Investment markets and key developments over the past week
After a bit of uncertainty and volatility early in the week, share markets pushed sharply higher as the US and Iran appeared to step back from escalating their conflict. This saw US shares push to a new record high and the positive global lead saw the same in Australia with the local market breaking more decisively above its pre GFC high. The risk on tone also saw global bond yields rise, but they fell in Australia on increasing expectations for RBA easing. Metal prices rose, but the iron ore price fell and gold and oil fell on the back of easing US/Iran tensions with the oil price falling to below where it was before Iranian general Soleimani was killed. The $A fell as the $US rose.
There was good news on the US/Iran conflict with Iran appearing to pull its punch in launching missiles at an Iraqi airbase housing US troops (in retaliation for the US killing of General Soleimani) such that it killed no Americans or Iraqis and President Trump toning down his rhetoric against Iran. All of this suggests Iran and Trump don’t want to go to a direct war. Iran’s leaders are not suicidal and know they probably would not survive a concerted US attack and Trump knows that a surge in gasoline prices on the back of another Middle East war would blow his re-election. The risk of a miscalculation and more Iran related volatility remains high, but our base case continues to be that Iran tensions won’t be enough to push oil prices up so far that they threaten global growth and hence the outlook for investment returns this year.
Out of interest, its worth noting that the sensitivity of economic activity in most developed countries to changes in the oil price has fallen substantially since the 1970s thanks to the growth of the services sector which doesn’t use as much oil and energy efficiencies. Higher oil/petrol prices can still impact though as a tax on consumers... just not as much as they used to.
Unfortunately, the news remains depressing on the bushfire front in Australia. We looked at the economic impact in detail here. But the bottom line is that:
- The bushfires are expected to result in around a 0.4% hit to GDP due to disruption in areas affected and the impact on consumer confidence and tourism. This will mainly occur in the March quarter and will then be followed by a rebuilding boost.
- The hit to consumer spending and tourism is likely to linger longer.
- The drag on economic activity has increased the pressure for more monetary and fiscal stimulus. We still see the RBA cutting the cash rate to 0.25%, with the RBA cutting next in February. The Government has already allocated an additional $2bn to rebuilding, albeit this is less than 0.1% of GDP on an annual basis. More fiscal stimulus is also likely with the Government downgrading the focus on achieving a budget surplus.
- The bushfires likely increase the pressure for more action on climate change and highlight the need for investors to be aware of industries and businesses that are vulnerable to climate change risk.
Just when you thought it couldn’t go any higher, President Trump’s tweet count hit a new high in December of 1146 (or 37 a day). Speaking of which this one from Thursday was particularly interesting: “@realDonaldTrump: STOCK MARKET AT ALL-TIME HIGH! HOW ARE YOUR 401K’s DOING? 70%, 80%, 90% up? Only 50% up! What are you doing wrong?” Since he was elected the US share market is up 57%. Is the implication that Americans should forget diversification and load up in maybe geared shares?
Major global economic events and implications
US economic data has remained mostly good with a rise in the December ISM non-manufacturing conditions index to a solid reading of 55, solid jobs indicators and a decline in the trade deficit.
Eurozone economic confidence improved slightly in December consistent with a stabilisation in growth, unemployment was unchanged at 7.5% and core inflation remained low at 1.3% year on year.
Japan saw a further modest improvement in consumer confidence, but wages growth softened further.
Chinese consumer price inflation remained unchanged at 4.5%yoy in December, but core inflation remained weak at just 1.4% and producer prices are still down -0.5%yoy, so there is no constraint on further PBOC easing here.
Australian economic events and implications
Australian economic data was mixed. On the negative side consumer confidence continued to slide according to the weekly ANZ/Roy Morgan survey, the AIG’s business conditions PMIs were weak in December and ANZ job ads fell sharply in December and are down 18.8% from a year ago. Against this building approvals had a good bounce in November and appear to be stabilising, job vacancies rose over the three months to November, retail sales had a strong 0.9% gain in November and the trade surplus rebounded. The lagged relationship from building approvals points to dwelling investment falling further over the next six months but the stabilisation in approvals suggest that this may have run its course by mid year. The rise in job vacancies though needs to be treated with some caution given the continuing weakness in more recent job ads. Similarly I wouldn’t get to excited about November’s bounce in retail sales as it was likely boosted by Black Friday sales which has likely pulled sales forward from December (with the ABS’ seasonal adjustment process yet to fully pick this up) and anecdotes suggest Christmas sales were soft. Finally, the rebound in the trade surplus suggests net exports may help support December quarter GDP growth – but it was partly due to a slump in imports suggesting domestic demand remains weak.
What to watch over the next week?
In the US, expect December core CPI inflation (Tuesday) to have remained unchanged at 2.3% year on year, retail sales to show solid growth of around 0.3% and the home builders conditions index for January to have remained strong at around 76 (both due Thursday), housing starts to show another rise of 1% and industrial production to gain 0.1% (with both due Friday). Manufacturing conditions for the New York and Philadelphia regions will also be released. December quarter earnings results will also start to be released – the consensus is for a fall in EPS of -1.6%yoy but its likely to come in around +0.5% given normal surprise levels. January 15 is scheduled to see the US and China sign their Phase 1 trade deal in Washington but this is likely already factored into markets.
Chinese December quarter GDP growth (Friday) is expected to come in unchanged at 6% year on year, resulting in 2019 calendar year growth of 6.2% which is in line with our expectations a year ago. December activity data (also Friday) is likely to show a fall back in retail sales growth to 7.8%yoy and in industrial production to 5.9% with investment growth unchanged at 5.9% all of which would be consistent with a stabilisation in growth. Trade data due Tuesday is expected to show a pick-up in export growth to 1.9%yoy and in import growth to 9.5%yoy.
In Australia, the weekly ANZ Roy Morgan consumer confidence survey (Tuesday) will be worth watching to see whether it continues to fall, September quarter housing commencements (Wednesday) are likely to show a further fall reflecting the earlier fall in building approvals and housing finance commitments for November (Thursday) are expected to show a further increase consistent with the property market recovery.
Outlook for investment markets
Improving 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 total returns around 9.5% in 2020 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 this year but with total returns also constrained to around 9% given sub-par economic & profit growth.
- 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, with the RBA expected to cut the cash rate to 0.25%.
- 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.
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