Market Update 20 December 2019

Investment markets and key developments over the past week

Share markets generally rose over the last week consistent with the Santa rally that often kicks off around mid-December. Japanese shares fell but other major markets rose benefitting from a continuing reaction to the US/China trade deal and okay economic data holding out the prospect of stronger growth in 2020. Australian shares benefitted from the positive global lead but saw very strong gains in utilities, industrials, real estate and health and consumer discretionary stocks. The risk on tone saw bond yields rise along with higher oil and metal prices, although the iron ore price fell slightly. The $A rose despite a slight rise in the $US.

So far so good for the Santa rally, but will it continue? The Santa rally normally runs from mid-December into year end and reflects a combination of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings. Last year Santa didn’t really come until after Christmas due to US related political risks. This year Santa seems to have come a bit early and markets are a bit overbought. Our best guess though is that shares will continue to push up into year end reflecting the positive seasonal tailwind, but with the risk of a short term pull back early in the new year.

Evidence continues to build that global monetary easing is getting traction with business conditions PMIs in the US, Europe and Japan flat to up slightly in December.  

President Trump’s impeachment by the House of Representatives is of little market consequence. It was widely expected. It was only supported by Democrat representatives with support from no Republicans. And most importantly, in the absence of damning new information, it’s extremely unlikely that the Senate trial early next year (assuming that House Democrats send the impeachment articles to the Senate) will vote to remove Trump from office as it would need the support of at least 20 Republicans which is most unlikely given that polls show only 46.8% of Americans support Trump’s removal from office and only 8.9% of Republican voters do. If anything, the House’s impeachment and ongoing politics around it may have played into Trump’s hands enabling him to claim he is the victim.

UK PM Johnson’s move to seek legislation to prevent an extension of the Brexit transition period beyond the end of next year provided a reminder that there is still a Brexit cliff edge out there and this could weigh on UK business confidence and conditions in 2020. Negotiations for a free trade deal between the EU and UK could end in a hard exit if no free trade agreement is reached, but the threat of economic disruption should help work against that.

In Australia, the Mid Year Economic and Fiscal Outlook (MYEFO) saw a downgrade in the economic outlook for the year ahead, much smaller budget surplus projections for the next four years thanks to lower revenue assumptions and no new fiscal stimulus beyond that already announced since the election. The risk for the Government is that its forecast pick-up in growth, wages and inflation in the years’ ahead looks too optimistic and so the increasingly small surpluses could disappear. There may be some off offset if the iron ore price remains higher than the conservative $US55 a tonne assumption but it is looking a bit harder to provide fiscal stimulus and surpluses at the same time. In the meantime, the additional fiscal stimulus that had already been announced since the April Budget (via infrastructure spending, drought support and aged care) at around 0.1-0.2% of GDP won’t have a big impact on the economy. So, the pressure remains on the RBA for more easing if its to meet its full employment and inflation objectives. On this front the Minutes from the RBA’s meeting two weeks ago has set up the February 2020 meeting as “live” for another rate cut noting that “it would be important to reassess the economic outlook in February 2020, when the Bank would prepare updated forecasts.” Since the last meeting, employment and housing finance have come in on the strong side but data for GDP growth, retail sales, trade, and confidence have all been soft. So we remain of the view that the RBA will cut rates again in February and is on its way to a 0.25% cash rate, a stronger commitment to keep rates down and ultimately quantitative easing.

Major global economic events and implications

US economic data was generally good with a further slight rise in the composite business conditions PMI for December, and gains in home builder conditions, housing starts and permits, job openings and industrial production. Against this, jobless claims remained elevated and still look distorted by the late Thanksgiving holiday, existing home sales fell, the Phily Fed manufacturing index was weak and the leading index was flat.

Eurozone business conditions PMIs were flat in December but remain up from their low and the German IFO index rose adding to confidence that Eurozone growth may be stabilising or improving.

The Bank of England left rates on hold with a neutral bias but may need to ease again given ongoing Brexit related risks. Meanwhile the Swedish central bank hiked rates from -0.25% to zero, ending roughly five years of negative rates. It could prove to be an interesting test case for what happens when negative rates end – but I suspect not much providing the economy is ok!

Japan’s composite business conditions PMI was flat in December and remained up from its sales tax hike related low in October but core inflation rose to 0.8%yoy in November, albeit it would be lower if the sales tax hike is excluded. The Bank of Japan left monetary policy on hold as expected.

Chinese economic data for November was generally better than expected, with a stronger than expected acceleration in growth in industrial production and retail sales. The PBOC also undertook further monetary easing.

Australian economic events and implications

In Australia, housing finance and employment data was strong. Housing finance commitments rose again in October and are now up 15% since May confirming the upswing in the property market long evident in clearance rates and prices. Meanwhile, although employment rebounded in November after October’s surprise slump it likely just reflects normal monthly volatility in the jobs data with trend monthly and annual jobs growth slowing down and leading jobs indicators – such as skilled vacancies which fell again in November – continuing to point to slower jobs growth ahead. Meanwhile, “spare capacity” as measured by labour market underutilisation remains high. Against this background its hard to see wages growth improving any time soon.

Australia’s population rose 381,600 or 1.5% over the year to the June qtr largely on the back of strong immigration. While its slowed slightly its still above the 30-year average of 1.4% pa. This is acting as a strong source of demand in the economy, but over the last year GDP growth barely exceed population growth which is consistent with very little growth in material living standards in contrast to the US, Eurozone and Japan which have been seeing faster per capita GDP growth.

What to watch over the next week?

The Christmas week is a bit quiet on the data front, but things will hot up again in the New Year week.

In the US, expect a modest rise in durable goods orders (due 22 Dec), a decent gain in pending home sales (30 Dec), continued gains in home prices and a rise in consumer confidence (31 Dec) and a lift in the manufacturing conditions ISM for December (3 Jan) to around 49. The minutes from the Fed’s last meeting (3 Jan) are likely to remain relatively dovish consistent with Fed Chair Powell’s guidance that he wants to see “a significant move up in inflation before raising rates.”

Japanese data is expected to show continuing strength the labour market and a rebound in industrial production for November after the sales tax hike depressed October (with both due on 27 Dec).

Chinese business conditions PMIs (due 31 Dec and 2 Jan) will be watched for further signs of stabilisation or improvement.

Australian credit growth (31 Dec) is likely to remain soft but with possible signs that new housing lending is starting to offset the rapid paydown of existing mortgages.

Outlook for investment markets

Improved global growth and still easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares and geopolitical risks are likely to constrain gains and create some volatility:

• Global shares are expected to see returns around 9.5% helped by better growth and easy monetary policy. 
• Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and trade threat recedes as we expect.
• Australian shares are likely to do okay but with returns also constrained to around 9% given sub-par economic & profit growth. Expect the ASX 200 to reach 7150 by end 2020.
• Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
• Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns. 
• National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole. 
• Cash & bank deposits are likely to provide very poor returns.
• The $A is likely to fall to around $US0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2020 little changed.