The US market was the best performer of the major developed markets, improving by 2.2%, boosted by a positive start to the second quarter profit reporting season, while the NASDAQ was slightly more subdued closing the month 1.2% higher. Other markets were fairly docile with the notable exception of China which fell a staggering 14% due to unexpected regulation of online learning stocks by the Chinese Communist Government. This serves as a stark reminder that while China has become the world’s second largest economy and is rapidly developing its financial market presence, it operates very differently to western capitalist democracies.
Bond markets were much firmer over the month, soothed by dovish comments from leading central banks that the short-term spike in inflation would not lead to an acceleration in their timetable for tightening interest rates or liquidity conditions. The Australian dollar continued its recent weakness falling 1.5% against the US dollar to close at 73.4 US cents, while in commodity markets, gold improved 2.6% and base metal prices were strong with lead up 6.6%, aluminium +4%, copper +3.7% and nickel +7.3%.
The US 10-year treasury yield fell by 24 basis points to finish at 1.2% while the Australian market was even stronger with our 10-year bond falling 35 basis points to finish close to parity with the US. The decline in bond yields over the past five months has supported equity valuations and helped underwrite the strong gains achieved in share markets.
The “delta variant” is unlikely to derail the global recovery
The emergence of the delta variant as the dominant strain of COVID 19 has seen a spike in the number of reported cases around the world, even in countries that have achieved significant levels of vaccination in their adult population. Importantly however, whilst case numbers have increased, hospitalisations, ICU admissions and deaths have not risen to anywhere near to the same degree they did prior to vaccinations becoming available. While it is true that the more infectious delta variant has reduced vaccine efficacy for preventing symptomatic infection, vaccines are still very effective at preventing serious illness, hospitalisation and death. In Australia, we have witnessed a major outbreak in Sydney which is proving very difficult to contain especially considering the relatively low level of full vaccination in the community. The lockdown that has been imposed across the greater Sydney area covering a population of over 5 million people is severely curtailing economic activity. It is quite likely that economic growth for Australia in the September quarter will contract by at least 2% raising the possibility that we could see the second recession of the pandemic. With the removal of lockdown restrictions in NSW seemingly now being tied to achieving minimum vaccination targets of 70%, it is likely that the national economy will operate well below capacity for the remainder of the year.
The effect of this will be to further delay the Reserve Bank’s timetable for raising interest rates, although somewhat surprisingly they did hold firm to their commitment to reduce the weekly purchases of government bonds from $5 billion to $4 billion from September. We know from the Victorian experience in 2020, that following the removal of lockdown restrictions the economy bounces back quite quickly so the market is prepared to look through this current economic slowdown.
Strategy and Outlook
As mentioned last month, the confluence of easy liquidity conditions, low interest rates together with positive revisions to corporate earnings, is proving a very potent combination for equity markets.
There is nothing that we can see in the short term that is likely to derail these powerful market drivers. While some market commentators point to full valuations, in an environment of low bond rates and positive earnings revisions, the market will naturally trade on a higher earnings multiple. The reality is there is a huge amount of money circulating through the global financial system which will gravitate to risk markets which offer by far the best return potential compared to more defensive assets such as cash, term deposits and government bonds.