Investment markets and key developments over the past week
Share markets continued to rise over the last week helped by talk of policy stimulus, notably in China, and optimism of a resolution to the US/China trade dispute. Over the week US shares rose 2.9%, Eurozone shares gained 2.3%, Japanese shares rose 2.5%, Chinese shares rose 2.4% and the Australian share market gained 1.8%. Bond yields rose in the US but were little changed elsewhere, commodity prices including oil rose and the US$ rose slightly which saw the A$ fall slightly.
Since Christmas US shares have rebounded 14%, reversing more than half their September to December fall of 20%, global shares have rallied 11% and Australian shares are up 8%. However, after such strong gains some sort of pull back or retest of the December low is a high risk. Major share market falls as we saw last year rarely end with a V bottom, shares are now overbought and there is a long list of uncertainties over the next few months that could trip markets. The list includes: soft data in the short term with the March quarter in the US renowned for soft growth, earnings reporting seasons, trade negotiations, the US government shutdown, the need to raise the US debt ceiling, the Mueller inquiry, Brexit, the Australian election, etc. But looking beyond the near-term uncertainties we are upbeat on shares for the year as a whole as valuations remain much improved from last year’s highs, the US/China trade dispute is likely to be resolved before too long with increasingly positive signs from the trade talks between the two countries, global growth is likely to stabilise and improve which should help support modest profit growth and policy stimulus should help growth. Speaking of which…
Shares fall, economic data softens, policy makers respond…The past week has seen more signs of a supportive policy shift globally with: Chinese officials promising more aggressive policy stimulus focussing on tax cuts and the PBOC undertaking a record money market cash injection; Angela Merkel’s political party calling for tax cuts in Germany; ECB President Draghi acknowledging that recent economic news has been weaker than expected and that significant monetary stimulus is still needed; and more Fed officials supporting a pause on rate hikes with former Fed Chair Yellen saying we may have seen the last hike for this cycle. An easing in global policy is one big reason why we expect the global growth slowdown to be limited as it was around 2012 and 2015-16 and why we see a better year for shares this year.
The US partial government shutdown posing a bigger risk. While it’s only partial, it’s now gone on for four weeks with a reported 800,000 public servants missing out on pay. The longer it goes on the more it will impact and add to trade as a factor worrying US companies. So far Americans are mostly blaming Trump and the Republicans. Trump is dug in over the wall. But like the trade war he won’t want this to drag on for too long, given the threat it would pose to US growth ahead of his desired re-election in 2020. So, expect some sort of compromise in the next few weeks.
Out of interest, 2019 is the third year in the four-year US presidential cycle and historically it’s normally the strongest as can be seen in the next chart, as the president does his best to ensure the economy is in good shape for his re-election year (i.e. next year for Trump). Of course, it doesn’t always work. But for this year it would be consistent with Trump seeking to support growth and this would include solving the trade war and ending the shutdown.
The Brexit comedy rolls on, but could be heading towards a softer Brexit or even no Brexit. It was no surprise to see UK PM May’s Brexit plan defeated, but one would be forgiven for expecting that it would have been greeted with a plunge in the British pound. But it held up, so how? The focus is now on cross party discussions to find a solution and with Parliament biased towards the EU this is likely to push towards a soft Brexit and against a “no deal” or hard Brexit (for which there is only around 10% support in parliament). Failing the cross-party discussions (and the risk of no solution is high, given May’s “red lines”) another referendum is likely (despite May’s denials). With the difficulties associated with Brexit now readily apparent, Bremain would likely win. In the meantime, the EU is likely to agree to delay the Brexit date. It should also be remembered though that while Brexit uncertainty is very bad for the UK economy and a no-deal Brexit could knock it into recession, it’s a second order issue globally as its implications for the survival of the Euro are minimal as support across Europe for the Euro remains solid. Hence global markets payed little attention to it over the last week.
My favourite quote from Vanguard founder John Bogle who passed away in the last week: “Don’t look for the needle in the haystack, just buy the haystack!” While actively managing a portfolio of shares has its merits, it’s not easy to pick winners consistently, particularly for individual investors who risk ending up way underperforming the market as a whole. The first priority is to get a broad exposure to the market and let compound interest do its job…picking managers and stocks is always second order.
Major global economic events and implications
US data was disrupted over the last week thanks to the partial government shutdown, but there were some positive signs of a soft landing. On the weak side, the Fed’s Beige Book of anecdotal evidence was less upbeat on the growth front and manufacturing conditions in the New York region deteriorated again in January. Against this though, manufacturing production was strong in December, manufacturing conditions in the Philadelphia regional improved, jobless claims fell and the NAHB’s home builder conditions index rose slightly in January, possibly helped by lower mortgage rates which helped drive a 27% rise in mortgage applications over the last two weeks, all of which supports the view that the housing sector will have a soft landing. Producer price and import price inflation were relatively benign consistent with the Fed being on hold.
The US December quarter earnings reporting season is off to an okay start. 56 S&P 500 companies have reported so far with 80% beating on earnings with an average beat of 0.9% and 55% beating on sales. But it’s early days and the focus is likely to be on outlook comments, which are likely to be cautious given the tight labour market and uncertainties about growth and trade.
Japanese headline and core inflation was just 0.3% year-on-year in December, highlighting the pressure on the Bank of Japan to stay ultra-easy or even ease further (if that’s possible).
Eurozone industrial production fell sharply in November, but annual growth data for 2018 as a whole implies that the German economy grew in the December quarter, albeit very slowly. That said, it will still put pressure on the ECB to ease.
Chinese exports and imports both fell in December supporting the view that the Chinese economy slowed further late last year, but against this home price gains remained solid and credit growth came in stronger than expected, with the latter possibly reflecting policy easing.
Australian economic events and implications
Australian data releases over the last week continued the weak run seen since Christmas, with falls in housing finance, new home sales, housing starts and consumer confidence. Sure, the Melbourne Institute’s Inflation Gauge perked up a bit in December but it’s a bit volatile month to month and in any case both on a headline and underlying basis is running below the RBA’s 2-3% inflation target.
House prices risk falling further than we are allowing for. For some time we have been of the view that Sydney and Melbourne home prices will have a top to bottom fall of around 20% out to 2020, translating into a fall in national average prices of around 10% (as other cities are in better shape). The plunge in clearance rates and acceleration in the pace of house price falls late last year along with the ongoing credit tightening, the record pipeline of units yet to be completed, reduced foreign demand, investor uncertainty over potential changes to negative gearing and capital gains tax along with price falls feeding on themselves suggest that the risks to Sydney and Melbourne prices are on the downside of our 20% forecast falls. The threat this poses to consumer spending, along with rising bank funding costs and out of cycle mortgage rate hikes, reinforces our view that the RBA will cut interest rates this year, but the cuts could come earlier than the second half that we have been allowing for.
What to watch over the next week?
US data releases are likely to continue to be affected by the shutdown, but in terms of what is scheduled to be released expect to see a pullback in existing home sales (Tuesday), continued modest gains in home prices (Wednesday), a slight further fall in business conditions PMIs for January (Thursday) and a slight improvement in underlying durable goods orders (Friday). If the shutdown ends, data already delayed for retail sales and housing starts may also be released.
The US earnings reporting season will also ramp up a notch, with companies such as Johnson & Johnson, Proctor & Gamble, Microsoft and Starbucks due to report.
The European Central Bank meets Thursday and is not expected to make any changes to monetary policy but could flag that another round of cheap bank financing or LTRO (which is a short-term form of quantitative easing) is on the way or being considered. Eurozone business conditions PMIs for January (also Thursday) are expected to remain weak.
The Brexit comedy will roll on, with PM May due to present Plan B on Monday.
he Bank of Japan is also expected to leave monetary policy on hold (Wednesday) and remain dovish.
Chinese December quarter GDP data due Monday is expected to confirm a further slowing in growth to 6.4% year-on-year from 6.5% in the September quarter. This will leave growth for 2018 as a whole at 6.6% which is slightly stronger than the 6.5% we had expected. Meanwhile, December data is expected to show a slight improvement in growth in retail sales and investment but a slight slowing in growth in industrial production.
In Australia expect jobs data on Thursday to show employment growth slowing to a gain of around 15,000, with unemployment falling to remaining at 5%. Growth in skilled vacancies (Wednesday) is expected to remain soft and the CBA’s business conditions PMIs will be released Thursday.
Outlook for investment markets
With uncertainty likely to remain high around the Fed, US politics, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018, as investors realise that recession is not imminent:
Global shares are likely to see volatility remain high, but valuations are now improved, and reasonable growth and profits should support decent gains through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
Emerging markets are likely to outperform if the US$ is more constrained, as we expect.
Australian shares are likely to do okay but with returns constrained by moderate earnings growth.
Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
National capital city house prices are expected to fall another 5% or so this year, led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and uncertainty around the impact of tax changes under a Labor Government. The risk is on the downside.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes, the A$ is likely to fall into the US$0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. Being short the A$ remains a good hedge against things going wrong globally.
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