, as the lockdown has shuttered many businesses and jobs have been lost with a frightening speed, contributing to the large drop. Flash PMIs will later be released in the US, EZ, Germany, France and the UK. Likely delivering the same cliff drop in activity as lockdowns have largely become more severe throughout April, with services leading the decline. The forward outlook subindices will be useful in gauging how quickly businesses expect activity to rebound, a useful read on the effectiveness of stimulus measures to date and the optimistic assumptions of a V-shaped recovery underpinning risk assets.
WTI leapt almost 25% overnight after the June contract traded down towards $10 at one stage, helping to keep risk buoyed in the US session. Gaining after the heavy sell off and President Trump resorting to other methods to pump the oil price ordering the US Navy to destroy any Iranian gunboats that hassle US ships. However, without some resolution of the ongoing storage issues and vast over supply, we are far from out of the woods. The issue is supply and demand, oil keeps being produced and not used, and the storage problem will be in effect post the shutdown ending whilst the global economy runs below potential. Meaning we may yet relive the horrors of the May contract roll when the June contract rolls, unless those fundamental issues are resolved. The only cure will be a restart of the global economy.
Overnight the ECB eased collateral rules, now accepting sub-investment grade debt in its financing operations which has also soothed nerves into the all-important, or “make or break” as our Christopher Dembik puts it, EUCO meeting tonight. This permits the ECB to continue to finance Italian banks if Italy lost its investment-grade status, relieving some pressure in BTPs.
Keep an eye on
- Beijing has shut down gyms once more fearing 2nd wave of infections. The risks of lockdowns easing too early, without widespread testing. We have seen the same 2nd wave in Singapore, a clear risk for some US states which are easing lockdowns and reopening very quickly whilst their daily new cases remain high. I am no epidemiologist, but anecdotally the balance of probabilities lie with opening up economies becoming a phased transition and the return to normality being slow. In that instance, it is far from likely the employment recovery will be V-shaped. This in itself creates another headwind as the negative externalities and second order implications then have the ability to cascade, presenting an additional lag on economic activity.
- Dollar Index – DXY looks poised for a move higher, one that could dent enthusiasm for risk assets
- Jobless claims – may decline from previous weeks although remaining at unprecedented levels
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