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Shane Oliver
Financial markets
+ About Shane Oliver

Shane Oliver is head of investment strategy at chief economist at AMP Capital.

3 reasons why shares rallied after the US midterms

Monday, November 12, 2018

The big surprise from the US midterm election was that there was no surprise! Unlike with Brexit and Trump’s election in 2016, the polls and betting markets were spot on! So why did shares rally in response?

There are basically three reasons.

First, while the Democrats now control the House it wasn’t the “blue wave” some had talked about as the Grand Old Party also increased its Senate majority, which means that while another round of tax cuts is unlikely (which may be a good thing as it would only mean more pressure on US interest rates), the Democrats won’t be able to wind back Trump’s first round of tax cuts and won’t be able to reregulate the US economy either. Similarly, while the Democrats will likely harass Trump with investigative committees and maybe even impeachment proceedings, they won’t get the 67 Senate votes necessary to remove him from office. (Unless of course Mueller or others can show he has done something really bad – mind you, Trump’s decision to sack Attorney General Jeff Sessions doesn’t inspire a lot of confidence on this front!).

Second, just getting the midterms out of the way provides relief.

And third, US shares have rallied over the 12 months after each midterm since 1946, as the president refocuses on his own re-election. Trump is likely to do the same, which means doing nothing to weaken the economy and fix the trade war with China some time in the next six months. 

However, it’s not going to be smoothing sailing. Key events on the US political front to watch out for in the next few months include:

• headlines around the Mueller inquiry;

• the Trump/Xi meeting later this month at the G20 summit;

• 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;

• the need to increase the debt limit sometime after March 1 next year – where the Democrats could try and force Trump to lift the corporate tax rate in return for raising the debt ceiling.

In terms of the US/China trade conflict, while Chinese President Xi Jinping in a speech in the last week made veiled criticism of Trump’s protectionism, he also indicated ongoing tariff cuts on imports and a tightening in protection for intellectual property, with China’s Vice Premier Wang indicating that China remains ready for negotiation on the trade issue. There is a long way to go here but I remain of the view that a deal will be made with China before the tariffs are allowed to cause too much damage to the US economy. 

On the property and interest rate front

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.

Our assessment is that the RBA is underestimating the threat posed by slowing growth in China, tightening credit conditions and a negative wealth effect, as house prices continue to fall. As a result, in contrast to the RBA, we see growth slowing to around 2.5-3% through 2019, which in turn will result in higher unemployment and keep wages growth and inflation lower for longer than the RBA is allowing. So we remain of the view that a rate hike is unlikely until late 2020 at the earliest and that a rate cut later next year can’t be ruled out. Out of interest its doubtful that even the RBA’s more optimistic 2019 forecasts would justify a rate hike next year as they only see wages growth getting up to a still anaemic 2.5% year-on-year and inflation rising to just 2.25%.

 

Is it bottom up from here?

Monday, November 05, 2018

Share markets bounced back over the past week, helped by good US earnings results and a lessening of trade war fears, following a phone call between President Trump and President Xi Jinping. US shares rose 2.4%, Eurozone shares gained 3%, Japanese shares rose 5%, Chinese shares rose 3.7% and Australian shares gained 3.2%. Reflecting the ‘risk-on’ tone and a strong US jobs report for October, bond yields rose. While the copper price rose, the iron ore price was flat and oil fell 6.6%. Although the $US was little changed, the ‘risk-on’ tone, along with a larger-than-expected trade surplus, saw the $A rise to around $US0.72.

A poor October — have we seen the bottom?

October was a bad month for share markets, with global shares losing 6.8% in local currency terms, which was their worst month since August 2011. Australian shares lost 6.1%, their worst month since August 2015. 

The good news though is that markets have had a good bounce from their lows of around 3%. Shares had become technically oversold and were due for a bounce. It’s possible that following top to bottom falls of 10% for global shares, 11% for Australian shares and 21% in emerging markets, we have now seen the low. But with risks remaining around US interest rates, the US/China conflict, tech stocks, emerging countries, the Italian budget and the US midterm elections this week, it’s impossible to be definitive. So there could still be another leg down.

Reasons to believe in a bounce

1. Investor sentiment has hit very bearish extremes, which is positive from a contrarian view.

2. Valuations have improved, with many markets now in cheap territory, including Australian shares, which have seen their forward PE fall from around 16 times to 14 times.

3. US shares tend to rally once the midterm elections (to be held tomorrow) are out of the way and global shares would follow.

4. We remain of the view that what we have seen (or may still see) is a correction or a mild bear market at worst (like 2015-16s circa 20% fall that was quickly reversed) rather than a deep bear market like the GFC, as the conditions for a US recession that invariably drive major bear markets are not in place: US monetary policy is not tight and the sort of excesses that normally precede recessions in terms of inflation, spending and debt are not present.

If we are right, then cyclical shares (like autos and energy) trading on very low PEs of 10 times or less are offering good investment opportunities.

US/China closer to a trade deal? 

At last, Trump and Xi are talking. Trump says he thinks “we’ll make a deal with China” and that “a lot of progress has been made” and the US is reportedly drafting a deal for Trump and Xi to consider signing at the G20 meeting in late November. This is all very positive and, sooner or later, a deal will be made before the economic pain gets too great. But we have seen several episodes of false hope on this front before, only to see the conflict worsen again. Both sides are still a long way apart, we have not heard comments from China matching Trumps and Trump’s comments may be aimed at boosting support for his party ahead of the midterms. So, it’s premature to get too excited.

What’s happening in Yankee land?

US economic data remains strong, with solid growth in September personal spending, an 18-year high in consumer confidence, still strong business conditions surveys (albeit the ISM manufacturing index fell back from its very high September reading) and continuing strong jobs data. The October jobs report was particularly strong, with payrolls up by 250,000, unemployment remaining very low at 3.7% as participation rose and wages growth (as measured by average hourly earnings) moving up to 3.1% year on year, its highest since 2009, as a decline in wages last October dropped out of the annual calculation. As can be seen in the next chart though, despite very low unemployment the rise in wages growth remains gradual and we are a long way from the 4% plus growth rate that preceded the last three recessions.

Source: Bloomberg, AMP Capital

Meanwhile, US core inflation remained at 2% year-on-year in September and growth in employment costs in the September quarter was unchanged at 2.8% year-on-year and rising productivity growth is helping keep growth in unit labour costs low. All up, the Fed remains on track to continue tightening, with the next move to be in December, but in the absence of a significant inflation threat, it can continue to do so gradually.

 

Yet again the US September quarter earnings reporting season is proving to be strong. With roughly 75% of results now in, 83% have beaten on earnings, 61% have beaten on revenue and earnings growth expectations for the quarter have now moved up to 26% (up from 20% a month ago). All of which is seeing earnings match their June quarter high. Of course, the uncertain environment has seen investors latch on to those companies that have disappointed, resulting in outsized share price declines relative to those that have exceeded expectations.

Source: Bloomberg, AMP Capital

The combination of continuing US economic strength relative to Europe, Japan and China points to ongoing upwards pressure on the $US (notwithstanding the scope for a short-term fall as excessive long positions are unwound) and in US bond yields relative to bond yields in other countries.

And the Eurozone?

Eurozone data was a bit disappointing, with a further slowing in GDP growth in the September quarter, confidence measures continuing to fall (albeit they remain high) and unemployment unchanged at 8.1%. Core inflation rose to 1.1% year-on-year but it’s still way below the ECB’s 2% target. While the ECB is probably on track to end QE next month, it won’t start raising rates till 2020, quantitative tightening is years away and it may even do another round of providing cheap funding to banks (LTRO), given the slowing in growth.

And in Deutschland?

The poor performances of the German grand coalition parties at state elections in Bavaria and Hesse do not signal a threat to the Euro. Merkel has confirmed she will step down as Christian Democrat Union party leader and won’t seek re-election as Chancellor in 2021. However, several points are worth noting: 

1. Comments by Social Democrat Party leader Nahles indicate that the grand coalition is not under immediate threat. 

2. Germany’s budget surplus and falling public debt indicate plenty of scope to provide needed fiscal stimulus which would be positive for Germany and the Eurozone and provide an electoral boost for the grand coalition partners. There is also the chance that the CDU will do what John Howard did in response to One Nation and adopt a tough stance on immigration to neuter the Alternative for Deutschland’s appeal. 

3. German Euroscepticism is not on the rise. In fact, support for the Euro in Germany has risen to 83% and it was support for the pro-Euro Greens that surprised in Bavaria and Hesse, not support for the AfD. Finally, a new election is unlikely as both the CDU and SPD have seen a loss of support, so they aren’t going to support an early election.

And in the land of the midnight sun?

Japanese data was mixed with strong jobs data (helped by a declining workforce) but weak industrial production. As expected the Bank of Japan remained on hold and monetary tightening remains a long way off.

What’s happening in China?

China PMI’s slowed further on balance in October, highlighting the downside risks to growth. Consistent with this, the past week’s Politburo meeting signalled greater urgency in combating the threats to growth and that even more policy stimulus is on the way.

How’s Brazil going?

Far right Jair Bolsonaro’s victory in the Brazilian presidential election is a short-term positive for Brazilian assets and pushed Brazilian shares to a record high, but maybe not in the long term. A right-wing Bolsonaro presidency will boost business confidence and allow pro-business policies, like corporate tax cuts and reduced regulation. But as a populist without a landslide victory margin, he lacks a mandate to do much about Brazil’s high public debt and unsustainable pensions. So, while there may be a short-term boost for Brazil, long-term problems will likely remain.

What’s the story here down under?

Australian data released over the last week highlighted the cross currents currently impacting. On the negative side, the trend remains down in building approvals, credit growth remains soft, retail sales were weaker than expected in September and rose just 0.2% in real terms in the September quarter and home prices continued to slide in October, posing an ongoing threat to consumer spending. Meanwhile, underlying inflation as measured by the trimmed mean and weighted median, fell to 1.7% year-on-year in the September quarter and is just 1.3% year-on-year using a US core inflation measure.

On the positive side, the trade surplus came in far stronger than expected in September, with upwards revisions to previous months. While this was mainly driven by higher prices, net exports look like providing a positive contribution to September quarter GDP growth and another rise in the terms of trade in the June quarter will provide a boost to national income. All of which indicate that trade, along with an approaching end to the mining investment slump, rising non-mining investment and surging infrastructure spending, will help offset the drag on growth from the declining housing cycle.

What about house prices?

Our view remains that home prices have more downside over the next two years, as tightening credit conditions, rising unit supply, lower foreign demand, the prospect of reduced negative gearing and capital gains tax concessions under a Labor government impact and as falling prices impact investors’ expectations. We continue to see Sydney and Melbourne prices falling 20% peak to trough and national capital city average prices falling around 10% from peak to trough.

On balance, our assessment remains that Australian economic growth will fall back into a 2.5% to 3% range and inflation will remain lower for longer than the RBA is allowing for. So an RBA rate hike is unlikely until late 2020 at the earliest. In fact, the threat to growth and inflation from falling home prices indicates the next move could, in fact, turn out to be a rate cut, but that’s a second half 2019 story at the earliest. This is because with unemployment at 5% and GDP growth recently surprising on the upside, the RBA will need to see broader signs of softness to consider cutting interest rates and that will take time. So, there is no prospect of imminent RBA rate cuts “rescuing” the housing market.

Keep your eye on these things this week

In the US, the main focus is likely to be on the midterm Congressional elections tomorrow, where polls and betting markets point to the Democrats taking control of the House but Republicans retaining control of the Senate. Such an outcome should already be factored into financial markets, but it may create increased uncertainty about the impeachment of Trump and policy direction. While a Democrat House may attempt to bring impeachment charges against Trump, it’s most unlikely to get the 67 Senate votes required to remove him from office. And while a Democrat House will likely prevent another round of Trump tax cuts, it won’t be able to roll back already legislated tax cuts and won’t change Trump’s policies around deregulation and tariffs.  The Fed (Thursday) is expected to acknowledge various risks to the outlook around trade, emerging markets and recent financial turbulence but indicate confidence in its base case of continuing solid growth and low unemployment and that continuing gradual rate hikes remain appropriate with the next hike on track for December. On the data front, the non-manufacturing ISM for October (today) is likely to slip back to a still very strong reading of 60, job openings and hiring (tomorrow) are likely to remain strong and core producer price inflation (Friday) is expected to remain at 2.5% year-on-year.

Chinese October trade data (Thursday) is likely to show a slowing in export growth to 12% year-on-year (from 14.5%) and import growth to around 10% year-on-year (from 14.3%) and consumer price inflation (Friday) is expected to remain around 2.5% year-on-year.

What about interest rates?

In Australia, the RBA will yet again leave interest rates on hold when it meets tomorrow. While recent news on unemployment coming on the back of news of above trend economic growth is good, the slide in home prices risks accelerating, as banks tighten lending standards, which, in turn, threatens consumer spending and wider economic growth, and inflation and wages growth remain low. As a result, it would be dangerous to raise rates. We don’t see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. The RBA’s Statement on Monetary Policy (Friday) is likely to raise its near-term growth forecasts and lower its unemployment and underlying inflation forecasts a bit but won’t signal any imminent move on interest rates. It will be mostly watched for its commentary around risks to house prices & credit growth and inflation & wages. ANZ job ads data will be released today and housing finance data (Friday) will likely show continuing weakness in lending, particularly to investors.

Finally, US sanctions on Iran will kick in today, potentially seeing a further threat to global oil supply at a time when the global oil market is already quite tight. However, the sanctions should already be reflected in markets, as they were announced in May. Since then, Iranian oil exports have fallen from 2.4 million barrels per day to 1.6 mbd. And reports that the US has agreed to waive sanctions against eight countries – including Japan, India, South Korea and even China – so they can keep buying Iranian oil, highlight that the US does not want to see oil prices driven up. Since its October 3rd high, the oil price has fallen 17%.

What about share markets?

Shares remain at risk of further short-term weakness, but we continue to see the trend in shares remaining up, as global growth remains solid, helping drive good earnings growth and monetary policy remains easy.

Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike.

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

Having fallen close to our target of $US0.70, the Australian dollar is at risk of a further short-term bounce, as excessive short positions are unwound. However, beyond a near-term bounce, it likely still has more downside into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory, as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

 

Eurozone shares rose 0.5% on Friday, but the US S&P 500 gave up early gains that had been driven by talk of a possible US/China trade deal to end down 0.6%, as bond yields rose on the back of strong jobs data and Apple shares led a decline in tech stocks. The soft US lead saw ASX 200 futures fall 5 points or 0.1%, pointing to a softish start to trade for the Australian share market today.

 

Is there a doctor in the house?

Friday, November 02, 2018

Australian capital city dwelling prices fell another 0.6% in October, marking 13 months of consecutive price declines since prices peaked in September last year. This has left prices down 4.6% from a year ago, their weakest since the GFC.

The decline is continuing to be led by Sydney and Melbourne. Sydney dwelling prices fell another 0.7% and have now fallen 8.2% from their August 2017 high. Melbourne prices fell another 0.7% and are down 4.9% from their November high. Perth (-0.8%) also saw prices fall, but Hobart (+0.9%) and Adelaide (+0.2%) saw prices rise with prices flat in Brisbane, Darwin and Canberra.

Source: CoreLogic, AMP Capital

Tighter bank lending standards particularly around tougher income and expense verification and total debt to income limits, poor affordability, rising unit supply, falling price growth expectations and FOMO (fear of missing out) risking turning into FONGO (fear of not getting out) for investors are pushing prices down in cities, which have seen strong gains since 2012, i.e. Sydney and Melbourne. This is continuing to be evident in very weak auction clearance rates and auction sales volumes in those cities. Recent auction clearance rates averaging around the mid 40s in Sydney and Melbourne are consistent with ongoing price declines of around 7% p.a.

Source: Domain, CoreLogic, AMP Capital

Source: CoreLogic, AMP Capital

The decline in Sydney and Melbourne property prices likely has much further to go as these considerations continue to impact potentially accentuated by further out of cycle bank mortgage rate increases and expectations that negative gearing and capital gains tax concessions will be made less favourable if there is a change of Government at the coming Federal election. In these cities we expect to see a top to bottom fall in prices of around 20% spread out to 2020. If anything, the risks are on the downside, particularly if negative gearing and capital gains tax arrangements are changed. So there is more to go yet!

Source: CoreLogic, AMP Capital

Having not had the same boom over the last five or six years, other capital cities are likely to perform better. Perth and Darwin are likely close to bottoming (albeit the bottoming process is taking a lot longer than I have been expecting!), Adelaide, Brisbane, Canberra and Hobart are likely to see moderate growth, with Hobart slowing down after its recent mini-boom.

Similarly, home prices in regional centres are likely to hold up better with modest growth as they haven’t had the same boom as Sydney and Melbourne and offer much better value and much higher rental yields. The average gross rental yield for regional areas is 5% compared to just 3.6% in the capital cities.

Overall, Sydney and Melbourne are likely to see a top to bottom fall of around 20% spread out to 2020, but for national average prices the top to bottom fall is likely to be around 10%. A crash landing – say a national average price fall in excess of 20% - remains unlikely in the absence of much higher interest rates or unemployment, but it’s a significant risk given the difficulty in gauging how severe the tightening in bank lending standards in the face of the Royal Commission will get and how investors will respond as their capital growth expectations collapse at a time when net rental yields are around 1-2%.

Implications for interest rates

Ongoing home price falls in Sydney and Melbourne will depress consumer spending, as the wealth effect goes in reverse. Homeowners will be less inclined to allow their savings rate to decline. It’s also a negative for banks. It’s consistent with our base case view that the RBA will leave rates on hold out to late 2020 at least. However, home price weakness is at levels where the RBA started cutting rates in 2008 and 2011 and the 2015-16 property slowdown was also turned around by rate cuts in May and August 2016. So we still can’t rule out the next move in rates being a cut rather than a hike – but at this point the RBA is a long way from contemplating a rate cut, as it would need to see evidence that the slump in home prices and the drag on consumer spending is seriously threatening to push inflation even lower - so it’s probably a second half 2019 story at the earliest.

 

Is this a story about a scary bear market?

Monday, October 29, 2018

The share market correction continues, with increasing concerns about global growth. From their recent highs to recent lows, global shares have fallen about 9% and Australian shares nearly 11%. It’s still too early to say we have bottomed but we remain of the view that it’s not a major bear market. The worry list of rising US interest rates, the US/China conflict, a correction in tech stocks, problems in the emerging world, the US midterm elections and the Italian budget is continuing to drive shares down and, as we have seen in the past, this is morphing into another global growth scare, with investors latching on to companies that had negative profit news in the US and declining Eurozone PMIs. Shares are technically oversold again and so may see a bounce, but a circa 20% fall as occurred through the 2015-16 global growth scare is possible and this would likely require some sort of global policy reaction to turnaround (e.g. the Fed hitting the pause button and the ECB extending QE – China is already easing).

But the following key points are worth bearing in mind:

1. Corrections are normal – global and Australian shares saw multiple pullbacks ranging from 7% to 20% since 2012.

Source: Bloomberg, AMP Capital

2. The main driver of whether we see a correction or even a mild bear market (say a 20% fall) as opposed to a major bear market, like the GFC is whether we see recession in the US. Right now, this still looks unlikely, as we haven’t seen the sort of build-up in excess that precedes a US recession. Don’t forget that the share markets often overreact to risk and the old Paul Samuelson saying that “share markets predicted nine of the last five recessions.”

3. Selling shares after a big fall just turns a paper loss into a real loss.

4. When shares fall in value, they become cheaper and offer better return prospects so in this sense, pullbacks are good.

5. While the value of shares has fallen, dividends haven’t and so if its income you are after it hasn’t changed if you have a well-diversified portfolio. In fact, the grossed up dividend yield on Australian shares is now around 6%.

6. Shares bottom when everyone is in a panic. I don’t know when that will be but the trick is to look out for when the crowd gets very negative.

7. Finally, to be a successful investor, you need to keep your head and that gets hard at times like the present, when negative news reaches fever pitch. So it’s best to turn down the noise and chill out a bit.

There’s just one other thing worth mentioning. October is known for share market volatility. Sometimes it’s referred to as a bear killer, given that in the US it often sees a share fall and then a rebound. But the point is that the share market traditionally strengthens through November and December in the US (and December in Australia). This is particularly the case in years of US midterm election (which is the second year of the US presidential term), particularly once the election uncertainty is out of the way. In fact, the US share market hasn’t declined in the 12 months after a midterm election.

Is this week’s The Economist cover – headed “Aussie rules” and showing a kangaroo bouncing through the clouds – the kiss of death for Australia? It reminded me of their 2009 cover showing Brazil/Christ the Redeemer blasting off, only to fizzle back into the mountain in a 2013 cover. 

Over in the US

US economic data was a bit mixed. Home sales data remained weak, consistent with the softness seen in other housing activity indicators lately but home prices are continuing to rise, durable goods orders were OK, business conditions PMIs rose in October and jobless claims remain ultra-low. Overall, September quarter profit results have been good so far, with 84% of results beating on earnings, 59% beating on revenue and earnings growth expectations moving up to 23%yoy. However, the level of earnings is down and investors have latched on to those who disappointed.

Source: Bloomberg, AMP Capital

The ECB made no changes to monetary policy, with none expected, and appeared to play down recent softer data. It remains on track to end QE in December, but it did refer to the possibility of using another round of cheap bank financing (LTROs if needed) and rate hikes still look to be a long way off. Meanwhile, Eurozone business conditions PMIs fell again in October albeit to a still reasonable 52.7 but adding to concerns that Eurozone growth is continuing to slow.

The PMIs across the G3 are shown below. In short, the US is tracking sideways, Japan is possibly moving up and only Europe is seeing a downtrend. So no sign of a major developed country growth downturn – well at least not yet anyway!

Source: Markit, Bloomberg, AMP Capital

What to watch over this week

In the US, the focus will be back on jobs, with October payroll data to be released Friday expected to show solid jobs growth of 190,000, unemployment remaining at 3.7% and an in wages growth to 3.1% year on year. Meanwhile consumer data (Monday) is expected to show a solid rise in real consumer spending and the core private consumption deflator inflation remaining at 2% year-on-year, home prices are likely to show further gains and consumer confidence is likely to remain high (both tomorrow), September quarter growth in employment costs (Wednesday) is likely to remain at 2.7% year-on-year, the October ISM index (Thursday) is likely to remain strong at around 59 and the trade deficit (Friday) is likely to get a bit worse. September quarter earnings reports will continue to flow.

Eurozone September quarter GDP data due tomorrow is expected to show moderate growth of around 0.3% quarter-on-quarter or 1.% year-on-year, unemployment is likely to have remained at 8.1% in September and core inflation for October is likely to have edged up to 1% year-on-year (both due Wednesday).

Japanese jobs data (tomorrow) is likely to remain strong but industrial production (Wednesday) is expected to be soft. Both the Bank of Japan (Wednesday) and the Bank of England (Thursday) are expected to leave monetary policy on hold. Chinese PMIs for October (Wednesday & Thursday) will be watched for signs any further slowing in growth.

And down under?

The focus will be on September quarter consumer price inflation data (Wednesday), which is expected to show headline inflation of 0.4% quarter-on-quarter or 1.9% year-on-year, with higher fuel prices and tobacco excise only partly offset by higher childcare rebates and lower electricity and gas prices. Underlying inflation is likely to remain subdued at 0.4% quarter-on-quarter or 1.9% year-on-year. Meanwhile, expect a 3% bounce back in building approvals (tomorrow), after their plunge in August, continued moderate credit growth (Wednesday), CoreLogic data for October (Thursday) to show a further decline in home prices, the trade surplus (also Thursday) to fall slightly and September retail sales (Friday) to show growth of 0.2%. Business conditions PMIs will also be released Thursday.

Outlook for markets

We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, the risk of a further short-term pull back is high, given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and election uncertainty add to the risks around Australian shares.

Low but rising yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds.

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

While the $A is now fallen close to our target of $US0.70, it likely still has more downside into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

 

Ah, what’s going on?

Monday, October 22, 2018

While share markets bounced from oversold levels early in the past week, they fell back to varying degrees, as worries around US interest rates, the US trade conflict with China, tech stocks and Italy’s budget deficit continued, along with tensions with Saudi Arabia regarding a missing journalist. 

All this left share markets mixed, with Eurozone shares up 0.3% and Australian shares up 0.7%, but US shares flat and Japanese shares down 0.7% and Chinese shares down 1.1%. 

Bull markets are characterised by relatively steady gains, punctuated by occasional sharp pull backs, as investors periodically cut their long positions on the back of adverse news events. 

Our view remains that recent falls represent a correction, but of course, it remains premature to conclude that we have seen the bottom, given the worry list around US interest rates, trade, oil prices, etc.

We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, the risk of a further short-term correction is high, given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around Australian shares.

The China syndrome

The US Treasury refrained from naming China as manipulating its currency and its been confirmed that Trump and Xi will meet on the sidelines of the November 29 G20 summit, but this does not mean the trade conflict is about to ease up. The currency decision was to be expected because the Renminbi does not meet all the US Treasury criteria to be defined as being “manipulated”. That said the report was critical of China and an “increasing reliance on non-market mechanisms” and so the US may still name it for manipulating next year. A Trump-XI meeting is positive but the gap between the two is huge so our base case remains that further escalation is likely.

Chinese economic growth slowed in the September quarter, with GDP growth slowing to 6.5% year-on-year and monthly data coming in mixed with weaker industrial production and credit growth but stronger retail sales and investment and lower unemployment. The slowdown reflects a crackdown on shadow banking and tariff uncertainty. While it’s consistent with our forecast for Chinese growth to slow to 6.5% this year, the trade threat suggests the risks are still on the downside, suggesting that further policy stimulus is likely. Meanwhile falling producer price inflation and core consumer price inflation of just 1.7% year-on-year provide no barrier to further policy stimulus.

The gig economy

And something completely different - is the “gig: economy just imagined? The term sounds cool and gets bandied around to explain things like low wages growth, but it’s doubtful it really exists. As the RBA’s Alex Heath pointed out in the last week, casual employment (i.e. workers without sick leave and holiday pay) has been around 20% of the workforce since the 1990s and the share of independent contractors has fallen over the last decade. And in the US, the share of self-employed in total employment has fallen from 14% to 6% over the last 70 years and workers are in their jobs for longer than 30 years ago. So there’s not a lot of evidence of the gig economy.

Down under

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

Source: ABS, Bloomberg, AMP Capital

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

And the Aussie dollar?

While the $A has now fallen close to our target of $US0.70, it likely still has more downside into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory, as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

 

Property & shares: where are markets heading?

Monday, October 15, 2018

Share markets fell sharply last week, led by the US share market, primarily on the back of worries about rising interest rates and bond yields and the deteriorating US/China relationship. More volatility is likely, even though it’s unlikely to be the start of a major bear market. Every so often, shares go through rough patches. We saw this most recently in February on the back of US inflation and interest rate concerns, which saw US shares fall 10% and Australian shares down 6%. Shares managed to get through the seasonably weak months of August and September surprisingly well (except in Australia) but the worry list has pulled them back down again. So far, shares are down around 7% from recent highs.

Given the ongoing worries around the Fed, inflation and bond yields, threats to tech stocks, the intensifying US/China conflict, rising oil prices, problems in the emerging world, the upcoming US mid-term elections, risks around President Trump and the Mueller inquiry and tensions in the Eurozone regarding the Italian budget, further weakness is likely. And given the usual global contagion, most major share markets, including the Australian share market, will be affected. However, we doubt it’s the start of a major bear market because history tells us that they invariably require a US recession. With US monetary conditions still far from tight, fiscal stimulus still impacting and no signs of the excess (in terms of overinvestment, debt growth, etc.) that normally precedes a recession, a US recession still looks a long way off and this in turn suggests that the trend in earnings and hence share markets is likely to remain up beyond the near term pull back.

We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, the risk of a further short-term correction is high, given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around Australian shares.

How confident are we?

Australian business and consumer confidence rose slightly in September and October respectively but both are well down on recent highs. 

How’s the property market heading?

Meanwhile, although housing starts fell in the June quarter consistent with falling building approvals and consistent with a peaking in housing construction activity, work yet to be done is at a record high, three times above where it was in 2009, telling us that there is still a lot of supply about to hit the softening homebuyer market. 

What about housing finance?

Housing finance also continued to slide, with commitments to both owner/occupiers and investors falling. All of which is consistent with ongoing falls in home prices.

What’s the outlook for residential property? 

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Source: ABS, AMP Capital

What’s the Reserve Bank’s position?

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

What to watch this week…

In Australia, expect September labour market data, due Thursday, to show employment growth slowing to a gain of 10,000 after a surprise 44,000 gain in August but with unemployment remaining flat at 5.3%. Meanwhile, the minutes from the last RBA board meeting (tomorrow) are likely to show the RBA still expecting the next move in rates to be up but seeing no case to move now and the by-election for the seat of Wentworth will be watched closely in regard to the Government’s narrow parliamentary majority.

 

Can’t help falling

Monday, October 08, 2018

Share markets fell over the last week, largely in response to a renewed move higher in global bond yields. US shares fell 1%, Eurozone shares lost 1.8%, Japanese shares fell 1.4% and Australian shares fell 0.4%. Oil, gold and iron ore prices rose but copper prices fell. Strong US economic data and rising expectations for Fed tightening saw the $US rise and this saw the $A fall below $US0.71.

Still more upside

Global bond yields have resumed their rising trend, with more upside ahead. The break higher was led by the US 10-year bond yield, reaching a seven year high on the back of strong US economic data, rising oil prices and, most importantly, investors starting to come around to the view that the Fed Funds rate has a lot more upside and will likely ultimately rise above the Fed’s guesstimate of the “neutral” Fed Funds rate, which is around 3%. Of course, the Fed has been telling us this for a long time, but the market didn’t really believe it. However, the past week saw several Fed speakers, including Fed Chair Powell and normally dovish Chicago Fed President Evans reinforce that the Fed Funds rate is at least going to neutral and probably beyond. On this front, there is a long way for the market to adjust, given the gap between the Fed’s dot plot, which shows the Fed Funds rate going up to nearly 3.4% and market expectations, which remain well below that. This adjustment, along with investors moving to factor in more normal inflation and growth expectations, rather than the subdued expectations for both of recent years, suggests US and global bond yields still have more upside. At some point, this will seriously threaten shares, but that point is likely a fair way off, given that US monetary policy is still far from tight, central banks in Europe and Japan are way behind the US in tightening, bond yields are still relatively low, US and global growth is still strong and this is supporting earnings. And as we have seen since the 2016 low in bond yields, the rise in yields won’t go in a straight line.

Possible interest rate cut

Australian bond yields may go up a bit as US yields rise but they are likely to continue to lag given that the lagging Australian economy means that the RBA will remain on hold with some chance of a rate cut. However, the rise in US and global bond yields adds to the risk of more out of cycle bank mortgage rate increases as global funding costs rise (with banks getting around 35% of their funding from sources other than deposits). Of course, if out of cycle mortgage rate hikes become a problem for the Australian economy, it will provide a reason for the RBA to cut the cash rate to pull mortgage rates back down.

Trade tension with China spills into other areas

The new north American trade deal to be called USMCA (or US Mexico Canada Agreement) is good news but does not mean the US/China dispute will soon be resolved. The USMCA deal, coming on the back of the revamped US/South Korea trade deal and trade talks with the EU and now Japan, confirms that Trump is not anti-trade per se, but just wants what he thinks is fairer trade for the US. But its also consistent with him wanting to make trade peace with his allies and focus more on China. And on the US/China trade front the differences remain significant and both sides are likely to remain dug in until after the mid-term elections at least. Which means that the tariff rate on the latest $US200bn tranche of imports will likely rise to 25% next year and another tranche of tariffs remains possible. The near collision between Chinese and US naval ships in the South China Sea and a speech by US VP Pence highlights that trade tension is spilling into other areas.

The Australian property market

Australian dwelling prices have now fallen for 12 months in a row and more downside is likely in Sydney & Melbourne as a result of the combination of tighter bank lending standards, rising supply, falling price growth expectations feeding back to weaker home buyer demand and the possibility of changes to negative gearing and the capital gains tax discount if there is a change of government impacting investor demand.   We continue to expect these cities to see a top to bottom fall in prices of around 15% spread out to 2020 which given falls already recorded since last year implies another 10% or so downside. And if anything, the risks are on the downside. Falling home prices will drive a weakening wealth effect which along with still low wages growth and an 11 year low in the household saving rate suggests that retail sales growth will slow over the year ahead.

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

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

What to watch out for

In Australia, we will get an update on confidence and housing finance. Expect the September NAB survey (tomorrow) to show continuing solid business conditions but more subdued confidence, consumer confidence (Wednesday) to show a slight improvement after its August fall and housing finance (Friday) to show continuing softness in loans to property investors. The RBA’s Financial Stability Review will also be watched closely given the house price downturn and fears that tightening lending standards risks turning into a credit crunch partly in response to the Royal Commission.

Outlook for share market

We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, the risk of a correction over the next month or so still remains significant, given the threats around trade, emerging market contagion, ongoing Fed rate hikes and rising bond yields, the Mueller inquiry, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around Australian shares.

And the Aussie dollar…

While the $A is now close to our target of $US0.70 it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.

 

Risky business

Thursday, October 04, 2018

While US shares fell slightly over the last week, most major share market saw gains. Bond yields fell a bit in the US and Australia but rose elsewhere. Oil prices rose after OPEC left output unchanged, but metal and iron prices fell. The $US rose, particularly as the Euro fell on renewed Italian budget worries, and this saw the $A slip back to around $US0.72.

Although major global share markets performed well in September, defying seasonal weakness, Australian shares fell after reaching a 10-year high in August as defensives, consumer stocks, financials and high yield sectors came under pressure not helped by rising bond yields.

The heat is on

The trade threat from the US has not gone away. While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared, it’s clear that the issue is far from resolved. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing a cut to its average tariff to 7.5% from 9.8% and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be rising, with Trump accusing China of interfering in the mid-term elections and some low-level signs that military tensions may be rising too. Our view remains that while the tariffs actually implemented so far are relatively small, further escalation in the US/China trade conflict is likely, with a negotiated solution still a way off. Meanwhile, the risk is rising that Canada will not agree to a revamped NAFTA deal with the US, the US and Japan are now to enter new trade talks, with Trump clearly wanting concessions from Japan and French President Macron said he would not agree to a new EU trade deal with the US unless the US commits to the Paris climate agreement. Of course, Trump wants to get US allies on side so he can focus on China but there is still a long way to go on that front too. So trade will remain a periodic issue for markets.

US rates up, Aussie down

The US Fed provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative”, it’s far from tight either and Fed officials’ interest rate expectations (the so-called dot plot) point to rates rising above the Fed’s estimate of the long run neutral rate, which is currently at 3%. We expect another hike in December and, like the Fed, three more hikes next year. Market expectations for just over two more hikes over the year ahead remain too dovish. Continuing US rate hikes mean ongoing downwards pressure on the Australian dollar and the risk of more out of cycle rate hikes by Australian banks to the extent global borrowing costs rise. Trump’s criticism of Fed rate hikes are clearly not having any impact though with Powell indicating the Fed’s focus is keeping the economy healthy and that it doesn’t consider politics.

Republicans losing control

The issues around Brett Kavanaugh’s nomination to the US Supreme Court add to the risk that the Republicans will lose control of the Senate as well as the House. While this will not change our views around Trump and his economic policy – there is a good chance he will get impeached but there still wouldn’t be enough votes in the Senate to remove him from office and Congress won’t change or reverse his economic policies – it will be something that markets will worry about in the run up to and after the November 6 mid-terms.

Aussie property market

In Australia, the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power. 

The risks around the housing market are continuing to mount, with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages, as the banks move to comprehensive credit reporting (i.e. sharing information on customer debts) and focusing on total debt to income ratios. The latter is significant, given estimates that nearly 1.5 million investment properties are held by investors with more than one property.

Credit growth to property investors remains very weak, as tighter lending standards and falling investor demand impact.

Source: RBA, AMP Capital 

Prices at the pump

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

Source: Bloomberg, AMP Capital

For the RBA, these considerations largely offset each other for now so we see no reason to change our view that it will remain on hold for a lengthy period. I am even tempted to the RBNZ approach that the next move in rates “could be up or down”.

What to watch

The RBA will yet again leave interest rates on hold when it meets tomorrow. While recent economic growth and jobs data has been good, we are still waiting for inflation and wages growth to pick up and the slide in home prices risks accelerating as banks tighten lending standards, which in turn threatens consumer spending and wider economic growth. As a result it would be dangerous to raise rates and we don’t see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. Meanwhile, on the data front expect CoreLogic data (today) to show another fall in home prices for September, August building approvals (tomorrow) to show a 2% bounce, the trade surplus (Thursday) to fall slightly to $1.4bn and retail sales (Friday) to rise 0.2%.

Outlook for share and property markets

We continue to see the trend in shares remaining up, as global growth remains solid helping drive good earnings growth and monetary policy remains easy. However, the risk of a correction over the month or so still remains significant given the threats around trade, emerging market contagion, ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around the Australian share market.

National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

 

Not going up

Wednesday, October 03, 2018

It’s getting hard to come up with anything new to say on this! But that’s as it should be, as raising rates just to get rates back to more “normal levels”, or so as to be able to cut them later if needed, would make no sense and would be bad for the economy. A premature hike would be akin to shooting yourself in the foot to be able to practice going to the hospital. (Sorry I know I have used that one before but couldn’t resist using it again!)

And don’t forget that official interest rates in Japan have been around zero for nearly 10 years, they have been around zero for around four years in Europe and they were stuck near zero for seven years from the GFC in the US. So just over two years at 1.5% in Australia is a non-event in terms of global comparisons.

On the one hand, the RBA can point to the continuing global expansion, above trend Australian GDP growth over the last year, an increase in the terms of trade and an improving labour market. But against this uncertainty remains high regarding consumer spending, underemployment remains very high, the drought will have a negative impact, house prices are continuing to fall in Sydney and Melbourne, “credit conditions are tighter than they have been for some time” and wages growth and inflation remain very weak. 

Given all these cross currents it remains appropriate for the RBA to leave rates on hold. And there remains nothing in the RBA’s latest post meeting Statement suggesting an imminent change in monetary policy. 

Our view remains that the RBA will keep rates on hold out to 2020 at least and the next move in rates could still turn out to be a rate cut given the risks around house prices and consumer spending, albeit this would not occur for at least another six months.

 

Is a property crash 60 minutes away?

Thursday, September 27, 2018

Australian data was light on over the last week but with the ABS confirming that home prices fell again in the June quarter. In terms of house prices, our assessment remains that the combination of tighter bank lending standards, rising supply, poor affordability and falling capital growth expectations point to more falls ahead, with Melbourne and Sydney likely to see top to bottom home price falls of around 15% out to 2020.

But what about the risk of a property price crash as suggested by the recent 60 Minutes report? Several things are worth noting in relation to this: predictions of a 30-50% property price crash have been wheeled out regularly in Australian media over the last decade including on 60 Minutes; the anecdotes of mortgage stress and defaults don’t line up well with actual data showing low levels of arrears; borrowers have already been moving from interest only to principle and interest loans over the last few years without a lot of stress; and the 40-45% price fall call on the program was “if everything turns against us”. Our view remains that in the absence of much higher interest rates, much higher unemployment or a multi-year supply surge (none of which are expected) a property crash is unlikely. But the risks are now greater than when property crash calls started to be made a decade or so ago and so deeper price falls than the 15% top to bottom fall we expect for Sydney and Melbourne are a high risk. This is particularly so given the risk that post the Royal Commission bank lending standards become excessively tight and if negative gearing is restricted and the capital gains tax discount is halved after a change in government in Canberra. There is also a big risk that FOMO (fear of missing out) becomes FONGO (fear of not getting out) for some.

One factor that supports the argument against a property price crash is ongoing strong population growth. Over the year to the March quarter, it remained high at 1.6%, which is at the top end of developed countries. As can be seen in the next chart net overseas migration has become an increasingly important driver of population growth in recent years.

However, there are a few qualifications to this: there is some risk that the migrant intake may be cut; while accelerating population growth in Queensland will support Brisbane property prices, population growth is slowing in NSW and Victoria so its becoming a bit less supportive of property prices in those states; and the supply of new dwellings has been catching up to strong population growth so undersupply is giving way to oversupply in some areas. The risk of the latter is highlighted by the continuing very high residential crane count which is still dominated by Sydney and Melbourne, indicating that there is still of lot of supply to hit the market ahead. Out of interest Australia’s total residential crane count alone of 528 cranes is way above the total crane count (i.e. residential and non-residential) in the US of 300 and Canada of 123! 

 

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