Investment markets and key developments over the past week
Share markets fell over the last week as uncertainty about whether the US and China will agree a Phase One trade deal ramped up amidst a range of conflicting reports. This comes at a time when markets are vulnerable to a consolidation or correction after strong gains since early October have left investor sentiment at elevated levels. Despite a small rally on Friday as President Trump said a deal was “very close” - I think we have heard that one before! - for the week US shares fell 0.3% and Eurozone shares fell 0.7%. Japanese shares dropped 0.8% and Chinese shares fell 0.7%. Australian shares fell 1.2% but the decline was accentuated by accusations that Westpac breached anti-money laundering and counter-terrorism laws more than 23 million times which dragged financial shares down heavily. Bond yields fell on the back of investor caution. Oil, copper and iron ore prices all rose but gold prices fell. The A$ fell slightly as the US$ rose.
Business conditions PMIs for November rose in the US and Japan and while they fell slightly in the Eurozone they remain above their September low. Overall, they appear to be stabilising after a roughly 18-month fall. This is consistent with monetary easing starting to get traction and a cyclical improvement next year.
A confusing week on the US/China trade talks front. Ever since the US trade war with China started it’s gone through periods of escalation then a truce as talks got underway (with President Trump saying “talks are going well – they want to make a deal”) only to see the talks break down and renewed escalation. Developments over the last week suggest that the risk of another breakdown in the latest trade talks and renewed escalation has increased. There has been talk that a deal may be delayed into next year and there have been conflicting reports on whether progress is being made. Chinese agricultural purchases and tariff rollback seem to be the key sticking points in negotiations. And the deteriorating situation in Hong Kong with the US Congress passing a bill supportive of the demonstrators has led to concerns that it will jeopardise the trade talks. President Trump’s comment on Friday that a trade deal was “very close” helped relieve the uncertainty a bit but investors are starting to get sceptical. Meanwhile, Mr Trump’s consideration of exemptions for Apple from tariffs on Chinese imports highlight the damage the tariffs are perversely doing to some US companies relative to foreign companies like Samsung from countries with which the US has a trade deal.
Our assessment remains that the pressure on both sides to ease trade tensions – even if it’s just for 6-12 months – is now far more intense than has been the case over the last 18 months. This includes slowing economic growth in both countries, President Trump’s desire for good news ahead of the elections and to offset the impeachment and a desire to avoid going through with the likely very unpopular 15% tariff on consumer goods on December 15. As a result, we still lean to the view that a deal will be reached. But the risks are high and it may get delayed into next year. The key to watch in the near term is the fate of the scheduled December 15 tariff hike.
There was some good political news in the US with agreement to fund Federal spending out to 20 December, avoiding a government shutdown. A shutdown will likely be avoided beyond 20 December too given neither side wants to start the election year with another debilitating shutdown.
A bit of extra fiscal stimulus in Australia - but not enough which leaves the pressure on the RBA. The past week saw several significant developments on the policy front in Australia.
- First the Government announced a welcome bring forward of infrastructure projects totalling around $1.8bn over the next 18 months which along with an extra $550m in drought assistance amounts to a near term fiscal easing of $2.35bn.
- Second, while the Treasurer indicated the Government is always looking for opportunities to cut taxes, a bring forward of personal tax cuts in next month’s mid-year budget review looks unlikely in the absence of a renewed weakening in September quarter GDP growth as a surplus remains the priority for the Government to pay down debt.
- Finally, the minutes from the last RBA Board meeting suggest another rate cut was a close call but the Bank decided to “wait and assess” & may have been influenced by criticism about the impact of rate cuts on savers and confidence.
The bring forward of infrastructure spending is good news and makes sense. The problem is that the extra fiscal stimulus is just 0.1% of GDP spread over 18 months and so is not enough to have a significant impact on the economy. And with a low prospect of any additional fiscal stimulus before the May budget the pressure remains on the RBA as the economy is set on its own forecasts to make little progress towards its goals of full employment and the inflation target over the next two years. As such we remain of the view that it will respond with more rate cuts taking the cash rate down to 0.25% by early next year, quantitative easing and more dovish forward guidance on rates. We still have the next move pencilled in for next month as the alternative means waiting till February which is too long.
While the RBA has been pointing to stronger forecast growth in the years ahead this has been the story for years now. The chart below shows the progression of the RBA’s GDP forecasts since 2012 from the first forecast for each year to the final outcome (or latest forecast). The average downgrade has been 1%. So, it’s been the norm to downgrade the current year and then point to a forecast pick up next year!
Major global economic events and implications
US data pointed to ongoing strength in the housing cycle with home builder conditions remaining strong and starts, permits and existing home sales up. Business conditions PMIs improved further in November, consumer sentiment rose and jobless claims remain low. Meanwhile, the minutes from the last Fed meeting offered little that was new with the Fed seeing rates “well calibrated” after their third cut but remaining dovish and focussed on downside risks and consistent with Fed Chair Powell’s data dependence.
Eurozone business conditions fell slightly in November, but they remain above their September low and look to be trying to stabilise.
Japanese core inflation rose in October to 0.7%yoy, but after adjusting for the sales tax hike and a cut in childcare costs it was flat at 0.5%yoy. The composite business conditions PMI for November rose slightly after its sales tax hike related slump in October.
China continued to ease monetary policy, but the moves were small with the benchmark rate only cut 5 basis points.
Australian economic events and implications
It was a quiet week for Australian data releases. Skilled job vacancies fell yet again in October and are now down 8.5% on a year ago nationally and down 14.4%yoy in NSW and are consistent with a further softening in jobs growth ahead. Meanwhile, the CBA’s flash business conditions PMIs for November fell slightly and are at the low end of the range they have been in this year and well below 2017 highs.
What to watch over the next week?
In the US the main focus may be on Black Friday retail sales on Friday following the Thanksgiving holiday. On the data front expect modest gains in home prices, consumer confidence and new home sales (all due Tuesday), a slight rise in core durable goods orders, September quarter GDP growth remaining unchanged at 1.9% and core private consumption deflator inflation remaining at 1.7%yoy (all due Wednesday).
In the Eurozone, confidence data is due Thursday, unemployment is expected to have remained at 7.5% in October and core inflation is likely to have remained weak in November (with both due Friday).
Japanese data for October to be released Friday is likely to show that the labour market remains strong (helped by a falling labour force) but that industrial production fell.
Chinese official business conditions PMIs for November will be released on November 30 and may show a small rise.
In Australia, a speech by RBA Governor Lowe on Tuesday on “Unconventional Monetary Policy: Some Lessons from Overseas” will likely be the focus. The Governor is likely to reiterate earlier RBA assessments that a combination of such policies can be effective, but the key will be whether he continues to describe negative interest rates as “extraordinarily unlikely” and QE as “unlikely”. The very fact that Governor Lowe is devoting a full speech to unconventional monetary policy options like QE on the back of the RBA’s comment a few weeks ago that each further rate cut brings us closer to “the point at which other [unconventional] policy options might come into play” suggests the RBA is seriously contemplating moving down this path. This makes sense as interest rates are closing in on zero, less of each rate cut is being passed on and there is an increasing debate about their effectiveness. Our assessment remains that the RBA won’t take interest rates negative but that it will strengthen forward guidance on rates to the effect they won’t rise unless inflation is closer to target and it will undertake some form of QE.
On the data front in Australia, expect a 1% gain in September quarter construction activity (Wednesday) with dwelling activity down but engineering and non-dwelling building up slightly, a 0.2% fall in business investment (Thursday) with a small improvement in capex plans and private credit growth (Friday) to show a slight pick-up in housing credit on the back of stronger housing finance commitments.
Outlook for investment markets
Share markets remain at risk of further short-term volatility given issues around trade, Iran & the Middle East, impeachment noise and weak global economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve through next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 month horizon.
Low yields are likely to see low returns from bonds once their yields bottom out if they haven’t already, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, low for longer bond yields will help underpin unlisted asset valuations.
The election outcome, rate cuts, tax cuts and the removal of the 7% mortgage rate test are driving a rebound in national average capital city home prices led by Sydney and Melbourne. But beyond an initial bounce which could run into first half next year, home price gains are likely to be constrained through this latest upcycle as lending standards remain tight and rising unemployment acts as a constraint. The risk though is that the recent surge in prices goes on for longer as property price gains in Australia have a habit of feeding on themselves.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.25% by early next year.
Our base case remains that the A$ still has more downside to around US$0.65 as the RBA cuts rates further. However, with the US dollar looking like it may have peaked and given excessive A$ short positions there is a growing risk that we may have already seen the bottom (at US$0.6671 early in October).
Subscribe to Oliver's Insights to receive my latest articlesDr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist
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