Investment markets and key developments over the past week
The past week saw most share markets rise, helped by good economic data, talk of another round of US/China trade talks and a bounce in emerging market shares after Turkey raised interest rates. US shares rose 1.2%, Eurozone shares gained 1.4%, Japanese shares rose 3.5% and Australian shares rose 0.4%. However, Chinese shares remained under pressure and fell another 1.1%. Bond yields mostly rose. Commodity prices also mostly rose helped by a weaker US dollar which also contributed to a small rise in the A$ to around US$0.7150.
The US trade threat has progressively increased all year, but every so often it takes a bit of a step back and that’s what occurred over the last week, with news that US/China trade talks may resume at the invitation of Treasury Secretary Mnuchin. Share markets reacted favourably as they have to previous news of trade talks, but I wouldn’t get too excited. Talks are better than no talks, the latest round of talks if they proceed looks like they could be at a more senior level than the last round and it’s in the interests of both China and Trump to find a solution. In particular, Trump’s approval rating is under some pressure again, indications are firming that the Democrats will retake the House in the mid-term elections, business groups are reportedly mounting public campaigns against the tariffs and it’s now hard for the US to increase tariffs without causing higher prices for consumers which in turn risks a backlash. So, it would be wrong to write new talks off. However, given the failure of the last four attempted US/China trade negotiations to make much progress, and in particular Mnuchin’s last attempt back in May, it’s doubtful that much progress will be achieved this time. It may all just be a negotiating tactic on the part of the US to make it look like it’s reasonable and help build a coalition of allies against China. And in any case Trump has reportedly issued instructions to proceed with the proposed next round of tariffs on US$200 billion of imports from China despite the offer of talks. This could be more negotiating tactics, but who knows? All up, it does seem that both sides remain dug in and our base case remains that more tariffs will be applied (albeit the US$200 billion may be implemented in tranches) and that a negotiated solution is unlikely until after the mid-term elections.
Notwithstanding the better trade news over the last week, we remain cautious of a short-term share market correction as we go through this seasonally weak part of the year and given risks around the emerging world, trade and tariffs, Trump and the Mueller inquiry and US political risks, Chinese growth and tech stocks.
In terms of US political risks, there is the threat of another government shutdown from 1st October, when current government funding runs out again (yep that issue is back again!) and the mid-term elections in November will create nervousness because if the Democrats get control of the House (as appears likely) investors will worry about an impeachment of President Trump and that it will put an end to major pro-market economic policies. On the last two: yes the Democrats will probably try and impeach Trump, but as with Clinton it’s unlikely that the 67 Senate votes will be found to remove him from office unless he has done something really bad. In any case Mike Pence will have the same economic policies but with just less noise; and Trump has already done the bulk of his pro-business policies (like tax cuts) anyway. None of this will stop markets worrying about it initially though.
Major global economic events and implications
The US remains in “Goldilocks” (not too hot, not too cold) with strong economic data and benign inflation. The past week has seen another run of strong data with US small business optimism rising to its highest level ever recorded in August, job openings and hiring remaining very strong, the rate of workers quitting for other jobs rising to a 17-year high and jobless claims remaining ultra low. While retail sales rose less than expected in August, this was partly due to lower price rises and, in any case, previous months were revised up so overall they remain very strong. Of course, the danger is that things can be so good that they are bad because the only way to go is back down – but at least inflation pressures (as a trigger for a more aggressive and growth threatening Fed) are not excessive, with producer and consumer price inflation actually dipping a bit in August. That said, with the US economy running hot and fiscal stimulus continuing, it seems there are more US Federal Reserve (Fed) officials saying the Fed Funds rate may have go above its estimates of the long-run neutral rate (between 2.5-3%) over the next year or so. Barring a blow up, e.g. around trade or emerging markets, this looks highly likely but will take a while to play out at the ongoing rate of one Fed rate hike every three months.
Damage from Hurricane Florence is very unlikely to dissuade the Fed from its next hike later this month, as while the human and property impact from such events is horrible, associated rebuilding activity will if anything boost overall economic growth in the short term. Hurricane Katrina in 2005 had no impact on Fed rate hikes that were coming every six weeks at the time.
The European Central Bank (ECB) left policy on hold and described the risks as balanced, with President Draghi positive on the labour market, not too fussed about Italy but concerned about global trade. Overall the ECB remains on track to taper its quantitative easing program over the December quarter, but rate hikes remain a long way off and, in our view, won’t happen until 2020. Weak July industrial production data are consistent with this, albeit PMIs point to some rebound.
The Bank of England also left monetary policy on hold.
Japanese data was generally good with indications of stronger business investment, higher confidence readings and an upwards revision to June quarter GDP growth.
Chinese economic activity data for August was a mixed bag with stronger retail sales, a slight fall in unemployment, industrial production in line with market expectations and weaker investment. It suggests that while growth may have a slowed a bit, it’s not a lot. Meanwhile, credit growth picked up a little bit in August, suggesting that policy easing may be impacting. Consumer price inflation ticked up, but core inflation is just 2% so it’s unlikely to impact the policy outlook, with more stimulus likely to combat the trade threat/
Australian economic events and implications
Australian data was a mixed bag, with strong jobs data and business conditions but falling confidence. Jobs data has been a source of strength in the Australian economy and this remained the case in August. The good news here is that full-time jobs growth has also been solid, this has helped reduce underemployment and strong jobs growth is an ongoing source of strength for household incomes. Against this though, the combination of unemployment and underemployment remains very high at 13.4% and points to the pick-up in wages growth being very gradual. Meanwhile, although the NAB business survey for August showed continued strength in business conditions, business confidence slipped further and September consumer confidence fell sharply, with political turbulence in Canberra and falling home prices in the case of consumer confidence not helping. Against this mixed backdrop, we remain of the view that an RBA rate hike is still a long way off.
What to watch over the next week?
In the US, news on trade and tariffs will remain a focus. On the data front, September Markit business conditions PMIs due Friday are likely to show that growth remains solid with readings around 55. Meanwhile, a bunch of housing data will be released with the September NAHB home builders’ conditions index (Tuesday) likely to remain solid, August housing starts (Wednesday) to show a decent bounce and existing home sales (Thursday) to rise. Manufacturing conditions indexes for the New York and Philadelphia regions will also be released.
Eurozone business conditions PMIs (Friday) for September are likely to remain solid at around 54.5.
The Bank of Japan is unlikely to make any changes to its ultra-easy monetary policy on Thursday and inflation data (Friday) is expected to show that core inflation rose slightly but only to 0.4% year-on-year.
In Australia, ABS data due Tuesday is likely to confirm the slide in home prices already reported in private surveys for the June quarter with a decline of around 1%. The minutes from the RBA’s last board meeting (also Tuesday) is likely to reiterate that it expects that the next move will more likely be up than down but for now there is no urgency to move. March quarter population data (Thursday) is likely to show continuing strong population growth.
Outlook for markets
We continue to see the trend in shares remaining up as global growth remains solid, helping drive good earnings growth and monetary policy remains easy. However, we are now into a seasonally weak period of the year for share markets and threats around trade and emerging market contagion at a time of ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations point to a potential correction ahead. Property price weakness and approaching election uncertainty add to the risks in relation to the Australian share market.
Low yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.
Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 10% or so, but Perth and Darwin property prices bottoming out, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
The A$ is likely to fall to around US$0.70 and maybe into the high US$0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid bulk commodity prices should provide a floor for the A$ though in the high US$0.60s. Being short the A$ remains a good hedge against things going wrong in the global economy – e.g. around trade and emerging markets.
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