The US Elections, What Does It Mean For Us?

Monthly Market and Economic Update – 5th October 2020

Peter Flannery CFP AFA

 

 

“If you have one economist on your team,
it’s likely that you have one more than you’ll need.” 

Warren Buffett

MARKETS

The chart on the left shows the US share market (the Dow Jones) over the last six months.  The chart on the right shows the US share market (the Dow Jones) over the last year.

 

Key Points: 

  • What if Joe Biden wins the US presidential elections?
  • Latest update on the spread of the coronavirus across America
  • The fight against COVID-19 is damaging – is it worth it?
  • What about the NZ / Aussie travel bubble?
  • What is happening with residential property across NZ
  •  

 

Donald Trump, coronavirus and …

Donald Trump has contracted the coronavirus.  What does this mean for the markets and the US economy?  We know already what it means for markets.  In a word, “volatility”.  In parochial share market speak, the phrase is “risk off”

Basically this means that the market has suddenly felt concerned about the implications of the uncertainty created and what that might mean for the US elections and the US economy.  Of course, (at the time of dictation, which is 5 October 2020) it is far too early to be suggesting that Donald Trump will not survive.  Although this information is changing daily, what we know is that he will receive the best care available; however, the risks are that he is over aged 70 and, by some measures, considered to be obese. 

All the data we have around the coronavirus suggests that those with at least one health problem in addition to COVID-19 are in danger of serious complications and even death from the coronavirus.  It seems unlikely at this point that this would be the case for the irrepressible Donald Trump. 

Interestingly, there are many who support Donald Trump, although it appears that his support base is beginning to fray around the edges as his highly unorthodox approach to the presidency and related matters seems to be catching up with him in some quarters. 

On the other hand, contrary to what many believe, Donald Trump has been neutral to positive for the US economy.  Joe Biden, on the other hand, should he win, operates on the left side of the centre line, which I suspect would be immediately negative for markets should he win the election.  Right now though, the election hangs in the balance.  Then there is the ongoing battle across the senate regarding the next round of stimulus, desperately needed to provide funding for mainstream mums and dads to be able to receive an income.  Some of the support packages that were in place are about to fall away or have done so already.  This particular item would appear to be urgent.

Markets very much dislike uncertainty.  The lack of agreement by government around the next significant stimulus package is creating a reasonable degree of uncertainty, causing some of the volatility that we have seen over the last week or two. 

House Democrats recently passed a US$2.2 trillion dollar fiscal aid package, however this bill is unlikely to be approved by the Republican controlled Senate.  The political wrangling continues, as those who support team Trump are saying that the opposition are deliberately holding up agreement on the fiscal package so that unemployment will continue to rise and generally the deteriorating economic situation will hit the news, making Donald Trump look bad.  Team Trump want the fiscal package passed immediately. 

For us as investors, it is worth bearing in mind that the US and other markets are expensive, although I would argue not in bubble territory as yet.  Still, it is worth bearing in mind that serious negative surprises can instantly upset markets, as we have seen over the last few weeks.  That said, we have not seen significant volatility.  Enough for some ‘nibbling’, if you like, but no real correction as such.  In theory, a 10% decline in trading prices is considered a correction.

Perhaps one final point with regard to markets right now relates to the graph below …

 

Interest rates – US

The above chart shows interest rate direction since 1995.

To be clear, inflation is worryingly low from the Federal Reserve’s perspective and interest rates of course supportive of the economy.  The short of it is, that if interest rates rise at some point, which is likely, then this would have some impact on market prices.  A sharp rise in interest rates would cause an instant correction across markets.

I raise this because, if you have been reading my material of late, you may have noticed that I mentioned for the first time recently, the US Federal Reserve have adjusted their policy settings for inflation.  Simply, they are looking to engineer inflation in order to help move the economic cycle away from a dangerously close proximity to deflation (which we would have had big time had central banks around the world not intervened) and to reduce the impact of the growing debt burden. 

I do not see an immediate threat to market prices from rising interest rates, but I raise it here because it is now on the agenda at some point in the future – difficult to gauge when at this point. 

I am not mentioning this so that we as investors can start to worry about an upcoming share market crash, but rather so that we are in the loop, fully informed and are in a position to take advantage of it. 

The smart way to manage it will be for me to keep you posted and whilst I cannot pretend to be able to predict the future, there may be signals that give us some clues so that we can progressively raise levels of cash and be ready to take advantage of lower prices. 

Our focus is on our big picture goals and investing requirements, rather than worrying about any market movements that may impact short term pricing.  Remember, we wait for the opportunities to come to us.  We are not a slave to market volatility.

The United States of America

The above graph shows the impact of the coronavirus on small business in America.

The coronavirus has exacted a significant impact on most countries around the world – the US is no exception.  We have seen economic contraction at record levels in a number of countries.  Thankfully, central banks around the world have provided the much needed support / stimulus.  It is not over yet.  The chart above highlights a particularly onerous story around main street America.  In short, small businesses are very important to economic activity in any economy.  The chart above shows that over 50% of small businesses have endured a significant decline in gross revenue. 

The above chart highlights the impact of the coronavirus on different sectors of the economy.

It is interesting to note from the chart above that those earning less income are more affected by the coronavirus. 

Apart from their own personal situations moving from difficult to dire, this could lead to all kinds of ramifications, such as increased crime.  Also, as the American economy, like most other developed economies, relies on people to spend money, if there is less money available for them to spend, this will also have a spin off impact in a negative way on economic growth. 

As you may know, the American economy is dependent on consumer spending for over 60% of economic activity.  When you look closely at the numbers, we all know that there are very few people in any economy who earn lots of money. 

Even if they spent lots and lots, they do not make much difference.  It is the collective spending power of the middle and lower income groups that make all the difference here.  That is why it is likely damaging to the economy when a significant proportion of those middle /  lower income earners are unable to spend in the usual way.

 

Rt COVID-19 USA

The above graph shows the increasing spread of the coronavirus across America.

There are many who argue that Donald Trump’s handling of the coronavirus has been underwhelming to say the least – ironic that he and potentially many in the Whitehouse have now contracted the virus (or are about to). 

Although it is not something they cannot work through, it will be distracting at the very least and potentially quite damaging to the Trump team as a number of key members are taken out of the picture, even if it is temporarily.  Worst case scenario, there may even be some deaths.  Perhaps the saddest commentary of all around this is the fact that it was avoidable. 

As the graph above shows, the spread of the coronavirus is ongoing as the Rt score above highlights.  Indeed, looking simply at this graph alone, we can see that little progress has been made in terms of containing the virus over the last several months.  The virus continues to spread.

There are numerous vaccine trials underway, a number of which are about to enter or are in the throes of stage three testing.  On the one hand, there are some who argue that the absence of a two year timeline to ascertain if there are any long term implications means that this is a rush-through job, and dangerous.

On the other hand, there are those that are less concerned about the long term implications and keen to see some containment measures implemented as soon as possible.  There are those who also know that if the spread continues, more people will die.  Then, those on the other side argue that other people, many more people arguably, are severely compromised, some forced into high stress situations and some even facing suicide because of the financial strain created by measures to contain the coronavirus.

I have suggested elsewhere that there is some likelihood of stage three trials being completed towards the end of this year which, let’s face it, is coming up fast. 

The data read of those trials is possible before the end of the year and if they prove successful then the roll-out of a containment-type vaccine could begin as early as first thing 2021.  By some estimates, it would take between nine and 12 months for a significant roll-out of any containment vaccine.  So, it would likely be 2022 / 2023 before the global economy might see the positive impact of such a containment vaccine – best guess, best case scenario.  Time will tell …

 

Inflation – USA

The above chart tracks the inflation rate since prior to the year 2000.

Jerome Powell, the Fed Chairman of the US Federal Reserve, announced a major policy shift recently, saying that the Fed are now willing to allow inflation to run hotter than usual, so that higher prices might support the labour market and therefore the broader economy. 

The Fed refer to it as a policy of “average inflation targeting”, which basically means that it will allow inflation to run moderately above the Feds 2% inflation goal for some time following periods when it may have run below that objective. 

I mention this again because it could be a potential game changer for the global economy, whereby there is a secular shift away from the threat of deflation, which has hung over the global economy for more than a decade.  This by the way, is another indicator that markets will watch closely in the future.  Simply, an increase in the inflation rate will inevitably lead to an increase in interest rates.  The markets will take a very negative view of any hint of rising interest rates in the future.

 

China

Economic activity (GDP) – China

The above graph tracks economic activity as measured by gross domestic product (GDP).

The Chinese economy contracted by -6.8% year on year in the March quarter of 2020.  This looks like the first economic contraction since reporting began in 1992 and is obviously a reflection of the severe impact from the coronavirus.  Since then though, the economy in China has grown by 3.2%, year on year in the second quarter of 2020, having rebounded from the prior quarter’s contraction.  This suggests that the Chinese economy has been effectively dealing with the spread of the coronavirus, largely has it contained and is getting back on track with a growing economy.  Interesting I know, when we compare it with the likes of Europe and the US. 

China celebrates its first major national holiday since the country emerged from the coronavirus.

Normally, this time of the year hundreds of millions of Chinese travel for vacation for the eight day mid-autumn festival holiday. 

This year, China’s Ministry of Tourism predicts approximately 550 million trips will be made within the country for this year’s holiday break, which compares with last year’s 782 million domestic trips made.  Holiday and travel tourism in China can signal China’s economic health.  It will be interesting this year to see what the numbers tell us.

The friction between America and China continues, with ongoing action in the technology space around Huawei, Tencent and Tik Tok.  It appears that even if Joe Biden wins the election, there may well be an ongoing tough stance against China.  Many Americans feel as though China’s success is America’s failure and that the Chinese are taking jobs away from Americans. 

We have also seen the closure of one embassy each in China and the US although interestingly, some regard the Chinese embassy in San Francisco as a much bigger centre of intelligence gathering (espionage) than the Houston centre that was closed. 

This could be because the Americans do not want their intelligence gathering (espionage) in one of the major centres in China being closed in retaliation. 

Right now though, the Chinese appear to be holding back a bit as they await the outcome of the US election, so they can then decide how to continue to respond and indeed to confront the United States of America. 

In addition, there have been charges made by America that China has interfered with the US election process.  Indeed, there is evidence that proves there was interference, not only by the Chinese but also the Russians and the Iranians, in the 2016 election in America.  Apparently, the security systems of some States in the US are less robust than others, allowing the likes of Russian and Chinese hackers to infiltrate some of those systems.

At the same time, there are a number of opportunities for China and the US to work together as opposed to against each other, notwithstanding the fact that some things that China does will remain unacceptable (e.g. security risks and intelligence gathering). 

For example, North Korea could be one opportunity where China and America can work together because it appears that China is, like America and the rest of the world, not too happy that North Korea now has nuclear missile capability and continues to grow its nuclear arsenal. 

So, whoever wins the American election, we will likely see ongoing confrontation between the two governments, but also there exists the opportunity for them to work together in some areas as well, particularly if a more diplomatic American government enters the arena.  Currently, the polls favour Joe Biden (no guarantee of a win though). 

  

The UK

 Economic growth (GDP) – UK

The above graph tracks economic expansion (contraction) in the UK economy.

The UK economy shrank by an historic -21.5% year on year in the second quarter of 2020.  This is the largest economic contraction since comparable records began in 1956.  It is important to the UK economy but as Britain is the sixth largest economy in the world and the second largest in Europe after Germany, the impact of this economic contraction ripples wider than just throughout the UK.  It also impacts on Europe and the global economy to some extent as well. 

 

Unemployment – UK

The above chart tracks the unemployment rate in the UK.

The UK unemployment rate rose to 4.1% in the three months to July 2020, up from 3.9% in the previous period.  This was the highest jobless rate since the three months to October 2018 and is obviously the impact of the coronavirus hitting the labour market.  Looking more closely at the numbers, we can see that from May to July 2020 there was an estimated 1.4 million people unemployed, which was up 104,000 on the year and up 62,000 on the quarter.  The quarterly increase appears to be mainly driven by an increase in unemployment among those aged 18-24, along with others who have been unemployed for up to six months.

The number of people estimated to be temporarily away from work (including furloughed workers) has declined but was nonetheless still more than five million in July 2020.  Over 2.5 million of these have been away for three months or more.  The data shows that there are also around 250,000 people away from work because of the coronavirus and receiving no pay in July 2020. 

Total pay fell by 1% over the year, the third consecutive decline in earnings.  Although compared to the US, unemployment in the UK looks better; however, the impact of the coronavirus is yet to be fully felt across the job market in Britain.

Elsewhere, the Brexit deal continues to remain elusive.  The latest hard deadline is the end of October this year to conclude negotiations. By automatic operation of the law, the transition period ends and the UK leaves the European Union single market and customs union.  Although I am oversimplifying it, Britain will still trade with Europe; however, after the 31st of December 2020 there will be an onslaught of paperwork that will basically slow everything down, increase costs and limit trade.  That is bad news for everybody (apart from the bureaucrats who are paid to administrate the whole process). 

In the event that there is no deal reached, then farmers and manufacturers will be hit with tariffs, which of course is extra costs to sell their goods and services.  Europe supplies approximately 30% of Britain’s food, and so it is likely that some of the items they have become used to having will become less available and likely more expensive too. 

There will be border delays and when it comes to the fishing industry, we can expect to see disagreements and skirmishes erupting around illegal water fishing and potentially increased blockades at ports.  I am only scratching the surface of this issue and there is much more involved. 

In the end, it does make things more complicated between the European Union and Britain, but at the same time, both parties can trade elsewhere in the world.  Still, it just seems odd that neighbours cannot get along with each other …

 

Australia

The above chart highlights a number of economic indicators.

 

Economic activity (GDP) – Australia

The above graph shows economic expansion (contraction) since July 2017.

Australia, like most other countries around the world, has not been immune to the impact of the coronavirus.  Australia’s economy shrank by -6.3% year on year in the second quarter of 2020.  Like a number of other countries around the world, this result goes down as the sharpest contraction on record. 

 

Unemployment rates – Australia

The above graph tracks unemployment over the last 12 months or so.

As the chart above shows, unemployment has increased materially because of the coronavirus.  This will mean headwinds for the Australian economy likely over the next 12-24 months, as the increase in unemployment translates into less consumption and slower economic activity.

However, like other economies around the world, I would expect economic contraction to change into economic growth, if not in the next quarter probably in the one following, all things equal.  As you may have gathered, I continue to highlight unemployment throughout this months update because it is a solid indicator of the impact of the coronavirus and the upcoming impact on economic activity. 

 

Property prices – Australia

The above chart shows movement in residential property prices across Australia for the month of September 2020.

It looks as though house prices generally increased over the month of September in Australia, except for ongoing falls in property prices in both Melbourne and Sydney.  Property price declines were not significant but were highlighted by the nationwide decline in property prices of 0.1%, a decline in property prices for Melbourne of -0.9% and for Sydney -0.3%. 

Although Victoria did see a significant spike in coronavirus infections, the rest of Australia appears to have a good degree of containment underway.  Therefore, we are seeing an improvement in sentiment along with low interest rates helping to support property prices. 

Some Australian renters are falling into arrears, with rent deferrals accruing into thousands of dollars of debt that some will struggle to ever repay.  Not a dilemma of huge significance from an economic perspective, but nonetheless a headwind for the Australian economy in the future to some degree. 

Australia rolled out significant job keeper and job seeker programmes, which have kept millions of Australians either in work or at least at a reasonable income level.  However, those programmes have now come to an end and it will be interesting to see what ongoing support might be available moving forward from here.

And in other news, Australia has opened up its borders to New Zealand, which may seem attractive although anecdotal evidence suggest that many Kiwis are cautious about heading over to Australia just yet.  Hopefully, Kiwis will think carefully about going to Australia to spend money (as though they somehow have cabin fever!) and might consider holidaying around New Zealand first before heading off to spend money in Australia.  The New Zealand economy could do with some help right about now. 

 

New Zealand

The above chart provides a number of economic indicators.

The New Zealand economy has held up reasonably well, although we took a severe hit economically with tourism being basically stopped in its tracks.  The Reserve Bank provided support and the economic wheels of the country keep turning. 

Like most events, the coronavirus affects different parts of the economy in different ways (tourism, hospitality hit the hardest) and also families and individuals throughout the economy are impacted differently.  From a health perspective, the government has executed reasonably well overall (despite some inevitable shortcomings) and again, I believe should be congratulated on a worthy result for New Zealanders. 

In addition to a lower death rate than many other countries, we have also been able to enjoy support from the Central Bank and importantly for markets and individuals, a high degree of certainty and transparency as the pandemic continued to spread.  Whether National would have done any better or worse is debatable and irrelevant. 

There is more debt now, but the alternative would have been immediately much more difficult.  The New Zealand economy remains in a reasonable position and now it’s time to innovate and improve levels of productivity across the New Zealand economy – beyond property.

 

Economic activity (GDP) – New Zealand

The above chart tracks economic expansion (contraction).

The New Zealand economy contracted by -12.4% in the second quarter of 2020 – you guessed it, the biggest decline on record.  Notably, it was actually the second contraction, with the previous one being recorded in the period prior at -0.1%.  If you have been reading my material over the last six months or so, you may have noticed my comments around ‘the upcoming slew of ugly economic data’, which we are now seeing.  My expectation is that this type of data will not go away quickly, but indeed will improve progressively.

 

Unemployment rate – New Zealand

The above graph tracks New Zealand unemployment from July 2017.

New Zealand’s unemployment rate fell to 4% in the second quarter of 2020, down from 4.2% in the previous period and surprisingly was below expectations of around 5.8%.  The number of unemployed people dropped by 6,000 to 111,000.  This is quite a good result, all things considered (COVID-19 etc), and of course is a direct result of Central Bank intervention here in New Zealand. 

The question on everyone’s mind is now about what happens moving forward, as those employee subsidies have come to an end.  It appears that the New Zealand government is looking to continue some support, although structured differently, taking into account current conditions.  The bottom line is that support, one way or another, will continue. 

 

Mortgage interest rates – New Zealand

The above graph tracks floating and two year fixed mortgage rates since the year 2000.

Interest rates in New Zealand, like elsewhere around the world, continue to track downwards.  This helps to support economic activity, and more specifically residential property prices.

The above diagram shows the median increase in residential property prices over the last 12 months for the period ended 31st of August 2020.

Residential property prices, after a brief hiatus over the last several months because of COVID-19, have continued to rise once again.  This is particularly interesting when you look more closely at it …  

We can see that, whilst property prices have continued to rise, economic activity shrunk the most ever on record and immigration has stopped (returning Kiwis are not replacing the previous demand).  This highlights the point that long term, residential property prices tend to track economic activity.  It further highlights the point that the market determines prices and the market is driven by interest rates.  More specifically, lower interest rates mean that some are able to afford slightly more each month to service debt.  This means increased demand for property – for now.  The gap between the fundamental support for residential property prices and current trading prices continues to widen.  Everything will be fine – until it is not.

You will be aware possibly, that banks have maintained a reasonably conservative approach to lending even though the Reserve Bank of New Zealand has loosened previous lending restrictions.  That has seen a minor boom for second tier lenders, who have stepped in to fill the gap here in New Zealand.  So for some, where the mainstream bank has said no, a second tier lender has been a good option.

 

Currency – cross rates

Of course, there is the New Zealand elections coming up and whilst it does have some impact, as I have mentioned elsewhere, it seems as though the major parties are in some sort of race to the centre line and almost stealing one another’s policies to try and outsmart the opposition.  Anyway, it will have minimal impact on us as investors. 

The New Zealand economy has held up reasonably well all things considered, especially when we think about the severe hit the coronavirus has created with the challenges faced by the tourism and hospitality sectors.  This has seen economic contraction of the New Zealand economy like we have never seen before.

However, the New Zealand Reserve Bank has provided support along with the New Zealand government, which has delivered a raft of measures, all of which have come together to enable New Zealand’s economy to continue ticking over. 

Debt has increased significantly but is manageable – especially if NZ Inc. can apply innovation and ramp up productivity.   

 

To summarise

The coronavirus continues to spread throughout most countries, although some are managing to gain a degree of control over the spread of the virus (e.g. New Zealand, Australia, China). 

Interestingly, Donald Trump and potentially half of the White House may wind up with coronavirus infection, which in the short term will be a distraction for the American government.  Although Donald Trump is odd when it comes to his style of presidency, he has been neutral to positive for the American economy.  He has also stood up to the Chinese in a way that few other leaders have in the past. 

The upcoming elections in America will create some uncertainty and also some volatility, particularly if Joe Biden wins as the current polls suggest (but let’s not rely on polls for predictions about the future). 

Most share markets continue to trade at premiums and are not cheap.  This means that uncertainty and volatility can see markets decline quite a bit.  The decline in markets as a result of the coronavirus provides some indication of the degree of decline that is possible. 

No need to be concerned about possible upcoming volatility – you can guarantee it will happen!  The point here is that you and I can sit back and allow lower prices to bring the opportunities to us as investors.  To be clear, it is inevitably a mistake to chase the markets or to try and second guess market direction or market events. 

Although New Zealand and Australia do not count much when it comes to the global economy.  China does and it, by all accounts, has the coronavirus contained, at least for now.

My best guess is that stage three trials will be able to be analysed later this year and going well, could see a control-type vaccine rolled out starting early 2021. 

Although it is difficult to gauge, again my best guess would be that it will take most of 2021 to see the vaccine distributed.  It will not be a cure, but more than likely a containment measure which if it is widespread enough, will do the trick. 

Remember though, markets will not wait for any vaccine to be distributed before it decides that opportunities exist.  That rebound of markets is already well underway and could potentially be further boosted by the confirmation of successful stage three trials.

As investors, we watch with interest the elections in the US, and to a lesser extent New Zealand. 

Whatever the outcome, it provides some cheap entertainment for us all.  Particularly in the case of the US election, there is the real possibility of uncertainty and market volatility, which as value/eco-Investors presents the opportunity.

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