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Weekly Market Update – 30th September 2018

Weekly Market Update

Investment markets and key developments over the past week

  • US, European and Japanese share markets rose solidly over the last week on increasing signs from the Fed that it is open to pausing or slowing its interest rate increases. Chinese shares rose slightly but Australian shares fell slightly. Weakness in resources, consumer, utility and real estate shares weighed heavily on the Australian share market over the last week offsetting gains in financials and industrials. Reflecting a more dovish Fed and generally low inflation readings bond yields mostly fell. Commodity prices were mixed with metals and oil up a bit, but iron ore down. The $A rose as the $US fell slightly.
  • Two weeks ago, three potential positives for shares were noted in this update: a Fed pause, the oil price crash extending the cycle and some hope on the trade front. We are still waiting for something on trade, oil prices have since fallen even further providing a boost to consumers and comments over the last week from Fed Chair Powell and Vice-Chair Clarida along with the minutes from the last Fed meeting have added confidence to the prospect of a pause in rate hikes next year. The key message from the Fed is that it remains upbeat on the US economy – consistent with another hike in December, but that rates are now “just belowneutral” and it needs to be aware of potential headwinds to growth including the lagged response in the economy to past monetary tightening and that there are no major excesses to deal with, which is all consistent with the Fed being open to a pause and slower pace of rate hikes next year. Following a hike in December the Fed is likely to lower its “dot plot” of rate hikes for 2019 and replace the reference to “further gradual [rate] increases” in its post meeting statement with a reference to being more data dependent. A pause on rates in the first half of next year is now highly likely particularly if core inflation continues to remain benign. A slower more cautious Fed would be positive for markets as it would reduce fears of a US downturn and take pressure of the $US which would provide some relief for emerging markets and commodity prices.
  • Waiting on Saturday night’s meeting between Presidents Trump and Xi. In the last week it appears that expectations of a break through on the trade dispute between the US and China have diminished particularly after Trump repeated his threat of additional tariffs on China and then sounded hot and cold on whether there would be a deal or no – although this looks a lot like pre-meeting negotiating tactics. There are several ways this meeting could go:
  1. It could end with no agreement and maybe even more hostility with the US remaining on track to raise the already imposed tariffs to 25% from 10% currently in January 1 and to put tariffs on the remaining circa $US267 of imports from China;
  2. Trump and Xi could provide a framework for future talks between their negotiators to resolve their differences. This may or may not be accompanied by the US committing to a ceasefire on further tariff hikes while talks proceed – although it’s hard to see how China will negotiate without one; or
  3. China could kick of negotiations offering a broad-based reduction in its tariffs. China’s average tariff rate last year was 9.8% and the US’ was 3.4%. While China is allowed a higher tariff rate under WTO rules as a developing country getting it down has been a key demand of Trump and China has been moving in this direction anyway and has been reportedly thinking about doing more.
  • It is likely to see some sort of positive outcome from the Trump/Xi meeting as both sides want a deal, but it’s a close call. Either way it is likely that Trump will want to resolve this issue sometime in the next six months before the tax/tariff hikes wipe out all of the remaining fiscal stimulus next year and start to act as a drag on US economic growth pushing up prices at Walmart and pushing up unemployment threatening his re-election in 2020.
  • Stronger Australian budget position likely to see the Government announce tax cuts ahead of next year’s Federal election. PM Morrison’s announcement that next year’s budget will be brought forward to April 2 is clearly designed to clear the way for an election in May (on either May 11 or May 18). Meanwhile, the Mid Year Economic and Fiscal Outlook report to be delivered on December 17 is likely to show that Federal budget is running around $9bn per annum better than expected thanks to higher than expected commodity prices and employment driving stronger tax revenue only partly offset by fiscal easing measures. This suggests this year’s budget deficit projection is likely to fall to around -$6bn (from a projection of -$14.5bn in the May Budget) and the 2019-20 surplus on unchanged policies will be projected to be around +$11bn (up from $2.2bn in May) with future surpluses looking even stronger. This is likely to enable the Government to announce $9bn in income tax cuts and other pre-election goodies starting in July 2019 and still maintain a surplus projection for 2019-20. The big risk of course is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows and wages growth remains weak. The upside of bigger and earlier income tax cuts is that it will inject a bit of spending power into household budgets providing a partial offset to what looks like being an intensifying negative wealth effect from falling house prices on consumer spending next year. So, while it’s likely to see pretty constrained consumer spending growth next year it’s not all doom and gloom.

Major global economic events and implications

  • US data releases over the last week were mixed. On the weak side home prices rose only slightly in September, home sales fell in October, the goods trade deficit deteriorated again in October and jobless claims rose again (although they remain very low). But against this, growth in consumer spending and income was solid in October, consumer confidence fell slight in November but remains around an 18-year high and Black Friday retail sales look to have been strong. Meanwhile, core inflation fell back to 1.8% year on year in October suggesting inflation may have peaked and providing plenty of scope for a Fed rate pause at some point next year.
  • Eurozone sentiment slipped for the 11th month in a row and bank lending slowed all of which will keep the ECB cautious.
  • Japanese jobs data slowed a bit in October but remains strong, industrial production rebounded after weather disruptions and core inflation measures in Tokyo tracked sideways at a low level. Ultra-easy Bank of Japan monetary policy will continue.
  • Chinese official PMIs softened further in November and momentum in industrial profits continued to slow in October which is all consistent with a further gradual slowing in growth and points to a more vigorous ramp up in policy stimulus.

Australian economic events and implications

  • Australia data released over the last week was messy with a sharp fall in September quarter construction activity that was broad based across residential and non-residential building and engineering activity, a fall in September quarter private new capital expenditure and continuing softness in credit growth. There was good news though in that business investment plans for the current financial year continue to improve with capital spending plans compared to a year ago growing at their fastest in six years as the slump in mining investment slows but non-mining investment improves. So, business investment should help provide an offset to the downturn in the housing cycle.

Source: ABS, AMP Capital

Source: ABS, AMP Capital

  • Credit growth remained soft in October with credit to property investors growing at its slowest on record and owner occupier credit continuing to slow. Fortunately, business credit growth has picked up possibly reflective of stronger investment.

Source: RBA, AMP Capital

Source: RBA, AMP Capital

What to watch over the next week?

  • Reaction to the outcome of the meeting between President Trump and Xi Jinping at the G20 summit will be a key driver of markets in the week ahead.
  • In the US, jobs data to be released Friday will be the focus. Expect to see another solid gain in payrolls of around 200,000, unemployment remaining at 3.7% and wages growth rising to around 3.2% year on year. In other data expect the November ISM manufacturing conditions index (Monday) to edge down to a still strong 57.5, the non-manufacturing conditions ISM index (Wednesday) to edge down to 59.5 and the trade deficit (Thursday) to widen slightly, Another speech by Fed Chair Powell (Wednesday) will likely reinforce the impression that it’s becoming open to a pause in rate hikes next year and the Fed’s Beige Book of anecdotal comments will be released the same day.
  • There is also another bout of shutdown risk in the US in the week ahead with the need for another “continuing government funding resolution” to avoid another US government shutdown from December 7 – this could create a bit of noise given Trump’s past threats to shut down the government if he doesn’t get funding for his wall but ultimately an extended shutdown in the run up to Christmas is in neither sides interest. And a lot of spending measures have already been approved so the scale of any shutdown will be small with little economic impact.
  • China’s Caixin manufacturing conditions index (Monday) will likely remain soft.
  • OPEC’s meeting on Thursday is likely to agree to production cuts designed to end the rout in oil prices since early October.
  • In Australia the RBA will leave rates on hold for the 26th meeting in a row. The RBA remains between a rock and a hard place on rates. Strong infrastructure spending, improving non-mining investment, a lessening drag from falling mining investment, strong export earnings and a fall in unemployment to 5% are all good news. But against this the housing cycle has turned down, this will act as a drag on housing construction and consumer spending via a negative wealth effect, credit conditions are tightening, wages growth remains weak, inflation is below target and share market volatility is highlighting risks to the global outlook which is a potential threat to confidence and export earnings. So yet again the RBA will remain on hold. Views remain that rates will be on hold out to second half 2020 at least with a rising risk that the next move will be a cut before a hike.
  • On the data front expect a continuing slide in home prices for November and a 1% decline in building approvals for October (both due Monday), trade data (Tuesday) to show a 0.2 percent contribution from net exports to September quarter GDP growth, September quarter GDP growth (Wednesday) to come in at 0.6% quarter on quarter or 3.3% year on year helped by solid net exports and public demand but soft consumer spending and dwelling investment and weak business investment, October retail sales to rise by 0.3% and the trade surplus to fall back to $2.9bn (both due Thursday).

Outlook for markets

  • Shares remain at risk of further short-term weakness, but it it likely to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.
  • Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit at a slower rate next year).
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • Having fallen close to the target of $US0.70 the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound and the Fed moves towards a pause on rate hikes. However, beyond a near term bounce the $A likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory. Being short the $A remains a good hedge against things going wrong globally.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

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Weekly Market Update – 16th November 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Risk off” returned to financial markets over the past week with most share markets falling and bond yields declining as last month’s worries returned, tech stocks came under renewed pressure and the continuing plunge in the oil price weighed on energy shares. US and Eurozone shares fell 1.6% over the week, Japanese shares lost 2.6% and Australian shares fell 3.2%, almost falling back to their October low with financial shares under strain again. Chinese shares were an exception and managed a 2.8% gain, but of course they have had a 31% decline from this year’s high. Copper and gold prices rose but the oil price continued its plunge with another 6.2% decline, and the iron ore price also fell. The $US fell on the back of relatively dovish comments from the US Federal Reserve (Fed) and this, along with strong Australian jobs data, saw the $A push above $US0.73.
  • It’s still too early to say we have seen the bottom in share markets. Put very simply there are three types of significant share market falls – corrections, with falls around 10%; “gummy” bear markets, with falls around 20%, but where the market is up a year later (like in 1998, 2011 and 2015-16); and “grizzly” bear markets, where a year after the initial 20% fall, the market is down another 20% or so (like in 1973-74, the tech wreck or the GFC). A grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession does not appear imminent, as the excesses that normally proceed recession (overinvestment, inflation surging, tight monetary policy) are not present on a significant enough scale. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls into the October lows) and it could still turn into gummy bear markets, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that left investors nervous, the rebound from late October was not particularly convincing, and many of the drivers of the fall are yet to be resolved.
  • However, there were three positive developments over the last week which added to the conviction that we are not going into a grizzly bear market. First, while Fed Chair Powell remains upbeat on the US economy and a December hike looks assured (for now), he is clearly aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of eight interest rate hikes and share market volatility, and he appears open to slowing the pace of interest rate hikes, or pausing at some point next year. The stabilisation in core inflation around 2%, seen lately, may be supportive of this. Overall, he now seems a lot more balanced than in early October when referring to rates going to neutral and beyond. Fed Vice-Chair Clarida delivered a very similar message to Powell in an interview two days later, reinforcing the impression that the Fed is open to softening its stance on rates.
  • Second, there have been more positive signs on trade. Talks between the US and China on trade have reportedly resumed “at all levels”, US Treasury Secretary Mnuchin and Chinese Vice-Premier Liu have spoken by phone, the China Daily has reported that China and the US have agreed to promote a bilateral relationship, China has sent a trade document to the US and President Trump has repeated that he is optimistic of a trade deal with China and that the US might put any further tariff increases on hold if there is progress in trade talks. All of this is on top of the Trump/Xi phone call a few weeks ago, and suggests that there was much more to it than just a pre-midterm election publicity stunt by Trump. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet at the G20 summit at the end of the month, but with Trump wanting to get re-elected, it is likely that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. And finally, for now at least, the US has held off on tariffs on automobiles. Of course, the market reaction to such positive developments has been relatively muted because investors are sceptical, given the failure so far this year of various US/China trade talks, but this just indicates there is all the more room for a positive response in markets if progress is actually made.
  • Finally, while the 27% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, ultimately it has the potential to extend the economic cycle as the 2014-16 plunge did (although it’s likely to be on a much smaller scale this time). Oil prices are short-term historically oversold and due for a bounce, but its increasingly looking like slower global demand than expected is a contributor to the price plunge along with US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil (which highlighted yet again that Trump doesn’t want to let anything damage US growth and weaken his re-election chances in 2020), rising US inventories, the rising $US, and the cutting of long oil positions. This means, while oil prices are unlikely to fall for as long, or as much, as they did in 2014-16 when they fell 75% (see below), they may stay lower for longer. This is bad for energy companies, but maybe not as bad for shale producers as in 2015, as they are now less geared and their break-even oil price has already been pushed down to $US50/barrel or less. And it’s less of a threat to the US economy, as energy investment is much smaller than it was in 2014. It will depress headline inflation (monthly US CPI inflation could be zero in November and December) and if it stays down long enough it could dampen core inflation. All of which may keep rates lower for longer. And it’s good news for motorists. For example, Australian petrol prices have plunged from over $A1.60 a litre a few weeks ago to now falling back to around $A1.30 in some cities, and prices could still fall further as the oil price fall flows through to the bowser with a lag. That’s a saving in the average weekly household petrol bill of around $A10.

Australian petrol prices versus Tapis oil prices

Source: Bloomberg, AMP Capital

  • Out of interest US energy production is continuing to surge.

Surging US energy production

Source: Bloomberg, AMP Capital

  • But a re-run of the 2014-16 75% oil price plunge is unlikely as, among other things, Organisation of Petroleum Exporting Countries (OPEC) spare capacity is much lower than it was then and they are already talking about cutting production, whereas back in 2015 Saudi Arabia initially refused to cut production and OPEC was in disarray.

OPEC spare capacity

Source: Bloomberg, AMP Capital

  • At times like the present it is good to have some comic relief and the Brexit mess is certainly providing that. Yes, the May Government and the EU have reached a draft agreement that would see the UK exit the EU, but remain in the single market with all its rights and responsibilities until a formal relationship is agreed. But no sooner than May’s Cabinet agreed to support it, various ministers started to resign (including the Brexit minister who presumably played a key role in the deal) begging the questions of whether May will survive, whether the deal will pass parliament, whether there will be a new election and maybe even another Brexit referendum. The bottom line is that it’s still too early to get upbeat on the British pound. The Brexit debacle should also make various Eurosceptic parties across Europe realise that if it’s this hard to work out how to get out of the EU it’s going to be even harder to get out of the Eurozone. Of course, investors should also realise that the Brexit mess is mainly an issue for UK assets for global markets as a whole, it’s not a big deal.

Major global economic events and implications

  • US economic data mostly remained favourable with solid growth in retail sales and manufacturing production, strong small business optimism, mixed but okay regional manufacturing conditions, continuing labour market strength and slightly slower than expected core CPI inflation of 2.1% year-on-year in October. In fact, the October CPI reading is consistent with the Fed’s preferred core private consumption deflator measure of inflation falling back to around 1.9% year-on-year. This is all consistent with the Fed continuing to raise rates for now, but at a “gradual” pace.
  • Eurozone GDP growth for the September quarter was confirmed at a relatively weak 0.2% quarter-on-quarter, or 1.7% year-on-year, but with the German economy actually contracting by 0.2%. There is clearly an economic, as well as a political, incentive for the German grand coalition government to agree a fiscal stimulus.
  • Japanese September GDP also contracted by 0.3% quarter-on-quarter but this looks to reflect payback after strong June quarter growth and the impact of natural disasters.
  • Chinese data for October was a mixed bag with soft readings for retail sales, money supply and credit growth, flat unemployment at 4.9%, but somewhat stronger readings for industrial production and investment, and continuing gains in home prices. The overall impression is that growth has slowed, but remains somewhere around 6-6.5% year-on-year.

Australian economic events and implications

  • Australian data over the past week provided another reminder that while the housing market is turning down, it’s not all doom and gloom for the Australian economy. In fact, jobs growth remained very strong in October, with full-time jobs growth dominating and unemployment remaining down at 5%, wage growth perked up a bit further in the September quarter and consumer confidence rose. All of these things are positive but not enough to justify an imminent interest rate hike as underemployment remains very high at 8.3%, wages growth has only really picked up because of a faster increase in the minimum wage and is still stuck around 2% year-on-year, consumer confidence is likely to be dampened as house prices continue to fall and business confidence has actually been trending down lately, and fell again in October.
  • So allowing for these things views remain that the Reserve Bank of Australia (RBA) won’t start raising interest rates until 2020 at the earliest, and given the housing-related downturn, there is a significant chance that the next move could turn out to be a rate cut although this would be unlikely before second half next year, as it will take a while to change the RBA’s relatively upbeat thinking on the economy and rates.

What to watch over the next week?

  • In the US, the focus is likely to be on business conditions Purchasing Managers’ Indexes (PMIs) for November to be released Friday which are expected to remain solid at around 55. Meanwhile, expect the NAHB housing market conditions index for October (Monday) to remain strong, housing starts (Tuesday) to bounce back a bit after a fall in September, existing home sales (Wednesday) to do the same and underlying durable goods orders (also Wednesday) to show modest growth.
  • Eurozone business conditions PMIs for November (Friday) will be watched for signs of improvement, or at least stabilisation, after a further fall last month.
  • Japanese headline inflation for October (Tuesday) is likely to show a rise to 1.4% year-on-year thanks to higher oil prices last month, but core inflation is likely to remain low at around 0.4% year-on-year. The manufacturing conditions PMI for November will be released Friday.
  • In Australia, a speech by RBA Governor Lowe on Tuesday will be watched for clues on the outlook for interest rates. Meanwhile, the minutes from the RBA’s last board meeting (also out Tuesday) are likely show that it remains relatively upbeat and still sees the next move in rates as most likely to be up, but that it remains in no hurry to move at present. Skilled vacancy data will also be released Wednesday.

Outlook for markets

  • Shares remain at risk of further short-term weakness, but it is likely to continue to see the trend in shares remaining up, as global growth remains solid helping drive good earnings growth, and monetary policy remains easy.
  • Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds, as the RBA holds and the Fed continues to hike.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at, or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • Having fallen close to the target of $US0.70, the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound. However, beyond a near-term bounce it likely still has more downside into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory, as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.
  • Eurozone shares fell 0.1% on Friday, but the US S&P 500 Index reversed early losses to close up 0.2%, helped by President Trump repeating that he is optimistic about a trade deal being reached with China, and Fed Vice-Chair Clarida echoing Fed Chair Powell’s more dovish comments from earlier in the week regarding the outlook for US interest rates. The positive US lead saw ASX 200 Index futures gain 17 points or 0.3% pointing to a positive start to trade for the Australian share market on Monday.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

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The Australian Parliamentary Review

The Australian Parliamentary Review showcases organisations considered as exemplifying ‘best practice’ in their given industry. The review submissions are used as a learning tool to the public and private sector, in particular to those in financial services.

The 2018 Finance Review was sent out to over 35,000 leading policymakers including members of the House of Representatives, Senators, Chief Executives, Managing Directors, Independent Financial Advisors, Executives at Government Agencies, Executives in Investment Banking, Retail Banking, Asset Management, Insurance.

FinSec Partners were honoured to have been invited to contribute in this, the inaugural issue published November 2018.

Please click here to read our submission.

Weekly Market Update 9th November 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets mostly rose over the last week, helped in particular by a favourable reaction to the US midterm elections. Chinese shares remained under pressure though. Bond yields continued to rise reflecting the “risk on” tone from investors and as the Fed showed no signs of pausing its rate hikes. Commodity prices were mixed though with oil falling further and metal prices down but the iron ore price continuing its ascent. While the $US rose slightly the $A got a boost from the RBA upgrading its growth forecasts.
  • The big surprise from the US midterm election was that there was no surprise! Unlike with Brexit and Trump’s election in 2016 the polls and betting markets were spot on! So why did shares rally? There are basically three reasons. First, while the Democrats now control the House it wasn’t the “blue wave” some had talked about as the GOP also increased its Senate majority. Which means while another round of tax cuts is unlikely the Democrats won’t be able to wind back Trump’s first round of tax cuts and it won’t be able to re-regulate the US economy either. Similarly, while the Democrats will likely harass Trump with investigative committees and maybe even impeachment proceedings they won’t get the 67 Senate votes necessary to remove him from office. (Unless of course Mueller or others can show he has done something really bad mind you Trump’s decision to sack Attorney General Jeff Sessions doesn’t inspire a lot of confidence on this front!). Second, just getting the midterms out of the way provides relief. Finally, US shares have rallied over the 12 months after each midterm since 1946 as the president refocuses on re-election. Trump is likely to do the same and this means doing nothing to weaken the economy and fixing the trade war with China sometime in the next six months.
  • In terms of the latter while Chinese President Xi Jinping in a speech in the last week made veiled criticism of Trump’s protectionism he also indicated ongoing tariff cuts on imports and a tightening in protection for intellectual property with China’s Vice Premier Wang indicating that China remains ready for negotiation on the trade issue. There is a long way to go here but it is likely that a deal will be made with China before the tariffs are allowed to cause too much damage to the US economy.
  • Global business conditions PMIs in October remained down from their highs earlier this year, but in aggregate they remain solid. No sign of a significant global economic downturn here. That said the global economy has become less synchronised with the rest of the world slowing relative to the US. A rising US dollar may help to reverse this a bit next year as its provides a competitiveness boost for the rest of the world relative to the US.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • US sanctions on Iran kicked in but the oil price is down 20% from its October high. So what happened? Basically a bunch of things happened: Iranian exports have already fallen as the sanctions were announced in May; the US granted sanction waivers on eight countries including China, Japan, South Korea and India; US inventories have been rising; and the market got all geared up going into the sanctions and so has been cutting long oil positions. This is good news for Australian motorists with petrol prices plunging from an average over $1.6 a litre a few weeks ago to now falling back to around $1.45 and prices could still fall another 5 cents or so as the oil price fall flows through to the bowser with a lag. However, don’t get too excited as the world oil market is now getting very tight with the Iranian sanctions suggesting that the rising trend is at risk of resuming.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

Major global economic events and implications

  • US economic data releases remained strong over the last week. The ISM non-manufacturing index remained very strong in October, job openings, hiring and quits remained solid in September and jobless claims remain ultra-low.
  • Meanwhile, the Fed made no changes to monetary policy but remains upbeat on the US outlook and continues to see gradual rate hikes as appropriate, which leaves it on track for another 0.25% rate hike next month. At this stage a December hike is only 74% priced in by the US money market and the market’s interest rate expectations over the next two years remain too dovish relative to the Fed’s dot plot expectations (by around 0.5%).
  • The US September quarter earnings reporting season has proven to be strong. 90% of S&P 500 companies have now reported September quarter earnings results with 82% beating on earnings against an average this decade of 75%, 60% beating on sales and earnings growth expectations for the quarter have now moved up to 27% which is 7 percentage points higher than expected going into the reporting season. Even excluding the impact of tax cuts profit growth is running around 18% in the US and compares to around 10% profit growth in the rest of the world – which partly explains why the US share market remains relatively strong.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • Japanese economic data was on the soft side with a fall in household spending in September, very weak machine orders and sluggish wage growth (despite a bit of excitement on this front a few months ago). The Ecowatchers sentiment index showed improved current conditions but a softer outlook.
  • Chinese growth in both exports and imports surprisingly accelerated to solid readings of 15.6% year on year (yoy) and 21.4%yoy in October suggesting little impact from tariffs and solid growth in domestic demand despite fears to the contrary. Survey data and the tariffs suggests the strength in exports won’t be sustained, but stronger imports may be reflective of stimulus measures. Meanwhile, inflation remained benign in October with core CPI inflation of just 1.8%yoy, so inflation is no constraint to further policy stimulus in China.

Australian economic events and implications

  • As expected the RBA left interest rates on hold again at 1.5% at its November Board meeting. But its forecast upgrades indicate somewhat greater confidence in the outlook. It could be too optimistic. The RBA’s latest Statement on Monetary Policy saw it revise its growth forecasts for this year to 3.5% (up from 3.25% previously), it still sees growth of 3.25% next year, it now sees unemployment falling to around 4.75% in 2020 (from 5% previously) and it continues to see wages and inflation moving gradually higher. Assessments are that the RBA is underestimating the threat posed by slowing growth in China, tightening credit conditions and a negative wealth effect as house prices continue to fall. As a result, in contrast to the RBA growth could slow to around 2.5-3% through 2019 which in turn will result in higher unemployment and keep wages growth and inflation lower for longer than the RBA is allowing. So, views remain that a rate hike is unlikely until late 2020 at the earliest and that a rate cut later next year can’t be ruled out. Out of interest its doubtful that even the RBA’s more optimistic 2019 forecasts would justify a rate hike next year as they only see wages growth getting up to a still anaemic 2.5%yoy and inflation rising to just 2.25%.
  • Australian data released over the past week was soft with a continuing slide in housing finance commitments, particularly to owner occupiers, a continuing loss of momentum in ANZ job ads and the Melbourne Institute’s Inflation Gauge showing both headline and underlying inflation remaining very weak over the last month.

What to watch over the next week?

  • In the US, October data for inflation and retail sales will be the main focus. Expect core CPI inflation (Wednesday) to remain stuck at 2.2%yoy and retail sales growth (Thursday) to remain strong at 0.5% month on month. The Philadelphia and New York regional manufacturing conditions surveys (Thursday) are likely to remain solid as is growth in industrial production (Friday). A speech by Fed Chair Powell (Thursday) will be watched closely for clues on the outlook for interest rates.
  • Japanese September quarter GDP growth (Wednesday) is expected to dip back into negative territory with a decline of 0.3% quarter on quarter resulting in annual growth of just 0.4% due to weakness in consumer spending.
  • Chinese activity data for October due for release Wednesday is likely to show a slight pick up in retail sales growth to 9.3%yoy and investment growth to 5.5% but growth in industrial production unchanged at 5.8%. Data on bank lending and credit will also be released.
  • In Australia the focus will be on wages growth and jobs data. September quarter wages data due for release on Wednesday is expected to show wages growth of 0.6% quarter on quarter with a 3.5% rise in the minimum wage providing a boost but partly offset by a reduction in Sunday penalty rates. This should see annual wages growth rise to 2.3%yoy from 2.1%. Bear in mind though that were it not for the acceleration in the minimum wage, wages growth would be stuck at 2%yoy so underlying wages growth is likely still very weak. October jobs market data (Thursday) is expected to show a 15,000 gain in employment but unemployment remaining unchanged at 5%. The jobs report is always a bit statistically noisy but this one may be more so given the impact of a changing survey sample that seems to be resulting in more variation than normal. The NAB business conditions survey will be also be released Tuesday and consumer confidence data will be released Wednesday.

Outlook for markets

  • Shares remain at risk of further short-term weakness, but it’s likely to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.
  • Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • Having fallen close to the target of $US0.70 the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound. However, beyond a near term bounce it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Weekly Market Update – 2nd November 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets bounced back over the past week helped by good US earnings results and a lessening of trade war fears following a phone call between President Trump and President Xi Jinping. US shares rose 2.4%, Eurozone shares gained 3%, Japanese shares rose 5%, Chinese shares rose 3.7% and Australian shares gained 3.2%. Reflecting the risk on tone and a strong US jobs report for October bond yields rose. While the copper price rose, the iron ore price was flat and oil fell 6.6%. Although the US$ was little changed the risk on tone along with a larger than expected trade surplus saw the A$ rise to around US$0.72.
  • A poor October but have we seen the bottom in the share market rout? October was a bad month for share markets with global shares losing 6.8% in local currency terms which was their worst month since August 2011 and Australian shares losing 6.1% which was their worst month since August 2015. The good news though is that markets have had a good bounce from their lows of around 3%. Shares had become technically oversold and were due for a bounce. It’s possible that following top to bottom falls of 10% for global shares, 11% for Australian shares and 21% in emerging markets we have now seen the low but with risks remaining around US interest rates, the US/China conflict, tech stocks, emerging countries, the Italian budget and the US midterm elections in the week ahead it’s impossible to be definitive so there could still be another leg down.
  • However, while it’s impossible to say for sure whether we have seen the bottom in share markets there are reasons to be optimistic beyond the near-term uncertainty.
    • First, investor sentiment has hit very bearish extremes which is positive from a contrarian view.
    • Second valuations have improved with many markets now in cheap territory, including Australian shares which have seen their forward PE fall from around 16 times to 14 times.
    • Third, US shares tend to rally once the midterm elections (to be held Tuesday) are out of the way and global shares would follow.
    • Finally, views remain that what we have seen or may still see is a correction or a mild bear market at worst (like 2015-16’s circa 20% fall that was quickly reversed) rather than a deep bear market like the GFC as the conditions for a US recession that invariably drive major bear markets are not in place: US monetary policy is not tight and the sort of excesses that normally precede recessions in terms of inflation, spending and debt are not present.
    • If correct, then cyclical shares (like autos and energy) trading on very low PEs of 10 times or less are offering good investment opportunities.
  • The US and China getting closer to a trade deal according to President Trump? At last Trump and Xi are talking, Trump says he thinks “we’ll make a deal with China” and that “a lot of progress has been made” and the US is reportedly drafting a deal for Trump and Xi to consider signing at the G20 meeting in late November. This is all very positive and sooner or later a deal will likely be made before the economic pain gets too great. But we have seen several episodes of false hope on this front before only to see the conflict worsen again, both sides are still a long way apart, we have not heard comments from China matching Trumps and Trump’s comments may be aimed at boosting support for his party ahead of the midterms. So, it’s premature to get too excited.

Major global economic events and implications

  • US economic data remains strong with solid growth in September personal spending, an 18 year high in consumer confidence, still strong business conditions surveys (albeit the ISM manufacturing index fell back from its very high September reading) and continuing strong jobs data. The October jobs report was particularly strong with payrolls up by 250,000, unemployment remaining very low at 3.7% as participation rose and wages growth (as measured by average hourly earnings) moving up to 3.1% year on year, its highest since 2009, as a decline in wages last October dropped out of the annual calculation. As can be seen in the next chart though, despite very low unemployment the rise in wages growth remains gradual and we are a long way from the 4% plus growth rate that preceded the last three recessions.
  • Meanwhile, US core inflation remained at 2%yoy in September and growth in employment costs in the September quarter was unchanged at 2.8%yoy and rising productivity growth is helping keep growth in unit labour costs low. All up the Fed remains on track to continue tightening, with the next move to be in December, but in the absence of a significant inflation threat it can continue to do so gradually.
  • Yet again the US September quarter earnings reporting season is proving to be strong. With roughly 75% of results now in 83% have beaten on earnings, 61% have beaten on revenue and earnings growth expectations for the quarter have now moved up to 26% (up from 20% a month ago). All of which is seeing earnings match their June quarter high. Of course, the uncertain environment has seen investors latch on to those companies who have disappointed resulting in outsized share price declines relative to those who have exceeded expectations.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • Eurozone data was a bit disappointing with a further slowing in GDP growth in the September quarter, confidence measures continuing to fall (albeit they remain high) and unemployment unchanged at 8.1%. Core inflation rose to 1.1%yoy but it’s still way below the ECB’s 2% target. While the ECB is probably on track to end QE next month, it won’t start raising rates till 2020, quantitative tightening is years away and it may even do another round of providing cheap funding to banks (LTRO) given the slowing in growth.
  • The poor performances of the German grand coalition parties at state elections in Bavaria and Hesse do not signal a threat to the Euro. Merkel has confirmed she will step down as Christian Democrat Union party leader and won’t seek re-election as Chancellor in 2021. However, several points are worth noting. First, comments by Social Democrat Party leader Nahles indicate that the grand coalition is not under immediate threat. Second, Germany’s budget surplus and falling public debt indicate plenty of scope to provide needed fiscal stimulus which would be positive for Germany and the Eurozone and provide an electoral boost for the grand coalition partners. There is also the chance that the CDU will do what John Howard did in response to One Nation and adopt a tough stance on immigration to neuter the Alternative for Deutschland’s appeal. Thirdly, German Euroscepticism is not on the rise. In fact, support for the Euro in Germany has risen to 83% and it was support for the pro-Euro Greens that surprised in Bavaria and Hesse, not support for the AfD. Finally, a new election is unlikely as both the CDU and SPD have seen a loss of support, so they aren’t going to support an early election.
  • Japanese data was mixed with strong jobs data (helped by a declining workforce) but weak industrial production. As expected the Bank of Japan remained on hold and monetary tightening remains a long way off.
  • China PMI’s slowed further on balance in October highlighting the downside risks to growth. Consistent with this the past week’s Politburo meeting signalled greater urgency in combating the threats to growth and that even more policy stimulus is on the way.
  • The combination of continuing US economic strength relative to Europe, Japan and China points to ongoing upwards pressure on the $US (notwithstanding the scope for a short-term fall as excessive long positions are unwound) and in US bond yields relative to bond yields in other countries.
  • Far right Jair Bolsonaro’s victory in the Brazilian presidential election is a short-term positive for Brazilian assets and pushed Brazilian shares to a record high, but maybe not in the long term. A right-wing Bolsonaro presidency will boost business confidence and allow pro-business policies like corporate tax cuts and reduced regulation. But as a populist without a landslide victory margin he lacks a mandate to do much about Brazil’s high public debt and unsustainable pensions. So, while there may be a short-term boost for Brazil, long term problems will likely remain.

Australian economic events and implications

  • Australian data released over the last week highlighted the cross currents currently impacting. On the negative side the trend remains down in building approvals, credit growth remains soft, retail sales were weaker than expected in September and rose just 0.2% in real terms in the September quarter and home prices continued to slide in October posing an ongoing threat to consumer spending. Meanwhile underlying inflation as measured by the trimmed mean and weighted median fell to 1.7%yoy in the September quarter and is just 1.3%yoy using a US core inflation measure.
  • On the positive side the trade surplus came in far stronger than expected in the September with upwards revisions to previous months. While this was mainly driven by higher prices net exports look like providing a positive contribution to September quarter GDP growth and another rise in the terms of trade in the June quarter will provide a boost to national income. All of which indicates that trade along with an approaching end to the mining investment slump, rising non-mining investment and surging infrastructure spending will help offset the drag on growth from the declining housing cycle.
  • Our view remains that home prices have more downside over the next two years as tightening credit conditions, rising unit supply, lower foreign demand, the prospect of reduced negative gearing and capital gains tax concessions under a Labor government impact and as falling prices impact investors’ expectations. Sydney and Melbourne prices are likely to continue falling 20% peak to trough and national capital city average prices falling around 10% from peak to trough.
  • On balance assessments remain that Australian economic growth will fall back into a 2.5-3% range, inflation will remain lower for longer than the RBA is allowing for and so an RBA rate hike is unlikely until late 2020 at the earliest. In fact, the threat to growth and inflation from falling home prices indicates the next move could in fact turn out to be a rate cut, but that’s a second half 2019 story at the earliest because with unemployment at 5% and GDP growth recently surprising on the upside the RBA will need to see broader signs of softness to consider cutting interest rates and that will take time. So, there is no prospect of imminent RBA rate cuts “rescuing” the housing market.

What to watch over the next week?

  • In the US, the main focus is likely to be on the midterm Congressional elections on Tuesday where polls and betting markets point to the Democrats taking control of the House but Republicans retaining control of the Senate. Such an outcome should already be factored into financial markets, but it may create increased uncertainty about the impeachment of Trump and policy direction. While a Democrat House may attempt to bring impeachment charges against Trump its most unlikely to get the 67 Senate votes required to remove him from office and while a Democrat House will likely prevent another round of Trump tax cuts it won’t be able to roll back already legislated tax cuts and won’t change Trump’s policies around deregulation and tariffs. The Fed (Thursday) is expected to acknowledge various risks to the outlook around trade, emerging markets and recent financial turbulence but indicate confidence in its base case of continuing solid growth and low unemployment and that continuing gradual rate hikes remain appropriate with the next hike on track for December. On the data front the non-manufacturing ISM for October (Monday) is likely to slip back to a still very strong reading of 60, job openings and hiring (Tuesday) are likely to remain strong and core producer price inflation (Friday) is expected to remain at 2.5% year on year.
  • Chinese October trade data (Thursday) is likely to show a slowing in export growth to 12% year on year (from 14.5%) and import growth to around 10%yoy (from 14.3%) and consumer price inflation (Friday) is expected to remain around 2.5%yoy.
  • In Australia, the RBA will yet again leave interest rates on hold when it meets Tuesday. While recent news on unemployment coming on the back of news of above trend economic growth is good, the slide in home prices risks accelerating as banks tighten lending standards which in turn threatens consumer spending and wider economic growth, and inflation and wages growth remain low. As a result, it would be dangerous to raise rates and unlikely to see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. The RBA’s Statement on Monetary Policy (Friday) is likely to raise its near-term growth forecasts and lower its unemployment and underlying inflation forecasts a bit but won’t signal any imminent move on interest rates. It will be mostly watched for its commentary around risks to house prices & credit growth and inflation & wages. ANZ job ads data will be released Monday and housing finance data (Friday) will likely show continuing weakness in lending, particularly to investors.
  • Finally, US sanctions on Iran will kick in on Monday potentially seeing a further threat to global oil supply at a time when the global oil market is ready quite tight. However, the sanctions should already be reflected in markets as they were announced in May and since then Iranian oil exports have fallen from 2.4 million barrels per day to 1.6 mbd. And reports that the US has agreed to waive sanctions against eight countries including Japan, India, South Korea and even China so they can keep buying Iranian oil, highlight that the US does not want to see oil prices driven up. Since its October 3rd high, the oil price has fallen 17%.

Outlook for markets

  • Shares remain at risk of further short-term weakness, but it’s likely to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.
  • Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • Having fallen close to the target of $US0.70 the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound. However, beyond a near term bounce it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Weekly Market Update – 26th October 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Most major share markets fell over the past week as worries about the global growth outlook continue. US shares fell 3.9%, Eurozone shares fell 2.6%, Japanese shares lost 6% and Australian shares fell 4.6%. Chinese shares rose 1.2% though thanks to stimulus measures. Bond yields fell on safe haven demand as is usually the case through significant share market falls and while iron ore prices rose, oil and metals fell. The $US rose and this weighed on the $A.
  • The share market correction continues and, as is often the case in significant falls, is morphing into broader concerns about global growth. From their recent highs to recent lows global shares have fallen about 9% and Australian shares around 11%. It’s still too early to say we have bottomed but views remain that it’s not a major bear market. The worry list of rising US interest rates, the US/China conflict, a correction in tech stocks, problems in the emerging world, the US midterm elections, the Italian budget and signs of a peak in global economic and profit growth is continuing to drive shares down and as we have seen in the past this is morphing into another global growth scare with investors latching onto companies that had negative profit news in the US and declining Eurozone PMIs. Shares are technically oversold again and so may see a bounce, but a circa 20% top to bottom fall in share markets as occurred through the 2015-16 global growth scare is possible and this would likely require some sort of global policy reaction to turnaround, e.g. the Fed hitting the pause button and the ECB extending QE. Of course, China is already easing.
  • But the following key points are worth bearing in mind:
  1. Corrections are normal. Since 2012 both global and Australian shares have seen multiple pullbacks ranging from 7% to 20%. See the next chart.Source: Bloomberg, AMP Capital
    Source: Bloomberg, AMP Capital
  2. The main driver of whether we see a correction or even a mild bear market (say a 20% fall) as opposed to a major bear market like the GFC is whether we see recession in the US. Right now this stil looks unlikely (even though the growth rate may have peaked) as we haven’t seen the sort of build-up in excess that precedes such a US recession. Don’t forget that share markets often overreact to risks as highlighted by the old Paul Samuelson saying that “share markets predicted 9 of the last 5 recessions”.
  3. Selling shares after a big fall just turns a paper loss into a real loss.
  4. When shares fall in value they become cheaper and offer better return prospects so in this sense pull backs are good.
  5. While the value of shares has fallen dividends have not and so if it is income you are after this has not changed if you have a well diversified portfolio. In fact, the grossed up dividend yield on Australian shares is now around 6%.
  6. Finally, to be a successful investor you need to keep your head and that gets hard in times like the present when negative news reaches fever pitch. So it’s best to turn down the noise.
  • There is just one other thing worth mentioning. October is known for share market volatilitySometimes it’s referred to as a bear killer given that in the US it often sees a share fall and then a rebound. But the point is that the share market traditionally strengthens through November and December in the US (and December in Australia). This is particularly the case in years of US midterm election (which is the second year of the US presidential term) particularly once the election uncertainty is out of the way.

Major global economic events and implications

  • US economic data was a bit mixed. Home sales data remained weak consistent with the softness seen in other housing activity indicators lately but home prices are continuing to rise, durable goods orders were okay, business conditions PMIs rose in October and jobless claims remain ultra-low. September quarter GDP growth came in slightly better than expected at 3.5% annualised. Growth in final demand was a strong 3% annualised driven by very strong consumer spending and public demand but offset by soft investment and housing. Growth is likely to slow a bit further in the current quarter but there is no sign of an impending recession.
  • At the half way point of the US September quarter profit reporting season overall results have been good with 82% of results beating on earnings, 58% beating on revenue and earnings growth expectations moving up to 24% year-on-year. However, the level of earnings are down from the June quarter and the uncertain environment has seen investors latch on to those companies who have disappointed resulting in outsized share price declines relative to those who have exceeded expectations.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • The ECB made no changes to monetary policy with none expected and appeared to play down recent softer data. It remains on track to end QE in December, but it did refer to the possibility of using another round of cheap bank financing (LTROs if needed) and rate hikes still look to be a long way off. Meanwhile, Eurozone business conditions PMIs fell again in October albeit to a still reasonable 52.7 but adding to concerns that Eurozone growth is continuing to slow.
  • The PMIs across the G3 are shown below. In short, the US is tracking sideways, Japan is possibly moving up and only Europe is seeing a downtrend. So no sign of a major developed country growth downturn well at least not yet anyway!

Source: Markit, Bloomberg, AMP Capital

Source: Markit, Bloomberg, AMP Capital

  • Details of personal tax cuts were announced in China and look like being bigger than expected at 0.5% of GDP.

Australian economic events and implications

  • It was a quiet week on the data front in Australia, but what was released was soft. The CBA preliminary business conditions PMI fell to 51 for October, down from 58 eighteen months ago and skilled vacancies fell for the sixth month in a row.

What to watch over the next week?

  • In the US, the focus will be back on jobs with October payroll data to be released Friday expected to show solid jobs growth of 190,000, unemployment remaining at 3.7% and an increase in wages growth to 3.1% year-on-year. Meanwhile consumer data (Monday) is expected to show a solid rise in real consumer spending and the core private consumption deflator inflation remaining at 2% year-on-year, home prices are likely to show further gains and consumer confidence is likely to remain high (both Tuesday), September quarter growth in employment costs (Wednesday) is likely to remain at 2.7% year-on-year, the October ISM index (Thursday) is likely to remain strong at around 59 and the trade deficit (Friday) is likely to get a bit worse. September quarter earnings reports will continue to flow.
  • Eurozone September quarter GDP data due Tuesday is expected to show moderate growth of around 0.3% quarter-on-quarter or 1.8% year-on-year, unemployment is likely to have remained at 8.1% in September and core inflation for October is likely to have edged up to 1% year-on-year (both due Wednesday).
  • Japanese jobs data (Tuesday) are likely to remain strong but industrial production (Wednesday) is expected to be soft.
  • Both the Bank of Japan (Wednesday) and the Bank of England (Thursday) are expected to leave monetary policy on hold.
  • Chinese PMIs for October (Wednesday & Thursday) will be watched for signs of further slowing in growth.
  • In Australia the focus will be on September quarter consumer price inflation data (Wednesday)which is expected to show headline inflation of 0.4% quarter-on-quarter or 1.9% year-on-year with higher fuel prices and tobacco excise only partly offset by higher childcare rebates and lower electricity and gas prices. Underlying inflation is likely to remain subdued at 0.4% quarter-on-quarter or 1.9% year-on-year. Meanwhile, expect a 3% bounce back in building approvals (Tuesday) after their plunge in August, continued moderate credit growth (Wednesday), CoreLogic data for October (Thursday) to show a further decline in home prices, the trade surplus (also Thursday) to fall slightly and September retail sales (Friday) to show growth of 0.2%. Business conditions PMIs will also be released Thursday.

Outlook for markets

  • We continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, the risk of a further short-term pull back is high given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and election uncertainty add to the risks around Australian shares.
  • Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • While the $A is now fallen close to the target of $US0.70 it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Labor’s franking policy is a ticking bomb for all super funds

The Australian Labor Party (ALP) proposal to limit cash refunds of franking credits will clearly impact many pension phase SMSFs, but we believe it also has the potential to impact many other superannuation funds.

In this paper, we build a model of the key variables which determine whether a superannuation fund is likely to lose refunds of net franking credits under the ALP proposal. Our model is consistent with and helps explain an article in The Australian which reported that $309 million in franking credit refunds were paid to over 2000 APRA-regulated superannuation funds, including 50 (out of a total of 240) large APRA funds, in 2015-16, impacting 2.6 million member accounts.

The ALP proposal

On 13 March 2018, the ALP announced a proposal to abolish the net refunding of franking credits to Australian investors other than for charities and endowments. The initial proposal was expected to impact 1.17 million individuals and superannuation funds and generate $59 billion in government savings over 10 years.

On 26 March, the ALP revised their proposal in the light of significant public criticism. Direct investments by welfare pensioners (part and full aged, disability and other Centrelink pensions) were also excluded, ensuring 306,000 pensioners will continue to receive cash refunds. SMSFs are also exempt if they had at least one welfare pensioner before 28 March 2018. Our understanding is this exemption does not apply to other superannuation funds.

Which super funds are affected?

Note that franking credits themselves are not abolished. Australian investors can continue to use franking credits to offset income tax payable and for a superannuation fund, contributions tax payable.

The ALP believes the main superannuation funds impacted by this proposal will be pension phase SMSFs. However, ATO taxation data (as quoted in The Australian) and analysis of APRA statistics show that many APRA-regulated funds will likely also be affected. This implies the impact may be far broader than initially predicted.

Analysis of key drivers (to losing franking credit refunds) and their potential magnitude.

Franking credits will be lost if total tax payable by a superannuation fund is less than franking credits received. Tax payable is a function of tax on investment earnings on the accumulation portion of a fund, as well as contributions tax payable on normal contributions. The percentage of pension phase assets, the level of taxable earnings and the level of contributions will vary from fund to fund and may vary from year to year.

For example, taxable investment earnings will be largely determined by the state of investment markets. The level of franking credits can also vary between funds and over time. We base our estimate of the typical impact of imputation assuming an average SMSF exposure to Australian shares based on March 2018 ATO statistics of 31%, and the franking credit yield of the S&P/ASX200 Index which has averaged approximately 1.5% pa over the 10 years to December 2017.

Investors with higher allocations to Australian shares, or allocations to higher-yielding Australian shares could earn even higher levels of franking credits. They stand to lose more if franking credit refunds are denied. In our analysis we double the level of franking credits in our high-franking scenario.

Loss of refunds depends on pension v accumulation and franking levels 

We then varied the proportion of a superannuation fund devoted to pension and accumulation as well as the levels of franking credits, contributions tax and taxable income [1].

Figure 1 illustrates the outcome of our sensitivity analysis varying the proportion of pension assets and the level of franking credits.

Clearly funds with 100% pension assets will lose all their franking credits. We estimate that for a typical level of franking credits, funds with 70% or less in pension assets should not expect to lose franking credits. For funds with double the typical level of franking credits, this number drops to 50%.

If accumulation phase (or 15% taxed) members aren’t paying contributions and therefore aren’t paying contributions tax, funds are more likely to lose franking credits. Funds with higher levels of taxable income would be less likely to lose franking credits. Higher levels of taxable income are usually associated with strong markets or the realisation of capital gains.

The number of funds impacted will vary from year to year in response to the level of investment returns. When investment returns are very low or negative, tax on investment earnings will also be low, increasing the chance that the value of franking credits received by a fund exceeds tax payable.

Accordingly, when investment returns are low, a higher percentage of superannuation funds may miss out on some or all of their franking credits, exacerbating the low investment returns.

The winners and the losers

We find that the loss of franking credits is likely to be positively related to:

1) The percentage of assets in pension, with maximum loss at 100% pension assets, but losses starting to occur from 50% to 70% pension assets

2) The level of franking credits generated by the underlying assets (the more franking credits generated the more likely you are to lose some).

The loss will be negatively related to:

3) The level of taxable income generated from the underlying assets (with losses in franking credits more likely in periods of weak investment markets meaning investors may receive a double hit to returns)

4) The level of contributions and contributions tax payable by accumulation members (the less contributions tax payable the more likely a fund loses franking credits).

Our model explains why The Australian reported that 50 large APRA-regulated superannuation funds (out of 240) received net refunds of franking credits in the 2015/16 tax year.

Mature funds may suffer most from loss of refund

Our scenario analysis finds that any relatively mature superannuation fund, where maturity is defined by the percentage of member balances in pension mode, may be in a net franking credit refund position.

While many SMSF members have been vocal critics of this proposal, we believe members of other superannuation funds probably don’t even know they receive franking credit refunds (they are not reported on investment summaries) and probably won’t know whether they might miss out on franking credits should this proposal be enacted.

Finally, we believe that as the superannuation industry matures as a whole, as more members migrate to pension status, the loss of franking credit refunds will impact a growing number of people, be they members of government, industry, retail or SMSFs.

As such we believe this proposal may represent a ticking time bomb for the whole superannuation industry.

This article was authored by Dr Don Hamson. Dr Don Hamson is Managing Director at Plato Investment Management Limited. This article is for general information only and does not take account of any person’s financial circumstances.

1. We vary pension proportions in rests of 10% from 0% to 100%. For franking credits we used a normal level of franking credits as discussed above and then we doubled the level of franking credits to reflect a higher exposure to Australian shares and/or a higher franking yield from the Australian portfolios. We use two levels of contributions – none (reflecting for instance pension phase SMSF with greater than $1.6 million balances per member) and 7% of the accumulation balance which attract contributions tax of 15%. Similarly, we varied the taxable income level which can be caused by (for instance) realisation of capital gains. Full details of our assumptions are available on request.

Weekly Market Update – 19th October 2018

Weekly Market Update

Investment markets and key developments over the past week

  • While share markets had a great bounce from oversold levels early in the last week they fell back to varying degrees as worries around US interest rates, the US trade conflict with China, tech stocks and Italy’s budget deficit continued along with escalating tensions with Saudi Arabia regarding a missing journalist. This left share markets mixed with Eurozone & Australian shares up, US shares little changed and Japanese & Chinese shares down. Bond yields rose slightly in the US but fell in Germany and Australia. While the oil price and metal prices fell, gold and iron ore rose. Despite a rise in the US dollar the Australian dollar was little changed.
  • Bull markets are characterised by relatively steady gains punctuated by occasional sharp pull backs as investors periodically cut their long positions on the back of adverse news events. Views are that recent falls represent a correction, but of course it remains premature to conclude that we have seen the bottom given the worry list around US interest rates, trade, oil prices, etc.
  • The minutes from the Fed’s last meeting provided a reminder that the median Fed official as per the Fed’s dot plot expects to gradually raise the Fed Funds rate to around 3.4% over the next two years which is just above what it regards as “neutral” (ie around 3%). Market expectations for a hike to 2.8% over two years remain too dovish indicating that bond yields still have more upside, but as we have seen since yields bottomed in 2016 this will likely come in fits and starts.

Source: US Federal Reserve, Bloomberg, AMP Capital

Source: US Federal Reserve, Bloomberg, AMP Capital

  • As expected the US Treasury refrained from naming China as manipulating its currency, but this does not mean the trade conflict is about to ease up. Such an outcome was to be expected because the Renminbi does not meet all the US Treasury criteria to be defined as being “manipulated” – yes, China has a large bilateral trade surplus with the US, but its overall current account surplus is small and so too is its foreign exchange intervention. That said the report was critical of China and an “increasing reliance on non-market mechanisms” and so the US may still name it for manipulating next year. So one less thing to worry about for now. But there is still no sign of any resolution on the trade conflict with further escalation still likely.
  • US/Saudi tensions over the murder of a journalist pose a new risk and could easily get a lot worse before it gets better, but ultimately it’s doubtful Trump or Saudi Arabia will sacrifice the US trade relationship with Saudi Arabia (given the threat to oil prices) or that Saudi Arabia will counter-retaliate to the extent that it adversely affects US support for it against Iran.
  • And something completely different – is the “gig economy” just imagined? The term sounds cool and gets bandied around to explain things like low wages growth, but its doubtful it really exists. As the RBA’s Alex Heath pointed out in the last week casual employment (ie workers without sick leave and holiday pay) has been around 20% of the workforce since the 1990s and the share of independent contractors has fallen over the last decade. And in the US the share of self employed in total employment has fallen from 14% to 6% over the last 70 years and workers are in their jobs for longer than 30 yrs ago. So, there is not a lot of evidence of the gig economy.

Major global economic events and implications

  • US economic activity data was mostly strong. Housing starts fell as Hurricane Florence impacted but strength in the NAHB home builders’ conditions index points to a rebound. Retail sales were weaker than expected in September but record high job openings and very strong hiring points to ongoing labour market strength which should support consumer spending. Industrial production rose solidly in September and regional manufacturing conditions indexes remained strong in October. And the US leading indicator for September continues to point to strong growth and jobless claims remain ultra-low. Meanwhile, the September quarter profit reporting season is off to a strong start with 87% of results so far exceeding profit expectations and 65% beating on revenue. That said only 75 S&P 500 companies have reported so far. But profits look like they will yet again beat market expectations for a 21% year on year rise and come in around 24%.
  • On the political front in Europe, the details of Italy’s budget plans were not as bad as fearedreducing the risk of a full speed head on with the European Commission and the Christian Social Union’s loss in Bavaria was not as bad as feared taking a bit off pressure off Chancellor Merkel. So, no Euro disaster brewing on either front.
  • UK Brexit uncertainty continues with the Irish border remaining a sticking point. The risk of a no deal Brexit (which would probably knock the UK into recession), a new election or another referendum is significant, but some sort of last-minute deal that punts off details for a future resolution remains the most likely scenario. Its hardly ever that such deals are resolved ahead of when they really need to be! Its too early to get bullish on the British pound though.
  • Chinese economic growth slowed in the September quarter with GDP growth slowing to 6.5% year on year and monthly data coming in mixed with weaker industrial production and credit growth but stronger retail sales and investment and lower unemployment. The slowdown reflects a crackdown on shadow banking and tariff uncertainty. While it’s consistent with forecasts for Chinese growth to slow to 6.5% this year, the trade threat suggests the risks are still on the downside suggesting that further policy stimulus is likely. Meanwhile falling producer price inflation and core consumer price inflation of just 1.7% year on year provide no barrier to further policy stimulus.

Australian economic events and implications

  • Another confusing jobs report in Australia – but its mostly strong. The September jobs report was confusing with soft employment growth but continuing strength in full time jobs and a sharp fall in unemployment to 5%. There are good reasons to be a bit sceptical about the plunge in the unemployment rate: sample rotation looks to have played a role and monthly jobs data is known for volatility. That said jobs growth running around 2.3% year on year is still strong, leading jobs indicators are still solid and its hard to deny the downtrend in unemployment. So, the RBA can rightly feel happy that this is going in the right direction. Against this though the US experience has been that unemployment will need to fall a lot further to spark stronger wages growth, and the combination of unemployment and underemployment remains very high in Australia at 13.3% compared to 7.5% in the US.

Source: CoreLogic, AMP Capital

Source: ABS, Bloomberg, AMP Capital

  • More broadly there seems to be a tussle in Australia between booming infrastructure spending, improving business investment, bottoming mining investment and falling unemployment on the one hand versus falling home prices, peaking housing construction, uncertainty around consumer spending, high underemployment and weak wages growth on the other. The outcome of which is likely to be neither a growth boom nor bust but rather constrained growth and the RBA continuing to leave interest rates on hold out to 2020 at least.

What to watch over the next week?

  • In the US, GDP data (Friday) will likely show that economic growth slowed in the September quarter to a 3.2% annual pace from 4.2% in the June quarter. June quarter growth was inflation by a bounce back from the seasonally weak March quarter and Hurricane Florence is also likely to have dampened September quarter growth so underlying growth is probably running around 3.5%. In other data, expect a further increase in home prices but a slight fall in new home sales (both Wednesday), October business conditions PMIs (also due Wednesday) to be solid, underlying durable goods orders to rise but pending home sales to fall (both Thursday). The flow of September quarter earnings reports will also pick up.
  • The European Central Bank is not expected to make any changes to monetary policy at its meeting on Thursday – having already scaled back its quantitative easing program this quarter and looking on track to end it in December. Its expected to leave the impression that interest rate hikes are still some way off probably not until 2020. Meanwhile, business conditions PMIs for October due on Wednesday are likely to have remained solid at around 54.
  • In Australia, it will be a quiet week on the data front, with only skilled vacancy data due Wednesday. There may be more interest on the political front though with the Liberal Partys loss of the Wentworth by-election. However, its should still be able to govern with the help of a conservative cross bencher.

Outlook for markets

  • We continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, the risk of a further short-term correction is high given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around Australian shares.
  • Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed hikes.
  • Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
  • National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices are at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • While the $A is now fallen close to targets of $US0.70 it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

Source: AMP CAPITAL ‘Weekly Market Update’

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Volatile Markets: A FinSec Comment

Global shares had a bumpy couple of weeks, as strong economic data and corporate earnings were offset by geopolitical concerns. Most major markets had a positive start to the week as investors regained their composure after last week’s sharp sell-off, with many indices posting their largest one-day rallies since March.

What caused the sharp sell-off?

The main reason underpinning the pullback was a response to concerns that rising interest rates (increasing bond yields) in the U.S. would cause a national or global slowdown.

This compounded with rising US – China trade tensions and other macro-economic news from around the world caused the market to ‘connipt’.

The obvious question is, what now?

Should inflation and wages in the U.S. surprise on the upside then the Fed may be forced to move rates more aggressively, this would definitely not play out well for equity markets. We continue to monitor risk and retain our view that whilst a cautious stance is warranted, we do not expect “the sky to fall” anytime soon. What we do expect is a choppy period of consolidation as markets come to terms with the normalisation of rates in the US.

If you have any questions regarding the recent market developments or your portfolio positioning, please contact your adviser.

For more regular updates please click here to ‘opt-in’ to receive our weekly market update.

Good People Doing Bad Things – How Did We End Up Here?

It is a story that has made news headlines the world over. A story about culture and greed impairing the judgement of people who should have known better. While both sides of politics have been very vocal in the wake of Hayne’s interim report, no one has touched the vexed question of how did we end up here?  

The impact on the victims has been devastating. The behaviour of the financial services community despicable and unforgivable. The viewing has been a mesmerising blend of ‘can’t watch but can’t look away’.

But to understand how we got here we need to look back nearly 30 years to the remarkable and visionary reforms of the Hawke/Keating government. That is, not at any level to lay blame at their feet but to point to a moment in time where the first piece of a complex puzzle was laid. A puzzle that through the next 25 years would gather a trifecta of seemingly unrelated circumstances to form what has become the tsunami that is now known as the Hayne Royal Commission into Misconduct in Banking and Financial Services.

 The Rise and Rise of the Big 4

Through the late 1980s and early 1990s, including the “recession we had to have” Hawke and Keating, followed later by Howard and Costello introduced reforms that led to Australian Banks becoming the most robust in the world. Reforms that would combine with the rise of China to open up the economy to what has now become 28 years of consecutive economic growth.

Throughout this period the market capitalisation of these banks has increased ten-fold which given that they occupy 4 of the top 10 holdings in almost every Australian superannuation fund has meant that every working Australian has benefited profoundly from their unmitigated success.

Forward to 2008 and the GFC. The worlds banks imploded under the weight of the subprime crisis and the freezing up of the credit markets. Bear Stearns and Lehman Bros were the high-profile casualties but there were hundreds of others. Australia was not immune. St George lurched into Westpac, Bankwest was rescued by CBA and Suncorp was saved by the timing of the government guarantee. But our big 4 banks prevailed, in-fact before long they were stronger.

We were applauded the world over for the way that our economy survived the worst economic crisis since the 1930s depression with barely a flesh wound. There are those that claim dumb luck, but the strength and management of our big banks were in no small way responsible for Australia dodging a bullet.

To this end, over 25 years Australia’s big 4 banks had developed ‘hero’ status. “Best in the world”, ”pillars of strength and resilience”. Their leaders were held on pedestals and retirees dined out on their ever-increasing flows of franked dividends.

The Mutation

Another of Keating’s great reforms was the introduction of the compulsory superannuation system to deal with Australia’s soon to retire, Baby Boomer generation. In the banks effort to broaden their revenue base and continue with the exponential expansion of their balance sheets, the lure of a multi-trillion dollar pool of retirement saving made a lot of sense. Through the early 2000s each of the major banks made acquisitions to gain a foothold in the market. CBA bought Colonial, NAB purchased MLC, ANZ purchased Mercantile Mutual in a JV with ING and Westpac purchased BT and Rothschild.

In these deals were the beginnings of the mutation that would see these banks lose their way.

The acquisitions were ostensibly, old life companies. Sales based organisations where ‘agents’ were paid a commission for selling a product to a consumer. There was often advice involved but often not. The principle approach was ‘caveat emptor’ and the assumption that if the consumer saved something rather than nothing, then some good had been done. If advice was provided it was paid for by commission from the product manufacturer and effectively the public was trained to place no value on it. Advice became something that came with the product.

But the need for considered, tailored advice was growing. The industry needed to become a profession and move to a fee based model where the public valued the advice and was prepared to pay for it. This was met with an innate resistance, ingrained over many years. The banks did not rail against this but rather acquiesced to their more learned wealth management sales executives who told them “it ain’t broke! Advice is paid for by the product manufacturer because consumers don’t value it”.

The tyranny of the vertically integrated business model prevailed.

The money flowed in. Billions of it. Further acquisitions were made to gain both product advantage and the favour of an increasingly spoilt force of advisors who had come to realise just how valuable their favour was. Consciously and in some cases subconsciously, advisors were adopting business models that made them more valuable to their product manufacturing friends by leveraging the risk of a change in loyalty in return for a large cheque ensuring tenure.

Product manufacturers referred to the advisors in their sphere of influence as ‘distributors’ and acquisitions of distribution networks were made, making many owners of these networks unimaginably wealthy.

The very word ‘distribution’ (not advice) said it all.

 The Regulators Weigh In

This then brings us to the issue of the regulators.

Let us not fool ourselves about the intent of the legislation that has been brought into play over several regimes. Quite rightly, it has been installed to change the behaviours of the industry and to ensure outcomes are focussed on ‘people before profit’. However, through a lack of understanding of the history of the business models and the products that were already in place, the impact these new laws have had is a disappointment.

As each new wave of law failed to gain traction, the complexity of the laws increased and became so prescriptive that tick a box compliance was the only way to comply. Thoughtless, tick a box compliance. This was exacerbated by the constant cries of foul play by the Industry Fund movement who refused to accept that the retail offerings may in fact have offered a reasonable alternative to the moral high ground claimed by the Union backed Industry Fund regime.

For every change the industry adapted, ‘the spirit’ of that change was compromised on both sides of the Retail/Industry fund divide. Thinking was dedicated to how to comply with the law without giving up the behaviour that the law was designed to change. As a result, consumer outcomes only ever improved marginally.

In defence of the self-licensed advice movement, there has always been a constant pressure on the product manufacturing community to improve features and reduce the price of the end superannuation products to the consumer. But this cause was lost in the politics of the broader campaign because advisors need product solutions to execute their advice and the institutions controlled the product and the margin.

War Rooms

When the major institutions were caught out they arrived with armies of lawyers from the top end of town to defend their position and ultimately negotiate on outcomes that were private, less costly and less damaging for the provider. The regulators could not afford to throw the same legal talent at the issue as they did not have the same budget or the internal talent to brief the legal team. It was a case of ‘bows and arrows against the lightening’. The regulator could not afford to lose for fear of loss of reputation or costs being awarded against them and so the ‘enforceable undertaking’ regime began.

This, in a world where the Banks were still harbouring hero status and had an air of invincibility about them. Who were the regulators to question their integrity?

Inside these institutions there was the ongoing pressure to improve dividends to the plethora of shareholders including the superannuation funds that most Australians were members of. There was a sense of untouchability that came with the fact that folklore had seen these institutions save our Nation from the full force of the GFC and that the senior management of these organisation was seen as the epitome of success in the corporate world. Geniuses who were to be revered at all costs and were never questioned or challenged.

Is it any wonder that a mutation in the moral code was let loose at some stage in this journey and went undetected and unmanaged until the blow torch of the Hayne Royal Commission? It was a culture where the unjustifiable became more justified each time the behaviours, the decisions, the mutation went unchallenged.

This Royal Commission has highlighted some heinous behaviours and the recommendations need to seek to ensure that we never find ourselves in this situation again, however it is worth reflecting on the 28 years of history that came together to all but justify the collapse in values that led to the outcomes that have been exposed.

A combination of hero status, invulnerability, shareholder pressure, cultural misalignment and in the end dumb luck led the management of our most revered organisations to turn a blind eye to the social responsibility that is at the core of their existence. Much like the leadership of Australian cricket after a similar period of invulnerability.

“Things are so bad that new laws might not help” Justice Kenneth Hayne

Let us hope that in the fall out we are not burdened with another wave of crippling regulation but laws that need to be thought about. Laws that challenge participants to ask ‘what is the spirit of this law and how do I need to interpret it?’. Tick-a-box compliance leads people to think about what they can get away with. We need new laws that acknowledge the role that these organisations can play in shaping a positive society and a positive economy and a code of conduct installed that all participants embrace as a way forward in the enhancement of a better financial community.

In the words of Commissioner Hayne:

“The law already requires entities to do all things necessary to ensure that the services they are licensed to provide be provided efficiently, honestly and fairly. Much more often than not, the conduct now condemned was contrary to law… Passing some new law to say, again, ‘do not do that’ would add an extra layer of legal complexity to an already complex regulatory regime. What would that gain?

What is needed is better enforcement in order to ensure that banks and other financial institutions apply basic standards of fairness and honesty by obeying the law, not misleading or deceiving, acting fairly, providing services that are fit for purpose, delivering services with reasonable care and skill, and, when acting for another, acting in the best interests of that other?”