Investment markets and key developments over the past week

Share markets fell earlier in the past week as the trade war continued to escalate, before rebounding helped by better economic and earnings news and hopes of a trade deal. This left share markets mixed with US and Chinese shares down slightly, but Eurozone, Japanese and Australian shares up. Australian shares saw strong gains in resources stocks helped by rising iron ore and oil prices and in property, health and consumer shares with ongoing talk of rate cuts also helping and this offset a sharp fall in the banks. Bond yields fell further on weak inflation and safe haven demand. Oil and iron ore prices rose but copper prices fell. The $A fell below $US0.69.

The US trade war continued to rattle investors over the last week, but the news wasn’t all bad. Yes, China announced retaliation to US tariff hikes, but it was small compared to what the US did. Yes, Trump continued to make threatening noises to China and moved to ban US companies from doing business with Huawei, but he also indicated that he will meet President Xi at the G20 summit in Tokyo next month which is shaping up as the most likely offramp from the current escalation of trade tensions. Trump also looks likely to delay a decision on auto tariffs (that was due by May 18) to give the EU and Japan six months to agree to limitations on their auto exports to the US which is consistent with the view that he doesn’t want to fight a trade war on three fronts. The trade issue could still get worse before it gets better (eg, the US is still preparing to tax all remaining Chinese imports at 25%), but our view remains that a deal will ultimately be reached to resolve the issue given the economic (and in Trump’s case political) damage that would be caused if a deal is not reached.

Federal financial support for first home buyers (FHBs) in Australia is now on the way but don’t get too excited by the First Home Loan Deposit (underwriting) Scheme. The scheme will be of some help in enabling FHBs to get in earlier and saving them mortgage insurance which can cost up to $10,000. But being capped at 10,000 FHBs a year its pretty small at around 10% of FHB loans in the last year, the borrowers will be taking on even bigger mortgages (when regulators have been trying to reduce the size of mortgages), which will come with a higher risk of negative equity, borrowers will still have to meet the tougher credit standards of recent times and it won’t kick in until next year. So, it’s probably not a game changer at this stage. That said I suspect it will morph into a far more attractive home buyer grant at some point (which is something we have seen in most major housing downturns in recent times) and will add to confidence along with RBA rate cuts, improving affordability and a slowing in new supply next year to help the property market bottom out short of the worst case falls some are putting out there.

The week ahead in Australia will no doubt be dominated by the outcome of the election. If the Coalition wins its business as usual with their strategy laid out in the April budget. If Labor wins (as opinion polls and betting agencies are pointing to, albeit Labor’s lead has narrowed to around 51/49) then on their current policies we will see a similar fiscal impact on the economy for the next few years as to what would have occurred under the Coalition (as their budget surplus projections are virtually identical for the next three years) but we will see a more interventionist approach in the economy – with various tax hikes, increased government spending, more aggressive action to reduce carbon emissions, increased regulation and some labour market re-regulation – which may adversely affect some share market sectors and the residential property market. If there is no clear result initially, as was the case in the 2010 election after which it took 17 days of negotiation to form a Government, it may cause a bit of short-term uncertainty, but investment markets would be unlikely to see a major impact until a government is formed. (The Australian share market fell 2.5% in the first two trading days after the 2010 election, but within a week was back to being unchanged and was 3% higher by the time the government was confirmed. It was similar for the $A which initially fell 1%, but within a week was back to being unchanged and was 3% higher by the time it was resolved.)

Vale Bob Hawke. The Hawke/Keating reforms of the 1980s & 1990s modernised the Australian economy and are a big part of the reason we have gone nearly 28 years without a recession.

Major global economic events and implications

US economic data was mostly good with weak readings for April retail sales (albeit after a very strong March) and industrial production but better manufacturing conditions in the New York and Philadelphia regions, higher small business confidence and stronger home builder conditions, a bounce back in housing starts and a fall in jobless claims. Weak import prices are adding to the downwards pressure on inflation though, which combined with the resumption of the trade war is increasing the risk that the next move by the Fed will be a cut.

Japanese data was soft with a sharp fall in machine tool orders and a downtrend in the Economy Watchers confidence survey. Coming on the back of a resumption of falling wages the pressure is on the Government to postpone October’s scheduled VAT rate hike and on the BoJ to do more.

Chinese data for industrial production, retail sales and fixed investment all slowed again in April. While this may be partly due to distortions caused by a VAT rate cut and Lunar New Year holiday timing and unemployment actually fell, coming on top of the resumption of the trade war it will likely result in a further ramping up of policy stimulus.

Australian economic events and implications

Australian data was soft over the last week. Housing finance resumed its downswing in March with investor finance (ex refinancing) back around 2009 and 2011 levels. Consumer and business confidence are running around long run average levels but the NAB’s business conditions index fell back to its December low and employment intentions fell sharply pointing to slower jobs growth ahead. Employment was solid in April but the full time part time mix was poor, and more significantly jobs growth is no longer keeping up with rapid labour force growth so unemployment and underemployment are both on the rise again. Finally, wages growth remained stuck at just 2.3% year on year in the March quarter. Sure its above inflation and up from its lows. But its still very weak and with unemployment and underemployment remaining very high and starting to rise again as the housing downturn hits employment its hard to see much fundamental acceleration in wages growth from here (even if the Government starts pushing up the minimum wage at a faster rate). The bottom line remains that to get wages growth and inflation up we need much lower unemployment and underemployment but to get that we will need even lower interest rates and more fiscal stimulus. The contrast between the US and Australian levels of labour market underutilisation remains stark and even with the much tighter labour market in the US wages growth has just managed to get up to 3%. With the election out of the way we expect the RBA to cut the cash rate to 1.25% in June and then to 1% in August.

Source: Bloomberg, ABS, AMP Capital

What to watch over the next week?

In the US, the minutes from the Fed’s last meeting are likely to confirm its neutral bias on interest rates. Our base case remains that the Fed’s pause will continue for another six months at least but the return of the US/China trade war and sub target inflation has increased the risk that the next move will be a cut rather than a hike. On the data front, expect a rebound in existing home sales (Tuesday) but a fall in new home sales (Thursday), business conditions PMIs for May (Thursday) to remain around the 53 level and underlying durable goods orders (Friday) to show modest growth.

European parliamentary elections on Thursday will no doubt see a lot of hype around Eurosceptics winning seats, but don’t read too much into it. The EU elections tend to see a higher turnout from motivated Eurosceptic voters, Eurosceptic/nationalist parties will still only get around a quarter of the seats, most of them are not serious about leaving the EU and/or the Euro (the Italians and Eastern Europeans) or are irrelevant (those from the UK), the EU Parliament doesn’t have a lot of power and in any case popular support for the Euro across the Eurozone has been rising and is strong at 75%. Meanwhile Eurozone business conditions PMIs (also due Thursday) will be watched for further signs of stabilisation.

Japanese March quarter GDP growth (Monday) is expected to show a small 0.1% dip continuing the up down pattern of the last year. Annual growth will be just 0.3% year on year.

In Australia, the initial focus will be on the outcome of the Federal election. Beyond that the focus will be back to monetary policy with the release of the minutes from the last RBA board meeting and a speech by RBA Governor Lowe on Tuesday, both of which we expect to signal some sort of shift towards an easing bias on interest rates ahead of rate cuts in the months ahead. On the data front, March quarter construction data will likely remain weak with another fall of around 1% quarter on quarter. Data for skilled vacancies and the CBA’s business conditions PMIs will also be released.

Outlook for investment markets

Share markets – globally & in Australia – have run hard and fast from their December lows and are vulnerable to a further short-term pullback. Geopolitical uncertainty around trade, North Korea, Iran and still mixed global economic data could be the drivers. But valuations are okay, global growth is expected to improve into the second half and monetary and fiscal policy has become more supportive of markets all of which should support decent gains for share markets through 2019 as a whole.

Low yields are likely to see low returns from bonds, but government bonds remain excellent portfolio diversifiers.

Unlisted commercial property and infrastructure are likely to see a further slowing in returns. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.

Our base case is for national capital city house prices to fall another 5% or so into 2020 on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government. An earlier rate cut in May could bring forward the bottom in house prices as in the last two cycles they bottomed four months or so after the first rate cut.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.

The $A is likely to fall further to around $US0.65 as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Excessive $A short positions and high commodity prices will likely prevent an $A crash though.