Investment markets and key developments over the past week

The past week saw most share markets push higher on the back of positive news regarding US/China trade talks, benign economic data and some optimism that global growth will pick up, with the US share market making it to a new record high. Australian shares benefitted from the positive global led by strong gains in resources, IT and consumer discretionary stocks more than offsetting declines in defensive high yield property, telco and utility stocks. Bond yields rose sharply across most countries on more positive expectations for global growth and falling safe haven demand. Oil and metal prices rose too, but gold fell on falling safe haven demand and the iron price slid further on rising production by Vale. The Australian dollar was little changed as the $US rose.

A delay in the signing of a Phase One trade deal into December is not a big deal, particularly on reports of some roll back in tariffs and as long as progress continues in negotiations which seems to be the case. Meanwhile pressure on Trump to get a win on this front continues to build going into the presidential election year as he needs to keep the economy growing and unemployment from rising and he needs distractions from the impeachment mess. In terms of the latter its looking worse for Trump with more testimony to the effect that Trump tied US aid to Ukraine or a meeting to the Ukraine probing Joe Biden. But while this is making it increasingly certain that the Democrat controlled house will vote for impeachment, its doubtful that 20 Senators will vote to remove him from office (which will be needed to reach the 67 Senate votes required) as long as support for impeachment from registered Republicans remains low. And so far it is just at 11%.

If President Trump’s tweets are any guide to his stress level then it looks to be still going up – he did a record 1018 tweets last month, or nearly 33 a day!

Source: Trump twitter archive, AMP Capital

The RBA left interest rates on hold as expected following its November meeting but we remain of the view that the RBA is likely to have to act on its preparedness to ease monetary policy further in order to get to “full employment and the achievement of the inflation target over time.”

• Yet again the RBA revised down its growth forecast for this year to 2.25% – a year ago it was forecasting 3.25%.
• While it sees growth picking to 2.75% next year the risk is that yet again it will be too optimistic. There is not much sign of a “gentle turning point” in consumer spending with real retail sales falling in the September quarter and vehicle registrations down again in October.
• The RBA sees little progress in getting unemployment down until 2021 and even then it remains well above its 4.5% estimate of NAIRU. Based on US experience it’s likely that NAIRU is actually well below 4.5%. And this is to say nothing about the 8.5% of the workforce that is underemployed.
• It sees wages growth stuck at 2.3% year on year for the next two years.
• It sees both headline and underlying inflation remaining below target for the next two years.

So on the RBA’s own – relatively upbeat – forecasts the economy will remain far away from full employment and the inflation target for the foreseeable future. Against this backdrop its hard to see it not having to act on its easing bias…unless we see significant fiscal stimulus soon.

I don’t buy the argument that rate cuts are making things worse, but the case for more fiscal stimulus is getting louder and louder. The historical experience shows that its quite normal for consumer confidence to fall during the initial phase of a rate cutting cycle. This is because both are reacting to the same bad news on the economy and because monetary easing only boosts growth after a lag. So, the current experience of falling rates and confidence is not unusual.

Source: RBA, Westpac/MI, AMP Capital

But given these lags and the likelihood that the positive impact of rate cuts is not as strong as it used to be due to high debt levels, the case to undertake more fiscal stimulus is overwhelming. This should involve a mix of measures such bringing forward some of the stage two tax cuts, boosting Newstart, inducements to large companies to investment more and increased infrastructure spending where possible. Fiscal stimulus would provide a far more assured boost to the economy and could be more fairly targeted than the blunt instrument of monetary easing. Drought assistance will help but it’s too small at less than 0.1% of GDP to have much impact on the whole economy. Finance Minister Cormann has implied an openness to bringing forward tax cuts but this may still be a long way off.

In the absence of significant fiscal stimulus soon, pressure clearly remains on the RBA for further easing if it is to achieve its mandate. As such, we continue to see the cash rate being cut to 0.5% in December and to 0.25% in February, but with bank interest margins under pressure as highlighted by Westpac and NAB results released in the last week this should come with quantitative easing measures designed to lower bank funding costs and increase the banks’ pass through of rate cuts to borrowers. The RBA’s forward guidance is also likely to be toughened in the next few months to say something along the lines that the RBA “doesn’t expect to consider raising interest rates until inflation is near the mid-point of the 2-3% inflation target.”

Out of interest the RBA’s November Statement on Monetary Policy had 87 pages (including covers, content pages, etc) which is a record. It’s interesting to note that as the cash rate has fallen to a record low the SOMP has blown out to a record length.

Source: RBA, AMP Capital

Treasurer Josh Frydenberg’s decision to make no changes to the RBA’s inflation target and its interpretation makes sense. To lower the inflation target to 1-3% as some were arguing for would have blown its credibility, pushed the $A up sharply and boosted the risk of deflation and falling wages which is the last thing we want given high household debt levels. Making the target stricter – by requiring say a BoE style letter each time the target is breached – could force the RBA to become inflation nutters. So thankfully it remains unchanged.

For some upbeat, sixties inspired cool music do yourself a favour and check out She and Him. I have long thought Zooey Dechannel was kind of cool and then my daughter got me into She and Him, but I only just worked out how good they really are. Don’t Look Back is particularly fab.

Major global economic events and implications

US data was mixed with the ISM non-manufacturing conditions index improving in October but labour market indicators presenting a mixed picture with openings down but still strong, while hiring and quits remained strong and jobless claims remain ultra-low.

US September quarter earnings results much better than feared. Around 90% of S&P500 companies have now reported, with 79% beating earnings expectations (against a norm of 75%) by an average of 4.7% and 59% beating on sales. Earnings growth for the September quarter look like they will end up somewhere around +1%yoy. That’s low, but its well up from market expectations a month ago which saw a 3% decline.

Source: Bloomberg, AMP Capital

Australian economic events and implications

Australian economic data was a mixed bag pointing to continued weak consumer spending but strength on the trade front and an ongoing pick up in the housing market. Retail sales disappointed yet again in September and fell 0.1% in the September quarter in real terms which along with an ongoing fall in motor vehicle registrations indicates that the tax cuts have so far failed to provide much of a boost to consumer spending. The rebound in home prices should turn the wealth effect from negative to positive but ongoing high levels of underemployment and low wages growth are clearly still weighing. Another fall in ANZ job ads in October pointing to slower jobs growth ahead is not good news either.

But at least another big trade surplus for September reminds us that its not all negative for the Australian economy. Net exports are likely to provide a small boost to September quarter GDP growth and the trade surplus points to an even bigger current account surplus in the September quarter of around 1.4% of GDP after the June quarter surplus of 1.2% which was the first since 1975. Lower iron ore prices as Vale production returns will be a drag going forward but the current account surplus also reflects strong export volumes (which should remain strong if we are right and global growth picks up), strong services exports and going forward an improving net income balance as offshore assets of super funds continue to build.

Source: ABS, AMP Capital

New housing finance rose for the fourth month in a row in September, confirming the turnaround in the property market and pointing to a pick-up in growth in the stock of housing credit.

Source: ABS, AMP Capital

Finally, in Australia the Melbourne Institute’s Inflation Gauge showed headline and underlying remaining weak at just 1.5%yoy in October. And soft wage rises under new EBA deals announced in the June quarter is consistent with ongoing weak wages growth.

What to watch over the next week?

In the US, expect October core CPI inflation (Wednesday) to remain around 2.4% year on year, retail sales (Friday) to bounce back after a dip in September and industrial production (also Friday) to remain soft. Small business optimism for October will be released Monday and the Empire survey manufacturing conditions for the New York region for November will be released Friday.

The outcome of the latest Spanish general election on November 10 will no doubt be watched closely, but while polls suggest that the centre left Socialist party will get the highest share of the vote again at around 28%, forming a coalition government looks likely to be no easier than it was after the April election. None of the major parties are advocating an exit from the Euro so the significance of the election outside of Spain is low (compared to Eurozone elections of a few years ago.)
Japanese September quarter GDP growth (Thursday) is expected to come in at around 0.2%qoq or 1.4%yoy.

Chinese economic activity data for October (Thursday) is expected to show a pull back in industrial production growth to around 5.4% year on year after the bounce seen in September, retail sales unchanged at around 7.8%yoy and fixed asset investment growth also unchanged at around 5.4%yoy. Credit and money supply data will also be released.

In Australia, the focus will likely be on September quarter wages data due Wednesday and October jobs data to be released Thursday. Wages growth is likely to have remained weak at 0.5% quarter on quarter or 2.2% year on year as the high level of unemployment and underemployment continues to weigh. Employment data is expected to show a 20,000 rise in employment, but a slight rise in unemployment back to 5.3%. Meanwhile the NAB business survey (Tuesday) is expected to show that business confidence remains subdued and the Westpac/MI consumer survey (Wednesday) is likely to show continued softness on consumer confidence.

Outlook for investment markets

Share markets remain at risk of further short-term volatility given issues around trade, Iran & the Middle East, impeachment noise and weak global economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 month horizon.

Low yields are likely to see low returns from bonds once their yields bottom out if they haven’t already, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, low for longer bond yields will help underpin unlisted asset valuations.
The election outcome, rate cuts, tax cuts and the removal of the 7% mortgage rate test are driving a rebound in national average capital city home prices led by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record supply of units continues to impact and rising unemployment acts as a constraint. The risk though is that the recent surge in prices goes on for longer as property price gains in Australia have a habit of feeding on themselves.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.25% by early next year.

Our base case remains that the $A still has more downside to around $US0.65 as the RBA cuts rates further. However, with the US dollar looking like it may have peaked and given excessive $A short positions there is a growing risk that we may have already seen the bottom (at $US0.6671 early in October).