Investment markets and key developments over the past week
US shares rose 0.8% over the last week, helped by strong earnings results, a bounce back in tech stocks and another “Goldilocks” jobs report.
However, Eurozone shares fell 1.1%, Japanese shares lost 0.8%, Chinese shares fell 5.9% and Australian shares lost 1% as trade war fears continue to escalate.
Despite this, bond yields were flat to up. Iron ore prices rose but oi land metal prices fell. The US$ continued to push higher but the A$ was little changed.
The drip-feed of escalating tariff threats from Trump and counter threats from China continues, with the US threatening that the proposed tariffs on US$200 billion of Chinese imports will be 25%, not 10%, and China announcing a list of US$60 billion of US imports to be subject to tariffs should the US proceed.
With a 25% tariff on another US$16 billion of Chinese imports likely to commence soon, Trump is clearly ramping up the pressure on China, but China is digging in.
A tariff of this magnitude will start to have a significant economic impact on China’s growth (potentially knocking up to 0.5% off growth) and probably also on the US as well.
While there has been talk that the US and China may be trying to restart trade talks, China does not appear to be interested given the gun to its head and the May experience.
It may prefer to wait till after the US mid-term elections, thinking that the longer this goes on the greater the chance of a backlash against Trump and that Trump will be weakened if the Republicans lose control of the House of Representatives.
In the meantime, it’s stepping up measures to support growth. Trump really believes China’s trade practices are unfair, but he’s also tapping a vein of anti-trade/anti-Chinese sentiment amongst his supporters and may also be motivated by a Quixotic desire to slow the ascendancy of China as an economic power.
Whatever the motivation, it’s looking likely a solution will not be reached until after the US mid-terms and that trade fears will continue to cause volatility in markets.
Meanwhile, Trump is offering to meet Iran’s leadership and has asked US Attorney General Sessions to stop the Mueller inquiry.
The former may be a good thing (but it’s doubtful as Iran is not North Korea and its leadership would regard a meeting as a media stunt) and the latter would be a Nixon-like disaster (but won’t happen because Sessions can’t do it as he recused himself from the inquiry and Trump would have to fire Deputy AG Rod Rosenstein and keep firing Justice Department officials until he finds someone who is willing to fire Mueller).
Meanwhile, Trump’s desire to end the Mueller inquiry does highlight that it may be a real threat to his presidency.
Ultra-easy monetary policy locked in for longer by the Bank of Japan, but with more flexibility.
Despite all the anticipation, the Bank of Japan left monetary policy little changed, with the overnight deposit rate remaining at -0.1% and the 10-year bond target at zero.
While it injected more flexibility into its bond yield target by allowing an effective range of +/-0.2%, up from +/-0.1%, new forward guidance effectively locks the central bank into ultra-easy monetary policy into 2020. Overall this is positive for Japanese shares, but not so for the yen.
While Japanese 10-year bond yields may drift up to test the 0.2% level, Japan is unlikely to be a source of significant upwards pressure on global bond yields.
In Australia, average home prices are continuing to fall, led by the once booming cities of Sydney and Melbourne – with more to go.
Our assessment remains that with tighter lending standards, poor affordability, rising supply and falling capital gains expectations, Sydney and Melbourne property prices will have a top to bottom fall of around 15% spread out to 2020, which given falls already seen implies further downside of 10 to 12%. We are not there yet, but FOMO (fear of missing out) risks becoming FONGO (fear of not getting out) for some investors.
Other cities are in much better shape and most are likely to see moderate growth such that the top to bottom fall in national average home prices will be more like 5%.
With falling home prices set to drive a negative wealth effect, it’s hard to see the Reserve Bank of Australia raising rates anytime soon and if anything, there is a significant chance that the next move will be a rate cut.
Major global economic events and implications
US economic data remains strong. Personal income and spending remained robust in June and consumer confidence is high.
The ISM business conditions indexes fell slightly in July but remain high. Home prices are continuing to rise.
And July saw another “Goldilocks” jobs report, with strong payroll growth including upwards revisions to prior months, falling unemployment and yet still soft wages growth. Consistent with this, the Fed remains upbeat describing growth as “strong” (up from “solid”) and seeing inflation near target and so it remains on track to continue with gradual rate hikes next month.
US June quarter earnings reports remain very strong. Of the 80% of S&P 500 companies to have reported, 85% have beaten one earnings by an average beat of 5.3% and 73% have beaten on sales. Earnings are up around 26% year-on-year.
Eurozone growth slowed further in the June quarter to 2.1% year-on-year, but at least core inflation rose to 1.1% in July.
However, with core inflation still way below target and growth slowing we still can’t see the ECB raising rates until 2020.While the Bank of England raised rates another 0.25%, they have still only made it to 0.75% (i.e. half the RBA’s 1.5%) and with Brexit uncertainty this maybe it for a while.
Japanese economic data is mixed supporting the continuation of ultra-easy monetary policy.
While unemployment rose slightly in June, the jobs to applicant’s ratio rose to its highest since January 1974, helped by a falling labour force. Industrial production fell more than expected, but the manufacturing PMI for July points to a rebound.
Chinese business conditions PMI’s softened in July with manufacturing export orders quite weak, suggesting some impact from the trade skirmish.
That said, the PMIs are still mostly in the range of the last year or so and are consistent with a softening in growth as opposed to a collapse.
Our forecast for GDP growth this year remains for a slowdown to 6.5%. Meanwhile, the July Politburo meeting reinforced expectations for more policy stimulus mainly from fiscal policy.
The meeting statement included 15 references to “stable”, “stability” or “stabilising” compared to an average of 6 such references in the previous 10 Politburo meetings, highlighting the greater focus on supporting growth in the face of the trade threat.
Meanwhile, policy is going the other way in India, with the Reserve Bank of India raising its repo rate by 0.25% for the second meeting in a row to 6.5%.
It makes sense when inflation is above the 4% target and GDP growth is around 7.4%.
Australian economic events and implications
Australian economic data was mixed.
Retail sales volumes were very strong in the June quarter, indicating consumer spending will help June quarter GDP growth, but the quarterly bounce looks distorted by food, retail price inflation is non-existent and with weak wages growth, high underemployment and falling home prices retail sales are likely to soften again this quarter.
Meanwhile, building approvals rebounded in June but after several weak months leaving a weak trend, the value of residential alterations & additions and non-residential approvals trending down, private credit growth continuing to slow with investor credit contracting, July manufacturing PMIs falling albeit remaining consistent with growth and home prices falling for the ninth month in a row in July.
While the June trade surplus doubled expectations, most of the surprise in relation to exports looks to be price-related and so it looks like net exports will contribute to June quarter GDP growth, but only modestly.
What to watch over the next week?
In the US, expect the core CPI (Friday) to remain around 2.3% year-on-year which is consistent with inflation according to the core private consumption deflator of around 2%.
Data for job openings, small business confidence and producer price inflation will also be released.
Japanese June quarter GDP data (Friday) is expected to show a return to positive growth of around 0.3% quarter-on-quarter.
Chinese July trade data (Wednesday) is expected to show import and export growth of around 10% year-on-year with consumer price inflation (Thursday) remaining around 1.9% year-on-year and producer price inflation slowing to 4.4% year-on-year.
In Australia, the Reserve Bank at its monthly meeting on Tuesday is expected to leave interest rates on hold for a record 24months in a row, or for those who want to get pedantic 22 meetings in a row.
The RBA’s own forecasts for decent growth and a gradual rise in inflation along with strong infrastructure investment, rising business investment and strong export volumes argue against rate cut, but the peak in the housing construction cycle, uncertainty about the outlook for consumer spending, the weakening Sydney and Melbourne property markets, low inflation and wages growth and tight bank lending standards all argue against a rate hike.
So the stand-off continues and the RBA will remain on hold.
The next move is still likely to be up, but not until 2020 at the earliest and there is a rising risk that the next move will actually be down. A speech by RBA Governor Lowe (Wednesday) and the Statement on Monetary Policy (Friday) is likely to confirm that the RBA is comfortably on hold for now.
The SOMP is not expected to contain any major changes to the RBA’s forecasts.
On the data front, housing finance for June (Wednesday) is expected to show ongoing weakness.
The Australian June half earnings reports will start to ramp up with 15 major companies reporting including Shopping Centres Australia, IOOF and Transurban (Tuesday), Tabcorp, AMP and CBA (Wednesday), AGL, Crown and Suncorp (Thursday) and James Hardie, REA and Newscorp (Friday).
We are expecting 2017-18 earnings growth to come in around 9%, with resources earnings rising around 25% (albeit down from 130% in 2016-17) thanks to solid commodity prices and rising volumes and the rest of the market seeing profit growth of around 5%.
Strong results are expected for insurers, health care, utilities, gaming and building materials offsetting softness for telcos, banks and consumer discretionary stocks.
Dividend growth is likely to remain solid.
Outlook for markets
While we see share markets being higher by year-end as global growth remains solid, helping drive good earnings growth and monetary policy remains easy, we are likely to see ongoing bouts of volatility and weakness as the US-driven trade skirmish with China could get worse before it gets better and as worries remain around the Fed, President Trump in the run up to the US mid-term elections, China, emerging markets and property prices in Australia.
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 as Sydney and Melbourne property prices continue to fall, but Perth and Darwin bottom out, and Adelaide, Canberra and Brisbane see moderate gains.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
We continue to see the A$ trending down to around US$0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Solid commodity prices should provide a floor for the A$ though in the high US$0.60s.