Investment markets and key developments over the past week
Share markets were mixed over the last week. US shares rose 1.2% to a new record high, helped by good earnings news and rising energy shares on the back of high oil prices. Japanese shares rose 0.3%. Following the US lead, Australian shares rose 1.8% to be back above last year’s high helped by banks, energy shares and talk of an imminent RBA rate cut. But Eurozone shares fell 0.2% and Chinese shares fell 5.6% with talk of less stimulus weighing on Chinese shares. Bond yields fell. Commodities were mixed with gold and iron ore up but metals and oil down. The A$ fell back to around US$0.70 in the face of a break higher in the US$ and more RBA rate cut talk.
Share markets back to around last year highs but is it sustainable? Having rebounded very sharply from their December lows, share markets are vulnerable to a decent pullback or correction. But putting short terms risks aside, they are still likely to end the year higher. Put simply, the rebound in shares reflects a reversal of last year’s negatives with more dovish central banks led by the Fed, lower inflation allowing lower bond yields, stabilisation and in some case improvement in global growth indicators which should underpin reasonable profit growth and the risks around a trade war receding.
Another curve ball from President Trump – this time on oil. Six months ago the decision by Trump to exempt China, India, Japan and a few other countries from US sanctions for buying around 1.4 million barrels a day of Iranian oil helped drive global oil prices down and it was thought the exemptions would be renewed. But just to confuse everyone they won’t be, leading to concerns about a new surge in oil prices as it removes Iranian oil from the global market at a time of supply disruptions in Libya and Venezuela. WTI crude at US$63 a barrel is still well below last year’s high of US$76 (as are Australian average petrol prices of around $1.50 a litre versus last year’s high around $1.60) and commitments by Saudi Arabia and the UAE to make up for lost supply may still keep prices below last year’s highs. But if it doesn’t - and prices keep rising in response to supply shortfalls or tensions around Iran - expect Trump to get nervous (as higher gasoline prices don’t please his base) and do something like bring back the sanction waivers.
Low March quarter inflation highlights the case for an imminent rate cut in Australia. Sure, a 9% decline in petrol prices drove the flat headline increase in quarterly inflation and petrol prices have since bounced back with the world oil price. But every measure of underlying inflation was weak, running between 1.2% year-on-year to 1.4% year-on-year. Businesses are still finding it hard to lift prices in the face of ongoing spare capacity, intense competition and weak demand. Yet again the RBA’s inflation forecasts are looking way too optimistic (see the next chart) and will likely be downgraded again in next month’s Statement on Monetary Policy. The longer inflation undershoots the 2-3% target, the greater the risk that the target will lose credibility. This in turn will see low inflation expectations become more entrenched, making it in turn even harder to get inflation back to target and leave Australia vulnerable to slipping into deflation during the next economic downturn. Lowering the 2-3% target would be a huge mistake and would see inflation targeting lose all credibility and only lock in low inflation (and the risk of deflation) for longer.
While the RBA would prefer to wait till after the election and see a rise in unemployment before moving on rates, March quarter’s much weaker-than-expected underlying inflation data will likely have shocked the RBA into thinking that waiting too much longer will be too risky. As a result, while it’s a close call we now see the RBA undertaking the first of the two rate cuts we expect this year in May. Out of interest, the RBA has changed interest rates twice in election campaigns in recent times – raising rates in the 2007 election campaign and cutting them in the 2013 election campaign. So if the RBA feels the need to move it will, even in election campaigns.
Major global economic events and implications
US data was mostly strong. Existing home sales fell in March, but new home sales rose, house prices continue to rise and underlying durable goods orders rose solidly. March quarter GDP rose at a much stronger than expected 3.2% annualised rate with contributions from trade (+1 percentage point) and inventory (+0.7 percentage points) offsetting slower growth in consumer spending and investment. Inventory will likely be a drag going forward, but expect consumption and investment to pick up again. Jobless claims bounced from their lowest since 1969 but this looks Easter holiday-related.
Nearly 50% of US S&P 500 companies have reported March quarter earnings results and so far, so good with 78% beating on earnings and 53% on revenue. Earnings growth started the reporting season with expectations for a 2% fall on a year ago, but have now risen to +0.5% and are likely to end up around 2.5% and this is likely to mark the low point for this year.
German and French business conditions indicators were down slightly and flat respectively, but look to be stabilising.
The Japanese jobs market remained tight in March, helped by a falling labour force but industrial production remains very weak. Meanwhile the Bank of Japan made no changes to its ultra easy monetary policy as expected, but it committed to keeping rates low for another year at least. Given it’s way off meeting its 2% inflation target, further easing is likely.
China pulling back from further policy stimulus, but this is because it has stabilised growth. This was the key message from recent policy meetings in China, including the March quarter Politburo Meeting with policy makers expressing more optimism about the Chinese economy in response to the recent improvement in growth indicators and therefore shifting back from stimulus to fine tuning. This is appropriate and signals that China does not want to over-stimulate Chinese growth.
Australian economic events and implications
Along with weak consumer price inflation, producer price inflation for the March quarter was also soft, import prices fell and skilled vacancies fell again. On the positive side, export prices continued to surge in the March quarter (helped by the higher iron ore price) pushing up the terms of trade. The flow-on of this to profits and tax revenue in Canberra, along with lower welfare payments, saw a further improvement in the Federal budget, making a surplus this financial year quite likely. Which in turn may mean scope for more fiscal stimulus.
What to watch over the next week?
In the US, it will be a busy week with the Fed meeting on Wednesday and April jobs data due Friday. Expect the Fed to remain patiently on hold as inflation remains below target and it waits for clearer evidence that the headwinds to growth are receding. April jobs data is likely to have remained solid with a 180,000 gain in payrolls, unemployment remaining at 3.8% and wages growth picking up slightly to 3.3% year-on-year. In other data, expect to see a solid rise in March personal spending but core private consumption deflator inflation (both due Monday) falling to 1.7% year-on-year, March quarter employment costs up around 3.1% year-on-year and a rise in April consumer confidence (both Tuesday), the manufacturing ISM for April (Wednesday) remaining strong around 55 and the non-manufacturing ISM (Friday) falling slightly to a still strong 55. The flow of US March quarter earnings reports will continue.
In the Eurozone, the focus is likely to be on March quarter GDP growth (Tuesday) which is likely to have remained subdued at 0.2% quarter-on-quarter with annual growth slowing to 0.9% year-on-year. Meanwhile economic confidence for April (Monday) will be watched for signs of stabilisation, March unemployment (Tuesday) is likely to be flat at 7.8% and core inflation (Friday) is likely to stay weak at 1% year-on-year in April.
The outcome of Spain’s general election on Sunday (28th April) is unlikely to have implications outside Spain and poses no threat to the eurozone, with support for the euro running high and populist parties not seeking to leave it.
Chinese business conditions PMIs to be released Tuesday and Thursday are likely to have held on to recent gains consistent with an improvement in Chinese economic growth.
Australian data is expected to show continuing modest growth in credit (Tuesday), a further fall in CoreLogic home price data for April (Wednesday) and a sharp 13% fall in residential building approvals for March after a 19% bounce in February.
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.
Our base case is for national capital city house prices to fall another 6% or so into 2020 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. An earlier rate cut in May 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 into the US$0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Excessive A$ short positions and high commodity prices will likely prevent an A$ crash though.
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