Investment markets and key developments over the past week
The past week saw major share markets push higher helped by generally good US earnings reports, benign geopolitical news and optimism that global recession will be avoided. US and Eurozone shares rose 1.2%. Japanese shares gained 1.4%, Chinese shares rose 0.7% and Australian shares gained 1.4%. US shares are now just 0.1% below their July record high and Australian shares are just 1.5% below their July record high. Australian shares benefitted from the positive global lead with strong gains in resources, utilities, consumer discretionary, health and property stocks. Bond yields rose in most major countries except in Australia. Oil, metal and iron ore prices rose but the Australian dollar fell slightly.
Business conditions PMIs for the US and Europe were flat to up slightly in October so they may be trying to stabilise and there are a bunch of market related signs possibly pointing to a more favourable cyclical global environment ahead: bond yields are up from their lows after failing to make new lows in the August trade war/growth scare; the US yield curve is now mostly positive; German and Japanese shares are looking better; emerging markets shares are looking better; cyclical stocks like consumer discretionary, industrials and banks are looking better; and the US dollar looks like it might have peaked. These could be pointers to monetary easing globally starting to get traction.
While the news on the trade front was generally favourable over the last week with the US saying it’s close to finalising some aspects of its “phase one” trade deal with China and more from President Trump about talks “doing very well with China” and “they want to make a deal very badly” – but impeachment risks are rising which means Mr Trump remains under pressure to generate good news. Following testimony that Mr Trump tied US aid to Ukraine to probing a political rival (Joe Biden) it’s looking increasingly likely that the Democrat controlled House will vote to impeach Mr Trump and public support for impeachment has increased to 49%/with 43% against from 40% support/51% against in mid-September. But while it may be looking tougher for Mr Trump it’s still doubtful that 20 Republican senators will vote to remove him from office (which will be needed to reach the 67 Senate votes required). While 83% of Democrats and 48% of independents support impeachment only 11% of Republicans do and unless this gets up a lot higher Republican senators are likely to stand by him. This would likely require more damning evidence against Mr Trump. But the risks are rising, and it does mean that Mr Trump is under pressure to generate good news including around trade so I suspect he wants to “make a deal very badly”!
There has been lots of Brexit noise over the last week and there is still room for a stuff up (what’s new!). But a no-deal Brexit is looking unlikely in the short term. However, this does not mean that it won’t happen at the end of 2020! While the UK parliament voted to slow down the timetable for PM Johnson’s Brexit deal bill, indications from the EU are that it will agree an extension (albeit with uncertainty as to whether its 3 months or 1 month as Mr Macron has been pushing for). The UK parliament voted with a clear majority to support the general principles of Mr Johnson’s Brexit deal. So it’s very likely that parliament will pass it. Which would be good news for the UK economy and assets in the short term. But it may be short lived because it will just allow the UK to continue its existing relationship with the EU - ie stay in the customs union - until its longer-term relationship is worked out. The deadline for this transitionary period is end 2020. But it’s taken more than three years just to get to this point and it typically takes several years for the EU to agree free trade deals so there is virtually zero chance this will be resolved in 14 months. Under Theresa May’s proposal the default if there was no agreement in the transition period would be that the UK would remain in the customs union, but under Mr Johnson’s proposal the default is that Northern Ireland would effectively remain part of the customs union but the rest of the UK would be out in the cold with a no-deal Brexit. The UK and EU could extend the transition period (which the UK would need to apply for by July 1 next year) and maybe just keep extending for years – resulting in what some have called a “half-life Brexeternity” but it’s doubtful Mr Johnson would agree to this. So, if Mr Johnson’s Brexit deal gets up as appears likely it’s no guarantee that there won’t be a hard or no-deal Brexit down the track. In other words, the Brexit comedy is far from over.
RBA Governor Lowe’s comments at the IMF have created a bit of uncertainty around the outlook for further monetary easing – even though it’s doubtful he really said anything new. Our view remains that further rate cuts and monetary stimulus are likely. Growth is likely to remain subdued and below trend for longer than the RBA is allowing. This will keep unemployment higher for longer and wages growth and inflation below target for longer. Consequently, more easing will be required to achieve full employment and clear progress to the inflation target. In the absence of more fiscal stimulus, pressure remains on the RBA which is likely to exhaust rate cuts before moving on to quantitative easing. While the RBA may prefer not to rush into another cut – given various commentators expressing concerns about rate cuts and maybe a desire to wait and get a better handle on the impact of rate and tax cuts to date – two events on Wednesday in the week ahead may force its hand: the September quarter CPI is expected to show inflation running well below target at around 1.5% year on year and the Fed is likely to cut interest rates again. A failure by the RBA to ease in November after another Fed rate cut and weak inflation would likely push the A$ higher making the RBA’s job of boosting growth even harder and further weaken the credibility of its inflation target. As Governor Lowe noted at the IMF: “…we have to take these shifts in global interest rates very seriously, if we sought to ignore them our exchange rate would go up…[which]…would be unhelpful.” So, we continue to pencil in another rate cut for November – but concede the risk is that it will be delayed into December particularly if market expectations for a November rate cut remain low at just 18%. Although it will be ironic if the RBA opts to leave rates on hold because the market is not expecting a cut on the grounds of reports that the RBA is not in a hurry to cut rates again. It would be like the boys watching the girls and the girls watching the boys in the 1967 Andy Williams classic Music to Watch Girls By.
Major global economic events and implications
US data was mixed with a fall in durable goods orders and home sales, but business conditions PMIs improved slightly in October with small gains in both manufacturing and services conditions and jobless claims remain ultra-low.
US September quarter earnings results are reasonable so far. About 40% of S&P500 companies have reported to date, with 82% beating earnings expectations by an average of 4.3% and 63% beating on sales. Consensus earnings forecasts for the quarter have increased to -0.8% year on year (from -3% two weeks ago) but are likely to end with a small positive.
Eurozone business conditions PMI’s were up slightly in October – which is a relief. The composite PMI rose 0.1 points reflecting strong services conditions with France up solidly and German conditions basically flat. The German manufacturing PMI rose only 0.2 points to a still very weak 41.9 but historically this level has actually been so bad that its actually good for subsequent German share market returns. Meanwhile, the ECB policy meeting offered nothing new as widely expected given the substantial easing it unveiled last month. It was Mario Draghi’s last meeting as President – but his legacy is immense. While he didn’t get inflation back to target he did “whatever it takes” to preserve and strengthen the Euro and in the process despite fiscal austerity helped drive Eurozone unemployment down from a high of 12.1% to 7.4% (which is low for Europe) and headed off deflation. New ECB President Christine Lagarde is likely to continue Draghi’s dovish pro-Euro stability approach.
The Japanese composite business conditions PMI fell sharply in September to its lowest level for this cycle. While it can be volatile from month to month it tells us that growth is continuing to slow.
Australian economic events and implications
Australian data was soft. Skilled vacancies fell again in September for the ninth month in a row and are down 7.1% from a year ago pointing to a slowing in jobs growth ahead. The CBA’s business conditions PMIs fell back in October led by services with the composite falling to 50.7 and leaving it in the same softish range it’s been in all year.
Australia’s crane count remains very high but is set to slow for residential. The latest Rider Levett Bucknall crane count for residential property edged down in September but mainly due to Brisbane, Canberra and the Gold Coast with the number of residential cranes in Sydney and Melbourne remaining high indicating that there is still a lot of unit supply to hit the market in Sydney and Melbourne. Falling approvals point to a reduction in cranes doing residential apartments ahead though and an eventual sharp drop in new supply.
While residential cranes are topping out (albeit slowly), the number of non-residential cranes is rising due to the construction of infrastructure, offices, education facilities and mixed used buildings. The total Australian crane count (comparing like with like) has been unchanged at a very high 735 for the last 18 months.
What to watch over the next week?
In the US, the main focus will be on the Fed which is expected to cut rates again for the third time this year on Wednesday taking the Fed Funds rate to a range of 1.5-2% as it seeks to provide insurance against various threats to US growth ranging from the trade war to slower global growth at a time when US inflation remains below target. The US money market puts the probability of another easing on Wednesday at 90%.
On the data front in the US key to watch will be the ISM manufacturing conditions PMI for October and jobs data for October both of which will be released Friday – both of which are likely to be softish supporting the Fed’s likely decision to ease. After its sharp fall into September the ISM is expected to improve slightly but to a still weak reading of 49. Jobs data is expected to show payroll growth slowing to around 100,000 consistent with various surveys pointing to slower jobs growth, unemployment is expected to rise slightly to 3.6% and wages growth is likely to pick up slightly to a still soft 3% year on year. Meanwhile, in other data expect to see a small rise in pending home sales and consumer confidence (Tuesday), September quarter GDP growth (Wednesday) slowing to an annualised pace of 1.6% on the back of weak business investment not helped by the trade war, growth in US employment costs remaining soft in the September quarter at around 2.8% year on year and core private final consumption deflator inflation falling slightly to 1.7%yoy (with both due Thursday). September quarter corporate earnings results will also continue to flow.
Eurozone data to be released Thursday is expected to show September quarter GDP growth remaining soft at 0.1% quarter on quarter or 1% year on year, core CPI for October remaining weak at around 1%yoy and unemployment for September unchanged at 7.4%
The Bank of Japan (Thursday) is likely to remain on hold and dovish but the risks are skewed towards more easing. Industrial production data (Thursday) is likely to show a small rise and labour market data (Friday) is likely to remain strong helped by a falling population.
Chinese business conditions PMIs for October to be released Thursday and Friday are likely to be relatively stable but softish.
In Australia, September quarter CPI data (Wednesday) is expected to show that inflation remains weak. We expect headline inflation of 0.5% quarter on quarter or 1.6% year on year and underlying inflation of 0.4% quarter on quarter or 1.4% year on year. Tobacco excise will drive another strong rise in alcohol and tobacco prices, but petrol prices look to have fallen slightly, seasonal weakness is likely in education and health costs and underlying inflation is likely to be kept down by ongoing spare capacity in the economy, weak wages growth and retailers struggling to pass through the impact of the lower A$ to consumers in the face of weak demand. Continuing weak and below target inflation is consistent with our view that the RBA will undertake further monetary stimulus initially via more interest rate cuts in the months ahead. A speech by RBA Governor Lowe (Tuesday) will likely be watched closely for any hints on how inclined the RBA is to cut rates again and when, but being on Tuesday night may date quickly depending on what the CPI shows on Wednesday.
In terms of other data releases in Australia expect to see a small rise in September building approvals (Thursday), a slight uptick in private credit growth (also Thursday) driven by an upturn in housing credit following the recent improvement in housing finance and CoreLogic data for October to show a further solid gain in dwelling prices driven again by Sydney and Melbourne but with Brisbane prices also starting to pick up.
Outlook for investment markets
Share markets remain at risk of further volatility in the months ahead 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 by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 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 election outcome, rate cuts, tax cuts and the removal of the 7% mortgage rate test are driving a rise in national average capital city home prices led by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record 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 0.25% by early next year.
The A$ is likely to fall further to around US$0.65 as the RBA cuts rates further. Excessive A$ short positions, still high iron ore prices and Fed easing will provide some support though with occasional bounces and will likely prevent an A$ crash.
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