Investment markets and key developments over the past week
Share markets mostly fell over the last week as worries around North Korea provocation continue, combining with concern about the impact of hurricanes on US growth. That said, most markets remain in the range they have been in for a while and have proven quite resilient in the face of bad news thanks to solid global growth and supportive monetary policy. While Eurozone shares rose 0.1%, US shares lost 0.4%, Japanese shares fell 2.1%, Chinese shares fell 0.1% and Australian shares fell 0.9%. Bond yields fell further helped by dovish comments from ECB President Draghi, a downwards revision to the ECB’s inflation forecasts and worries about the impact of hurricanes on the US. However, the Euro rose as President Draghi wasn’t seen as dovish enough resulting in a new down leg in the US$ which also saw the A$ push back above US$0.80. Oil and gold prices rose but iron ore fell.
Having broken key technical support levels the US dollar could fall further in the short term – which would be positive for US shares as it boosts US profits, global liquidity and the emerging world with US$ debt – but it’s likely to reverse sometime in the next few months. The impact of hurricanes on US growth will be temporary and on a 3-6 month horizon they will provide a rebuilding boost so the Fed will look through them – as it did with Hurricane Katrina in 2005. And more fundamentally the falling US$ is unwinding the Fed’s monetary tightening which then risks it becoming more aggressive at some point, while the rising Euro is driving a tightening of monetary conditions in Europe at a time when Europe still needs an easier monetary environment and so will eventually force the ECB to counter it. This could mean a slower reduction than expected in its quantitative easing program. The rising A$ will also constrain Australian growth and inflation, further delaying RBA tightening.
We thought Hurricane Harvey made a US Government shutdown and debt ceiling crisis this month very unlikely and this has proved to be the case with President Trump and Congress agreeing to extend government funding and raise the debt ceiling out to mid-December. So no shutdown and no debt default for now. This continues the period of budget and spending stability that has been in place since the 2013 “crisis”. Uncertainty will rise again in December but a shutdown/debt default is also unlikely then. At the margin the move adds to confidence that tax reform will happen.
Trump’s threatening tweets – for instance, that he will stop all trade with countries trading with North Korea (read China) – creates great media headlines but just remember that the trick with Trump is to take him seriously but not literally. His approach is all about setting up a tough negotiating stance, getting some movement in his direction and then settling. So yes he is trying to put more pressure on China regarding North Korea but don’t expect the US to cease trade with China.
Uncertainty around the Fed ramped up a bit over the last week with Vice Chair Fischer resigning and reports that President Trump’s economic adviser Gary Cohn was no longer in the running for Fed Chair, raising the possibility that Trump’s replacements may see the Fed take a more hawkish turn. This is not necessarily the case and in fact it’s in Trump’s interest to have stability at the Fed and he has indicated a leaning towards a “low interest rate” Fed. These considerations suggest he is unlikely to rock the boat with hawkish appointments. Yellen remains in with a chance to retain the Chair should she want it, but her supportive comments for post GFC financial regulation work against her to some degree.
North Korean risks continue to escalate. Our view remains that the risk of a skirmish or war has grown – particularly due to a miscalculation by either side in the conflict, but that a diplomatic solution remains most likely as North Korea is not quite so stupid to set off a war in which it will be annihilated, while the US and its allies are aware of the potential huge loss of life in South Korea and potentially Japan that would flow from a pre-emptive military response. However we are still a long way from a diplomatic solution, therefore the issue is likely to escalate further, posing the risks of triggering additional downside in share markets and increased demand for safe havens.
The September 24 German election and October 1 Catalan election are of limited relevance for investors. Polling has Angela Merkel on track to easily “win” the German election with the issue being who she forms a coalition with: the Social Democrats again - in which case the outcome is more pro-Europe - or the Free Democratic Party which is less pro-Europe. It’s probably irrelevant as Merkel has migrated to a more pro-Europe stance anyway. The nationalist anti-Euro Alternative for Deutschland is a sideshow, receiving less than 10% support. The Catalan independence referendum on October 1 may generate a bit of noise but it’s essentially a Spanish issue with not much relevance to the Eurozone. In any case the referendum is illegal, most Catalans prefer to stay in Spain but with more fiscal independence, independence is a long way off anyway even if there is support for it amongst a majority of Catalans and in any case Catalonia wants to stay in the Euro. The Italian election to be held before May 2018 is the one to watch but even here the populist Five Star Movement is wavering in its anti-Euro stance and it remains doubtful it will be able to form government (even if it gets more parliamentary seats than any other party). So a Euro break up continues to look unlikely and in the meantime its economy is getting stronger and its shares are cheap. The only fly in the ointment is the rising Euro.
What about Bitcoin? Crypto currencies led by Bitcoin are generating much interest. They and the block chain technology underpinning them seem to hold much promise but there is reason to be cautious. Lots of them are popping up, the ascent of Bitcoin’s share price looks very bubbly (although its potential ramifications if it bursts are nowhere near as significant as the other bubbles shown on the chart below) and regulators are starting to take a closer look. I also still struggle to fully understand how it works and one big lesson from the GFC is that if you don’t fully understand something you shouldn’t invest (who really understood CDOs? – obviously not many!)
Major global economic events and implications
It was a quiet week for US data, but the ISM non-manufacturing conditions index rose in August to a strong reading of 55.3 and the trade deficit widened less than expected. Jobless claims rose 62,000 but this reflects the impact of Hurricane Harvey with Texas up 52,000. Hurricane Katrina saw a 100,000 rise in claims over three weeks but after eight weeks they were back to where they started. Houston is much bigger than New Orleans and Hurricane Irma will impact too so the rise this time may be greater, but Houston is recovering quicker so again the impact is likely to be temporary.
The ECB made no changes to monetary policy. It revised up its growth forecasts but revised down its inflation forecasts and President Draghi was dovish and the ECB effectively tied a decision on what it will do about its quantitative easing program for 2018 (to be announced in October) to what the Euro does. The surprise was that Draghi was not more forceful in expressing concerns about the rising Euro, but if it continues it will likely see the ECB taper its asset buying at a slower rate, for example initially cutting it to say €50 billion per month rather than say €35 billion.
China’s Caixin services conditions PMI rose and import growth accelerated indicating Chinese growth is remaining strong.
Australian economic events and implications
Australian data was the usual mixed bag. GDP growth bounced back nicely in the June quarter driven by consumer spending, investment and trade and ANZ job ads continue to grow strongly, pointing to ongoing labour market strength. With the drag from mining investment slowing, non-mining private investment picking up, strong public capital spending and an ongoing contribution to growth from trade volumes, economic growth is likely to improve further. However, July retail sales and trade were off to a soft start for the current quarter, and with continuing low wages growth (with average wages -0.1% in the June quarter and up just 0.1% over the last year) constraining consumer spending and dwelling construction topping out, the rebound in growth will remain constrained relative to the RBA’s expectations for 3% plus growth. In turn, this implies the risks to underlying inflation remain on the downside.
So despite RBA Governor Lowe sounding upbeat, we remain of the view that the RBA will leave rates on hold out to late 2018 at least before starting to gradually raise rates. If the A$ continues to rise – with it back above US$0.80 over the last week – then any hike could be pushed further out.
What to watch over the next week?
In the US, expect small business confidence and job openings (both Tuesday) to remain strong, solid growth in underlying retail sales and a modest rise in industrial production (both Friday). Jobless claims are likely to see a further spike reflecting hurricane disruption. While headline CPI inflation (Thursday) is expected to rise to 1.8% year-on-year (YoY) (from 1.7%), core inflation is expected to fall to 1.6% YoY (from 1.7%) keeping the Fed gradual in undertaking monetary tightening.
Chinese activity data for August due Thursday is expected to show a slight rise in both retail sales growth to 10.5% YoY and growth in industrial production to 6.7% year-on-year, but stable growth in fixed asset investment at 8.3% YoY. Money supply and credit data for August will also be released.
In Australia, expect the August NAB survey (Tuesday) to show continuing solid levels for business confidence, the Westpac consumer confidence index (Wednesday) to remain soft and August employment (Thursday) data to show jobs up 10,000 but with unemployment rising to 5.7%.
Outlook for markets
Share markets remain at risk of a further consolidation or short term correction, particularly with North Korean risks remaining high and seasonal weakness around September and October. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets remaining in place into 2018.
Low yields point to ongoing low returns from bonds.
Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.
National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
While further short term upside in the A$ is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed tightens and the RBA holds.
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