Investment markets and key developments over the past week
The past week saw global share markets recover some of their recent losses until President Trump’s trade war escalated again on Friday swamping dovish comments from Fed Chair Powell and whacking US stocks sharply lower with a flow on to other share markets likely to be seen early in the week ahead. This saw US shares fall 1.4% for the week which took them back down to their August lows. Other share markets managed gains over the last week with Eurozone shares up 0.3%, Japanese shares up 1.4%, Chinese shares up 3% and Australian shares up 1.8% but all are likely to fall early in the week ahead in response to a sharp 2.6% fall in US shares on Friday. Bond yields were mixed over the last week with initial rises that were reversed on Friday as the trade war escalated again. Oil, metal and iron ore prices fell but the gold price rose. The A$ fell despite a rise in the US$.
Another escalation in the trade war with no end in sight. China announced its anticipated retaliation to the tariffs announced by President Trump on August 1 with an additional tariff averaging around 6% on US$75bn of imports from the US to commence in September and December. Mr Trump then announced that the tariff rate on US$250bn of Chinese imports will rise from 25% to 30% in October and the new tariff starting in September on US$270bn will be 15% and not 10%. So again, Chinese tariff hikes have been less than proportional to US tariff hikes. This latest escalation and Mr Trump’s tweet that “our great American companies are hereby ordered to immediately start looking for an alternative to China” will be a further blow to US business confidence, supply chains and investment plans. As Fed Chair Powell basically said in Jackson Hole, while monetary policy is a “powerful tool” it cannot resolve trade uncertainty. It’s getting very hard to square the often-repeated lines from the White House in relation to the trade talks that “things are going well” and “they want a deal” with reality. Maybe the maximum pressure strategy is not working! Our view remains that President Trump will likely have to end the trade war if he wants to avoid a US recession and get re-elected next year but at this stage there is still no end in sight and so share markets likely have to fall further to pressure Mr Trump to solve the issue and de-escalate.
Business conditions may be stabilising in Europe and Japan, but not in the US and Australia. Given the worries about recession on the back of President Trump’s trade wars monthly business conditions PMIs are being watched even more closely than normal and the message for August was mixed with PMIs pointing to a stabilisation if not gradual improvement in Europe and Japan but a continuing softening in the US and Australia. The weakness in the US which is likely to worsen further as long as the trade war continues to escalate poses the risk of further falls in share markets and keeps central banks and policy makers under pressure to provide more stimulus.
Stimulus drumbeat getting louder, but we might have to wait a while for fiscal stimulus. While central banks are already at it, the move towards more stimulus gathered pace over the last week with an increasing focus on fiscal stimulus. First, China looks to be refocusing on cutting interest rates with a new policy rate called the Loan Prime Rate set at 4.25%. While its only down slightly from the old 1-year benchmark rate of 4.35% it’s likely that more rate cuts lie ahead. Second, Fed Chair Powell’s speech at Jackson Hole was dovish, noting that a lot has changed since the July Fed meeting in terms of new tariffs and a further global slowdown and that President Trump’s trade war seems to be contributing to the global slowdown and slower US manufacturing and investment. He was probably thinking that another 0.25% cut was appropriate for next month’s meeting but after Friday’s latest trade war escalation 0.5% is increasingly possible. Third, Germany looks to be considering a fiscal stimulus of around €50bn or 1.3% of GDP. But this may take a while to happen as politics could complicate it and it may only come if there is a German recession say later this year. Finally, President Trump looks to be considering more tax cuts – maybe a payroll tax cut. Again, this could be complicated by politics as it would need Congressional approval and the Democrats would be mindful that an economic downturn would aid them in 2020 so why cooperate with Mr Trump! Of course, its early days and things likely have to get rougher (with share markets falling further) to get governments to pull the fiscal stimulus lever but at least they are thinking about it.
Italy falls apart…again. Up until the May election both Australia and Italy had seen six changes in PM this decade and it looked like Australia might take the lead with seven, but our election put paid to that. Now Italy looks like jumping out in front again with PM Conte resigning as far right Northern League leader Salvini withdrew support for the coalition Government as he looks to take advantage of his strong poll support via a fresh election. The far right NL/far left Five Star Movement coalition always did look a bit dodgy and it did well to survive just over a year. The 5SM and the centre left Democratic Party are now trying to form a new coalition but failing that it’s off to another election. It’s a case of same old same old with Italy, with populists dominating and blaming someone else (the EU, migrants etc) and nothing being done to fix up Italy’s economic mess. Contrast this with Spain which has made immense strides in reforming its economy. Another bout of instability in Italy will naturally raise concerns about an Itexit (here we go again!) but its noteworthy that a majority of Italians still like the Euro. The best thing the EU could do is for Germany and those countries that can to undertake a decent fiscal stimulus. This will help their own economies and Italy too.
I haven’t bothered much with the Brexit comedy lately as it’s become a big drag but it’s worth an update. Basically, PM Boris Johnson wants the withdrawal agreement with the EU to remove the Irish ‘backstop’ and failing that is threatening a no-deal withdrawal (ie no more free trade with the EU) on 31 October. The problem with the former is that the EU has basically said no. To preserve the integrity of its free trade zone the EU has to have all of the UK in it or Northern Ireland. The UK Government won’t accept the latter as it splits up the UK and it’s hard to imagine a trade border between Ireland and Northern Ireland which is not a hard border which Ireland won’t accept. So, it’s a mess. The problem with a no-deal withdrawal is that parliament won’t support it. So that would be another mess. Just remember though that while it’s a big mess for the UK as 46% of its exports go to the EU, it’s only a little mess for the EU as just 6% of its exports to the UK.
Back in 1965 song writer Burt Bacharach and lyricist Hal David had a hit with Jacquie DeShannon called “What the World Needs Now Is Love”…sweet love. To some it may sound like a piece of nice elevator music with its saccharin lyrics. But when reading Burt’s autobiography, I discovered that Hal was motivated to write the lyrics by the Vietnam War that was ramping up at the time and so the song does have a lot of meaning. Maybe it even inspired The Beatles “All You Need Is Love” and they even ended the last substantive song on their last recorded album in 1969 with “and in the end the love you take is equal to the love you make.” The world always needs a lot of love but sometimes more than ever and now looks to be one of those times.
Major global economic events and implications
US business conditions PMIs fell further in August with the composite PMI falling to 50.9 driven by weakness in services and manufacturing, suggesting a further hit from President Trump’s latest salvo in the trade war with China. Against this though, jobless claims remain ultra-low, the leading index rose in July and existing home sales rose. Payroll employment growth over the last year was revised down suggesting a greater slowing than the 1.5% year on year previously reported but it’s still a solid 1.3% year on year.
The minutes from the Fed’s last meeting highlighted the differences of opinion at the Fed as to whether rate cuts were needed as these have been evident in the last week with several Fed presidents indicating resistance to further rate cuts. However, several of these presidents are not current voting members and Fed Chair Powell’s Jackson Hole comments are expected to be more dovish.
In contrast to the US, Eurozone business conditions PMIs surprisingly rose in August with the composite PMI rising to an okay 51.8 from 51.5 leaving in place a gradual uptrend from early this year. It’s still well down from the highs of early last year though.
Japan’s composite business conditions PMI also rose in August to an okay 51.7 driven by the services sector. Core inflation rose slightly to 0.6% year on year in July, but it remains a long way below the Bank of Japan’s 2% target with no reason to expect it to reach it anytime soon.
Australian economic events and implications
RBA minutes didn’t really offer anything new except on two fronts. First the RBA tweaked its willingness to further ease monetary policy from a narrow linkage to the labour market in previous statements to a broader focus on “an accumulation of additional evidence”. There is a danger in relying too much on RBA comments (if I had I wouldn’t have been forecasting rate cuts from last December!) and it may just be word games but it does suggest a broader focus by the RBA beyond the labour market to issues such as the escalating trade war, slowing global growth and easing by other central banks. This makes sense as the RBA’s focus on the labour market lately seemed a bit too myopic given it’s a lagging indicator. On balance its a dovish tweak and we continue to see two more rate cuts this year. Only question is why the wording in the post meeting statement and the minutes from the same meeting in relation to the consideration of further interest rate cuts is so different? Second, the RBA reiterated that it’s been looking at non-conventional monetary policies (like QE). It didn’t give much away but it’s clearly getting prepared to deploy them if needed. Otherwise it wouldn’t be devoting so much time to thinking about them.
Skilled job vacancies rose slightly in July after six months of falls, but the CBA’s composite business conditions PMI for August fell sharply to 49.5 from 52.1 led down mainly by the services sector. This took the PMI back to around its February low and it continues to warn of soft growth ahead.
The Australian June half reporting season is now around 75% done in terms of companies and about 85% done by market cap and it’s been relatively soft. Only 37% of results have surprised on the upside which is below the long-term norm of 44% and is the lowest since 2012. 61% have seen earnings rise from a year ago but this time last year it was 77%. 53% of companies have raised their dividends but this compares to 77% doing so a year ago and 25% have cut their dividends which is the highest in the last seven years suggesting greater caution. Downgrades have dominated upgrades with 2018-19 consensus earnings growth expectations cut to 1.5% from around 2% at the start of August. Resources stocks are seeing earnings growth around 13% compared to a 2% decline for the rest of the market, but with healthcare stocks also seeing double digit earnings growth. Downgrades have been greatest amongst energy stocks, financials, telcos and industrials. Some retailers surprised on the upside and were confident about rate cuts and tax cuts boosting spending but others still saw tough conditions and BHP saw falling commodity prices. Fortunatley investors have been relatively forgiving thanks to low interst rates and hopes for a stimulus boost to growth to come. While consensus earnings expectations are for a pick up in earnings growth to 7.5% this financial year, the slowdown in economic growth, cautious outlook statements and falling commodity prices suggest some downside risk to this.
What to watch over the next week?
In the US expect to see a modest rise in underlying durable goods orders for July (Monday), small gains in home prices and a fall back in consumer confidence for August (Tuesday) as talk of tariffs on consumer goods hits, flat pending home sales (Thursday), a solid gain in personal spending for July (Friday) and core private final consumption deflator inflation remaining low at 1.6% year on year.
Eurozone economic data due on Friday is expected to show unemployment remaining around 7.5% in July and core inflation for August staying weak at 0.9%yoy. The German IFO survey will be released on Monday and Eurozone economic confidence data will be released on Thursday.
Japanese data due on Friday is likely to show an ongoing tight labour market helped by the declining labour force and a rebound in industrial production albeit it remains in a weak trend.
In Australia, June quarter construction and business investment data will provide an input into June quarter GDP growth expectations. Expect construction data (Wednesday) to have remained weak with a further fall in dwelling construction but a slight rise in other construction and capex data (Thursday) to show a modest rise. Business investment intentions to be released with the capex data are likely to show an ongoing gradual improvement in the investment outlook. Meanwhile, expect to see a slight fall in building approvals for July but continued soft credit growth with both to be released on Friday.
The Australian June half earnings report season will wrap up with 65 major companies reporting including Fortescue and Boral (Monday), Caltex and Wesfarmers (Tuesday), OZ Minerals, Afterpay and Ramsay Health (Wednesday), Woolworths (Thursday) and Harvey Norman (Friday).
Outlook for investment markets
Share markets are at high risk of further weakness in the months ahead on the back of the ever-escalating US/China trade war, Middle East tensions and mixed economic data as we are in a seasonally weak part of the year for shares. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6- to 12-month horizon.
Low yields are likely to see low returns from bonds once their yields bottom out, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.
The combination of the removal of uncertainty around negative gearing and the capital gains tax discount, rate cuts, tax cuts and the removal of the 7% mortgage rate test suggest national average capital city house prices have probably bottomed. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the supply of units continues to impact and rising unemployment acts as a constraint.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.
The A$ is likely to fall further to around US$0.65 this year as the RBA cuts rates further. Excessive A$ short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an A$ crash.
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