Investment markets and key developments over the past week
Share markets remained under pressure over the past week, with many falling back to, or below, their late October lows on worries about trade, tech and energy stocks, and global growth. US shares fell 3.8%; Eurozone shares lost 1.6%; Japanese shares were flat; Chinese shares fell 3.5%; and Australian shares declined 0.3%. Reflecting the “risk off” tone, bond yields fell; credit spreads widened; and commodity prices fell, with the oil price down another 11% over the last week, leaving it down 34% from its high in early October. The $US rose slightly and this weighed on the $A.
Shares retesting October lows – double bottom or resumption of the slump? Share markets fell back to around their October lows over the past week. A retest of the lows is quite normal after the sort of fall we saw in October. Whether markets form a double bottom and head back up, or break decisively lower to new lows, is unclear. In favour of the former, less stocks have made new lows into the latest fall, and Asian and emerging markets are looking a lot healthier (having led this share slump and having had much deeper falls). But against this, many of the triggers for the fall in markets remain in place. The bottom line is that, I don’t know whether it will remain just a correction, or maybe slide deeper into what I like to call a “gummy bear” market (where markets have a 20% top-to-bottom fall, but are up a year after the initial 20% decline). But I remain of the view it’s unlikely we are sliding into a deep or “grizzly bear” market, as the conditions are not in place for recession in the US, globally or Australia.
Potential triggers to watch for a rebound include a meeting at the G20 meeting between Presidents Xi and Trump in the week ahead; more signs of a possible US Federal Reserve (Fed) pause on interest rates; and a stabilisation/improvement in growth indicators outside the US. In terms of the Trump/Xi G20 meeting, the APEC debacle between the US and China, and a report by the US Trade Representative repeating criticism of China, are driving low market confidence of a deal being reached between the US and China. However against this, Trump appears to want a deal, knowing that further tariff hikes (which are really tax hikes) will start to offset his fiscal stimulus next year, and may be starting to impact business confidence and hence capital spending. All of which may start to negatively impact Trump’s 2020 re-election prospects. Reports that White House trade adviser and protectionist, Peter Navarro, will not be attending the meeting are also a positive.
While the 34% plunge in the oil price since early October is weighing heavily on energy shares, it’s positive for growth going forward and hence an eventual recovery in share markets. Lower oil prices help take pressure off inflation and put discretionary spending power back into the hands of households. So far it’s a saving of around $11 a week for a typical Australian household, but this could increase as the fall in oil prices flows through, with a lag to lower petrol prices. This, along with the high likelihood of more income tax cuts (which could be announced in next month’s mid-year budget review), means that despite falling house prices it’s not all doom-and-gloom for consumer spending in Australia. Further falls in world oil prices may be limited though, as OPEC is likely gearing up to cut production at its December 6 meeting.
In Europe, Italy looks to be heading into what is called an Excessive Deficit Procedure (EDP) – a process administered by the European Commission, but approved by Eurozone finance ministers, designed to get its expansionary budget deficit back on track with debt limits – but a major crisis still looks unlikely. More likely is some sort of fudge, combining various delays in enforcing any deficit reduction and some compromises. The rest of Europe won’t want to put too much pressure on Italy for fear of fuelling anti-Euro sentiment, and in any case, by the time Italy has to respond to any requests under the EDP, it won’t be till later next year, by which time the 2019 budget will be largely history.
Major global economic events and implications
US economic data was on the soft side. Home building conditions fell sharply in October, albeit catching down to other housing related indicators; housing starts and existing home sales rose, but are trending sideways; underlying capital goods orders were soft; leading indicators were weak in October, with the falling share market acting as a drag; and business conditions Purchasing Managers’ Indices (PMIs) fell slightly in November, albeit they remain strong. Naturally, the weakness in housing indicators raises memories of the Global Financial Crisis (GFC), but note that housing investment is running at a relatively modest 3.9% of Gross Domestic Product (GDP) and has not kept up with demographic demand, in contrast to prior to the GFC when it reached 6.7% of GDP and was way ahead of demographic demand. While you can get hurt falling out of high rise, you are less likely to get hurt falling out of the ground floor.
Eurozone business conditions PMIs continued their slide this month and although at around 52 are still reasonable, their downtrend suggests that it may be premature for the European Central Bank to end quantitative easing next month, and that Eurozone rate hikes remain a long way away. This is an ongoing drag on the Euro relative to the $US.
Japanese headline inflation rose to 1.4% year-on-year in October, but this will fall back with the oil price in November, and meanwhile, core inflation is stuck at 0.4% year-on-year, so the Bank of Japan is no closer to being able to tighten monetary policy.
Australian economic events and implications
Australia was a bit quiet on data over the past week, with a rise in the Commonwealth Bank of Australia’s business conditions PMI for November, albeit it remains well down on last year’s high; but skilled vacancies fell again in October and the trend is now down for seven months in a row pointing to a slowing in employment growth. Comments by Reserve Bank of Australia (RBA) Governor Lowe and Prime Minister Scott Morrison provided more interest though.
RBA Governor Lowe’s comments in the past week were particularly significant for two reasons. Firstly, he looks to be becoming more concerned about credit tightening in saying that “a few years ago credit standards were way too loose, there has been a correction of that, but I am starting to be a bit concerned the pendulum might be swinging a bit too far the other way.” Second, he also acknowledged the risks around wages remaining weak, even if unemployment falls further: “I suspect nationally we could sit at [an unemployment rate] around 4.5% without seeing wage growth pick up by too much”. He is clearly aware that estimates putting the so-called NAIRU (Non-Accelerating Inflation Rate of Unemployment) at 5% are rubbery. Perhaps he is starting to question the RBA’s own mantra that the next move in rates is more likely up than down.
Lower immigration levels on the way? There is always a debate going on about the appropriate level of immigration in Australia, but this has been mainly outside the major political parties, or on the fringe of them. Prime Minister Scott Morrison changed all that in the last week, flagging a cut to the annual immigration cap of 190,000 by 30,000. At present this sounds like just affirming the actual level of immigration, which has already slowed by about 30,000, so no big deal. But, having brought the debate into the centre of politics, he now risks seeing immigration getting cut further, given angst about the issue, particularly in Melbourne and Sydney. This is particularly relevant to the property market, as it was the surge in population growth from around mid-last decade, without a housing supply pick up (until around 2015), that has played a big role in the surge in house prices relative to incomes. Yeah, yeah, yeah, the surge in credit, speculation, foreign demand, etc, also played roles too. But the point is that, if immigration starts to fall back at a time of rising supply, it will be one more factor sending property prices south in Sydney and Melbourne (which take something like 60% of immigrants) – along with tighter credit; rising supply; a significant pool of borrowers having to switch from interest-only to principle-and-interest mortgages; reduced foreign demand; fears around tax changes reducing future investor demand; etc. Our view remains that these two cities will see 20% top-to-bottom price declines out to 2020, but there are clearly some risks on the downside to this.
What to watch over the next week?
The big event in the week ahead will be the meeting between Presidents Trump and Xi on the sidelines of the G20 meeting (Friday & Saturday) in Buenos Aires to discuss trade.
In the US, the focus is likely to be on the Fed. While the minutes from the last Fed meeting (Thursday) will likely confirm that it remains upbeat and on track to raise rates again in December, another speech by Fed Chair Powell (Wednesday) is likely to repeat that he is aware of the various headwinds to the US economy, leaving the impression that the Fed is open to a pause on interest rates next year. Of particular interest will be what, if anything, he has to say about continuing share market volatility, and recent softness in housing and business investment indicators. On the data front, expect home price data (Tuesday) to show continuing modest gains; consumer confidence for November (also Tuesday) to show a slight fall from 18 year highs; new home sales (Wednesday) to show a bounce; September quarter GDP growth (also Wednesday) to be revised up slightly to 3.6% from 3.5%; personal spending growth (Thursday) to have remained solid, but with core private consumption deflator inflation falling back to 1.9% year-on-year.
Eurozone economic confidence for November (Wednesday) will be watched for any stabilisation after several months of softness; unemployment for October (Friday) is likely to be unchanged at 8.1%; and core inflation for November (also due Friday) is likely to be unchanged at 1.1% year-on-year.
Japanese data to be released Friday is likely to show continuing labour market strength, helped by a falling population, but industrial production is likely to show a bounce.
Chinese business conditions PMIs for November will be released Friday, with the focus likely to be on the manufacturing PMI which has been slowing lately.
In Australia, speeches by RBA Governor Lowe and Assistant Governor Kent on Monday will be watched for any clues on rates. On the data front expect to see a 1% gain in construction data for the September quarter (Wednesday), a 1.5% gain in September quarter business investment (Thursday) and continuing moderate credit growth (Friday), with ongoing weakness in lending to investors. A key focus will be whether investment intentions data points to further improvement.
Outlook for markets
Shares remain at risk of further short-term weakness, but 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.
Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit they may slow down a bit).
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 15% or so, but Perth and Darwin property prices at, or close to, bottoming, 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%.
Having fallen close to our target of $US0.70, the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound. However, beyond a near term bounce it likely still has more downside into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Being short the $A remains a good hedge against things going wrong globally.
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