Investment markets and key developments over the past week
The past week has all been about the US presidential election with share markets first falling and bonds and gold rallying on news of Donald Trump’s likely victory as investors initially worried about a global trade war and policy uncertainty, only to see a sharp reversal and then some as investors focussed on the stimulatory aspects of his policy platform. The key turning point appears to have been Donald Trump’s conciliatory victory speech which appeared to drive a focus on the more positive aspects of his policy platform (including tax cuts, deregulation and infrastructure spending) which could boost growth, inflation and interest rates in the US. Reflecting this, major share markets saw strong gains for the week overall but with emerging market shares falling, bond yields rose sharply on expectations for higher inflation and interest rates and the US$ rose and this along with sharp falls in Asian currencies weighed on the A$ despite sharp gains in prices for metals and iron ore. For the week US shares rose 3.8%, Eurozone shares rose 2%, Japanese shares rose 2.8%, Chinese shares rose 1.9% and Australian shares rose 3.7%.
US share market sectors that will benefit from deregulation and infrastructure spending under Trump – like industrials, financials, healthcare, energy and materials – rose the most but bond yield sensitive REITs and utilities struggled. This pattern was also reflected in the Australian share market but with resources stocks doing particularly well. While US financials stand to benefit from plans to dismantle the US Dodd-Frank financial sector law that cracked down on banks post the GFC, global and Australian banks have rallied too on the basis that what happens in the US often goes global and that the shift back to financial sector deregulation in the US will take the wind out of the sails for further global regulatory moves under the Basle framework.
Three key points on Donald Trump’s election as President of the United States. First, Trump’s victory adds impetus to the backlash against economic rationalist policies and specifically globalisation that got kicked off by the Brexit vote. On the face of it this is a threat to global growth and investment returns if it ushers in a period of lower productivity. However, with Trump there is a twist – while his trade policies could be bad for productivity and global growth his proposed tax cuts, infrastructure spending and industry deregulation will likely boost productivity and growth. So it could all turn out to be positive.
Second, what ultimately matters is whether we get Trump the pragmatist focussing on the fiscal stimulus (tax cuts and infrastructure spending) and industry deregulation aspects of his program or Trump the populist focussing particularly on aggressive protectionism. The populist is what we saw in the election campaign but economic and political realities usually force politicians to become more pragmatic once in office. Trump’s conciliatory victory speech provided a bit of confidence that he will be more pragmatic as does his business background.
Finally, Trump’s victory adds impetus to the “great policy rotation” from relying solely on monetary policy to boost growth to a greater reliance on fiscal stimulus (tax cuts and infrastructure spending) and structural reform (deregulation). While House Republicans are likely to want to limit any budget deficit blow out, expect agreement between Trump and Congress to be reached pretty quickly. This will likely all mean stronger growth, higher inflation, more upwards pressure on bond yields and more upwards pressure on the US Federal Reserve (Fed). In the absence of much negative fallout in investment markets from Trump’s victory the Fed remains on track to hike in December (with the US money market pricing in an 84% probability), but assuming the US$ does not push too high we could see three to four rate hikes next year rather than the one hike that the money market has priced in.
Summarising, this is neutral to positive for shares (with stronger economic and profit growth offsetting the negative impact from faster Fed tightening), mostly positive for commodities (with US infrastructure spending adding to China’s), negative for bonds and positive for the US$. Emerging market shares could be relative losers though on trade fears and the risk of a dollar funding crisis if the US$ continues to rise and yield sensitive share market sectors like REITs and utilities are likely to be under pressure for longer as bond yields rise with cyclical sectors outperforming.
For Australia, the impact of Trump’s victory also comes down to whether we get Trump the populist – as US tariffs on Chinese imports will likely invite retaliation and see Australia caught in the cross fire with a fall in demand for our exports – or Trump the pragmatist – as stronger US growth and the avoidance of a debilitating trade war will ultimately be good for Australia. I have a leaning towards the latter. In the meantime with little negative fallout in investment markets from Trump’s victory there is little in the way of implications for the Reserve Bank of Australia (RBA) regarding Australian interest rates in the short term. Looking out further if Trump’s policies help drive stronger US growth and inflation then the beneficial impact on Australia could help eventually help drive higher interest rates here – but that’s a 2018 story at the earliest.
Major global economic events and implication
US data remained good with a rise in small business optimism, job openings and hiring remaining strong, jobless claims remaining low and a reported easing in bank lending standards to households. Meanwhile the mortgage delinquency rate for US households has fallen to its lowest since 2006.
Japanese wages growth remained very weak in September and machine orders fell but bank lending and the Eco Watcher’s economic confidence index rose more than expected and corporate bankruptcies are down 8% yoy.
Chinese import and export data for October remained weak but consumer price inflation rose slightly to 2.1% yoy (from 1.9%) and producer price inflation rose to 1.2% yoy which is up from -5.9% a year ago. The upswing in producer prices is driven by stronger commodity prices and a stabilisation in Chinese economic growth and is positive for nominal economic growth and profits in China.
Australian economic events and implications
In Australia, housing finance unexpectedly rose in September led by strength in lending to investors and ANZ job advertisements rose by 1%, but business and consumer confidence fell slightly leaving them slightly above or around their long term averages. Nothing to get too excited about here, but the reinvigoration of lending to property investors at a time when Sydney and Melbourne price growth and auction clearance rates remains robust is a bit of a concern.
What to watch over the next week?
In the US, the consumer will be back in focus with October retail sales data (Tuesday) expected to show solid growth although election uncertainty may have acted as a bit of a drag. Meanwhile, expect modest growth in industrial production (Wednesday), continued strength in home builder conditions (also Wednesday) and a rebound in housing starts (Thursday) and core inflation remaining around 2.2% yoy.
In Japan, September quarter GDP growth (Monday) is expected to come in around 0.2% quarter on quarter (unchanged from the June quarter).
Chinese activity data for October (Monday) is likely to show a slight rise in industrial production to 6.2% year on year (from 6.1%), but retail sales growth is expected to remain unchanged at 10.7% yoy and investment at 8.2% yoy.
In Australia, wages (Wednesday) are expected to rise 0.6% qoq, leaving annual growth at a record low of 2.1% yoy. Meanwhile, October jobs data (Thursday) is expected to show a 30,000 bounce in employment with unemployment rising to 5.7% (from 5.6%) as participation bounces back after recent falls. The Minutes from the last RBA Board meeting and a speech by Governor Lowe are likely to confirm that the RBA has a neutral bias on interest rates for now.
Outlook for markets
While the US election is out of the way event risks could still cause short term volatility in share markets with policy uncertainty remaining high in the US (watch the senior appointments to Trump’s team in the weeks ahead), Eurozone break up risks likely coming back into focus with the Italian Senate referendum & Austrian presidential election re-run (both on December 4) and European Central Bank (ECB) and Fed meetings in December. Bond yields could also see more upside in the short term. However, despite continuing volatility we anticipate shares to be higher by year end and to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets.
Sovereign bonds are now very oversold and due for a bounce in price (or pullback in yield). But still low bond yields point to a poor medium term return potential from them. While it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks, the abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the cyclical decline in bond yields (and likely too the long term decline since the early 1980s) is probably over. Expect the trend in bond yields to be up.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors though as these two asset classes never fully adjusted to the full decline in bond yields.
Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.
Cash and bank deposits offer poor returns.
A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the A$ remain down.
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