Investment markets and key developments over the past week
The past week saw share markets fall further on the back of ongoing worries about growth not helped by a “not dovish enough” Fed, new threats to US/Chinese negotiations, worries about a US government shutdown, a court ruling against America’s Affordable Care Act and problems at various US companies. US shares lost 7.1% in their worst week since August 2011, Eurozone shares fell 3.2%, Japanese shares lost 5.7%, Chinese shares fell 4.3% and Australian shares lost 2.4%. This saw credit spreads continue to widen and bond yields fall. Oil and metal prices also fell but the iron ore price continued to defy the gloom and rose. While the US dollar fell against a range of currencies on the back of a more dovish Fed, the $A also fell back towards $US0.70 on global growth worries.
From their highs a few months ago global shares have fallen around 16% and Australian shares have fallen around 14%. While it would be nice to see a decent Santa rally (Australian shares have been trying!), even if we do see one the risks remain skewed to further weakness into the early part of next year as uncertainty remains high regarding global growth, there are still too many political uncertainties around and investor sentiment looks like its still not fully washed out. However, we remain of the view that is more likely part of a “gummy bear” market that leaves shares down 20% or so from their highs a few months back, after which they start to rally again (like we saw most recently in 2015-16), rather than as part of a long and deep “grizzly bear” market like we saw in the GFC. The main reason for this is that we don’t see the US, global or Australian economies sliding into recession any time soon. But some action by policy makers is likely to be necessary to see markets stabilise and start to recover. This is likely to come in the early part of next year with the Fed pausing, more monetary stimulus by the ECB and more aggressive stimulus in China.
In this regard, while there was much to worry markets over the last week there were some positives too (but as is often the case in times like these the positives get overlooked as investor fear takes over from fundamentals) that provide a bit of confidence that we are not going into a long deep “grizzly bear” market:
First, while the Fed’s commentary following its latest 0.25% rate hike was not as dovish as the market was hoping for and Fed Chair Powell needs to get some lessons from Yellen or Bernanke in how to talk to markets, it does represent a dovish shift (with the Fed softening its expectations for future rate hikes) and indicates that it is aware of the risks around global growth and financial markets. This was subsequently reinforced by NY Fed President Williams who indicated that the Fed is “listening very carefully” to markets and that it’s quantitative tightening program is not on “autopilot” and can be adjusted if needed. We remain of the view that the Fed is going to have a pause in the first half of next year and that this will help provide confidence. We may also see a slowing or pause in the rate of Quantitative Tightening.
Second, the People’s Bank of China announced more targeted easing and China’s annual Economic Work Conference signalled more fiscal and monetary stimulus in 2019.
Third, while President Xi’s speech and news of a US case against Chinese officials allegedly involved in intellectual property theft did nothing to add to confidence that there will be a solution on the US/China dispute, it has been confirmed that the US and China are planning meetings in January to resolve their differences and China’s Economic Work Conference was positive on finding a solution and pledged to strengthen the protection of intellectual property.
Fourth, the European Commission and Italy reached agreement over Italy’s budget deficit target for 2019 (lowering it from 2.4% of GDP to 2%) thereby avoiding placing Italy in an “Excessive Deficit Procedure”. This has seen a sharp fall in Italian bond yields and makes it easier for the ECB to consider a new round of cheap funding for banks.
Fifth, the oil price plunged again, taking its fall from early October to 41%. This is bad for energy stocks but it’s great news for households (with Australian petrol prices falling to around $1.20 a litre) and industry.
Sixth, the fall in share markets this month has been far more severe in the US, which has fallen 12.5% with other markets more resilient. This is a good sign in that it suggests that other share markets which underperformed the US on the way up and initially fell harder have already seen their adjustment, and now it’s the US share market catching down as it works off overvaluation in some areas (like in FAANG stocks). Chinese shares, emerging markets and Asian shares fell much earlier and harder and so far are holding up much better.
Finally, a year ago investors were feeling upbeat about 2018 on the back of US tax cuts, stronger synchronised global growth and strong profits and yet 2018 didn’t turn out well. So, it may be a good sign for 2019 from a contrarian perspective that there is now so much doom and gloom around.
As I write, the US is on the brink of another Federal government shutdown with funding for President Trump’s wall being the sticking point. This is adding to uncertainty around Washington ahead of the need to raise the debt ceiling after March next year and following the resignation of Defense Secretary Mattis. It should be noted though that shutdowns historically have had very little economic impact and this time around it will only affect 10% or so of the government because 75% is already funded, only non-essential services will shut and many public servants will still work and get paid once it ends.
Australia saw some good news over the last week with the mid year budget review confirming that the budget is in much better shape than expected in May, providing scope for tax cuts next financial year. In fact, the Government is even budgeting for tax cuts of around $3 billion a year starting from next July and yet still projects rising surpluses. That said, a $3 billion a year tax cut is just 0.1% of GDP, so it would be a pretty small stimulus (maybe $6 a week for an average earner which won’t buy a lot these days). The other issue is that the budget numbers may not get much better than this, given threats to global growth (and hence commodity prices), wages growth continuing to run below the Government’s assumptions and signs from job ads that employment growth may start to slow.
Meanwhile also in Australia, it’s hard to get too excited by APRA’s removal of the 30% cap on the proportion of mortgage lending that can go to interest-only borrowers. This served its purpose well when it was introduced in March last year when interest-only lending was north of 40%. But now it’s running around 16% and so the cap has become irrelevant, the focus has shifted away from arbitrary lending caps to a focus on “responsible lending” (hence the focus on borrower income, expenses and total debt) and with property market psychology now very negative the desire for interest-only loans has shrunk and banks are a lot more reluctant to make them. So, it’s doubtful that the removal of the cap will have any impact on property lending or property prices, where we continue to see further weakness in the year ahead. In fact, since the removal of the 10% growth limit on lending to investors in April, lending growth to property investors has just slowed to record lows.
Our view remains that the RBA will cut the official cash rate twice in 2019, taking it to 1%.
Major global economic events and implications
US data releases were mixed with strong consumer spending in November, solid consumer sentiment and a rise in housing starts and home sales but another fall in home builder conditions, weak durable goods orders and softer December readings for the New York and Philadelphia manufacturing conditions surveys. Core private final consumption deflator inflation remained benign at 1.9% year-on-year in November.
The Bank of Japan left monetary policy unchanged in ultra-easy mode and with core inflation in November at 0.3% year-on-year it’s set to remain that way for a long while yet.
The Bank of England also left monetary policy on hold, which is not surprising given the Brexit mayhem.
Australian economic events and implications
Australian jobs data for November was mixed. Headline jobs growth remained strong, but the quality was low with full time jobs falling and unemployment and underemployment actually rose. What’s more, skilled job ads fell again as they have been since March pointing to softer jobs growth ahead.
Meanwhile population growth remained strong at 1.6% or 391,000 people over the year to the June quarter with 60% coming from immigration. So, it remains a source of support for headline economic growth and for underlying housing demand, assuming immigration levels are not radically cut.
What to watch over the next three weeks?
In the US, the main focus will be on December labour market data (due Jan 4) which are expected to show a solid 180,000 rise in payrolls, unemployment flat at 3.7% and wages growth still around 3.1% year-on-year. In other data, expect consumer confidence (Dec 27) to remain strong, a pullback in the December manufacturing ISM index (Jan 3) and the non-manufacturing ISM (Jan 7) to readings around a still solid 57-58 and core CPI inflation (Jan 11) to remain around 2.2% year-on-year. Public comments by Fed Chair Powell on Jan 4 will likely support our expectation for a Fed pause.
Eurozone data is expected to show core inflation (Jan 4) still low around 1% year-on-year and unemployment (Jan 9) flat at 8.1%.
Chinese business conditions PMIs for December (Dec 31 and Jan 2) will be watched closely to see if the slowdown in the Chinese economy is stabilising. December data due for release around Jan 7 is likely to show inflation remaining low and growth in imports and exports remaining subdued and credit data to be released around the same time will be watched for the impact of recent policy easing.
In Australia, expect credit growth (Dec 31) to remain modest, CoreLogic data for December to show another fall in dwelling prices (Jan 2) (Sydney and Melbourne prices are reportedly already down more than 1% for December so far), building approvals (Jan 9) to remain in a downtrend and only modest growth of 0.2% in November retail sales (Jan 11).
Outlook for investment markets in 2019
With uncertainty likely to remain high around US interest rates, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018, as investors realise that recession is not imminent:
Global shares are likely to make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high, but valuations are now improved and reasonable growth and profits should see a recovery through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
Emerging markets are likely to outperform if the $US is more constrained as we expect.
After a low early in the year, Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth.
Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
Unlisted commercial property and infrastructure are likely to see some slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
National capital city house prices are expected to fall another 5%, led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and tax changes under a Labor Government impact.
Cash and bank deposits are likely to provide poor returns, as the RBA cuts the official cash rate to 1% by end 2019.
Beyond any near-term bounce as the Fed moves towards a pause on rate hikes next year, the $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will still likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.
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