Financial markets are betting big the COVID-19 vaccine rollout will be a success

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There’s a bizarre narrative playing out in the Australian economy right now.

As we stare down the potential of a so-called “double-dip recession”, asset markets are booming.

Treasury and most market economists now forecast the economy will contract by more than 2 per cent in the September quarter.

There’s also a credible risk economic growth in the December quarter will be negative, which would produce another “technical” recession.

Meanwhile, both the stock and property markets keep powering ahead, with the share market regularly pushing all-time highs.

At a fundamental level, record-low interest rates have helped drive billions of dollars worth of investments into shares and property, but there’s more to it than that.

While the present-day reality of COVID is being felt by millions of Australian households, the stock and property markets are looking through this to the other side, and they see blue skies.

Dark economic clouds are still gathering

The signs of present economic weakness are clear.

Retail sales slumped in June after the Greater Sydney lockdown had only been in effect for a week and the construction industry has also had disruptions — both will have ripple effects across the economy.

But it’s business investment that makes up a fair whack of gross domestic product, which now looks very shaky.

One way you can tell how keen bosses are to spend on their businesses is via their hiring intentions.

The latest National Skills Commission Report (August) shows the damaging economic impact of COVID-19 restrictions, particularly in New South Wales.

The state recorded the strongest decline in recruitment activity over the month, down by 10.3 per cent (8,100 job advertisements).

This was twice the rate of decline in the Northern Territory (down 5.2 per cent), which recorded the second-strongest percentage fall in the month.

Victoria recorded the only increase in job advertisements during July 2021 (up 3.9 per cent) after recording the strongest fall in job advertisements in June 2021 (down 4.2 per cent).

But the National Australia Bank’s July business survey captures the overall plight of businesses:

 

“Both [business] conditions and confidence deteriorated sharply in [July], with the latter now back in negative territory,” the bank reported.

“Overall, the survey shows that the strength in the business sector seen in early-to-mid 2021 has faded on the back of fresh disruptions in the economy.”

 

Stock market is booming

On the flip side, the Australian share market has never looked so shiny.

After taking the biggest dive in a generation, which began in February and March last year, stocks have since soared to new heights.

There are a few key reasons for this, according to AMP Capital’s head of investment strategy Shane Oliver.

“The combination of improving global growth and earnings helped by more fiscal stimulus, vaccines allowing reopening once herd immunity is reached, and still-low interest rates augur well for shares over the next 12 months,” said Dr Oliver.

You see, the share market isn’t valuing companies for today, it’s projecting what businesses will likely be worth in 6 to 12 months from now.

The share market is right now looking through to the end of this year, and early next year, and sees a fully vaccinated population with little if any need for lockdowns.

And record low interest rates and ongoing fiscal stimulus remain key in providing broader economic support for the market.

Several investment analysts and market economists keep saying the same thing to me over and over: “There really is nowhere else for money to go apart from the stock market.”

Property markets hit new highs

Record low interest rates are also driving the property market.

But COVID-19 and lockdown restrictions have made it very challenging to go through due process when selling a property.

What it’s led to, said the Real Estate Institute, is a massive demand and supply imbalance. That is, there’s still plenty of demand for property but supply is enormously constrained.

This is forcing property prices higher.

Most banks now have home prices rising between 15 per cent to 20 per cent this year before slowing to around 5 per cent next year.

Record low mortgage rates and the fear of missing out (FOMO) remain the key price drivers.

It’s clear there are factors looming that could slightly cool down the market by next year: poor affordability, fewer government home buyer incentives, rising fixed mortgage rates and the potential for a reintroduction of macro-prudential tightening by the regulators.

For now, though, the property market remains robust.

Vaccine wildcard

But there’s a significant wildcard: the vaccine rollout.

Without 70 to 80 per cent of the eligible population vaccinated, states and territories face the risk of extended lockdowns.

As the CEO of the Australian Industry Group, Innes Willox, put it, “businesses don’t like lockdowns”.

Speaking publicly this week, he said businesses need “momentum” and “continuity” and lockdowns act as a circuit-breaker.

At least one major bank believes Greater Sydney will exit lockdown sometime in September.

AMP Capital forecasts 70 per cent of the eligible population vaccinated in November and 80 per cent by December, which would obviously see restrictions eased across the country at that time.

But as Reserve Bank governor Philip Lowe pointed out before a parliamentary economics committee last week, it’s difficult to predict exactly what will happen in terms of the vaccine rollout.

Yes, more doses of Pfizer, for example, may be available, but will a critical number of Australians get the jab?

It’s impossible to say at this point.

Precisely how much the stock market is banking on 70 to 80 per cent of the eligible population being partially or fully vaccinated is also impossible to work out.

However, if short-sharp lockdowns continue, as is the federal government’s wish (in the absence of a fully vaccinated population), the economy will continue to suffer and, as Dr Oliver puts it, “shares remain vulnerable to a short-term correction with possible triggers being the upswing in global coronavirus cases.”

The property market is less vulnerable. As we saw last year, if there’s even a whiff property prices may drop materially, the banks begin sandbagging the market by offering grace to mortgagors in terms of repayments.

The banks are certainly well capitalised now, so offering mortgage deferrals again shouldn’t be a problem.

Making sense of it

NAB chief economist Alan Oster summed up the paradox of robust financial markets and a crumbling economy.

“[The market is] looking through the lockdown,” Mr Oster said.

“That is a fair reading on what’s going on.”

And it is a fair reading. For now.

The reality though is that property and share markets, fundamentally, rely on robust economies for growth (notwithstanding short-term government income support).

If Australia does not reach a 70 per cent to 80 per cent vaccination rate for the eligible population, you can throw out the economic forecasts — because it’ll be anyone’s guess as to how ongoing short-sharp lockdowns will influence the economy and financial markets.

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By David Taylor (Original ABC Article)