Investment markets and key developments over the past week
While Eurozone shares were flat over the past week and US shares only rose 0.2% (with good data offset by uncertainty about tax reform and President Trump’s end to Obamacare related health insurance subsidies acting as constraints), Japanese shares rose 2.2%, Chinese shares rose 2.2% and Australian shares had a good 1.8% rebound from the bottom of the range they have been in for the last few months. Bond yields fell in the US, partly reflecting another weak US inflation reading, and in Europe and Australia. The A$ rose as commodity prices rose and the US dollar slipped after several weeks of gains.
Reflecting the ongoing improvement in the global growth outlook, the IMF yet again revised its global growth forecasts upwards for 2017 and 2018, highlighting yet again how the global growth story has switched from disappointment over the 2012 to 2016 period to upside surprises more recently. This is supporting profits and hence growth assets like shares.
The risks around Catalonia receded a little bit over the last week, with Catalonia’s president suspending a supposed declaration of independence in favour of talks with the Spanish Government. However, the issue has a long way to go and the Spanish Government is likely to play hardball and may yet take over Catalonia’s government, which it is able to do under Article 155 of the Spanish Constitution. We remain of the view that it’s not a major European (let alone global) issue: a Catalan declaration of independence won’t mean much; Catalans are unlikely to rise up and use force to back it; the damage to the Catalan economy (which accounts for 20% of Spanish output) could be immense; and the issue is not about the survival of the euro with Catalonia wishing to remain in it.
Rising female participation in the Australian economy is good for growth as it will boost the workforce and a more gender diverse workforce is good for productivity. The latest Financy Women’s Index (which can be found here) shows that women are continuing to make economic progress both in absolute terms and relative to men, particularly in terms of workforce participation and wages. This is great news but there is much further to go. Boosting female workforce participation could add up to 8% to the size of the economy or $147 billion to annual GDP and help offset the impact of the ageing population. There would likely be an additional boost to the extent that greater female participation will result in increased workplace diversity which in turn will contribute to a more productive workforce – as Australian company boards are starting to recognise.
It was great to see Richard Thaler’s work around behavioural economics recognised in this year’s Nobel prize for economics. Thaler along with others including 2002 Nobel economics prize winner Daniel Kahneman has been a major contributor to economics and finance through his work showing that people are not always rational when making decisions. This goes a long way to explaining why asset prices can deviate significantly from fundamentally justified levels and has had a huge impact on my career as an economist and investor which commenced with my PhD thesis, that partly related to such insights. As Thaler pointed out after winning the prize “in order to do good economics, you have to keep in mind that people are human.” Some economists still seem to forget that!
Major global economic events and implications
US data remains solid. Retail sales surged in September and were revised up for August, consumer confidence rose to a 13-year high, small business optimism remained high in September, August readings for job openings, hiring and quits were all strong, initial jobless claims are continuing to unwind their hurricane-related boost and producer price inflation is continuing to trend up. While core inflation disappointed yet again in September and remained at 1.7% year-on-year, we remain of the view that an uptick in US inflation is still on the way thanks to strong growth and the tight labour market. As such, the US Federal Reserve (the Fed) is still likely on track for a rate hike in December. Meanwhile, the Goldilocks combination of good growth and low inflation keeps the Fed benign for now which bodes well for shares.
Eurozone industrial production rose by more than expected in August. But with European Central Bank (ECB) President Draghi saying “we’re still not there yet” in terms of wages and sticking to the commitment to only raise interest rates “well past” the conclusion of its quantitative easing program - which we think will be extended at the rate of €30 billion a month from January for another 6-9 months – this means that as things currently stand the ECB is unlikely to raise interest rates until well into 2019.
Japan saw strong reading for machine orders and economic sentiment. Reflecting strong economic conditions, Tokyo’s office vacancy rate has fallen to just 3.17%.
Chinese foreign exchange reserves rose again in September, highlighting that capital outflows remain under control and export and import growth accelerated, which tells us that global and domestic demand remains strong.
Australian economic events and implications
Australian data was more upbeat over the last week with continuing strength in business conditions, a slight rise in business confidence and an improvement in consumer confidence. September quarter home price data from Domain added to evidence that the Sydney property market has rolled over with significant price declines. It would be wrong to read too much into just one quarter’s data, however price softness is consistent with a sharp fall in auction clearances and anecdotal evidence. Housing finance data showing a surge in lending to first home buyers indicates that recent NSW and Victorian government moves to increase stamp duty concessions for first home buyers have worked, which along with still strong population growth and various other factors highlights why a property crash is unlikely.
The Reserve Bank of Australia’s (RBA) Financial Stability Review saw the Australian financial system as being strong with low non-performing loans but continues to see the main risks as relating to household debt and the housing market. However, the RBA does note slower growth in riskier types of lending and signs of easing in the Sydney and Melbourne property markets. The RBA also announced that it will be conducting bank stress tests, which is surprising given that’s normally the role of the Australian Prudential Regulation Authority. Early conclusions suggest the banks are resilient, excepting in situations of extreme shocks. It’s possible such tests could be used to justify a further tightening of macro-prudential standards at some point.
What to watch over the next week?
China will likely be the main focus globally in the week ahead with the commencement of the Communist Party Congress on Wednesday and September inflation and economic activity data due for release. The Congress is almost certain to see President Xi Jinping continue as General Secretary and Li Keqiang remain as Premier, but the leadership team will be renewed around them with President Xi seeing his authority enhanced. Post the Congress we may see a refocus on reform, but it’s doubtful that there will be an abrupt policy change and as we have seen over the first five years of President Xi’s leadership there will be a careful balancing of reform and maintaining growth.
On the data front in China, September inflation data (Monday) is likely to show a drop in CPI inflation to 1.6% year-on-year and producer price inflation is expected to fall slightly to 6.2% year-on-year. More importantly, economic activity data (Thursday) is expected to show a modest slowing in GDP growth in the September quarter to 6.8% year-on-year, September industrial production growth is expected to pick up to 6.5% year-on-year, retail sales growth is likely to remain at 10.1% year-on-year and investment is likely to slow to 7.6% year-on-year. None of these reads will cause much excitement in financial markets or at the People’s Bank of China.
In the US September industrial production (Tuesday) is likely to see a return to growth and October home builder conditions (also Tuesday) are likely to bounce back up a bit however September housing starts (Wednesday) and existing home sales (Friday) are likely to remain subdued thanks to the hurricanes. Regional manufacturing conditions’ indicators for October are likely to remain strong. The Fed will also release its Beige Book of anecdotal indicators (Wednesday) and Fed Chair Yellen in a speech on Friday may reiterate the case for another rate hike in December. The September quarter profit reporting season will also start to ramp up and will likely show another increase in profits from a year ago, although the hurricanes may have temporarily dampened things later in the quarter.
Japan’s election (Sunday October 22) is likely to see PM Abe’s LDP-led coalition comfortably returned with poll support for the new Party of Hope declining. Abenomics will continue! (although I suspect it would have anyway but under a different name if the Party of Hope were to win.)
In Australia, the minutes from the RBA's last board meeting (Tuesday) are unlikely to add anything new and will continue to imply that the RBA retains a neutral short-term bias with respect to interest rates. September jobs data (Thursday) is likely to show a 10,000 fall in jobs but with unemployment unchanged at 5.6%.
Outlook for markets
This is still a seasonally volatile time of the year for shares, North Korean risks remain high, Trump-related risks remain and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short-term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This should eventually drag Australian shares up from their range-bound malaise.
Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.
Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.
Residential property price growth in Sydney and Melbourne is likely to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.
While further short term upside in the A$ is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.
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