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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 – 23rd November 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets remained under pressure over the last week with many falling back to or below their late October lows on worries about trade, tech stocks and global growth. Despite the risk off tone bond yields were little changed but the oil price remained under pressure and the iron ore price fell a bit too. The $US rose slightly and this weighed on the $A.
  • Shares retesting October lows – double bottom or resumption of the slump? Share markets fell back to around their October lows over the last week. A retest of the lows is quite normal after the sort of fall we saw in October. Whether markets form a double bottom and head back up or break decisively lower to new lows is unclear. In favour of the former less stocks have made new lows into the latest fall and Asian and emerging markets are looking a lot healthier (having led this share slump and having had much deeper falls). But against this many of the triggers for the fall in markets remain in place. The bottom line is that it’s hard to tell whether it will remain just a correction or maybe slide deeper into what we call a gummy bear market (where markets have a 20% top to bottom fall but are up a year after the initial 20% decline). But it’s unlikely that we’re sliding into a deep or grizzly bear market as the conditions are not in place for recession in the US, globally or Australia.
  • Potential triggers to watch for a rebound include; a meeting at the G20 meeting between Presidents Xi and Trump in the week ahead, more signs of a possible Fed pause on interest rates and a stabilisation/improvement in growth indicators outside the US. In terms of the Trump/Xi G20 meeting, the APEC debacle between the US and China and a report by the US Trade Representative repeating criticism of China are driving low market confidence of a deal being reached between the US and China. However, against this Trump appears to want a deal knowing that further tariff hikes (which are really tax hikes) will start to offset his fiscal stimulus next year and may be starting to impact business confidence and hence capital spending. All of which may start to negatively impact Trump’s 2020 re-election prospects. Reports that White House trade adviser and protectionist Peter Navarro will not be attending the meeting is also a positive.
  • In Europe, Italy looks to be heading into what is called an Excessive Deficit Procedure – a process administered by the European Commission but approved by Eurozone finance ministers designed to get its expansionary budget deficit back on track with debt limits – but a major crisis still looks unlikely. More likely is some sort of fudge combining various delays in enforcing any deficit reduction and some compromises. The rest of Europe won’t want to put too much pressure on Italy for fear of fuelling anti-Euro sentiment and in any case by the time Italy has to respond to any requests under the EDP it won’t be till later next year by which time the 2019 budget will be largely history.

Major global economic events and implications

  • US economic data was on the soft side. Home building conditions fell sharply in October, albeit catching down to other housing related indicators, housing starts and existing home sales rose but are trending sideways, underlying capital goods orders were soft and leading indicators were weak in October with the falling share market acting as a drag. Naturally the weakness in housing indicators raises memories of the GFC but note that housing investment is running at a relatively modest 3.9% of GDP and has not kept up with demographic demand in contrast to prior to the GFC when it reached 6.7% of GDP and was way ahead of demographic demand.
  • Japanese headline inflation rose to 1.4% year on year in October, but this will fall back with the oil price in November and meanwhile core inflation is stuck at 0.4%yoy so the BoJ is no closer to being able to tighten monetary policy.

Australian economic events and implications

  • Australia was a bit quiet on the data over the last week with a rise in the CBA’s business conditions PMI for November, albeit it remains well down on last year’s high, but skilled vacancies fell again in October and the trend is now down for seven months in a row pointing to a slowing in employment growth. Comments by RBA Governor Lowe and PM Scott Morrison provided more interest though.
  • RBA Governor Lowe’s comments in the past week were particularly significant for two reasons. Firstly, he looks to be becoming more concerned about credit tightening in saying that “a few years ago credit standards were way too loose, there has been a correction of that, but the pendulum might be swinging a bit too far the other way.” Second, he also acknowledged the risks around wages remaining weak even if unemployment falls further: “I suspect nationally we could sit at [an unemployment rate] around 4.5 per cent without seeing wage growth pick up by too much”. He is clearly aware that estimates putting the so-called NAIRU at 5% are rubbery. Perhaps he is starting to question the RBA’s own mantra that the next move in rates as more likely up than down.
  • Lower immigration levels on the way? There is always a debate going on about the appropriate level of immigration in Australia, but this has been mainly outside the major political parties or on the fringe of them. PM Scott Morrison changed all that in the last week flagging a cut to the annual immigration cap of 190,000 by 30,000. At present this sounds like just affirming the actual level of immigration which has already slowed by about 30,000. So, no big deal. But having brought the debate into the centre of politics risks seeing immigration getting cut further given angst about the issue particularly in Melbourne and Sydney. This is particularly relevant to the property market as it was the surge in population growth from around mid-last decade without a housing supply pick up (until around 2015) that has played a big role in the surge in house prices relative to incomes. Yeah, yeah, yeah, the surge in credit, speculation, foreign demand, etc, also played roles too. But the point is that if immigration starts to fall back at a time of rising supply it will be one more factor sending property prices south in Sydney and Melbourne (which take something like 60% of immigrants) – along with tighter credit, rising supply, a significant pool of borrowers having to switch from interest only to principle and interest mortgages, reduced foreign demand, fears around tax changes reducing future investor demand, etc. Views remain that these two cities will see 20% top to bottom price declines out to 2020 but there are clearly some risks on the downside to this.

Home construction vs population growth

Source: ABS, AMP Capital

What to watch over the next week?

  • The big event in the week ahead will be the meeting between Presidents Trump and Xi on the sidelines of the G20 meeting (Friday & Saturday) in Buenos Aires to discuss trade.
  • In the US, the focus is likely to be on the Fed. While the minutes from the last Fed meeting (Thursday) will likely confirm that it remains upbeat and on track to raise rates again in December another speech by Fed Chair Powell (Wednesday) is likely to repeat that he is aware of the various headwinds to the US economy leaving the impression that the Fed is open to a pause on interest rates next year. Of particular, interest will be what if anything he has to say about continuing share market volatility and recent softness in housing and business investment indicators. On the data front expect home price data (Tuesday) to show continuing modest gains, consumer confidence for November (also Tuesday) to show a slight fall from 18 year highs, new home sales (Wednesday) to show a bounce, September quarter GDP growth (also Wednesday) to be revised up slightly to 3.6% from 3.5%, personal spending growth (Thursday) to have remained solid but with core private consumption deflator inflation falling back to 1.9% year on year.
  • Eurozone economic confidence for November (Wednesday) will be watched for any stabilisationafter several months of softness, unemployment for October (Friday) is likely to be unchanged at 8.1% and core inflation for November (also due Friday) is likely to be unchanged at 1.1% year on year.
  • Japanese data to be released Friday is likely to show continuing labour market strength helped by a falling population but industrial production is likely to show a bounce.
  • Chinese business conditions PMIs for November will be released Friday with the focus likely to be on the manufacturing PMI which has been slowing lately.
  • In Australia, speeches by RBA Governor Lowe and Assistant Governor Kent on Monday will be watched for any clues on rates. On the data front expect to see a 1% gain in construction data for the September quarter (Wednesday), a 1.5% gain in September quarter business investment (Thursday) and continuing moderate credit growth (Friday) with ongoing weakness in lending to investors. A key focus will be whether investment intentions data points to further improvement.

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 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 they may slow down a bit).
  • 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. Being short the $A remains a good hedge against things going wrong in globally.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

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

FinSec Partners Disclaimer

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

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’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Weekly Market Update – 12th October 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets fell sharply over the last week led by the US share market primarily on the back of worries about rising interest rates and bond yields and the deteriorating US/China relationship. Bond yields generally declined though reflecting safe haven demand which also benefitted the gold price. Iron ore prices rose which is good for Australia, but the oil price fell. A fall in the US dollar saw the Australian dollar push back above $US0.71.
  • Volatility: There is likely more to go even though its unlikely to be the start of a major bear market. Every so often shares go through rough patches. This was seen most recently in February on the back of US inflation and interest rate concerns which saw US shares fall 10% and Australian shares down 6%. Shares managed to get through the seasonably weak months of August and September surprisingly well (except in Australia) but the worry list has pulled them back down again. So far shares are down around 7% from recent highs. Given the ongoing worries around the Fed, inflation and bond yields, threats to tech stocks, the intensifying US/China conflict, rising oil prices, problems in the emerging world, the upcoming US mid-term elections, risks around President Trump and the Mueller inquiry and tensions in the Eurozone regarding the Italian budget, further weakness is likely. And given the usual global contagion most major share markets including the Australian share market will be affected. However, it’s doubtful it’s the start of a major bear market because history tells us that they invariably require a US recession and with US monetary conditions still far from tight, fiscal stimulus still impacting and no signs of the excess (in terms of overinvestment, debt growth, etc) that normally precedes a recession, a US recession still looks a long way off and this in turn suggests that the trend in earnings and hence share markets is likely to remain up beyond the near term pull back.
  • Jair Bolsonaro’s strong showing in the first round of the Brazilian presidential election points to a likely victory in the final round which would be positive for Brazilian assets in the short term but maybe not in the long term. A right-wing Bolsonaro presidency and a right-wing Congress as also appears likely would probably boost business confidence and allow pro-business policies like corporate tax cuts and reduced regulation. But as a populist he is unlikely to do much about Brazil’s high public debt and unsustainable pension system. Bolsonaro’s anti-democratic stance is also seen as a concern. So, while there may be a short-term boost for Brazil, long term problems are likely to remain.

Major global economic events and implications

  • US economic activity data was light on, but small business optimism remained around historic highs in September with employee compensation also very strong and jobless claims remain ultra-low. Meanwhile, producer price and consumer price inflation came in weaker than expected in September, with the core CPI stuck at 2.2% year on year and consistent with the core private consumption deflator running around 1.9% year on year which is just below the Fed’s inflation target. This is all consistent with the Fed continuing to raise rates but only gradually, ie every three months.
  • In Japan machine orders rose solidly and an economic conditions index held up pretty well in September given the earthquake and typhoon.
  • China’s Caixin services conditions PMI rose in September consistent with the official non-manufacturing PMI in indicating that services sector strength may be partly offsetting manufacturing sector softness. Meanwhile, the PBOC cut most banks required reserve ratios and a State Council meeting indicated a further step up in stimulus measures, all designed to support growth in the face of US tariff hikes.

Australian economic events and implications

  • Australian business and consumer confidence rose slightly in September and October respectively, but both are well down on recent highs. Meanwhile, although housing starts fell in the June quarter consistent with falling building approvals and consistent with a peaking in housing construction activity, work yet to be done is at a record high three times above where it was in 2009 and telling us that there is still a lot of supply about to hit the softening homebuyer market. Housing finance also continued to slide with commitments to both owner occupiers and investors falling. All of which is consistent with ongoing falls in home prices.

Source: CoreLogic, AMP Capital

Source: ABS, AMP Capital

  • The RBA’s latest Financial Stability review remained positive on global conditions but does see risks around trade and low risk premia – and remains relatively sanguine about the risks around the slowing Australian housing market and household debt. However, it does acknowledge that some existing borrowers may have difficulty refinancing and that its possible (but not probable) that tightening lending standards will worsen the housing slowdown. It is worth noting that despite all the talk about mortgage stress and foreclosures the major banks non-performing loans remain very low, although they have been rising mainly in WA.

What to watch over the next week?

  • In the US, September retail sales data to be released Monday is likely to show a decent gain telling us that consumer spending remains strong supported by strong employment growth, rising wealth, tax cuts and high levels of confidence. In other data, industrial production is likely to see a modest rise, job openings and hiring are likely to remain strong and the home builders conditions index (all due Tuesday) is likely to remain strong, housing starts (Wednesday) are likely to fall back after a strong gain in August and exist home sales (Friday) are likely to fall slightly. Manufacturing conditions surveys will also be released for the New York and Philadelphia regions. Meanwhile, the minutes from the Fed’s last meeting (Wednesday) will reiterate that it remains on track for gradual interest rate hikes ultimately taking the Fed Funds rate to above “neutral.” The September quarter earnings season will start to hot up with the consensus expecting profit growth of around 21% year on year thanks to strong economic conditions and tax cuts. Corporate commentary around wages and tariffs will be watched closely.
  • Japanese inflation data for September due Friday is likely to show a further rise in core inflation to 0.5% year on year, which is good news but still a long way from the 2% inflation target.
  • Chinese economic activity data will be watched closely given signs of a slowdown in response to last year’s credit tightening and US tariffs. Expect September quarter GDP data to be released Friday to slow down to 6.5% year on year (from 6.7% in the June quarter), industrial production growth for September to slow to 5.9% year on year but retail sales growth to hold at 9% and investment growth to pick up slightly to 5.5%. Meanwhile, inflation data to be released on Tuesday is likely to show a fall in producer price inflation to 3.6% year on year but a rise in consumer price inflation to 2.5%.
  • In Australia, expect September labour market data due Thursday to show employment growth slowing to a gain of 10,000 after a surprise 44,000 gain in August but with unemployment remaining flat at 5.3%. Meanwhile, the minutes from the last RBA board meeting (Tuesday) are likely to show the RBA still expecting the next move in rates to be up but seeing no case to move now and the by-election for the seat of Wentworth will be watched closely in regard to the Government’s narrow parliamentary majority.

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 10% 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 has now fallen close to $US0.70 it likely still has more downside into the $US0.60sas 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 – 5th October 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets fell over the last week, largely in response to a renewed rise in bond yields. Commodity prices rose, although this was mainly due to higher oil prices. Strong US economic data and some rise in expectations for Fed tightening saw the $US rise and this saw the $A fall below $US0.71.
  • Bond yields have resumed their rising trend, with more upside ahead. The break higher was led by the US with the US 10 year bond yield rising to a seven year high on the back of a combination of strong US economic data, rising oil prices and, most importantly, investors finally coming round to the view that the Fed Funds rate has a lot more upside and will likely rise above the Fed’s guesstimate of the “neutral” Fed Funds rate, which is around 3%. Of course, the Fed has been telling us this for a long time but the market didn’t really believe it. However, the past week saw several Fed speakers, including Fed Chair Powell and normally dovish Chicago Fed President Evans reinforce that the Fed Funds rate is at least going to neutral and probably beyond. On this front there is a long way for the market to adjust given the gap between the Fed’s dot plot which shows Fed Funds rate going up to nearly 3.4% and market expectations which remain way below that. This adjustment along with investors factoring in more normal inflation and growth expectations, rather than the subdued expectations for both of recent years, suggests US and global bond yields still have more upside. At some point this will seriously threaten shares, but that point is likely a fair way off given that US monetary policy is still far from tight, central banks in Europe and Japan are way behind the US in tightening, bond yields are still relatively low, US and global growth is still strong and this is supporting earnings. And as we have seen since 2016 low in bond yields, the rise in yields won’t go in a straight line.
  • Australian bond yields may go up a bit as US yields rise but they are likely to continue to lag given that the lagging Australian economy means that the RBA will remain on hold with some chance of a rate cut. However, the rise in US and global bond yields adds to the risk of more out of cycle bank mortgage rate increases as global funding costs rise (with banks getting around 35% of their funding from sources other than deposits). Of course, if this becomes a problem for the Australian economy, it will provide a reason for the RBA to cut the cash rate to pull mortgage rates back down.
  • The new north American trade deal to be called USMCA (or US Mexico Canada Agreement) is good news but does not mean the US/China dispute will soon be resolved. The USMCA deal coming on the back of the revamped US/South Korea trade deal and trade talks with the EU and now Japan confirms that Trump is not anti-trade per se, but just wants what he thinks is fairer trade for the US. But its also consistent with him wanting to make trade peace with his allies and focus more on China. And on the US/China trade front the differences remain significant and both sides are likely to remain dug in until after the mid-term elections at least. Which means that the tariff rate on the latest $US200bn tranche of imports will likely rise to 25% next year and another tranche of tariffs remains possible. The near collision between Chinese and US naval ships in the South China Sea and a speech by US VP Pence highlights that trade tension is spilling into other areas.
  • Fears that the Italian budget issue is the start of a slide towards an Itexit are way overblown. If the populist coalition was focussed on Italy exiting the Euro it would have come up with a much bigger budget deficit target than 2.4% of GDP. Tension between the European Commission and Italy regarding the budget will likely be high causing occasional market volatility, but we remain of the view that the deficit target is not high enough to cause a major problem, France and Germany will not want to embolden Italian Eurosceptics and the rest of Europe will likely leave market forces (via higher Italian bond yields) to discipline Italy. And it appears that the Italian Government is aware of the risks with reports that its targeting a reduction in its budget deficit to below 2% of GDP by 2021.

Major global economic events and implications

  • US economic data remained robust over the last week with strong ISM business conditions readings and strong labour market data. Meanwhile, various Fed speakers reiterated that the Fed Funds rate will likely have to move to “neutral”, ie around 3%, or above highlighting that market expectations for just three hikes over the next two years remain too dovish, which in turn implies more adjustment ahead in market expectations putting further upwards pressure on bond yields.
  • Japan’s Tankan September quarter business conditions indexes softened for large companies but overall remain solid. Household spending accelerated but wages growth slowed.
  • Chinese manufacturing conditions PMI’s slowed in September consistent with tariffs starting to impact but it was offset by a rise in the non-manufacturing conditions PMI suggesting that overall growth is holding up well helped by policy stimulus.

Australian economic events and implications

  • Australian economic data was mixed. While retail sales improved in August, business conditions PMIs remain good and the trade surplus improved slightly, home prices are continuing to fall, new home sales are falling and building approvals are trending down pointing to slowing dwelling investment. It should also be noted that the improvement in retail sales was after a flat July so growth in the September quarter is on track to slow from the June quarter. And trade is also on track to make no contribution to September quarter GDP growth.
  • Australian dwelling prices have now fallen for 12 months in a row and more downside is likely in Sydney and Melbourne as a result of the combination of tighter bank lending standards, rising supply, falling price growth expectations feeding back to weaker home buyer demand and the possibility of changes to negative gearing and the capital gains tax discount if there is a change of government impacting investor demand. Continue to expect these cities to see a top to bottom fall in prices of around 15% spread out to 2020 which given falls already recorded since last year implies another 10% or so downside. And if anything, the risks are on the downside. Falling home prices will drive a weakening wealth effect which along with still low wages growth and an 11 year low in the household saving rate suggests that retail sales growth will slow over the year ahead.

Source: CoreLogic, AMP Capital

Source: CoreLogic, AMP Capital

  • Against this back drop its not surprising to see the RBA leaving interest rates on hold again this month. Yes, the RBA can point to the continuing global expansion, above trend GDP growth, an increase in the terms of trade and an improving labour market. But against this, uncertainty remains high regarding consumer spending, underemployment remains very high, the drought will have a negative impact, house prices are continuing to fall in Sydney and Melbourne, credit conditions have tightened, and wages growth and inflation remain very weak. Views remain that the RBA will keep rates on hold out to 2020 at least and the next move in rates could still turn out to be a rate cut given the risks around falling house prices and the threat this poses to consumer spending.

What to watch over the next week?

  • In the US, the focus will be on inflation with producer price data for September out on Wednesday and consumer price inflation data out on Thursday. The CPI is expected to show a fall in headline inflation to 2.5% year on year but core CPI inflation is expected to remain around 2.2%yoy which is consistent with inflation as measured by the private consumption deflator remaining around 2%yoy which is the Fed’s target. Small business optimism data will be released on Monday and is likely to remain very high. September quarter earnings results will also start to flow with corporate tax cuts and strong economic conditions expected to see profits up by over 20% from a year ago. Corporate commentary around the impact of tariffs and wages will be watched closely.
  • Chinese economic data for September will start to be released with credit data to be watched for evidence of the recent policy easing and trade data (Friday) expected to show a moderation in import growth to around 18% year on year but export growth remaining around 10% year on year.
  • In Australia we will get an update on confidence and housing finance. Expect the September NAB survey (Tuesday) to show continuing solid business conditions but more subdued confidence, consumer confidence (Wednesday) to show a slight improvement after its August fall and housing finance (Friday) to show continuing softness in loans to property investors. The RBA’s Financial Stability Review will also be watched closely given the house price downturn and fears that tightening lending standards risks turning into a credit crunch partly in response to the Royal Commission.

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 correction over the next month or so still remains significant 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 10% 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 close to $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

Weekly Market Update – 28th September 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets were mixed over the last week with US shares down 0.5% and Eurozone shares down 1.1% on renewed worries about Italy’s budget, but Japanese shares rose 1%. Chinese shares rose 0.8% and Australian shares rose 0.2%. Bond yields were little changed except in Italy where they rose on budget concerns. Oil prices rose after OPEC left output unchanged, but metal and iron prices fell. The $US rose, particularly as the Euro fell on renewed Italian budget worries, and this saw the $A slip back to around $US0.72.
  • Although US, Japanese and Chinese shares performed well in September, Australian shares fell 1.8% after reaching a ten year high in August as defensives, consumer stocks, financials and high yielders fell not helped by rising bond yields.
  • While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared its clear the US trade threat is far from over. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing more big tariff cuts and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be broadening with the Trump accusing China of interfering in the mid term elections and some low-level signs that military tensions may be rising too. Views remain that while the tariffs actually implemented so far are relatively small further escalation in the US/China trade conflict is likely with a negotiated solution still a way off. Meanwhile, the risk is rising that Canada will not agree to a revamped NAFTA deal which could see increased tariffs imposed on Canada, the US and Japan are now to enter new trade talks with Trump clearly wanting concessions from Japan and French President Macron said he would not agree to a new EU trade deal with the US unless the US commits to the Paris climate agreement. So, trade will remain a periodic issue for markets.
  • The US Fed provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative” its far from tight either and Fed officials’ interest rate expectations point to rates rising above the Fed’s estimate of the long run neutral rate which is currently at 3%. Expect another hike in December and three more hikes next year. Market expectations remain too dovish. Continuing US rate hikes mean ongoing downwards pressure on the $A and the risk of more out of cycle rate hikes by Australian banks to the extent global borrowing costs rise. Trump’s criticism of Fed rate hikes are clearly not having any impact though with Powell indicating the Fed’s focus is keeping the economy healthy and not on politics.
  • The issues around Brett Kavanaugh’s nomination to the US Supreme Court add to the risk that the Republicans will lose control of the Senate as well as the House. While this will not change views around Trump and his economic policy there is a good chance he will get impeached but there still wouldn’t be enough votes in the Senate to remove him from office and Congress won’t change or reverse his economic policies it will be something that markets will worry about in the run up to and after the November 6 mid-terms.
  • Italy targeting a higher budget deficit a negative for the Euro & Italian assets, but not as bad as feared. News that the Italian Government will target a 2019 budget deficit of 2.4% of GDP has pushed the Euro down and is a negative for Italian shares and bonds. 2.4% is not low enough to reduce Italy’s public debt to GDP ratio and will lead to some conflict with the European Commission. However, its far less than the 5-6% of GDP feared a few months ago and is not high enough to see the rest of Europe pressure Italy too much (particularly as France and Germany don’t want to fuel Italian anti-Euro populist sentiment). Rather the rest of Europe is likely to leave market forces via higher Italian bond yields to discipline Italy. So not good for Italian bonds but not a disaster for the Eurozone.

Major global economic events and implications

  • US data remains strong with a new 18 year high in consumer confidence, strong consumer spending and durable goods orders and rising imports. Meanwhile, core inflation in August remained at the Fed’s 2% target, indicating no need for the Fed to get more aggressive in raising rates.
  • Eurozone economic sentiment slipped in September but remains strong and private lending continues to accelerate. Meanwhile, core inflation fell back to just 0.9% yoy supporting the view that ECB rate hikes are a long way off.
  • The Japanese labour market remained strong in August, industrial production rose and core inflation in Tokyo edged up to 0.6% yoy, but it’s still a long way from the BoJ’s 2% target.

Australian economic events and implications

  • In Australia, there was good news on the budget, but the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power. First the good news from the last week:
  • The 2017-18 budget deficit came in at $10bn which is $8bn less than expected in May. While part of this owes to spending delays, the Government has announced more spending ahead and risks remain around wages growth, it nevertheless indicates that the Government has some scope to provide more stimulus ahead of the next election.
  • And ABS job vacancy data remains very strong up 16.5% yoy, albeit it did slow down a lot in the 3 months to August.
  • Against this though:
  • The risks around the housing market are continuing to mount with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages as the banks move to comprehensive credit reporting (ie sharing info on customer debts) and focusing on total debt to income ratios. The latter is significant given estimates that nearly 1.5 million investment properties are held by investors with more than one property.
  • Credit growth to property investors remains very weak as tighter lending standards & falling investor demand impact.Source: RBA, AMP Capital

Source: RBA, AMP Capital

Source: RBA, AMP Capital

  • Petrol prices over the last week have pushed higher on global oil supply concerns with more upside likely as supply from Iran and potentially Venezuela is cut at a time of strong global demand and low stockpiles. The weekly Australian household petrol bill is now running over $10 a week higher than a year ago. So, while higher petrol prices (if sustained) will add to headline inflation, they will also cut into household spending power and dampen spending elsewhere which will keep underlying inflation down.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • For the RBA, these considerations largely offset each other for now, so there is no reason to suspect that it won’t remain on hold for a lengthy period.

What to watch over the next week?

  • In the US, it’s back to focussing on jobs and wages with September labour market data due Friday expected to show another strong 190,000 gain in jobs and unemployment falling to 3.8%, but wages growth slipping back to 2.8% year on year, albeit maintaining a gradual rising trend. In other data expect the September ISM manufacturing index (Monday) to fall back to a still strong reading of 60, the non-manufacturing ISM index (Wednesday) to remain around 58 and the trade deficit (Friday) to worsen.
  • Eurozone unemployment (Monday) is expected to fall to 8.1%.
  • The Japanese September quarter Tankan business conditions survey (Monday) is expected to remain solid.
  • In Australia, the RBA will yet again leave interest rates on hold when it meets on Tuesday. While recent economic growth and jobs data has been good, we are still waiting for inflation and wages growth to pick up and the slide in home prices risks accelerating as banks tighten lending standards which in turn threatens consumer spending and wider economic growth. As a result it would be dangerous to raise rates and don’t expect to see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. Meanwhile, on the data front expect CoreLogic data (Tuesday) to show another fall in home prices for September, August building approvals (Wednesday) to show a 2% bounce, the trade surplus (Thursday) to fall slightly to $1.4bn and retail sales (Friday) to rise 0.2%.

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 correction over the month or so still remains significant given the threats around trade, emerging market contagion, ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around the Australian share market.
  • Low 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 10% or so, but Perth and Darwin property prices bottoming out, 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 working off very negative short positions it’s still likely to fall to around $US0.70 and maybe into the high $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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