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Weekly Market Update – 15th February 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Global share markets rose over the last week helped by optimism on US/China trade talks, progress towards averting a renewed partial government shutdown in the US along with okay earnings results. Australian shares were little changed having outperformed sharply in the previous. Bond yields were little changed. The oil price rose but metal and iron ore prices fell. The $A was little changed as the $US rose.
  • Progress in US/China trade talks and the (likely) avoidance of a return to the partial government shutdown in the US are both positive to the extent that they help dial down the political risk that weighed on investors last year. If the March 1 tariff deadline is delayed it’s likely that the US auto tariff threat will also be delayed as Trump has been inclined to avoid multiple battles at once. Avoiding a return to the shutdown even if Trump goes down the contentious path of declaring a National Emergency to get Wall funding – is good news as it removes a threat to the economy and adds a bit to confidence that a debilitating battle over the need to raise the debt ceiling from March will be avoided.
  • Some lessening in political threats (for now) along with a swing to more dovish/stimulatory economic policy globally are consistent with views that this year will be a decent year for share markets. However, with share markets having run hard from their December lows and technically overbought and economic data still weak the risk of a short term pull back is high. The Australian share market particularly looks to have run ahead of itself. Earnings results have been better than feared but economic growth looks to be slowing, the earnings outlook is constrained, and RBA rate cuts are still a way off.

Major global economic events and implications

  • US data was messy over the last week. Retail sales fell sharply in December possibly reflecting the impact of the shutdown and share market falls at the time, small business confidence continued to fall and jobless claims rose continuing a rising trend. Against this, job openings and hiring were all strong. Meanwhile, headline inflation was weak thanks to falling energy prices, but core inflation was flat at 2.2% year on year and with momentum accelerating again. The weakness in retail sales is consistent with the Fed pausing, but the acceleration in core CPI inflation in recent month means that it’s premature to conclude that the Fed has finished tightening for this cycle. Expect the Fed to be on hold for the next six months with maybe one hike later this year.
  • The US December quarter earnings reporting season continued to surprise on the upside over the past week, but its still showing a slowdown from previous quarters as the tax boost and underlying earnings growth has slowed. 80% of S&P 500 companies have now reported with 72% beating on earnings with an average beat of 3.3% and 60% beating on sales. Earnings growth is running at 18.5% year on year for the quarter. As can be seen in the next chart the level of surprises and earnings growth is slowing down. US earnings growth is likely to be around 5% this year.

US earnings growth slowing

Source: Bloomberg, AMP Capital

  • Eurozone December quarter GDP growth was confirmed at 0.2% quarter on quarter or 1.2% year on year. Germany just missed out on falling into a technical recession with growth of just 0.02% qoq. Pressure on the ECB and the German government for more stimulus is intensifying.
  • Japan’s economy grew again in the December quarter after a natural disaster affected September quarter. But GDP is flat on a year ago. That said inventory, trade and public investment were the drags on growth and consumption & investment were solid. The BoJ will still have to keep the pedal to the metal.
  • Chinese exports and imports bounced back in January suggesting that things aren’t as bad as feared. That said it would be wrong to get too excited either way as the Lunar New Year holiday is known to distort Chinese data around this time of year. Meanwhile inflation continued to fall in January.

Australian economic events and implications

  • After weeks of poor data, Australian data was mixed over the last week. On the positive side the NAB survey measure of business conditions and consumer confidence bounced back in January and February respectively although both remain at uninspiring levels. Pressure remains on the housing market though with housing finance sliding sharply in January, reports that China has moved to make it even tougher for its citizens to move money out of China destined for property markets in Australia and elsewhere and ASIC moving to toughen up its regulatory guidance to lenders to the effect that Household Expenditure Measure benchmarks are too low an estimate of borrowers’ living expenses and that actual verification of income is required. In terms of the latter while many lenders have already moved in this direction its likely that there is still further to go in terms of tightening up lending standards.
  • The Australian December half earnings reporting season has been better than feared but shows a slowdown in growth and caution regarding the outlook. So far about a third of results have been released. 60% of companies have seen their share price outperform on the day of reporting (which is above a longer term norm of 54%) and 45% have surprised analyst expectations on the upside which is around the long term average, but a more than normal 33% have surprised on the downside, the proportion of companies seeing profits up from a year ago has fallen and only 55% have raised their dividends which is a sign of reduced confidence in the outlook – six months ago it was running at 77%. Concern remains most intense around the housing downturn and consumer spending.

Australian company profit results relative to market expectations

Source: AMP Capital

Australian company profit results relative to a year ago

Source: AMP Capital

Australian company dividends relative to a year ago

Source: AMP Capital

What to watch over the next week?

  • In the US, expect the minutes from the Fed’s last meeting (Thursday) to confirm that the Fed remains upbeat but that it is waiting patiently to decide what to do next in terms of interest rates and that it might end its quantitative tightening process earlier than previously expected. On the data front expect a slight rise in the National Association of Homebuilders’ conditions index (Tuesday), a modest rebound in underlying durable goods orders, business conditions PMIs for February to remain around 54-55 and existing home sales (all due Thursday) to rise slightly.
  • In the Eurozone the focus will be on whether the business conditions PMIs (Thursday) show signs of trying to stabilise after falling through most of last year or continue to fall.
  • Japanese inflation data for January is expected to show core inflation rising slightly but only to 0.4% year on year.
  • In Australia the minutes from the last RBA board meeting (Tuesday) will confirm the shift to a neutral bias in terms of the immediate outlook for interest rates and Governor Lowe’s parliamentary testimony on Friday will be watched for further clues in terms of how the RBA is seeing the outlook for the economy. On the data front expect December quarter wages growth (Wednesday) to hold around 0.6% quarter on quarter or 2.3% year on year as the lift in the minimum wage increase to 3.5% continues to feed through. January jobs data is expected to show a 5000 gain in employment and a rise in unemployment to 5.1%. Data for skilled vacancies and the February CBA business conditions PMIs will also be released.
  • The Australian December half earnings results season will see its busiest week with 70 major companies reporting including Ansell, Brambles and Coles (Monday), BHP, Bluescope and Cochlear (Tuesday), Fortescue, Stockland, Seven Group and Woolworths (Wednesday), and Coca-Cola Amatil, Nine and Wesfarmers (Thursday). 2018-19 consensus earnings growth expectations are around 4% for the market as a whole. Resources, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained.

Outlook for investment markets

  • Shares are likely to see volatility remain high with the high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
  • The $A is likely to fall 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 as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.

Weekly Market Update – 8th February 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Global share markets were little changed or down over the past week, not helped by weak economic data and trade uncertainty. US shares rose less than 0.1%, Eurozone shares fell 1.2% and Japanese shares lost 1.6%. Australian shares saw a strong 3.6% gain though, as the banks had a ‘Royal Commission relief rally’; the prospect of Reserve Bank of Australia (RBA) rate cuts provided a boost to retailers; industrial stocks, yield-sensitives and miners continued to benefit from the surging iron ore price. Bond yields generally fell on the back of soft data. While the oil price fell, the iron ore price continued to surge on the back of production cuts due to Vale’s problems. The $A fell below $US0.71 on the prospect of RBA rate cuts and as the $US rebounded.
  • Our view on global and Australian share markets hasn’t changed. They have run hard and fast since their December lows and some sort of short-term pull back is likely. There are plenty of potential triggers for a pull-back including ongoing trade uncertainty (both between the US and China, but also with Trump still threatening auto tariffs on the European Union); a risk of a resumption of the shutdown in the US; and ongoing soft economic data globally, most notably in Europe over the past week. Australian shares look to have run too-far-too-fast as economic growth looks to be slowing and while it is expected that the RBA will cut rates, it’s probably still a way off.
  • But as global policy swings to being more stimulatory and growth indicators improve, shares should perform well for the year as a whole. Key to watch for will be further policy support globally and rate cuts in Australia; a decisive end to the US government shutdown dispute and signs the US debt ceiling will be raised relatively smoothly; a bottoming in profit revisions and good earnings reporting seasons globally and in Australia; stronger than expected economic data and a bottoming in Purchasing Managers’ Indexes (PMIs); and share markets breaking through resistance on strong breadth.
  • RBA downgrades the outlook and moves to a neutral bias on interest rates. In the past week the RBA acknowledged increased downside risks globally and in Australia, and its Statement on Monetary Policy revised down its Australian growth and inflation forecasts. Consistent with this, it has dropped its mild-tightening bias (the mantra that the next move in the cash rate is ‘more likely to be an increase than a decrease’) and replaced it with a neutral bias, ie the next move could be up or down. It is likely the RBA’s downwardly revised growth forecasts for 3% this year and 2.75% next year are still too optimistic, and it is likely to be closer to 2.5% at most as the housing downturn depresses housing construction and consumer spending. This in turn will mean that inflation will stay even lower for longer than the RBA is forecasting.
  • We continue to see the RBA cutting the cash rate this year and it’s now moving in this direction, but there is still a way to go yet. In the absence of a significant negative shock, this was never going to happen over night, but would occur as part of a process starting with the RBA revising down its forecasts (done); moving to a neutral bias on rates (done); more downwards revisions to its forecasts; moving to an easing bias; and then easing. It’s likely this will require several more months of soft data and the RBA is likely to prefer to see what sort of tax cuts/fiscal stimulus will flow from the upcoming April Budget and the outcome of the election. So they will likely prefer to wait until after the budget and election. Which is why it is thought the first easing is likely to be around August, but it could come as early as June. View remains that the cash rate will be cut to 1% by year end in two moves of 0.25% each.
  • While the Final Report from the banking Royal Commission does not point to a further tightening in lending standards, it did put a stamp of approval on the Australian Prudential Regulation Authority driven tightening by the banks, that is continuing, and there is nothing to suggest it will be reversed even though RBA Governor Lowe continues to express concern that it may have gone too far. There is still more to go in shifting away from using benchmarks to assess borrower spending and in terms of debt-to-income limits, particularly with the start up of Comprehensive Credit Reporting this year. So with the housing downturn having further to go and the economy slowing, the Royal Commission relief rally seen in bank share prices may have gone a bit too-far-too-fast. One worry from the Royal Commission recommendations is in relation to mortgage brokers – they have played a huge roll in injecting competition into the mortgage market by making it possible for small lenders, without a big shopfront presence, to take mortgage business away from the big banks via the mortgage brokers. Moving to having borrowers pay for the services of mortgage brokers at a time when they are cash strapped, is likely to significantly reduce competition in the mortgage market, which would be bad for borrowers. So it’s understandable that the Government is not so sure about this recommendation.

Major global economic events and implications

  • US data was a bit light on. The non-manufacturing conditions Institute for Supply Management index for January slowed consistent with slowing growth, but it’s still solid at 56.7. The trade deficit also fell with weaker imports. Meanwhile, the US Federal Reserve’s (Fed’s) latest bank lending officer survey showed some tightening in lending standards for corporate loans and less demand for both corporate and consumer loans. All of this is consistent with the Fed’s pause on rates.
  • The US December quarter earnings reporting season has been stronger than expected but it’s not as good as previous quarters, as the tax boost and underlying earnings growth has slowed. 333 S&P 500 companies have now reported with 72% beating on earnings with an average beat of 3.4% and 59% beating on sales. Earnings growth is running at 18% year-on-year for the quarter. As can be seen in the next chart, the level of surprises and earnings growth is slowing down. US earnings growth is likely to be around 5% this year.
US earnings growth slowing
Source: Bloomberg, AMP Capital
  • Eurozone data continues to weaken, with falls in German factory orders and German and Spanish industrial production, and the European Commission revising down its growth forecasts. While the European Central Bank may be dithering as to what to do next, views remain that another round of cheap bank financing (LTRO) is on the way soon.
  • The Bank of England left monetary policy on hold as expected and also downgraded its growth forecasts, with Brexit uncertainty weighing.
  • Japanese wages growth slowed to 1.4% year-on-year in December and household spending growth improved but only to 0.1% year-on-year.
  • China’s private sector Caixin services conditions PMI for January confirmed the impression from the official PMIs, which is that while manufacturing has slowed sharply, the services sector is holding up well. This is important as the services sector is now far bigger than the manufacturing sector.

Australian economic events and implications

  • Australia has just seen yet another week of soft data, with a further sharp fall in home building approvals; very weak retail sales; a sharp fall in the services sector conditions PMI; a fall in job ads; and the Melbourne Institute’s inflation gauge showing continuing weak inflation in January. Sure, the December trade surplus was much better-than-expected, but this was due to a slump in imports. Retail sales and trade look like making a zero contribution to December quarter Gross Domestic Product growth, suggesting another quarter of weak economic growth. The bottom line is that the housing construction cycle is turning down, the downturn in house prices looks to be weighing on retail sales, the labour market appears to be starting to slow and inflation remains MIA.
Building approvals are pointing to a fall in home building
Source: ABS, AMP Capital

What to watch over the next week?

  • In the US, it’s going to be ‘back to politics’ to see whether Trump and the Democrats can resolve their squabble over ‘the Wall’ and avoid a restart of the government shutdown from Friday – it appears that Congressional negotiators are making progress on a compromise, but it will come down to whether Trump will accept it. Meanwhile, US Treasury Secretary Mnuchin and Trade Representative Lighthizer will be in Beijing for another round of trade talks, with the March 1 deadline for the talks likely to be extended until Presidents Trump and Xi next meet. The focus may also shift to auto tariffs, with the Commerce Department’s auto tariff report due by Sunday. On the data front, expect core Consumer Price Index inflation for January (Wednesday) to fall slightly to 2.1% year-on-year, December retail sales (Thursday) to show reasonable underlying growth, and industrial production (Friday) to show a reasonable gain. Data on small business confidence, job openings and the New York regional manufacturing conditions survey will also be released. It will also be another busy week in the US earnings reporting season.
  • Japanese December quarter Gross Domestic Product (Thursday) is expected to show a gain of 0.3% quarter-on-quarter or 0.1% year-on-year.
  • Chinese January data is expected to show a further fall in exports and imports (Thursday), continued benign inflation (Friday) and credit data will be watched for a further pick up.
  • In Australia, expect a further fall in housing finance (Tuesday). The NAB business survey (Tuesday) and the Westpac Melbourne Institute’s consumer confidence survey (Wednesday) are expected to remain softish.
  • The flow of Australian December half earnings results will start to pick up with 44 major companies reporting including JB HiFi and GPT (Monday), Transurban and Amcor (Tuesday), Cochlear and CSL (Wednesday), South32, Woodside and AMP (Thursday) and Sonic Healthcare (Friday). 2018-19 consensus earnings growth expectations have fallen to around 4% for the market as a whole, not helped by slower growth globally, as well as locally, with a large number of Australian companies warning of tough trading conditions. Resources profit growth is running around 8% and the rest of the market around 2%. Resources, building materials, insurance and healthcare look to be the strongest, with telcos, discretionary retail, media and transport the weakest, and banks constrained. Key issues will be around the impact of the housing downturn, possible changes to franking credits and how the consumer is holding up.

Outlook for investment markets

  • Shares are likely to see volatility remain high, with the high risk of a short-term pull back. However, valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole, helped by more policy stimulus in China and Europe, and the Fed pausing.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5-10% this year, led again by 15% or so price falls in Sydney and Melbourne. This is on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves, and uncertainty around the impact of tax changes under a Labor Government.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
  • The Australian dollar is likely to fall 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 as the RBA moves to cut rates. Being short the Australian dollar 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

FinSec Partners Disclaimer

Weekly Market Update – 1st February 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets were mixed over the last week. US shares rose 1.6%, helped by a more dovish and supportive Fed and mostly good economic and earnings news, Chinese shares gained 2% helped by continuing progress in US/China trade talks and Japanese shares rose 0.1%, but Eurozone shares fell 0.1% and Australian shares fell 0.7%. Bond yields mostly declined, helped along by a dovish Fed. Commodity prices rose with the iron ore price getting a big boost as Vale announced production cuts as a result of its dam disaster amounting to around 2-3% of global iron ore production. The US dollar fell on the back of Fed dovishness and this along with a surge in the iron ore price saw the $A rise.
  • While the Fed was not dovish enough in December with shares plunging accordingly, it made up for it in the past week going very dovish. Thanks to various “cross currents” that are clouding the outlook, gone is the reference to “further gradual increases” in the Fed funds rate to be replaced by “patience” as it assesses what to do next. Gone too is leaving the normalisation of its balance sheet (or Quantitative Tightening, QT) on “autopilot”, to be replaced by greater flexibility and an end to it at a higher level for the balance sheet than earlier expected. If the end point for the Fed’s balance sheet is around $3.5-3.7 trillion as Fed Chair Powell implied, then QT could be over by year-end. We see the Fed being on hold regarding rates for the next six months at least. The Fed’s dovish shift and its flexibility on rates and its balance sheet is akin to its 2016 interest rate pause and so is positive for investment markets.

  • There was also more progress on the US/China trade front after two days of talks, with talks to continue in Beijing this month. Big differences appear to remain, e.g. around intellectual property, and may require a meeting between Presidents Trump and Xi to finalise. We remain of the view that a deal will be reached as both sides are under pressure from slowing growth, but it may require the March 1 deadline to be extended.
  • The Fed’s dovishness and progress on trade help tick off some of the conditions for shares to do better this year. Others include Chinese stimulus getting the upper hand, ECB easing, a decisive end to the US government shutdown dispute and signs the US debt ceiling will be raised relatively smoothly, a bottoming in profit revisions and good earnings reporting seasons globally and in Australia, stronger than expected economic data and a bottoming in PMIs and share markets breaking through resistance on strong breadth. Some of these are still likely to drive volatility and setbacks in shares (as deep V style rebounds from falls like those seen last year are unusual) but at least we are making progress.

Major global economic events and implications

  • US data was mostly good over the last week. While consumer confidence fell sharply again, the ISM manufacturing conditions index rebounded in January to a solid 56.6 but with the prices paid component falling further, construction activity rose more than expected in November and payrolls rose by a stronger than expected 304,000 jobs in January. Even with downwards revisions in previous months, payroll growth has been a strong 241,000 over the last three months. While unemployment rose to 4%, this looks to have been due to the partial government shutdown. Meanwhile, although wages growth is trending up, it remained relatively benign in January at 3.2% year-on-year, which is well below the inflation danger zone of around 4% (see the chart below). Overall the data supports the Fed both in terms of the economy remaining solid and the case for a pause on rates with inflation pressures remaining benign. The US money market got a bit ahead of itself though in factoring rate cuts.
  • The US December quarter earnings reporting season remains good, but it’s softer than previous quarters. 220 S&P 500 companies have now reported with 73% beating on earnings with an average beat of 2.3% and 60% beating on sales. Earnings growth is now running at 16.7% year-on-year for the quarter. But as can be seen in the next chart the level of surprises and earnings growth is slowing down as the tax cut boost fades. US earnings growth is likely to be around 5% this year as the tax cut boost drops out.
  • The Eurozone remains weak. GDP growth remained soft in the December quarter at just 0.2%, seeing year ended growth drop to just 1.2% its lowest since 2014. Unemployment was unchanged in December at 7.9% and economic sentiment fell further in January. All this means increasing pressure on the ECB to ease again.
  • Japanese data is also soft, with lower consumer confidence and industrial production. But at least jobs related data remains strong, albeit its being helped by a falling labour force.
  • Chinese business conditions PMIs showed stronger services conditions but still weak manufacturing conditions, particularly for small businesses. Pressure for more stimulus remains.

Australian economic events and implications

  • More soft Australian data with the NAB business survey for December showing a sharp fall in business conditions, house price falls continuing in January and credit growth remaining soft. The terms of trade rose solidly in the December quarter thanks to strong export price gains but this means that the contribution to growth from net exports will be weaker than expected which will be a drag on December quarter GDP growth.
  • December quarter inflation of 1.8% year on year for both headline and underlying inflation highlights that pricing power continues to remain weak in the economy. That said the December result was not low enough to bring on an imminent rate cut, but the longer inflation stays below target the harder it will be to get it up again as inflation expectations will move down as they did in Japan after years of very low inflation. So with growth likely to disappoint the RBA we see inflation staying below target for longer than the RBA is allowing and see this driving the RBA to cut the cash rate to 1% this year.
  • Meanwhile, CoreLogic data showed a further sharp fall in dwelling prices in January with national capital city prices now down 7.8% from their September 2017 high which is more severe than their fall in the GFC. Sydney prices have now seen their biggest fall since the early 1980s recession. Tight credit, rising supply, falling foreign demand and falling prices feeding on themselves have combined to create a perfect storm for Sydney and Melbourne, with Perth and Darwin still falling and most other cities pretty soft. We see Sydney and Melbourne home prices falling another 15% or so this year as part of a total top to bottom fall of 25%, which with little change in average prices across other cities will see national average home prices fall another 5 to 10% this year. While this is a drag on economic growth it’s unlikely to drive a recession as property price weakness will mainly be concentrated in Sydney and Melbourne, the growth drag from falling mining investment is fading, non-mining investment and infrastructure spending are rising, the RBA can and we think will cut interest rates again and a likely further fall in the Australian dollar will help support growth.

What to watch over the next week?

  • In the US, data releases delayed by the shutdown are expected to show a rise in durable goods orders, December core consumption deflator inflation remaining around 1.9% year on year, December quarter GDP growth of around 2.6% annualised, a modest rise in retail sales and a fall in housing starts. In terms of scheduled releases expect to see the non-manufacturing conditions ISM (Tuesday) fall to around the 57 level. Comments by Fed Chair Powell (Thursday) are likely to remain dovish. Finally, it will be another busy week in the US earnings reporting season, with companies including Alphabet, Walt Disney, Ely Lilly and GM due to report.
  • The Bank of England (Thursday) is unlikely to make any changes to monetary policy.
  • The Australian earnings reporting season for second half of 2018 will also start to get underway but with only 15 major companies reporting including James Hardie (Tuesday), the CBA, IAG and Dexus (Wednesday), Mirvac, AGL and Newscorp (Thursday) and REA (Friday). 2018-19 consensus earnings growth expectations have fallen to around 3% for the market as a whole not helped by slower growth globally as well as locally, with resources running around 8% and the rest of the market around 2%. Resource, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained. Key issues will be around the impact of the housing downturn, possible changes to franking credits if there is a change of government and how the consumer is holding up.

Outlook for investment markets

  • Global shares are likely to see volatility remain high with the high risk of a re-test of December 2018 lows, but valuations are now improved, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.
  • Australian shares are likely to do okay but with returns constrained by moderate earnings growth.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property. National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and uncertainty around the impact of tax changes under a Labor Government.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
  • Beyond any further near-term bounce as the Fed pauses on rate hikes, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. 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

FinSec Partners Disclaimer

Weekly Market Update – 25th January 2019

Weekly Market UpdateInvestment markets and key developments over the past week

  • Global share markets pulled back a bit over the last week on the back of trade and growth worries, but the Australian share market managed a small rise led by consumer stocks and yield sensitive utilities and real estate shares. Bond yields fell, helped by a dovish ECB. Commodity prices mostly fell and the $US rose and this saw the $A decline helped down by increasing expectations of lower interest rates in Australia.
  • The IMF catches up to markets. While the IMF revised down its 2019 growth forecast from 3.7% to 3.5% and its 2020 global growth forecast from 3.7% to 3.6% and warned of threats to global growth there was nothing new here. As usual the IMF is just catching up to the slowdown in global growth seen last year and the falls seen in share markets. That said the return to the post GFC norm of growth downgrades (where global growth forecasts start near 4% and end near 3%) reminds us that we have still yet to escape the caution and fragility that has characterised the post GFC period. This is clearly a threat, but it also keeps inflation down and monetary policy easy which is a positive for investment markets.

IMF global 2019 GDP growth forecasts shaved to 3.5%

Source: IMF, AMP Capital

  • Business conditions PMIs indicate that the global growth slowdown has continued into January.While January “flash” PMIs rose in the US, they fell in Europe, Japan and Australia. See the next chart. This will maintain pressure for global policy easing.

Business conditions PMIs stable in the US, down elsewhere

Source: Bloomberg, AMP Capital

  • Our view remains that shares will do better this year thanks to much improved valuations, likely policy support and a stabilisation and improvement in global growth. But after a huge rebound since the December lows shares are vulnerable to a short term pull back/re-test of December lows in the face of a long worry list. Things that would get us more bullish from here regarding the short term are: a successful retest of the December lows or technical support levels, stimulus in China getting the upper hand, confirmation of an easier Fed, ECB easing, continuing progress in US/China trade talks, an end to the US government shutdown and signs the debt ceiling will be raised, a bottoming in profit revisions and good earnings reporting seasons globally and in Australia, stronger than expected economic data and a bottoming in PMIs and share markets breaking through resistance on strong breadth. We are making some progress on these and we don’t necessarily need to see all of them, but we do have a way to go yet.
  • The past week saw no real definitive progress on a Brexit plan but a “no deal” Brexit continues to look unlikely. As we pointed out last week parliamentary support for a “no-deal” or hard Brexit is very low (at maybe just 10% of parliament) and signs of bipartisan support to extending the Brexit deadline if agreement is not reached just adds to confidence we will see either a “soft” Brexit or no Brexit as opposed to a “no deal” Brexit. There is a long way to go though and the uncertainty is not helping the UK economy.
  • In Australia, the decision by NAB to catch up to last year’s mortgage rate increases put through by other banks highlights ongoing funding cost pressures faced by the banks on the roughly 35% of their funding that they get outside of bank deposits. With short term funding costs rising sharply again in recent months (as evident by a rise in the spread between the 90 day bank bill rate and the expected cash rate to around 60 basis points compared to a norm of around 23 basis points) pressure remains on the banks, putting ongoing upwards pressure on mortgage rates, resulting in a de facto monetary tightening. Coming at a time when households with a mortgage are being adversely affected by falling home prices in Sydney and Melbourne its consistent with views that the RBA will lower the cash rate this year.

Major global economic events and implications

  • US economic data was mostly good. Existing home sales fell sharply and the leading index fell in December (although this was due to the share market fall), but against this the Markit composite business conditions PMI rose marginally in January to a solid reading of 54.5, jobless claims fell to a 49-year low and home prices continue to rise.
  • The US December quarter earnings reporting season is actually coming in pretty good. 108 S&P 500 companies have reported so far with 76% beating on earnings with an average beat of 1.9% and 59% beating on sales. Earnings growth is running at 15.8% year on year for the quarter.
  • As widely expected the ECB left monetary policy unchanged but its acknowledgement that the risks to growth are on the downside opens the door to more monetary easing ahead with President Draghi reiterating that all the ECB’s tools are on the table. Assessments show that the ECB will announce another round of cheap bank funding (or LTROs) at their March meeting and a rate hike is years away. Another slide in Eurozone business conditions PMIs in January indicates that growth is continuing to slow.
  • Similarly the Bank of Japan made no change to its monetary stimulus keeping the pedal as it revised down its inflation outlook. Japan’s business conditions PMI also fell sharply in January warning of slower growth.
  • No surprises from Chinese data – growth is slowing but not collapsing. December quarter GDP growth came in at 6.4% year on year which left 2018 growth as a whole at 6.6% which was actually a little bit stronger than the expectation for 6.5% growth. Meanwhile, growth in industrial production and retail sales actually perked up a bit and while unemployment rose to 4.9% from 4.8% its in the same range its been in for a year. Nevertheless, growth is still likely to slow a bit further – as exports fall after frontloading to avoid tariff hikes – necessitating more policy stimulus. Expect Chinese growth this year of 6.2%.

Australian economic events and implications

  • Australian jobs up but house prices down. Labour market data for December presented a mixed bag with better than expected jobs growth and a fall in unemployment back to 5%, but a fall in full time jobs, a further slowing in annual jobs growth and still high underemployment. Forward looking labour market indicators remain solid but have lost some momentum. Consistent with this, the CBA’s business conditions PMI fell further in January continuing the downtrend since March 2017.
  • Meanwhile, data from Domain confirmed that property prices continued to slide in the December quarter driven by the once booming cities of Sydney and Melbourne as a combination of negative forces impact led by tight credit, rising supply and falling prices feeding on themselves. It is now likely to see Sydney and Melbourne home prices falling another 15% or so this year as part of a total top to bottom fall of 25% which with broadly stable prices elsewhere will see national average prices fall another 5 to 10% this year. What’s driving the falls is well known, but what will cause the downswing to bottom out? It’s a while off yet but expect a combination of RBA rate cuts flowing to lower mortgage rates, improved affordability thanks to lower prices, continuing strong population growth, the prospect of slowing new supply and possibly some form of Government support (like a new round of Federal First Home owner grants) to help prices stabilise next year.

What to watch over the next week?

  • Globally the Fed on Wednesday and continuing US/China trade talks (with Vice Premier Liu He travelling to the US for talks on Wednesday and Thursday) will likely dominate whereas in Australia the focus will be on December quarter inflation data to be released on Wednesday.
  • Our expectation is that the Fed will leave interest rates on hold and repeat the “patient” and “watching” message of late supporting expectations for an extended pause in rate hikes and flexibility to do whatever it can to keep the expansion going. The trade talks are expected to make further progress – but it looks like there is still a long way to go in terms of the structural issues with plenty of potential for periodic upsets albeit views remain that a solution will be reached in the months ahead.
  • US data releases are likely to continue to be affected by the shutdown but in terms of what is scheduled to be released expect to see a slight dip in consumer confidence (Tuesday), December quarter GDP (Wednesday) to rise 2.6% annualised, inflation as measured by the core private consumption deflator for December (Thursday) to remain at 1.9% year on year, employment costs in the December quarter (also Thursday) to have risen 2.9%yoy, the January ISM manufacturing conditions index (Friday) to stay around 54 and January jobs data (Friday) to show a solid 160,000 gain in January payrolls (after the huge 312,000 gain in December), unemployment to fall to 3.8% and wages growth to remain around 3.2% year on year. The US earnings reporting season will also ramp up.
  • Eurozone December quarter GDP growth (Thursday) is expected to show growth stuck around 0.2% quarter on quarter which will see annual growth slow further to 1.2%yoy. Meanwhile, economic confidence (Wednesday) is likely to have slipped again in January, December unemployment (also Thursday) is likely to have remained at 7.9% and core inflation for January (Friday) is expected to remain at 1%yoy. All of which is consistent with more ECB stimulus.
  • Japanese data is expected to show a slight fall in industrial production (Thursday) but continuing solid labour market indicators (Friday).
  • China will release business conditions PMIs for January on Thursday and Friday which are likely to remain just below 50 for manufacturing but around 53 to 54 for services.
  • In Australia, expect headline and underlying inflation for the December quarter (Wednesday) of around 0.5% quarter on quarter or 1.8% year on year. Underlying inflationary pressures are likely to remain weak and falls in petrol prices and health costs are likely to have been offset by an increase in tobacco excise. Meanwhile, expect the NAB business survey (Tuesday) to show a further fall in confidence, credit growth (Thursday) to remain modest and CoreLogic data for January to show a further fall in home prices (Friday). The Banking and Finance Royal Commission report will also be delivered to the Government on Friday and amongst other things will be watched in terms of its implications for bank lending.

Outlook for investment markets

  • With uncertainty likely to remain high around the Fed, US politics, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018 as investors realise that recession is not imminent:
  • Global shares are likely to see volatility remain high with the high risk of a re-test of December 2018 lows, but valuations are now improved, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed having a pause.
  • Australian shares are likely to do okay but with returns constrained by moderate earnings growth.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and uncertainty around the impact of tax changes under a Labor Government.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
  • Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. 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

FinSec Partners Disclaimer

Weekly Market Update – 18th January 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets continued to rise over the last week helped by talk of policy stimulus (notably in China) and optimism of a resolution to the US/China trade dispute. Bond yields rose in the US but were little changed elsewhere, commodity prices including oil rose and the $US rose slightly which saw the $A fall slightly.
  • After a great rally since Christmas with US shares up 11%, global shares up 10% and Australian shares up 8% some sort of pull back or retest of the December lows remains a high risk. Major share market falls as we saw last year rarely end with a V bottom, shares are now overbought and there is a long list of uncertainties over the next few months that could trip markets. The list includes: soft data in the short term with the March quarter in the US renowned for soft growth, earnings reporting seasons, trade negotiations, the US government shutdown, the need to raise the US debt ceiling, the Mueller inquiry, Brexit, the Australian election, etc. But looking beyond the near-term uncertainties, shares are looking upbeat for the year as a whole as valuations remain much improved from last year’s highs, the trade dispute is likely to be resolved before too long, global growth is likely to stabilise and improve which should help support modest profit growth and policy stimulus should help growth. Speaking of which…
  • Shares fall, economic data softens, policy makers respond. The past week has seen more signs of a supportive policy shift globally with: Chinese officials promising more aggressive policy stimulus focussing on tax cuts and the PBOC undertaking a record money market cash injection; Angela Merkel’s political party calling for tax cuts in Germany; ECB President Draghi acknowledging that recent economic news has been weaker than expected and that significant monetary stimulus is still needed; and more Fed officials supporting a pause on rate hikes with former Fed Chair Yellen saying we may have seen the last hike for this cycle. An easing in global policy is one big reason why it is expected to see the global growth slowdown to be limited as it was around 2012 and 2015-16 and why it’s a better year for shares this year.
  • The US partial government shutdown posing a bigger risk. While its only partial it’s now gone on for four weeks with a reported 800,000 public servants missing out on pay. The longer it goes on the more it will impact and add to trade as a factor worrying US companies. So far American’s are mostly blaming Trump and the Republicans. Trump is dug in over the wall. But like the trade war he won’t want this to drag on for too long given the threat it would pose to US growth ahead of his desired re-election in 2020. So, expect some sort of compromise in the next few weeks.
  • Out of interest, 2019 is the third year in the four-year US presidential cycle and historically its normally the strongest as can be seen in the next chart as the president does his best to ensure the economy is in good shape for his re-election year (ie next year for Trump). Of course, it doesn’t always work. But for this year it would be consistent with Trump seeking to support growth and this would include solving the trade war and ending the shutdown.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • The Brexit comedy rolls on, but could be heading towards a softer Brexit or even no Brexit. It was no surprise to see UK PM May’s Brexit plan defeated but one would be forgiven for expecting that it would have been greeted with a plunge in British pound. But it held up, so how? The focus is now on cross party discussions to find a solution and with Parliament biased towards the EU this is likely to push towards a soft Brexit. Failing that (and the risk of no solution is high given May’s “red lines”) another referendum is likely and with the difficulties associated with Brexit now readily apparent, Bremain is likely to win. In the meantime, the EU is likely to agree to delay the Brexit date. It should also be remembered though that while Brexit uncertainty is bad for the UK and a no-deal Brexit could knock it into recession it’s a second order issue globally as its implications for the survival of the Euro are minimal as support across Europe for the Euro remains solid. Hence global markets payed little attention to it over the last week.

Major global economic events and implications

  • US data was disrupted over the last week thanks to the partial government shutdown but there were some positive signs of a soft landing. On the weak side the Fed’s Beige Book of anecdotal evidence was less upbeat on the growth front and manufacturing conditions in the New York region deteriorated again in January. Against this though manufacturing conditions in the Philadelphia regional improved, jobless claims fell and the NAHB’s home builder conditions index rose slightly in January possibly helped by lower mortgage rates which helped drive a 27% rise in mortgage applications over the last two weeks all of which supports the view that the housing sector will have a soft landing. Producer price and import price inflation were relatively benign consistent with the Fed being on hold.
  • The US December quarter earnings reporting season is off to an okay start. 49 S&P 500 companies have reported so far with 79% beating on earnings with an average beat of 0.8% and 54% beating on sales. But its early days & the focus is likely to be on outlook comments which are likely to be cautious given the tight labour market and uncertainties about growth and trade.
  • Japanese headline and core inflation was just 0.3% year on year in December highlighting the pressure on the Bank of Japan to stay ultra-easy or even ease further (if that’s possible).
  • Eurozone industrial production fell sharply in November, but annual growth data for 2018 as a whole implies that the German economy grew in the December quarter albeit very slowly. That said it will still put pressure on the ECB to ease.
  • Chinese exports and imports both fell in December supporting the view that the Chinese economy slowed further late last year, but against this home price gains remained solid and credit growth came in stronger than expected with the latter possibly reflecting policy easing.

Australian economic events and implications

  • Australian data releases over the last week continued the weak run seen since Christmas with falls in housing finance, new home sales, housing starts and consumer confidence. Sure, the Melbourne Institute’s Inflation Gauge perked up a bit in December but it’s a bit volatile month to month and in any case both on a headline and underlying basis is running below the RBA’s 2-3% inflation target.
  • House prices risk falling further than originally thought. For some time views have been that Sydney and Melbourne home prices will have a top to bottom fall of around 20% out to 2020 translating into a fall in national average prices of around 10% (as other cities are in better shape). The plunge in clearance rates and acceleration in the pace of house price falls late last year along with the ongoing credit tightening, the record pipeline of units yet to be completed, reduced foreign demand, investor uncertainty over potential changes to negative gearing and capital gains tax along with price falls feeding on themselves suggest that the risks to Sydney and Melbourne prices are on the downside of the 20% forecast falls. The threat this poses to consumer spending along with rising bank funding costs and out of cycle mortgage rate hikes reinforces the likelihood that the RBA will cut interest rates this year but the cuts could come earlier than the second half that had been previously expected.

What to watch over the next week?

  • US data releases are likely to continue to be affected by the shutdown but in terms of what is scheduled to be released expect to see a pullback in existing home sales (Tuesday), continued modest gains in home prices (Wednesday), a slight further fall in business conditions PMIs for January (Thursday) and a slight improvement in underlying durable goods orders (Friday). If the shutdown ends data already delayed for retail sales and housing starts may also be released.
  • The US earnings reporting season will also ramp up a notch with companies such as Johnson & Johnson, Proctor & Gamble, Microsoft and Starbucks due to report.
  • The European Central Bank meets Thursday and is not expected to make any changes to monetary policy but could flag that another round of cheap bank financing or LTRO (which is a short-term form of quantitative easing) is on the way or being considered. Eurozone business conditions PMIs for January (also Thursday) are expected to remain weak.
  • The Brexit comedy will roll on with PM May due to present Plan B on Monday.
  • The Bank of Japan is also expected to leave monetary policy on hold (Wednesday) and remain dovish.
  • Chinese December quarter GDP data due Monday is expected to confirm a further slowing in growth to 6.4% year on year from 6.5% in the September quarter. This will leave growth for 2018 as a whole at 6.6% which is slightly stronger than the 6.5% that was expected. Meanwhile December data is expected to show a slight improvement in growth in retail sales and investment but a slight slowing in growth in industrial production.
  • In Australia expect jobs data on Thursday to show employment growth slowing to a gain of around 15,000 with unemployment falling to remaining at 5%. Growth in skilled vacancies (Wednesday) is expected to remain soft and the CBA’s business conditions PMIs will be released Thursday.

Outlook for investment markets

  • With uncertainty likely to remain high around the Fed, US politics, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018 as investors realise that recession is not imminent:
  • Global shares could still make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high but valuations are now improved and reasonable growth and profits should see decent gains through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
  • Emerging markets are likely to outperform if the $US is more constrained as is expected.
  • Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5% or so this year led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and uncertainty around the impact of tax changes under a Labor Government. The risk is on the downside.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end of 2019.
  • Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. 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

FinSec Partners Disclaimer

Weekly Market Update – 11th January 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Since the last weekly update three weeks ago investment markets have been on a bit of a roller coaster ride, with Santa missing Christmas for markets but arriving the day after. Global shares led by the US continued to plunge into Christmas as the US saw the start of a partial government shutdown taking the decline in the US share market to 19.8% from its September high. But since Christmas share markets have rebounded, credit spreads have narrowed and the $US has fallen as investors have become a bit less nervous about the outlook helped by a more dovish Fed, signs of progress on the US/China trade issue and maybe a bit of Christmas/New Year cheer. The past week has seen shares continue to rally, government bond yields decline, oil and the iron ore price move higher and the $US fall which has seen the $A push higher.
  • While the recent rebound in share markets has come on good breadth (ie strong participation across sectors and stocks) and is confirmed by other markets like credit and a rally in “risk on” currencies it’s too early to say that we have seen the lows. Global growth indicators look like they could still slow further in the short term and there are a bunch of issues coming up that could trip up markets including US December quarter profit results, US/China trade negotiations, the US government shutdown, the need to raise the US debt ceiling, the Mueller inquiry, Brexit uncertainties, the Australian election, etc. So markets could easily have a retest of the December low or even make new lows in the next few months.
  • However, views remain that the falls in share markets amounting to 18% for global shares, 20% for US shares and 14% for Australian shares from their highs last year to their December lows and any further falls to come in the next few months are unlikely to be the start of a deep (“grizzly”) bear market like was seen in the GFC and that by year end share markets will be higher. The main reason is that it’s likely not to see a US, global or Australian recession anytime soon as monetary conditions are not tight enough and we haven’t seen the sort of excesses in terms of debt, investment or inflation that normally precede recessions. In relation to this the following points are also worth noting:

    First, the US share market has seen six significant share market falls ranging from 14% to 34% since 1984 that have not been associated with recession and saw strong subsequent rebounds.

    Second, each of these have seen some sort of policy response to help end them and on this front recent indications from the Fed including Fed Chair Powell about being ‘patient, flexible and using all tools to keep the expansion on track’ are consistent with it pausing its interest rate hikes this year, Chinese officials are continuing to signal more policy stimulus including cutting banks’ required reserve ratios and expect the ECB to provide more cheap bank funding.

    Third, negotiations between the US and China on trade look to be proceeding well although they are still in early stages. China in particular announced more tariff cuts and a commitment to treat foreign firms equally.

    Fourth, President Trump wants to get re-elected in 2020 so he is motivated to do whatever he can to avoid a protracted bear market and recession and this includes seeking to resolve the trade dispute and ending the partial government shutdown before it causes too much damage.

    Fifth, while the oil price has bounced off its lows it’s still down 30% from its high taking pressure off inflation and providing a boost to spending power.

    Finally, a year ago investors were feeling upbeat about 2018 on the back of US tax cuts, stronger synchronised global growth and strong profits and yet 2018 didn’t turn out well. So, it may be a good sign for 2019 from a contrarian perspective that there is now so much uncertainty and caution around.

Major global economic events and implications

  • US data was mixed over the last three weeks. Consumer confidence, the ISM business conditions indexes, small business optimism and job openings all fell. And on the strong side, jobs growth in December was much stronger than expected and wages growth continued to edge higher. This mixed data is consistent with the Fed’s more cautious approach.
  • Eurozone unemployment fell to 7.9% in November which is well down from its 2013 high of around 12%. The trouble is that economic confidence slid for the 12th month in a row in December suggesting that growth momentum may be continuing to slow. Which with core inflation stuck at just 1% in December will keep the ECB dovish.
  • Japan saw stronger wages growth, but still not by enough to move the Bank of Japan.
  • Chinese data has been soft. Services conditions PMIs rose slightly in December but manufacturing PMIs fell and this is of greater significance globally. Reflecting the slowdown in China Apple cut its outlook citing slower demand from China. Falling consumer and producer price inflation in China for December is also consistent with slower growth. Reflecting China’s growth slowdown the PBOC cut banks’ required reserve ratio again freeing up more funds for lending.

Australian economic events and implications

  • Australian economic data over the last three weeks has been soft with weak housing credit, sharp falls in home prices in December, another plunge in residential building approvals pointing to falling dwelling investment (see chart), continuing weakness in car sales, a loss of momentum in job ads and vacancies and falls in business conditions PMIs for December. Retail sales growth was good in November but is likely to slow as home prices continue to fall. Anecdotal evidence points to a soft December and reports of slowing avocado sales (less demand for smashed avocado on rye?) may be telling us something. Income tax cuts will help support consumer spending, but won’t be enough so it is likely that the RBA will cut the cash rate to 1% this year.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

  • Another blowout in bank funding costs is adding to the pressure for an RBA rate cut. The gap between the 3-month bank bill rate and the expected RBA cash rate has blown out again to around 0.57% compared to a norm of around 0.23%. As a result, some banks have started raising their variable mortgage rates again. This is bad news for households seeing falling house prices. The best way to offset this is for the RBA to cut the cash rate as it drives around 65% of bank funding.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

What to watch over the next week?

  • In the US, expect to see a solid gain in December retail sales (Wednesday), a slight rise in homebuilder conditions (also Wednesday) but a fall in housing starts (Thursday) and a modest rise in industrial production (Friday). January manufacturing conditions surveys for the New York and Philadelphia regions should show a slight rise and will be watched closely given their plunge last month. US December quarter earnings will start to flow with an 18% yoy rise expected, although the focus will be on corporate guidance with profit growth likely to slow to 5% this year as the corporate tax cut drops out.
  • In the UK, PM May’s Brexit deal faces likely defeat in a parliamentary vote on Tuesday. Even though the UK parliament will force May to come up with a Plan B there is no majority supporting in parliament for any alternative. So the Brexit comedy will continue. A no deal Brexit could knock the UK into recession and maybe knock 0.5% of Eurozone growth.
  • Chinese trade data for December (Monday) is likely to show subdued growth in exports and imports.
  • In Australia, expect declines in both consumer confidence (Wednesday) and housing finance (Thursday).

Outlook for investment markets

  • With uncertainty likely to remain high around the Fed, US politics, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018 as investors realise that recession is not imminent.
  • Global shares could still make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high but valuations are now improved and reasonable growth and profits should provide decent gains through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
  • Emerging markets are likely to outperform if the $US is more constrained.
  • Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5% or so this year led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and tax changes under a Labor Government impact. The risk is on the downside.
  • Cash and bank deposits are likely to provide poor returns particulrly if the RBA cuts the official cash rate to 1% by end of 2019.
  • Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. 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

FinSec Partners Disclaimer

Weekly Market Update – 21st December 2018

Weekly Market Update

Investment markets and key developments over the past week

  • The past week saw share markets fall further on the back of ongoing worries about growth not helped by a “not dovish enough” Fed, new threats to US/Chinese negotiations, worries about a US government shutdown, a court ruling against America’s Affordable Care Act and problems at various US companies. US shares lost 7.1% in their worst week since August 2011, Eurozone shares fell 3.2%, Japanese shares lost 5.7%, Chinese shares fell 4.3% and Australian shares lost 2.4%. This saw credit spreads continue to widen and bond yields fall. Oil and metal prices also fell but the iron ore price continued to defy the gloom and rose. While the US dollar fell against a range of currencies on the back of a more dovish Fed, the $A also fell back towards $US0.70 on global growth worries.
  • From their highs a few months ago global shares have fallen around 16% and Australian shares have fallen around 14%. While it would be nice to see a decent Santa rally (Australian shares have been trying!), even if we do see one the risks remain skewed to further weakness into the early part of next year as uncertainty remains high regarding global growth, there are still too many political uncertainties around and investor sentiment looks like its still not fully washed out. However, views remain that is more likely part of a “gummy bear” market that leaves shares down 20% or so from their highs a few months back, after which they start to rally again (like was seen most recently in 2015-16), rather than as part of a long and deep “grizzly bear” market like was seen in the GFC. The main reason for this is that it is unlikely don’t see the US, global or Australian economies sliding into recession any time soon. But some action by policy makers is likely to be necessary to see markets stabilise and start to recover. This is likely to come in the early part of next year with the Fed pausing, more monetary stimulus by the ECB and more aggressive stimulus in China.
  • In this regard, while there was much to worry markets over the last week there were some positives too (but as is often the case in times like these the positives get overlooked as investor fear takes over from fundamentals) that provide a bit of confidence that we are not going into a long deep “grizzly bear” market:
  • First, while the Fed’s commentary following its latest 0.25% rate hike was not as dovish as the market was hoping for and Fed Chair Powell needs to get some lessons from Yellen or Bernanke in how to talk to markets, it does represent a dovish shift (with the Fed softening its expectations for future rate hikes) and indicates that it is aware of the risks around global growth and financial markets. This was subsequently reinforced by NY Fed President Williams who indicated that the Fed is “listening very carefully” to markets and that it’s quantitative tightening program is not on “autopilot” and can be adjusted if needed. Views remain that the Fed is going to have a pause in the first half of next year and that this will help provide confidence. A slowing or pause in the rate of Quantitative Tightening may also be seen.
  • Second, the People’s Bank of China announced more targeted easing and China’s annual Economic Work Conference signalled more fiscal and monetary stimulus in 2019.
  • Third, while President Xi’s speech and news of a US case against Chinese officials allegedly involved in intellectual property theft did nothing to add to confidence that there will be a solution on the US/China dispute, it has been confirmed that the US and China are planning meetings in January to resolve their differences and China’s Economic Work Conference was positive on finding a solution and pledged to strengthen the protection of intellectual property.
  • Fourth, the European Commission and Italy reached agreement over Italy’s budget deficit target for 2019 (lowering it from 2.4% of GDP to 2%) thereby avoiding placing Italy in an “Excessive Deficit Procedure”. This has seen a sharp fall in Italian bond yields and makes it easier for the ECB to consider a new round of cheap funding for banks.
  • Fifth, the oil price plunged again, taking its fall from early October to 41%. This is bad for energy stocks but it’s great news for households (with Australian petrol prices falling to around $1.20 a litre) and industry.
  • Sixth, the fall in share markets this month has been far more severe in the US, which has fallen 12.5% with other markets more resilient. This is a good sign in that it suggests that other share markets which underperformed the US on the way up and initially fell harder have already seen their adjustment, and now it’s the US share market catching down as it works off overvaluation in some areas (like in FAANG stocks). Chinese shares, emerging markets and Asian shares fell much earlier and harder and so far are holding up much better.
  • Finally, a year ago investors were feeling upbeat about 2018 on the back of US tax cuts, stronger synchronised global growth and strong profits and yet 2018 didn’t turn out well. So, it may be a good sign for 2019 from a contrarian perspective that there is now so much doom and gloom around.
  • The US is on the brink of another Federal government shutdown with funding for President Trump’s wall being the sticking point. This is adding to uncertainty around Washington ahead of the need to raise the debt ceiling after March next year and following the resignation of Defense Secretary Mattis. It should be noted though that shutdowns historically have had very little economic impact and this time around it will only affect 10% or so of the government because 75% is already funded, only non-essential services will shut and many public servants will still work and get paid once it ends.
  • Australia saw some good news over the last week with the mid year budget review confirming that the budget is in much better shape than expected in May, providing scope for tax cuts next financial year. In fact, the Government is even budgeting for tax cuts of around $3 billion a year starting from next July and yet still projects rising surpluses. That said, a $3 billion a year tax cut is just 0.1% of GDP, so it would be a pretty small stimulus (maybe $6 a week for an average earner which won’t buy a lot these days). The other issue is that the budget numbers may not get much better than this, given threats to global growth (and hence commodity prices), wages growth continuing to run below the Government’s assumptions and signs from job ads that employment growth may start to slow.
  • Meanwhile also in Australia, it’s hard to get too excited by APRA’s removal of the 30% cap on the proportion of mortgage lending that can go to interest-only borrowers. This served its purpose well when it was introduced in March last year when interest-only lending was north of 40%. But now it’s running around 16% and so the cap has become irrelevant, the focus has shifted away from arbitrary lending caps to a focus on “responsible lending” (hence the focus on borrower income, expenses and total debt) and with property market psychology now very negative the desire for interest-only loans has shrunk and banks are a lot more reluctant to make them. So, it’s doubtful that the removal of the cap will have any impact on property lending or property prices, where continue to see further weakness in the year ahead. In fact, since the removal of the 10% growth limit on lending to investors in April, lending growth to property investors has just slowed to record lows.
  • Our view remains that the RBA will cut the official cash rate twice in 2019, taking it to 1%.

Major global economic events and implications

  • US data releases were mixed with strong consumer spending in November, solid consumer sentiment and a rise in housing starts and home sales but another fall in home builder conditions, weak durable goods orders and softer December readings for the New York and Philadelphia manufacturing conditions surveys. Core private final consumption deflator inflation remained benign at 1.9% year-on-year in November.
  • The Bank of Japan left monetary policy unchanged in ultra-easy mode and with core inflation in November at 0.3% year-on-year it’s set to remain that way for a long while yet.
  • The Bank of England also left monetary policy on hold, which is not surprising given the Brexit mayhem.

Australian economic events and implications

  • Australian jobs data for November was mixed. Headline jobs growth remained strong, but the quality was low with full time jobs falling and unemployment and underemployment actually rose. What’s more, skilled job ads fell again as they have been since March pointing to softer jobs growth ahead.
  • Meanwhile population growth remained strong at 1.6% or 391,000 people over the year to the June quarter with 60% coming from immigration. So, it remains a source of support for headline economic growth and for underlying housing demand, assuming immigration levels are not radically cut.

What to watch over the next three weeks?

  • In the US, the main focus will be on December labour market data (due Jan 4) which are expected to show a solid 180,000 rise in payrolls, unemployment flat at 3.7% and wages growth still around 3.1% year-on-year. In other data, expect consumer confidence (Dec 27) to remain strong, a pullback in the December manufacturing ISM index (Jan 3) and the non-manufacturing ISM (Jan 7) to readings around a still solid 57-58 and core CPI inflation (Jan 11) to remain around 2.2% year-on-year. Public comments by Fed Chair Powell on Jan 4 will likely support the expectation for a Fed pause.
  • Eurozone data is expected to show core inflation (Jan 4) still low around 1% year-on-year and unemployment (Jan 9) flat at 8.1%.
  • Chinese business conditions PMIs for December (Dec 31 and Jan 2) will be watched closely to see if the slowdown in the Chinese economy is stabilising. December data due for release around Jan 7 is likely to show inflation remaining low and growth in imports and exports remaining subdued and credit data to be released around the same time will be watched for the impact of recent policy easing.
  • In Australia, expect credit growth (Dec 31) to remain modest, CoreLogic data for December to show another fall in dwelling prices (Jan 2) (Sydney and Melbourne prices are reportedly already down more than 1% for December so far), building approvals (Jan 9) to remain in a downtrend and only modest growth of 0.2% in November retail sales (Jan 11).

Outlook for investment markets in 2019

  • With uncertainty likely to remain high around US interest rates, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018, as investors realise that recession is not imminent:
  • Global shares are likely to make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high, but valuations are now improved and reasonable growth and profits should see a recovery through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
  • Emerging markets are likely to outperform if the $US is more constrained as expected.
  • After a low early in the year, Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see some slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5%, led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and tax changes under a Labor Government impact.
  • Cash and bank deposits are likely to provide poor returns, as the RBA cuts the official cash rate to 1% by end 2019.
  • Beyond any near-term bounce as the Fed moves towards a pause on rate hikes next year, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. 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

FinSec Partners Disclaimer

Weekly Market Update – 14th December 2018

Weekly Market Update

Investment markets and key developments over the past week

  • Share markets were mixed over the last week with nervousness around trade and global growth continuing, not helped by weak Chinese economic data. US, Eurozone and Chinese shares rose but Japanese and Australian shares fell. Despite a rise in material stocks over the last week the Australian share market was particularly dragged down by telcos, consumer staples, utilities and financials – seeing defensive sectors getting hit so hard (not helped by regulatory risks) makes this a rather confusing downswing! Bond yields rose in the US and Europe but were little changed in Australia and Japan. The oil price rose on the back of supply cuts from Saudi Arabia to the US (flowing from next year’s oil production cuts) with iron ore prices also up. The $A was little changed.
  • Notwithstanding market nervousness, the past week has actually seen more positive news on the US/China trade front with a the round of negotiations kicked off by a phone call between Chinese Vice Premier Liu and US Treasury Secretary Mnuchin and Trade Representative Lighthizer, Chinese officials reportedly travelling to the US to negotiate, China reportedly moving to cut its trade war tariffs on imported US cars and purchasing US soy beans, President Trump indicating he would intervene in the Huawei case if it helped get a deal with China on trade, China reportedly preparing to give foreign firms greater access along with reports that it’s working to soften and replace its Made in China 2025 plan. This is all far more positive than markets appear to be allowing for. But scepticism is understandable after the experience back in May. Views remain that there is a strong incentive for both sides to make a deal to resolve the issue before it weakens their economies (which won’t be good for Trump’s 2020 re-election). It may take more than 90 days, but expect a deal to be reached in the next six months.
  • US Government shutdown risk delayed to December 21. While US Government funding was extended from December 7 it was only out to December 21 and, as a meeting between President Trump and Democrat Congressional leaders highlighted, their remains the risk of a shutdown then as Trump seeks to get funding for his wall. That said, much of this looks to be posturing for the cameras, we have seen all this before, its hard to see either side allowing a Christmas shutdown as the public doesn’t like them. It’s still a risk though – but note that 75% of funding has already been passed into law so it would only be a partial shutdown and only non-essential services would shut so it wouldn’t have much economic impact at all. The big one to watch is the coming fight over the debt ceiling sometime after March 1 next year – as the Democrats could try and force Trump to lift the corporate tax rate in return for raising the debt ceiling.
  • It’s still too early to say we have seen the low in shares. Here’s a possible road map though. Shares have a nice Santa rally over the next two weeks or so, but we get more weakness in early 2019 as global growth indicators remain softish. Which in turn prompts more stimulus in China, the Fed to pause, the ECB to provide more cheap bank funding and a bit of fiscal stimulus out of Europe (was Macron’s concession over the last week to the “yellow shirts” a sign of things to come for fiscal stimulus in Europe?). US/China trade negotiations make progress. Shares then bottom around March. Economic data starts to improve, and it looks like 2015-16 all over again (albeit a bit more compressed in time). Who knows for sure – but while some remain confident that a “grizzly bear” market (where shares fall 20% only to be down another 20% of so a year later) is unlikely because a US/global recession is unlikely anytime soon, a further leg down in shares turning the correction we have seen so far into a “gummy bear” market (down 20% or so from top from but up a year later) is a high risk.
  • Speaking of the Santa rally, it normally kicks in around mid-December on the back of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings. Over the last ten years the period from mid-December to year end has seen an average gain of 1% in US shares with shares up in this two week period 7 years out of ten, albeit it’s been less reliable in the last few years. In Australia, over the last ten years the average gain over the last two weeks of December has been 2.2% with shares up 8 years out of ten, including in all of the last six years. Which is why December is normally a strong month.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • The British always do good comedy and Brexit keeps getting funnier with PM May delaying a vote on her deal to avoid certain defeat before then facing a confidence vote from her party. While she survived the vote more than one third of her party voted against her leaving her weakened and she is now a bit of a lame duck as she won’t be leading into the next election. She still faces an uphill battle to improve her deal with the EU and then win parliamentary support. All of which is leading to an increased risk of a new election and a no deal Brexit in March (which risks plunging the UK into recession). As Lance Corporal Jack Jones kept saying in Dad’s Army “don’t panic! don’t panic!”. This is all bad news for the UK and UK assets with the British pound taking most of the hit, but despite reports to the contrary it remains a second order issue for global markets.

Major global economic events and implications

  • US data releases over the last week were strong. Job openings and hiring remain robust, small business confidence fell in November but remains very high and jobless claims fell sharply back to their lows after several weeks of increases. Meanwhile, November headline CPI inflation fell back to 2.2% year on year helped by lower energy prices with more to go this month and core inflation rose to 2.2%yoy but short-term momentum in inflation is running around 2%. The November CPI is consistent with the core private final consumption deflator at 1.9%yoy. Core inflation stabilising around 2% gives scope for the Fed to pause/go slower next year after it hikes in the week ahead.
  • The European Central Bank remains dovish. While it confirmed that its quantitative easing program will end this month, it was really a dovish tightening with Draghi seeing the economic risks as “broadly balanced” but “moving to the downside” consistent with downwards revisions to the ECB’s growth and inflation forecasts, a hint of more cheap financing (or LTRO) for banks, a continued reference to rates being on hold through summer 2019 (we can’t see a hike until 2020 at the earliest) and a commitment to continue reinvesting maturing bonds for an extended period. Next to watch will be another round of cheap bank financing early next year.
  • The further downwards revision to Japanese September quarter GDP growth to -0.6%qoq was bad news, but various business surveys seem to be holding up at reasonable levels including the Tankan business survey and machine orders rose in October.
  • Chinese economic data for November was on balance soft with weaker growth in imports, exports, industrial production and retail sales, but a slight pick-up in investment growth, stronger than expected growth in lending and credit and lower jobless. The overall impression is that growth is continuing to slow, which will likely drive more decisive policy stimulus in the months ahead.

Australian economic events and implications

  • Australian economic data releases over last week were nothing to get excited about. The ABS reported that house prices fell 1.5% in the September quarter, but this just confirmed declines already reported by private sector surveys which show an intensification over the last two months. Housing finance rose in October, but this could just be a statistical bounce after several weak months. Consumer confidence was little changed in December, but business confidence continued to slip below consumer confidence after running above it since the 2013 election. The problem is that neither are particularly strong and with house prices falling and wages growth likely to remain weak its hard to see consumer confidence rising much and a continuing slide in business confidence may threaten business investment. Finally, the CBA’s December business conditions PMIs slowed slightly.

What to watch over the next week?

  • In the US, the focus is likely to be on the Fed on Wednesday which is expected to raise the Fed funds rate by another 0.25% to a range of 2.25-2.5% but its likely to be a “dovish hike” with the Fed dropping the reference to further “gradual” rate hikes and replacing it with language that signals a greater data dependency. Basically, with the Fed Funds rates getting close to neutral, US core inflation stabilising around the 2% target, interest sensitive sectors like housing and auto demand slowing and various headwinds to the US economy next year the Fed is likely to signal that its open to a pause on interest rates or at least moving more slowly in raising them. It is likely is that the Fed will hold the Fed Funds rate flat during the first half of next year and only raise rates once or twice in the second half.
  • On the data front in the US expect flat to softish readings for the NAHB home builders’ conditions index (Monday), housing starts (Tuesday) and existing home sales (Wednesday) and Friday data to show a rise in durable goods orders, solid growth in personal spending and a rise in inflation as measured by the core private consumption deflator of 1.9% year on year.
  • The Bank of Japan is not expected to make any changes to monetary policy when it meets Thursday, with core CPI inflation (Friday) likely to remain stuck around 0.4% yoy and providing one reason why this is likely to remain the case for a long while yet.
  • The Bank of England is also expected to leave its cash rate at 0.75% when it meets Thursday with Brexit uncertainty likely to weigh heavily on its thinking.
  • In Australia, the Mid Year Economic and Fiscal Outlook to be released on Monday is likely to show that the 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 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 around $9bn in income tax cuts and other pre-election goodies ahead of next May’s election 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 Government’s growth forecast for this financial year of 3% is expected to remain unchanged but it may lower forecasts for 2.25% inflation and 2.75% wages growth as both look too optimistic.
  • The minutes from the RBA’s last meeting (Tuesday) will likely repeat the mantra that it expects the next move in rates to be up although there is no strong case for a near term move, but investor interest is likely to be on what the Bank has to say about the housing market and credit conditions with recent speeches suggesting that it may be getting a bit more concerned about the risks. On the data front expect November labour force data (Thursday) to show a 10,000 gain in jobs and unemployment remaining at 5%. June quarter population data (also Thursday) will likely show some slowing in population growth to around a still strong 1.5%yoy.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Weekly Market Update – 7th December 2018

Weekly Market Update

Investment markets and key developments over the past week

  • The past week has seen a roller coaster ride in equity markets. Shares initially rose on the positive outcome from the Trump/Xi meeting. Then they plunged in a panic as investors lost faith in what Trump claimed was agreed, the arrest of a senior Huawei executive in relation to a possible violation of sanctions on Iran raised concerns it will threaten US/China negotiations and concerns grew about the US economic outlook as parts of the US yield curve went negative (or inverted). Then shares rebounded in the US, helped by reports that the Fed is considering a wait and see approach after a December hike. Only to then see US shares fall again on Friday on ongoing growth and trade concerns. For the week US shares fell 4.6% (reversing the previous week’s 4.8% gain), Eurozone shares fell 3.6% and Japanese shares lost 3%. Chinese shares rose 0.3%, with Australian shares also up (but don’t forget the Australian market fell the previous week while global markets rose). Growth worries also pushed bond yields lower and metal prices fell, but the oil price rose 3.3% helped by an agreement by OPEC and its partners to cut oil production by 1.2 million barrels a day. The A$ fell back to US$0.72 on the back of trade concerns and weak Australian economic data.
  • It’s still too early to say shares have seen the bottom. So far what we have seen is just a correction (with global and Australian shares having had falls of around 10%) and shares may be trying to build a base, with US/global shares holding around their October and November lows, ahead of a year-end Santa rally. But investor scepticism remains very high, evident in good news being ignored (like strong US ISM reports and another “Goldilocks” jobs report for November) and bad news being blown out of proportion (like in the Fed’s Beige Book) and many of the concerns around share markets notably in relation to the Fed and trade remain unresolved. So, share markets could yet go down further into early next year in what has been referred to as a “gummy bear” market, i.e. where markets come down 20% or so before rebounding, similar to what was seen in 2015-16. However, views are that a “grizzly bear” market where shares fall 20% and a year later are down another 20% or so because a US/global recession is unlikely soon. The two big concerns of the last week look overdone.
  • First, while the Huawei arrest adds to the risks and despite Trump’s exaggeration causing confusion, Trump and Xi do look to have made progress on trade in Buenos Aires. In fact, Trump remains positive, further tariff hikes are on hold, China has confirmed the 90-day timetable for negotiations, it has indicated it will push forward with negotiations and has reportedly restarted imports of certain products. And note that this statement from China – that “the teams of both sides are now having smooth communications and good cooperation with each other. It is highly likely that an agreement can be reached within the next 90 days” – came after the Huawei arrest. It could still go off the rails, but progress was made in Buenos Aires and there is a strong incentive for both sides to make a deal to resolve the issue before it weakens their economies (which won’t be good for Trump’s 2020 re-election). Note the Fed’s Beige Book referring to capex plans being put on hold, partly due to trade uncertainty.
  • Second, the sudden frenzy over a bit of the US yield curve is whacko. Prior to the past week it was rare to hear of anyone focussing on the gap between US 5 year and 2-year bond yields which has now gone negative. Similar to the Fed’s own research our view remains that the yield curve to watch is the gap between the 10-year bond yield and the Fed Funds rate and it’s flattened but is still positive at 72 basis points. And another useful version of the yield curve (inspired by Fed research) in the form of the gap between 2-year bond yields and the Fed Fund’s rate is also a long way from negative. As can be seen in the next chart, prior to the last three US recessions both of these yield curves inverted but there were several false signals and the gap between the initial inversion and recession can be long averaging around 15 months. So even if they both invert now, recession may not occur until 2020 and yet historically share markets only precede recessions by around 3-6 months so it would be too far away for markets to anticipate.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • Of course, when investors want to sell they will, and so markets can still head lower until there is a sentiment washout. But our assessment remains that this is overdone, and share markets aren’t going down into another “grizzly bear” market as the conditions aren’t in place for a US/global recession: we haven’t seen the sort of excess in discretionary spending, debt and inflation that normally precede recessions; monetary policy is not tight (and the Fed is likely to pause next year); and the slowdown in growth indicators looks like the short-lived shallow slowdowns seen going into 2012 and 2016.
  • The Brexit comedy continued over the last week with the Government being defeated on several votes in parliament and PM May’s plan looks likely to be rejected on December 11. It could pass on a second vote if the UK markets kick up a fuss and some groups abstain. But the alternatives are not flash: do some tweaks to the deal (but it’s doubtful the EU will agree); have a ‘no deal’ Brexit (but this would likely plunge the UK into recession); or cancel Brexit (but this would cause a huge fuss in the absence of another referendum and that would take longer than March to organise). The key for investors though is that while it’s a critical issue for the UK and UK assets, apart from adding to the noise Brexit is really just a second order issue for global markets.

Major global economic events and implications

  • Despite investors’ fears of a collapse in US growth, US data releases over the last week were mostly strong. Yes, the Fed’s Beige book referred to some waning of optimism in some districts as contacts cited tariffs, rates and the tight labour market and construction spending fell. However, the ISM business conditions PMIs were very strong and actually increased in November and jobs data was strong. While payroll growth was a less-than-expected 155,000 in November, it’s still well above growth in the labour force, it followed much stronger than expected jobs growth in October so the two-month average pace of jobs growth remains very strong at 196,000 and unemployment remains ultra-low at 3.7%. Meanwhile, wages growth held at 3.1% year-on-year so it’s still trending up but remains well below the levels that in the past have seen the Fed slam the brakes on and preceded recessions. So, all up it’s another “Goldilocks” jobs report which keeps the Fed on track for a December hike but is consistent with a pause and slower pace of hikes next year.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital

  • China’s Caixin PMI’s surprisingly rose in November, painting a more upbeat picture than the official PMIs.
  • India’s composite business conditions PMI rose to its highest in two years bucking the global trend to weaker PMIs.

Australian economic events and implications

  • Australian economic data was weak, and it is now likely to see the RBA cutting interest rates in the year ahead. September quarter GDP came in at just 0.3% quarter-on-quarter driven by very weak growth in consumer spending which saw annual growth fall back to just 2.8% which is well below the RBA’s expectation for growth around 3.5%, building approvals continue to trend down, retail sales rose modestly but the previous month was revised down, momentum in job ads is continuing to slow pointing to slower employment growth ahead, the trade surplus fell, and the slump in home prices accelerated in November led by Sydney and Melbourne. And to cap it off the Melbourne Institute’s Inflation Gauge showed even slower inflation in November.
  • Growth is nowhere near as strong as the RBA is expecting and it’s likely to revise down its forecasts. Yes, public spending is strong, business investment is looking healthier and export earnings are doing well but the housing construction cycle is turning down and falling house prices will weigh on consumer spending. As such growth is likely to be constrained around 2.5-3% over the year ahead. Given the combination of falling house prices, tight credit conditions and constrained growth which will keep wages growth weak and inflation below target, it is likely to see the next move being a rate cut. However, it will take a while to change the RBA’s thinking, so it is unlikely to see rates being cut until second half next year but won’t rule out an earlier move if things are weaker earlier than expected. By end 2019 the cash rate is likely to have fallen to 1%.
  • Sure the RBA is repeating the mantra that the next move in rates is more likely up than down, but just not yet (with the latest being Deputy Governor Debelle’s speech this week), but RBA commentary won’t always tell us what it might soon do (remember the February 2015 rate cut!) and the RBA has recently indicated that it is getting a bit more focussed on the risks around credit and Deputy Gov Debelle has pointed that the RBA has more to go to the bottom of the easing barrel (i.e. 150 basis points on rates and quantitative easing if needed).

What to watch over the next week?

  • In the US, the focus will be back to inflation with the CPI data due Wednesday, expected to be flat in November thanks to the oil price plunge and annual inflation falling back to 2.2% from 2.5%. Core inflation is expected to remain around 2.1% year-on-year. In other data, expect to see strong job openings (Monday), continued high small business optimism (Tuesday) and retail sales and industrial production (Friday) to remain strong. US business conditions PMIs for December (also due Friday) are likely to remain solid at around 55.
  • The European Central Bank meets Thursday and is expected to confirm that it will end quantitative easing this month, but it’s likely to commit to re-investing maturing bonds for an extended period, indicate that it will provide more cheap funding for banks if needed and reiterate that a rate hike is a long way away. December business conditions PMIs (Friday) will likely show further slippage but should still be at okay levels.
  • In Japan, the Tankan business survey (Friday) is likely to show some slippage in conditions.
  • Chinese economic data for November due to be released on Friday is expected to show growth in industrial production remaining around 5.9% year-on-year but a pick-up in investment to 5.9% and a pick up in retail sales to around 8.8%.
  • In Australia, expect to see another fall in housing finance (Monday) of around 1%, ABS data on Tuesday to show a 1.7% fall in house prices for the September quarter consistent with private sector surveys and soft readings for business and consumer confidence (Tuesday and Wednesday).

Outlook for markets

  • Shares remain at high risk of further short-term weakness, but it is 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%.
  • Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes next year, the A$ likely still has more downside into the US$0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the A$ 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

FinSec Partners Disclaimer

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’

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