Investment markets and key developments over the past week
Global share markets fell slightly over the last week on global growth concerns and renewed US/Europe trade war fears. Australian shares rose though playing catch up to the previous week’s rally in global shares with energy, tech and real estate stocks being the main drivers. Bond yields were flat in the US but fell elsewhere. Oil and iron ore prices continued to push higher with supply issues supporting both. The US$ fell slightly and this saw the A$ rise slightly.
There were lots of headlines over the last week about the IMF downgrading its global growth forecasts to 3.3% for this year from 3.5% - but it’s really just catching up to last year’s growth slowdown which was reflected in last year’s share market falls. So, while the IMF headlines caused a one-day blip in markets its nothing new. Particularly with central banks already having swung back to being dovish and signs emerging that global growth may be bottoming and starting to improve. But from a big picture sense the return to a downgrade cycle for global growth forecasts after a year or so of upgrades around 2017 provides a reminder that we are still in the constrained growth/low inflation/low rate world that we have been in since the GFC.
Is a US/European trade war going to take over where the US/China one left off? This issue reared its head again over the last week as progress continues to be made in resolving US/China trade tensions and the US threatened tariffs on US$11bn worth of imports from the EU in retaliation to the EU subsidies of Airbus. And of course, President Trump has to resolve by mid-May whether he will impose tariffs on auto imports from the EU. However, beyond a lot of noise a US trade war with the EU is unlikely. First, the Airbus issue is occurring in the context of a WTO dispute that’s been going for years so it’s not Trump going out on his own. Second, the proposed tariffs on $11bn of imports from the EU is small versus the $360bn of imports from China. Third, it looks designed to get the EU moving on trade talks. Fourth, there is little support for a trade war with the EU amongst the US public or Congress (unlike v China) and the US trade deficit with the EU is small compared to that with China anyway. Finally, another trade war would pose a new threat to Trump’s 2020 re-election. That said the trade issue with EU could go on for a bit and so cause a bit of volatility. But it’s unlikely to be anything like that seen with the US/China trade dispute.
The great central bank retreat to dovishness continues. The minutes from the Fed’s last meeting are consistent with it remaining on hold and bringing quantitative tightening to a tapered end this year. And at its meeting in the last week the European Central Bank was dovish, formally considering making its negative interest rate on bank deposits less onerous for the banks and with President Draghi erring on the side of doing more rather than less to stimulate growth. With Chinese monetary policy remaining easy it’s clear that one of the big concerns for markets last year – ie that central bank policy would be too tight – remains in retreat for now.
The start of the Australian Federal election campaign ahead of the May 18 election has ushered in a period of economic policy uncertainty for investors. Elections normally see a bit of market nervousness but with a Labor Government promising a very different approach to economic policy than the Coalition involving higher taxes, larger government and more intervention in the economy the May election presents a starker choice than has been the case since elections back in the 1970s and so suggests greater uncertainty for investors than normal around elections.
Meanwhile in Australia, bank funding costs have continued to fall. Bond yields have collapsed driving down the funding cost for fixed rate mortgages, the interest rates on which the banks are now cutting again. And the gap between the bank bill rate and the expected RBA cash rate has now fallen back to around its longer term average of around 0.23% cutting the funding costs for variable rate mortgages and pointing to a reversal of the 0.1 to 0.15% mortgage rate hikes the banks put through last year or at the very least it indicates that they have little excuse not to pass on any RBA rate cuts in full.
Major global economic events and implications
US economic data was confusing but on balance strong. While job openings fell in February since then payrolls have rebounded and unemployment claims have collapsed to a post October 1969 low suggesting that job openings and hirings will rebound again. Small business optimism rose slightly in March and remains solid. Meanwhile core inflation was weaker than expected in March. Which is of course partly why the Fed can remain on hold for now but with the labour market remaining very tight and energy costs pushing back up it’s hard to see them cutting rates any time soon. Which could mean that the next big move in US bond yields will be up (not down).
Chinese CPI inflation rose in March to 2.3%yoy, but core inflation remained low 1.8%yoy. Underlying inflation pressure is low and won’t constrain policy stimulus.
Australian economic events and implications
Australian economic data was mixed with a modest rise in consumer sentiment and a bounce in housing finance after several months of falls but another fall in job advertisements.
The RBA’s latest Financial Stability Review highlighted the risks around global growth, high household debt, the housing slowdown and bank culture but seemed reasonably confident that the financial system will weather these risks. In particular it noted improved lending standards, stress tests indicating banks have sufficient capital to withstand a 30% or greater fall in house prices and that even in WA where house prices have fallen nearly 20% and unemployment has increased by 3%, mortgage arrears remain relatively low. Overall, the Review looks to be consistent with the RBA’s neutral bias on interest rates for now.
Are prospects for rate cuts fading? Somewhat better economic data lately, tax cuts for low and middle income earners regardless of who wins the election and ongoing RBA optimism about the economy picking up have seen rate cut expectations fade a little bit. However, while this could see the first rate cut pushed back out a bit we continue to see the RBA cutting rates twice this year as the housing downturn dampens economic growth and keeps inflation below target for longer.
What to watch over the next week?
In the US, the highlight is likely to be a bounce back in March retail sales (due Thursday) after a soft patch seen late last year. In other data expect to see modest growth in March industrial production and a solid reading for the NAHB’s April home builders’ conditions index (both Tuesday), a slight deterioration in the trade deficit (Wednesday), continued solid readings for April business conditions PMIs (Thursday) and a bounce back in housing starts (Friday).
The flow of US March quarter earnings reports will start to pick up. The consensus expectation is for a 2% decline in earnings per share on a year ago as last year’s tax cut drops out and reflecting slower economic growth. But given the sharp downgrade to expectations seen in recent months there is a good chance we will see greater than normal earnings beats suggesting that actual earnings growth will come in around flat or up slightly. Either way it’s likely that the March quarter will be the low point for earnings growth this year.
Eurozone business conditions PMIs (Thursday) will be watched for more signs of stabilisation.
Japanese inflation data (Friday) is likely to show that core inflation remained weak at 0.4% year on year in March.
Chinese economic activity data due Wednesday is likely to confirm a further slowing in GDP growth, but also show that momentum is likely to improve a bit going forward. March quarter GDP growth (Wednesday) is likely to show a further slowdown to 6.3% year on year from 6.4% in the December quarter, with quarterly growth slowing to 1.4% from 1.5%. However, consistent with recent stimulus and a lessening of trade war fears, March activity data is expected to show a pick up in momentum with growth in retail sales accelerating to 8.4% year on year, industrial production accelerating to 5.9% growth and investment growth picking up slightly to 6.3%.
In Australia, the minutes from the last RBA’s board meeting (Tuesday) are expected to show that the RBA’s neutral bias on future interest rate moves remains in place. Meanwhile, March jobs data (Thursday) is expected to show a 10,000 gain in employment and a rise in unemployment back to 5%.
Outlook for investment markets
Share markets – globally and in Australia - have run hard and fast from their December lows and are vulnerable to a short-term pullback. But valuations are okay, global growth is expected to improve into the second half of the year, monetary and fiscal policy has become more supportive of markets and the trade war threat is receding all of which should support decent gains for share markets through 2019 as a whole. Low yields are likely to see low returns from bonds, but government bonds continue to provide an excellent portfolio diversifier. Expect Australian bonds to outperform global bonds.
Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.
National capital city house prices are expected to fall another 5-10% into 2020 led by Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.
The A$ is likely to fall into the US$0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates.
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