Investment markets and key developments over the past week

Global shares slipped over the last week on the back of uncertainty ahead of the Trump/Xi meeting at the G20 and fears that the Fed may not be dovish enough in the face of soft data. Bond yields were flat to down reflecting global uncertainties, expectations for monetary easing and safe haven demand. Oil prices rose on continuing US/Iran tensions and gold and copper prices rose helped by a falling $US but the iron ore price was little changed. The $A rose to $US0.70 as RBA Governor Lowe referred again to the limitations of monetary easing and the $US fell.

All eyes on Trump and Xi at the G20. Their meeting won’t solve the trade war but markets are expecting that it will get negotiations going again with the US suspending tariff hikes on the remaining roughly $US300bn of imports from China pending a deal. The end result if the negotiations are successful is likely to be something like the US removing all tariffs if China passes into law agreed changes to protect intellectual property, prevent forced technology transfer, etc. It’s in both sides interests to get there given the economic damage the trade war is causing and we think they ultimately will but there is a long way to go and China may reason that its better to wait for a more conventional and respectful US president.

Tensions between the US and Iran continue to increase with the US announcing more sanctions and Iran saying diplomatic channels are closed in response. The threat to the passage of oil through the Strait of Hormuz – through which nearly 20% of world crude oil moves – is clearly continuing to increase and this is driving the world oil price back up. Trump’s maximum pressure approach may have an Art of the Deal logic to it but is not clear it will work with a country like Iran. And support from many traditional US allies like Europe is weak because they didn’t support Trump’s decision to break off from the 2015 nuclear deal with Iran. Middle East tensions and wars regularly flare up only to fade or end with no more than a short-term impact on oil prices, the global economy and share markets and the same could be expected this time. But any significant further flare up from here could cause a bout of weakness in global markets at a time when they are already vulnerable.

Fed heading to rate cuts but not as dovish as the market would like. Fed Chair Powell reiterated the message from the last Fed meeting in terms of downside risks and openness to cutting rates, but Fed dove James Bullard’s comment that a 0.25% cut would help but 0.5% may be overdone got the market concerned that the Fed is not dovish enough. Ultimately, the market is over-reacting and the Fed will do whatever is necessary, but – assuming there is a resolution to the US/China trade war – its unlikely to be the 100 basis points of easing factored into money markets. More likely around 50-75 points.

Overall, we remain optimistic on shares on a 6-12 month view partly on the back of central bank easing. But after a strong rebound in June – which saw Australian shares gain around 4% leaving them up 18% year to date – they are vulnerable to a short term pull back in the months ahead on weak data, trade uncertainties and Middle East tensions.

Bitcoin bounces back with a 340% gain from its December low. But that’s after losing 84% of its value from its December 2017 high. And after surging in the last week it had a 25% plunge. Bitcoin is definitely something. It’s good to talk about and for some to speculate on! And there is a bright future for blockchain technology. But it can’t seriously be taken as a currency. Amongst other things a currency should be a reliable store of value, and its hardly that. The value of the $A50 note in my wallet is far more reliable.

Major global economic events and implications

US economic data was weak. Pending home sales rose but new home sales fell sharply, and house prices were flat in April. While underlying durable goods order including for capital goods rose the slump in Boeing orders weighed on headline orders and shipments and this will likely weigh on June quarter business investment. Hopefully it should be temporary once Boeing gets back on track. Consumer confidence fell back to 2017 levels with signs that consumer perceptions of the strength of the jobs market may be topping out. This should be a concern for President Trump – sounding tough on trade may appeal to his base but if it starts to affect consumer confidence and the jobs market it won’t be good for his re-election prospects next year.

Eurozone economic sentiment fell in June leaving the ECB on track for more easing. Ideally, Europe needs fiscal stimulus. Italy wants to do it but can’t (within European Commission fiscal rules), Germany can do it but doesn’t want to.

Japan’s jobs market remained strong in May, but this was helped by a falling labour force. Industrial production bounced in May, but the trend remains soft.

Australian economic events and implications

Credit data for May showed a further slowing in credit growth to its weakest since 2013 with growth in lending to property investors remaining stalled & at its weakest on record as is growth in total housing credit. Personal credit growth is at its weakest since the GFC. Clearly the combination of tight lending conditions and reduced demand for debt continue to impact, consistent with slowing economic growth overall.

Source: RBA, AMP Capital

In other data, new interest only loans provided in the March quarter fell to a new low of just 14.9% of new home loans which is well down from their 2015 high of 46% of new home loans. Similarly the total stock of outstanding interst only loans as share of all outstanding housing loans has fallen to 23% which is down from a record high of nearly 40% in 2015. Clearly interest only loans remain well and truly out of favour despite the relaxation of the 30% limit on loans going to interest only borrowers back in December. It’s consistent with the ongoing weakness in investor lending given it has a high share of interest only loans. With interest returning to the Sydney and Melbourne property markets its likely that interest only loans may soon bottom out, but given the tougher lending standards of banks its doubtful they will return to anything like the 40% share of total loans seen a few years ago.

RBA Governor Lowe’s often repeated request for more fiscal stimulus and structural reform looks to being heeded to some degree. Infrastructure spending is continuing apace and the Federal Government has noted it was looking at trying to bring some of it forward and in the last week PM Morrison flagged a new focus on reducing business regulation and to taking a fresh look at improving the industrial relations system.

What to watch over the next week?

Reaction to the outcome of the meeting between Presidents Trump and Xi at the G20 and tensions between Iran and the US will likely dominate in the week ahead.

In the US, the focus will be on whether payroll employment growth for June due Friday bounced back after a soft May. Expect to see payrolls up a solid 160,000, unemployment remaining low at 3.6% and wages growth remaining subdued at 3.2%yoy. In other data, expect a further fall in the ISM manufacturing conditions index (Monday) to around 51 based on soft PMIs and regional surveys and the non-manufacturing conditions PMI (Wednesday) to remain solid at around 56.

Eurozone unemployment for May (Monday) is expected to remain unchanged at around 7.6%.

The Japanese June quarter Tankan business survey (Monday) is expected to show some softening.

Chinese business conditions PMIs for June will be released Sunday June 30 and Monday and are expected to remain softish but relatively stable.

In Australia, the RBA is expected to cut the cash rate by another 0.25% on Tuesday taking it to a new record low of 1%. June’s cut is unlikely on its own to achieve the RBA’s objective of lower unemployment and higher inflation, economic data since the last easing has been mixed with notably softish GDP and jobs reports, RBA Governor Lowe has signalled that “it’s not unrealistic to expect a further reduction in the cash rate” and while the Government looks to be listening to the RBA’s request for help with fiscal stimulus and structural reform it’s not clear how strong the response will be and it will take a while to be put in place and longer to impact. Of course, it’s a close call as to whether the RBA cuts on Tuesday or waits till August. But rate moves usually come in at least twos and the risks to the economic outlook have increased so it’s probably best to get another cut out of the way and then the RBA can sit back a bit and see whether it’s working. Ultimately, we remain of the view that the RBA will then cut again to 0.75% around November and then to 0.5% around February next year.

n the data front in Australia, expect CoreLogic data to show a 0.1% fall in house prices for June (Monday) with roughly flat prices in Sydney and Melbourne helped by the election result and the rate cut, June building approvals to show a 2% bounce and the trade surplus (both Wednesday) to remain at record levels and retail sales (Thursday) to rise 0.2%. Job vacancies data will also be released Thursday.

Outlook for investment markets

Share markets remain vulnerable to short term volatility and weakness on the back of uncertainty about trade, Middle East tensions and mixed economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve into the second half if the trade issue is resolved and monetary and fiscal policy is likely to become more supportive all of which should support decent gains for share markets over the next 6-12 months.

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 reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.

National average capital city house prices remain under pressure from tight credit, record supply and reduced foreign demand. However, the combination of rate cuts, support for first home buyers via the First Home Loan Deposit Scheme, the relaxation of the 7% mortgage rate test and the removal of the threat to negative gearing and the capital gains tax discount point to house prices bottoming out by year end. We see a 12% top to bottom fall in national capital city average prices. Next year is likely to see broadly flat prices as rising unemployment acts as a constraint.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.

The $A is likely to fall further to around $US0.65 this year as the RBA moves to cut rates by more than the Fed does. Excessive $A short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an $A crash.