Investment markets and key developments over the past week
- The solid rally in sharemarkets since the beginning of the year continued this week with US (up by 1.6% over the week) and Australian shares hitting a record high (+2.1% this week) as investor optimism lifted on good US and China data and the signing of Phase One of the US/China trade deal. Eurozone stocks lagged behind ( 0.4%) but this followed a strong rally last week. At the time of writing Japanese shares are up by 0.8% but Chinese shares are down 0.2% over the week. US 10 year yields are tracking at just over 1.8% and have room to lift further in the near term. Oil prices have settled at just under $65/barrel and iron ore prices are rising again at over $90/tonne on fears of cyclone season potentially disrupting exports from Port Hedland in Australia. The Australian dollar has been tracking at just under 0.69 US dollars.
- The US and China have signed a formal trade agreement, formalising “Phase One” of their trade talks. Not too many surprises here, with the main areas covered including:
- Intellectual property rights protection and fair market access;
- More rights for transfer of technology;
- Market access for financial services;
- Refraining from currency manipulation (with the US removing China from its list of currency manipulators this week but replacing it with the Swiss Franc);
- Expanding trade with China to import at least an additional $77bn from the US in 2020 and $123bn in 2021 (from 2017 levels) for manufactured goods, agriculture, energy and services which will partly shrink the US/China trade deficit and cause some narrowing in the China trade surplus (see the following chart).
Source: Deutsche Bank, AMP Capital
- It remains to be seen how this agreement will addresses the many US grievances. There is no third party arbitrator so technically either side can find each other at fault at any point in time. And there are still more areas around trade that need to be addressed such as China hacking US businesses and government institutions and around Chinese state subsidies which assist its export companies – these are likely to be included in “Phase Two” discussions. For markets ‘trade talks’ will remain a sticking point in 2020.
- Although the US agreed to reducing the rate of tariffs on some products (December), tariffs remain in place on nearly three-quarters of Chinese imports to the US. The effective US tariff rate in 2020 is around 5.2% (on all US trade) which is around 0.5% lower than in 2019 but well above the 1.7% 2017 tariff rate before the trade dispute started, so the pain on US importers and consumers (along with the Chinese economy) will still continue. And for businesses considering production lines and supply chains it does little to provide clarity around future trade channels. This said, at least the trade talks are not breaking down and so we take it as a positive for sentiment.
- We don’t expect much further roll-back in tariffs from those already announced in December (a halving in the 15% tariffs put in place in September which will start in February) for a while with some news reports this week stating that the current tariffs will remain in place until after the US election. Keeping pressure on China may be a tactic used by President Trump to gather more support pre-election as it would suggest that he is the only one that can get the negotiations done.
- The US House of Representatives voted to refer Trump’s impeachment article to the Senate. It was previously mentioned that the Republican-controlled Senate is unlikely to find Trump guilty. The bigger issue is that the start of the impeachment trial could take away Senators Bernie Sanders and Elizabeth Warren who are both key potentials for the Democratic nomination as well as Amy Klobuchar and Michael Bennet who are also in the running (but less likely to be the Democratic nominee).
- US fourth quarter reporting season got underway this week with reporting from some of the major banks and so far earnings growth looks decent. Consensus is looking for a small decline in quarterly profit growth but it is likely earnings will show a small rise over the quarter and to see earnings up by around 2-3% on a year ago.
Major global economic events and implications
- US broad inflation pressures remain well contained. Growth in core consumer prices was up by 2.3% over the year to December while core producer prices were 1.1% higher. Along with some slowing in average hourly earnings growth this shows that there is room for the US Federal Reserve to cut interest rates again, if required. While it is unlikely to see another US rate cut, the market is pricing in the small chance of another cut. The NFIB small business confidence index fell back in December and was relatively unchanged over 2019 after solid increases in 2018 (see chart below). Consumer confidence has also been tracking sideways although the US consumer remains in good shape with retail sales growth up by 0.3% in December.
Source: Bloomberg, AMP Capital
- Chinese data was strong and indicated some improvement in growth momentum. December quarter GDP data showed annual GDP growth of 6%, in line with the 6-6.5% growth target. Industrial production growth rose to 6.9% year on year to December, retail sales were up by 8% and fixed asset investment increased by 5.4% year to date. Chinese credit growth still remains solid with M2 (or broad money) supply up by 8.7% over the year to December, from 8.2% previously. Trade data showed strong growth in exports over the year to December (+7.6%) and with imports also up by a high 16.3%, up from November and beating expectations.
Australian economic events and implications
- November housing finance data showed that the value of housing lending to owner-occupiers (ex-refinacing) was up by a solid 1.8% in November, with a large rise in investor lending.
What to watch over the next week?
- US manufacturing and services PMI’s for January are released – the best leading indicator to business activity are released. Manufacturing conditions weakened in the US over 2019 but the PMI has been holding up much better than the ISM because of the broader scope of the survey. Manufacturing conditions are expected to start improving in the US (and globally). Various housing indicators are also due next week and we expect to see some recovery in housing construction and prices.
- The European Central Bank meet next week and no changes are expected to the central bank’s current quantitative easing program of 20bn/month or its current interest rate settings. Monetary policy is expected to remain easy in the Eurozone over 2020. January manufacturing and service PMI’s are also released and should show a stabilisation in activity.
- In Japan, December consumer prices are released which is expected to show that inflation remain less than 1% per annum, below the Bank of Japan’s 2% target.
- In Australia, the December jobs data should show lower jobs growth, around 8-10K over the month with the unemployment rate remaining at 5.2% which indicates some underutilisation. January consumer sentiment data is likely to take a hit from the bushfires over recent months.
Outlook for investment markets
- Improving global growth and easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares and geopolitical risks are likely to constrain gains and create some volatility:
- After very strong gains and with investor sentiment now bullish, shares are due for a short-term correction or consolidation.
- But for the year as a whole global shares are expected to see total returns around 9.5% helped by better growth and easy monetary policy.
- Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and trade threat recedes as expected.
- Australian shares are likely to do okay this year but with total returns also constrained to around 9% given sub-par economic & profit growth.
- Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
- Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns.
- National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
- Cash & bank deposits are likely to provide very poor returns, with the RBA expected to cut the cash rate to 0.25%.
- The $A is likely to fall to around $US0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2020 little changed.