Investment markets and key developments over the past week
Share markets had a messy week with trade war concerns dominating, despite some good US economic and earnings news. Eurozone shares gained 1.4% helped by President Trump’s decision to delay auto tariffs, but US shares fell 0.8%, Japanese shares lost 0.4% and Chinese shares fell 2.2%. Australian shares rose 0.9% though, reflecting gains in resources stocks - helped by rising iron ore and oil prices - and in property, health and consumer shares with ongoing talk of rate cuts also helping. This offset a sharp fall in the banks. Bond yields fell further on weak inflation and safe-haven demand. Oil and metal prices fell but iron ore prices rose. The A$ fell below US$0.69.
The US trade war continued to rattle investors over the last week, but the news wasn’t all bad. Yes, China announced retaliation to US tariff hikes, but it was small compared to what the US did. Yes, President Trump continued to make threatening noises to China and moved to ban US companies from doing business with Huawei and (probably in response) China talked down the chance of talks resuming, but Trump indicated that he will meet President Xi at the G20 summit in Tokyo next month which is shaping up as the most likely offramp from the current escalation of trade tensions. Trump also declared that auto imports were a threat to national security (protectionists love that one!) but delayed imposing tariffs on them for six months to give the EU and Japan time to agree to what looks likely to be quotas on their auto exports to the US which is consistent with the view that he doesn’t want to fight a trade war on three fronts. The trade issue still looks like it will get worse before it gets better, but our view remains that a deal will ultimately be reached to resolve the issue given the economic (and in Trump’s case political) damage that would be caused if a deal is not reached. Further share market falls may be necessary to push Trump and Xi down this path though.
The week ahead in Australia will no doubt be dominated – at least for those not more enthralled by Eurovision - by the outcome of the election which has seen the Coalition returned probably with a majority or as a minority. While there will no doubt be much debate about the role played by Clive Palmer’s UAP it seems Australians were not prepared to support the higher taxes, increased government spending and redistribution offered by the alternative. The Morrison Government faces four key challenges: minimising the fallout from the housing downturn to maintain improved affordability and not just set off another housing boom; getting wages growth up to more reasonable levels and this will require getting growth up and underemployment down; addressing the perceptions of unfairness that have grown since the 2014 Budget; and solving the climate action/high energy price puzzle which may become essential if support from independents is required to govern. (In terms of the latter it perplexes me deeply as to how we can be world beaters in terms of per capita emissions and in terms of electricity prices!)
Apart from the housing deposit scheme the Coalition did not promise a lot in this election - which is a good thing - beyond what was laid out in the Budget so it’s back to business as usual in terms of the immediate economic policy outlook with modest tax cuts for low- and middle-income earners on track for the next few months. Our view remains that growth will average around 2% in the short term, unemployment will move up to around 5.5% and the RBA will cut the cash rate twice this year to 1% with the first cut likely next month. Increased short term fiscal stimulus on the back of a still improving budgetary position (with the 2018-19 budget likely now in or close to surplus) thanks to the still surging iron ore price is on the cards though but is unlikely to be big enough or come early enough to head off rate cuts.
Will we see a post-election share market bounce? While Australian shares are typically cautious going into elections the next table shows that after 9 out of the 13 elections since 1983 shares were up 3 months later with an average gain of 4.8%. With the return of the Coalition with its more pro-business policies and uncertainty now removed around changes to excess franking credits, changes to negative gearing and capital gains tax adversely affecting the property market and increased industrial relations regulation it’s possible we will see a bit of a short-term bounce in the share market. Property related shares, banks and retail shares could be the key beneficiaries. Against this though the Australian share market has already performed pretty well over the last few months and is likely be dominated by issues around global trade, slowing growth, interest rates and the iron ore price and so will quickly move on from the election I suspect.
Australian shares before and after elections
Federal financial support for first home buyers (FHBs) in Australia is now on the way but don’t get too excited by the First Home Loan Deposit (underwriting) Scheme announced during the election. The scheme will be of some help in enabling FHBs to get in earlier and saving them mortgage insurance which can cost up to $10,000. But being capped at 10,000 FHBs a year it’s pretty small at around 10% of FHB loans in the last year, the borrowers will be taking on even bigger mortgages (when regulators have been trying to reduce the size of mortgages), which will come with a higher risk of negative equity, borrowers will still have to meet the tougher credit standards of recent times and it won’t kick in until next year. So, it’s probably not a game changer at this stage. That said, with the budget looking even healthier and probably already in surplus thanks to the surging iron ore price, I suspect that the deposit scheme will morph into a far more attractive home buyer grant at some point. This is something we have seen in most major housing downturns in recent times and it will likely add to confidence along with RBA rate cuts, the removal of the threat to negative gearing and the capital gains tax discount and a slowing in new supply next year to help the property market bottom out short of the worst case falls some are putting out there.
Vale Bob Hawke. The Hawke/Keating reforms of the 1980s & 1990s modernised the Australian economy and are a big part of the reason we have gone nearly 28 years without a recession.
Major global economic events and implications
US economic data was mostly good with weak readings for April retail sales (albeit after a very strong March) and industrial production, but better manufacturing conditions in the New York and Philadelphia regions, higher small business confidence and stronger home builder conditions, a bounce back in housing starts, very strong consumer confidence and a fall in jobless claims. Weak import prices are adding to the downward pressure on inflation though, which combined with the resumption of the trade war is increasing the risk that the next move by the Fed will be a cut.
Japanese data was soft with a sharp fall in machine tool orders and a downtrend in the Economy Watchers confidence survey. Coming on the back of a resumption of falling wages the pressure is on the Government to postpone October’s scheduled VAT rate hike and on the BoJ to do more.
Chinese data for industrial production, retail sales and fixed investment all slowed in April. While this may be partly due to distortions caused by a VAT rate cut and Lunar New Year holiday timing, unemployment actually fell and coming on top of the resumption of the trade war it will likely result in a further ramping up of policy stimulus which is consistent with Government pronouncements in relation to the trade war.
Australian economic events and implications
Australian data was soft over the last week. Housing finance resumed its downswing in March with investor finance (ex refinancing) back around 2009 and 2011 levels. Consumer and business confidence are running around long-run average levels but the NAB’s business conditions index fell back to its December low and employment intentions fell sharply pointing to slower jobs growth ahead. Employment was solid in April but the full-time part-time mix was poor, and more significantly jobs growth is no longer keeping up with rapid labour force growth so unemployment and underemployment are both on the rise again. Finally, wages growth remained stuck at just 2.3% year on year in the March quarter. Sure its above inflation and up from its lows. But its still very weak and with unemployment and underemployment remaining very high and starting to rise again as the housing downturn hits employment its hard to see much fundamental acceleration in wages growth from here (even if the Government starts pushing up the minimum wage at a faster rate). The bottom line remains that to get wages growth and inflation up we need much lower unemployment and underemployment but to get that we will need even lower interest rates and more fiscal stimulus. The contrast between the US and Australian levels of labour market underutilisation remains stark and even with the much tighter labour market in the US wages growth has just managed to get up to 3%. With the election out of the way we expect the RBA to cut the cash rate to 1.25% in June and then to 1% in August.
What to watch over the next week?
In the US, the minutes from the Fed’s last meeting are likely to confirm its neutral bias on interest rates. Our base case remains that the Fed’s pause will continue for another six months at least but the return of the US/China trade war and sub-target inflation has increased the risk that the next move will be a cut rather than a hike. On the data front, expect a rebound in existing home sales (Tuesday) but a fall in new home sales (Thursday), business conditions PMIs for May (Thursday) to remain around the 53 level and underlying durable goods orders (Friday) to show modest growth.
European parliamentary elections on Thursday will no doubt see a lot of hype around Eurosceptics winning seats, but don’t read too much into it. The EU elections tend to see a higher turnout from motivated Eurosceptic voters, Eurosceptic/nationalist parties will still only get around a quarter of the seats, most of them are not serious about leaving the EU and/or the Euro (the Italians and Eastern Europeans) or are irrelevant (those from the UK), the EU Parliament doesn’t have a lot of power and in any case popular support for the Euro across the Eurozone has been rising and is strong at 75%. Meanwhile Eurozone business conditions PMIs (also due Thursday) will be watched for further signs of stabilisation.
Japanese March quarter GDP growth (Monday) is expected to show a small 0.1% dip continuing the up-down pattern of the last year. Annual growth will be just 0.3% year on year.
In Australia, the initial focus will be on the outcome of the Federal election. Beyond that the focus will be back to monetary policy with the release of the minutes from the last RBA board meeting and a speech by RBA Governor Lowe on Tuesday, both of which we expect to signal some sort of shift towards an easing bias on interest rates ahead of rate cuts in the months ahead. On the data front, March quarter construction data will likely remain weak with another fall of around 1% quarter on quarter. Data for skilled vacancies and the CBA’s business conditions PMIs will also be released.
Outlook for investment markets
Share markets – globally and in Australia - have run hard and fast from their December lows and are vulnerable to a further short-term pullback. Geopolitical uncertainty around trade, North Korea, Iran and still mixed global economic data could be the drivers. But valuations are okay, global growth is expected to improve into the second half and monetary and fiscal policy has become more supportive of markets 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 remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see a further slowing in returns. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.
Our base case is for national capital city house prices to fall another 5% or so into 2020 on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves. A rate cut in June could bring forward the bottom in house prices as in the last two cycles they bottomed four months or so after the first rate cut.
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 further to around US$0.65 as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Excessive A$ short positions and high commodity prices will likely prevent an A$ crash though.
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