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Economic Update: Why is it so? Equity markets and the AUD

Updated: Feb 21, 2022

Equity market overview

'Why is it so?' was an educational TV series in the 1960-80s hosted by Julius Sumner Miller that illustrated physics experiments. That same question has popped up regularly over recent months as to why the share market has performed so well given that the Australian (and global) economy is having its weakest year since the Great Depression.

Share market performance this year can be split into three periods. The equity market rose modestly at the start of the year. There was then the sharp drop during the peak concern about the pandemic. Finally, there has been the substantial bounce where the Australian market (according to Refinitiv figures) is up over 30% and the US and world indices are up over 50% from their lows. Overall, the US and world index looks to be on track for a double-digit rise this year although the Australian market is currently down year to date.

What has driven the bounce? For a start not all the decline reflected worries about the impact of COVID-19 on the economic outlook but the sudden change in market positioning. In late February a critical mass of investors became convinced that the virus would have worldwide implications. The rapid change in view caught numerous investors napping. A number of those investors had highly leveraged positions (i.e. they borrowed a lot of money to make their investments). The result was that many investors either had to unwind some of their positions quickly or had to sell other assets quickly to get their hands on some cash. This resulted in massive moves in financial markets that ended up requiring central bank (including from the RBA) intervention to become 'buyers of last resort'.

The GDP figures haven't yet been released for Australia (or New Zealand). But the expectation is that the decline of GDP also won't be as bad as had been initially feared. One reason was that the lockdown action by Governments helped resolve the crisis quicker than expected. An important factor has been the massive stimulus provided by central banks and Governments. In Australia, the combination of JobKeeper, a more generous JobSeeker, interest and rent holidays and the ability to partially access superannuation has enabled households to absorb the shock to incomes. Australia has also been aided by the impressive rebound of the Chinese economy that has stimulated demand for iron ore.

Currency market update

Recent comments from the RBA indicate they think that the AUD is pretty close to fair value. The 'real' exchange rate (AUD against all major trading partners after adjusted for inflation differences) suggests that the AUD at current levels is a little 'cheap'.

A stronger AUD will require ongoing improvement in the domestic and global economies and a reasonably tranquil financial market. In the coming months there will be a number of key events that will put this to the test. Results from the trials of the six leading vaccine candidates are likely to become available between September-November. Good news will be needed to confirm financial markets thinking about when a vaccine will become available.

Original post by Bank of Queensland



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