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Shane Oliver
Financial markets
+ About Shane Oliver

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

Will interest rates rise or fall in 2019?

Thursday, December 13, 2018

Australian economic data was weak, and we now see the RBA cutting interest rates in the year ahead. September quarter GDP came in at just 0.3% q-o-q, 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 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, we see the next move being a rate cut. However, it will take a while to change the RBA’s thinking, so we don’t see rates being cut until second half next year, but won’t rule out an earlier move if things are weaker earlier than we are expecting. 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 Governor 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?

Expect to see another fall in housing finance in Australia of around 1%, ABS data 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.

Outlook for 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.

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.

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 $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.

 

The week ahead

Monday, December 03, 2018

Two weeks ago, I noted three potential positives for shares: a Fed pause, the oil price crash extending the cycle and some hope on the trade front. 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 below…neutral" 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 some pressure off the $US, which would provide some relief for emerging markets and commodity prices. 

I have a leaning towards some sort of positive outcome from the Trump/Xi meeting – as both sides want a deal, but it’s a close call. I remain of view 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 we see pretty constrained consumer spending growth next year it’s not all doom and gloom.

Around the globe

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.

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.

Down under

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

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

What to watch over the next week?

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 (today) 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 its 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 (today) 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. We remain of the view 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% 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 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 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 our 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.

 

No grizzly bears in this market

Monday, November 26, 2018

US shares fell 3.8%, Eurozone shares lost 1.6%, Japanese shares fell 0.2%, Chinese shares fell 3.5% and Australian shares declined 0.3%. Reflecting the “risk off” tone bond yields fell, credit spreads widened and commodity prices fell, with the oil price down another 11% over the last week, leaving it down 34% from its high in early October. The $US rose slightly and this weighed on the $A.

Shares retesting October lows – double bottom or resumption of the slump? Share markets fell back to around their October lows over the last week. A retest of the lows is quite normal after the sort of fall we saw in October. Whether markets form a double bottom and head back up or break decisively lower to new lows is unclear.

In favour of the former, less stocks have made new lows into the latest fall and Asian and emerging markets are looking a lot healthier (having led this share slump and having had much deeper falls). But against this, many of the triggers for the fall in markets remain in place. The bottom line is that I don’t know whether it will remain just a correction or maybe slide deeper into what I like to call a gummy bear market (where markets have a 20% top to bottom fall but are up a year after the initial 20% decline). But I remain of the view it’s unlikely we are sliding into a deep or grizzly bear market as the conditions are not in place for recession in the US, globally or Australia.

Potential triggers to watch for a rebound include a meeting at the G20 meeting between Presidents Xi and Trump in the week ahead, more signs of a possible Fed pause on interest rates and a stabilisation/improvement in growth indicators outside the US. In terms of the Trump/Xi G20 meeting, the APEC debacle between the US and China and a report by the US Trade Representative repeating criticism of China are driving low market confidence of a deal being reached between the US and China. However, against this, Trump appears to want a deal, knowing that further tariff hikes (which are really tax hikes) will start to offset his fiscal stimulus next year and may be starting to impact business confidence and hence capital spending. All of which may start to negatively impact Trump’s 2020 re-election prospects. Reports that White House trade adviser and protectionist Peter Navarro won’t be attending the meeting is also a positive.

On the petrol front

While the 34% plunge in the oil price since early October is weighing heavily on energy shares, it’s positive for growth going forward and hence an eventual recovery in share markets. Lower oil prices help take pressure off inflation and put discretionary spending power back into the hands of households. So far it’s a saving of around $11 a week for a typical Australian household but this could increase, as the fall in oil prices flows through with a lag to lower petrol prices.

Along with the high likelihood of more income tax cuts (which could be announced in next month’s mid-year budget review), this means that despite falling house prices, it’s not all doom and gloom for consumer spending in Australia. Further falls in world oil prices may be limited though as OPEC is likely gearing up to cut production at its December 6 meeting.

Source: Bloomberg, AMP Capital

What’s happening in Italy?

Italy looks to be heading into what is called an Excessive Deficit Procedure – a process administered by the European Commission but approved by Eurozone finance ministers, designed to get its expansionary budget deficit back on track with debt limits – but a major crisis still looks unlikely. More likely is some sort of fudge combining various delays in enforcing any deficit reduction and some compromises. The rest of Europe won’t want to put too much pressure on Italy for fear of fuelling anti-Euro sentiment, and in any case, by the time Italy has to respond to any requests under the EDP it won’t be till later next year by which time the 2019 budget will be largely history.

What’s happening in the US?

US economic data was on the soft side. Home building conditions fell sharply in October, albeit catching down to other housing-related indicators, housing starts and existing home sales rose but are trending sideways, underlying capital goods orders were soft, leading indicators were weak in October, with the falling share market acting as a drag and business conditions PMIs fell slightly in November, albeit they remain strong. Naturally, the weakness in housing indicators raises memories of the GFC but note that housing investment is running at a relatively modest 3.9% of GDP and hasn’t kept up with demographic demand, in contrast prior to the GFC when it reached 6.7% of GDP and was way ahead of demographic demand. While you can get hurt falling out of high rise, you are less likely to get hurt falling out of the ground floor.

And Down Under?

RBA Governor Lowe’s comments in the past week were particularly significant for two reasons. Firstly, he looks to be becoming more concerned about credit tightening in saying that “a few years ago credit standards were way too loose, there has been a correction of that, but I am starting to be a bit concerned the pendulum might be swinging a bit too far the other way.”

Second, he also acknowledged the risks around wages remaining weak, even if unemployment falls further: “I suspect nationally we could sit at [an unemployment rate] around 4.5 per cent without seeing wage growth pick up by too much”.

He is clearly aware that estimates putting the so-called NAIRU at 5% are rubbery. Perhaps he is starting to question the RBA’s own mantra that the next move in rates is more likely up than down.

Lower immigration levels on the way? 

There is always a debate going on about the appropriate level of immigration in Australia, but this has been mainly outside the major political parties or on the fringe of them. PM Scott Morrison changed all that in the last week flagging a cut to the annual immigration cap of 190,000 by 30,000. At present, this sounds like just affirming the actual level of immigration, which has already slowed by about 30,000. So, no big deal. But having brought the debate into the centre of politics risks seeing immigration getting cut further, given angst about the issue particularly in Melbourne and Sydney. This is particularly relevant to the property market as it was the surge in population growth from around mid-last decade without a housing supply pick up (until around 2015) that has played a big role in the surge in house prices relative to incomes.

Yeah, yeah, yeah, the surge in credit, speculation, foreign demand, etc, also played roles too. But the point is that if immigration starts to fall back at a time of rising supply, it will be one more factor sending property prices south in Sydney and Melbourne (which take something like 60% of immigrants) – along with tighter credit, rising supply, a significant pool of borrowers having to switch from interest only to principle and interest mortgages, reduced foreign demand, fears around tax changes reducing future investor demand, etc. Our view remains that these two cities will see 20% top to bottom price declines out to 2020 but there are clearly some risks on the downside to this.

Source: ABS, AMP Capital

Keep an eye on these this week

The big event this will be the meeting between Presidents Trump and Xi on the sidelines of the G20 meeting (Friday & Saturday) in Buenos Aires to discuss trade.

In the US, the focus is likely to be on the Fed. While the minutes from the last Fed meeting (Thursday) will likely confirm that it remains upbeat and on track to raise rates again in December, another speech by Fed Chair Powell (Wednesday) is likely to repeat that he is aware of the various headwinds to the US economy, leaving the impression that the Fed is open to a pause on interest rates next year. Of particular interest will be what, if anything, he has to say about continuing share market volatility and recent softness in housing and business investment indicators. On the data front, expect home price data (tomorrow) to show continuing modest gains, consumer confidence for November (also tomorrow) to show a slight fall from 18-year highs, new home sales (Wednesday) to show a bounce, September quarter GDP growth (also Wednesday) to be revised up slightly to 3.6% from 3.5%, personal spending growth (Thursday) to have remained solid but with core private consumption deflator inflation falling back to 1.9% year on year.

In Australia, speeches by RBA Governor Lowe and Assistant Governor Kent today will be watched for any clues on rates. On the data front, expect to see a 1% gain in construction data for the September quarter (Wednesday), a 1.5% gain in September quarter business investment (Thursday) and continuing moderate credit growth (Friday) with ongoing weakness in lending to investors. A key focus will be whether investment intentions data points to further improvement.

Outlook for markets

Shares remain at risk of further short-term weakness, but 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 yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit they may slow down a bit).

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. Being short the $A remains a good hedge against things going wrong globally.

Eurozone shares rose 0.4% on Friday, but the US S&P 500 fell 0.7% with energy shares down 3.3% as the oil price continued to plunge. The weak US lead saw ASX 200 futures decline 37 points (or 0.6%) pointing to a weak start to trade for the Australian share market on Monday, with energy shares particularly likely to be under more pressure.

 

The story of the three bears

Monday, November 19, 2018

It’s still too early to say we have seen the bottom in share markets. Put very simply, there are three types of significant share market falls – corrections with falls around 10%, “gummy” bear markets with falls around 20% but where the market is up a year later (like in 1998, 2011 and 2015-16) and “grizzly” bear markets, where a year after the initial 20% fall the market is down another 20% or so (like in 1973-74, the tech wreck or the GFC). A grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession does not imminent as the excesses that normally proceed recession (overinvestment, inflation surging, tight monetary policy) are not present on a significant enough scale. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls into the October lows) and it could still turn into a gummy bear market, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that has left investors nervous, the rebound from late October was not particularly convincing and many of the drivers of the October fall are yet to be resolved.

However, there were three positive developments over the last week, which help add to our conviction that we are not going into a grizzly bear market:

1. While Fed Chair Powell remains upbeat on the US economy and a December hike looks assured (for now), he is clearly aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of 8 interest rate hikes and stock market volatility and appears open to slowing the pace of interest rate hikes or pausing at some point next year. The stabilisation in core inflation around 2% seen lately may be supportive of this. Overall, he now seems a lot more balanced than in early October when referring to rates going to neutral and beyond. Fed Vice-Chair Clarida delivered a very similar message to Powell in an interview two days later, reinforcing the impression that the Fed is open to softening its stance on rates.

2. There have been more positive signs on trade. Talks between the US and China on trade have reportedly resumed “at all levels”, US Treasury Secretary Mnuchin and Chinese Vice-Premier Liu have spoken by phone, the China Daily has reported that China and the US have agreed to promote a bilateral relationship, China has sent a trade document to the US and President Trump has repeated that he is optimistic of a trade deal with China and that the US might put any further tariff increases on China on hold, if there is progress in trade talks. All this is on top of the Trump/Xi phone call a few weeks ago and suggests that there was much more to it than just a pre-midterm election publicity stunt by Trump. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet at the G20 summit at the end of the month but with Trump wanting to get re-elected, I remain of the view that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. And finally, for now at least, the US has held off on tariffs on automobiles. Of course, the market reaction to such positive developments has been relatively muted because investors are sceptical, given the failure so far this year of various US/China trade talks, but this just indicates there is all the more room for a positive response in markets, if progress is actually made.

3. While the 27% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, ultimately it has the potential to extend the economic cycle as the 2014-16 plunge did (although it’s likely to be on a much smaller scale this time). Oil prices are short term historically oversold and due for a bounce but it’s increasingly looking like slower global demand than expected is a contributor to the price plunge – along with US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil (which highlighted yet again that Trump doesn’t want to let anything damage US growth and weaken his re-election chances in 2020), rising US inventories, the rising $US, and the cutting of long oil positions. This means while oil prices are unlikely to fall for as long or as much as they did in 2014-16, when they fell 75%, they may stay lower for longer. This is bad for energy companies but maybe not as bad for shale producers, as in 2015 as they are now less geared and their break-even oil price has already been pushed down to $50/barrel or less. And it’s less of a threat to the US economy, as energy investment is much smaller than it was in 2014. It will depress headline inflation (monthly US CPI inflation could be zero in November and December) and if it stays down long enough, it could dampen core inflation. All of which may keep rates lower for longer. And it’s good news for motorists. For example, Australian petrol prices have plunged from over $1.60 a litre a few weeks ago to now falling back to around $1.30 in some cities and prices could still fall further as the oil price fall flows through to the bowser with a lag. That’s a saving in the average weekly household petrol bill of around $10.

The outlook…

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.

 

3 reasons why shares rallied after the US midterms

Thursday, November 15, 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.

 

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Macron to face Le Pen: A good outcome for investment markets

Weekly economic and market update

Will APRA's move cool Sydney and Melbourne property?

Trump's pro-business agenda remains on track

5 reasons why the RBA won't raise rates this year

Fed on track for rate hike

US Fed on track for March rate hike

Shares at risk of short-term correction

Eurozone risks to present buying opportunities

Trump's pro-growth agenda alive and well

Trump jitters persist

Investors focused on Trump, US earnings and data

The uncertainty of President Trump

What to watch over the week

Bad news is good news for the stock markets

Will interest rates rise in 2017?

What to watch over the next week

Trump the pragmatist, or protectionist?

3 things you need to know about Donald Trump's victory

3 things you need to know about Donald Trump's victory

How the US election result could impact the markets

Why has the Australian market slipped?

3 reasons not to fear the Fed

7 reasons not to worry about a Fed rate hike

What to watch over the week

Weekly economic and market update

Shares rally on central bank moves

Are central banks out of bullets?

Could this market correction have further to run?

What to watch this week: Aussie growth numbers

What to watch this week: reporting season ends

What to watch over the week

Another rate cut in November?

Reporting season ramps up