Notwithstanding market nervousness, the past week has actually seen more positive news on the US/China trade front with a the round of negotiations kicked off by a phone call between Chinese Vice Premier Liu and US Treasury Secretary Mnuchin and Trade Representative Lighthizer, Chinese officials reportedly travelling to the US to negotiate, China reportedly moving to cut its trade war tariffs on imported US cars and purchasing US soy beans, President Trump indicating he would intervene in the Huawei case if it helped get a deal with China on trade, China reportedly preparing to give foreign firms greater access along with reports that it’s working to soften and replace its Made in China 2025 plan. This is all far more positive than markets appear to be allowing for. But scepticism is understandable after the experience back in May. Our view remains that there is a strong incentive for both sides to make a deal to resolve the issue before it weakens their economies (which won’t be good for Trump’s 2020 re-election). It may take more than 90 days, but we expect a deal to be reached in the next six months.
US Government shutdown risk delayed to December 21. While US Government funding was extended from December 7 it was only out to December 21 and, as a meeting between President Trump and Democrat Congressional leaders highlighted, their remains the risk of a shutdown then as Trump seeks to get funding for his wall. That said, much of this looks to be posturing for the cameras, we have seen all this before, its hard to see either side allowing a Christmas shutdown as the public doesn’t like them. It’s still a risk though – but note that 75% of funding has already been passed into law so it would only be a partial shutdown and only non-essential services would shut so it wouldn’t have much economic impact at all. The big one to watch is the coming fight over the debt ceiling sometime after March 1 next year – as the Democrats could try and force Trump to lift the corporate tax rate in return for raising the debt ceiling
It’s still too early to say we have seen the low in shares. Here’s a possible road map though. Shares have a nice Santa rally over the next two weeks or so, but we get more weakness in early 2019 as global growth indicators remain softish. Which in turn prompts more stimulus in China, the Fed to pause, the ECB to provide more cheap bank funding and a bit of fiscal stimulus out of Europe (was Macron’s concession over the last week to the “yellow shirts” a sign of things to come for fiscal stimulus in Europe?). US/China trade negotiations make progress. Shares then bottom around March. Economic data starts to improve, and it looks like 2015-16 all over again (albeit a bit more compressed in time). Who knows for sure – but while I remain confident that a “grizzly bear” market (where shares fall 20% only to be down another 20% of so a year later) is unlikely because a US/global recession is unlikely anytime soon, a further leg down in shares turning the correction we have seen so far into a “gummy bear” market (down 20% or so from top from but up a year later) is a high risk.
Speaking of the Santa rally, it normally kicks in around mid-December on the back of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings. Over the last ten years the period from mid-December to year end has seen an average gain of 1% in US shares with shares up in this two week period 7 years out of ten, albeit it’s been less reliable in the last few years. In Australia, over the last ten years the average gain over the last two weeks of December has been 2.2% with shares up 8 years out of ten, including in all of the last six years. Which is why December is normally a strong month.
Source: Bloomberg, AMP Capital
The British always do good comedy and Brexit keeps getting funnier with PM May delaying a vote on her deal to avoid certain defeat before then facing a confidence vote from her party. While she survived the vote more than one third of her party voted against her leaving her weakened and she is now a bit of a lame duck as she won’t be leading into the next election. She still faces an uphill battle to improve her deal with the EU and then win parliamentary support. All of which is leading to an increased risk of a new election and a no deal Brexit in March (which risks plunging the UK into recession). As Lance Corporal Jack Jones kept saying in Dad’s Army “don’t panic! don’t panic!”. This is all bad news for the UK and UK assets with the British pound taking most of the hit, but despite reports to the contrary it remains a second order issue for global markets.
Major global economic events and implications
US data releases over the last week were strong. Job openings and hiring remain robust, small business confidence fell in November but remains very high and jobless claims fell sharply back to their lows after several weeks of increases. Meanwhile, November headline CPI inflation fell back to 2.2% year on year helped by lower energy prices with more to go this month and core inflation rose to 2.2%yoy but short-term momentum in inflation is running around 2%. The November CPI is consistent with the core private final consumption deflator at 1.9%yoy. Core inflation stabilising around 2% gives scope for the Fed to pause/go slower next year after it hikes in the week ahead.
The European Central Bank remains dovish. While it confirmed that its quantitative easing program will end this month, it was really a dovish tightening with Draghi seeing the economic risks as “broadly balanced” but “moving to the downside” consistent with downwards revisions to the ECB’s growth and inflation forecasts, a hint of more cheap financing (or LTRO) for banks, a continued reference to rates being on hold through summer 2019 (we can’t see a hike until 2020 at the earliest) and a commitment to continue reinvesting maturing bonds for an extended period. Next to watch will be another round of cheap bank financing early next year.
The further downwards revision to Japanese September quarter GDP growth to -0.6%qoq was bad news, but various business surveys seem to be holding up at reasonable levels including the Tankan business survey and machine orders rose in October.
Chinese economic data for November was on balance soft with weaker growth in imports, exports, industrial production and retail sales, but a slight pick-up in investment growth, stronger than expected growth in lending and credit and lower jobless. The overall impression is that growth is continuing to slow, which will likely drive more decisive policy stimulus in the months ahead.
Australian economic events and implications
Australian economic data releases over last week were nothing to get excited about. The ABS reported that house prices fell 1.5% in the September quarter, but this just confirmed declines already reported by private sector surveys which show an intensification over the last two months. Housing finance rose in October, but this could just be a statistical bounce after several weak months. Consumer confidence was little changed in December, but business confidence continued to slip below consumer confidence after running above it since the 2013 election. The problem is that neither are particularly strong and with house prices falling and wages growth likely to remain weak its hard to see consumer confidence rising much and a continuing slide in business confidence may threaten business investment. Finally, the CBA’s December business conditions PMIs slowed slightly.
What to watch over the next week?
In the US, the focus is likely to be on the Fed on Wednesday which is expected to raise the Fed funds rate by another 0.25% to a range of 2.25-2.5% but its likely to be a “dovish hike” with the Fed dropping the reference to further “gradual” rate hikes and replacing it with language that signals a greater data dependency. Basically, with the Fed Funds rates getting close to neutral, US core inflation stabilising around the 2% target, interest sensitive sectors like housing and auto demand slowing and various headwinds to the US economy next year the Fed is likely to signal that its open to a pause on interest rates or at least moving more slowly in raising them. Our base case is that the Fed will hold the Fed Funds rate flat during the first half of next year and only raise rates once or twice in the second half.
On the data front in the US expect flat to softish readings for the NAHB home builders’ conditions index (Monday), housing starts (Tuesday) and existing home sales (Wednesday) and Friday data to show a rise in durable goods orders, solid growth in personal spending and a rise in inflation as measured by the core private consumption deflator of 1.9% year on year.
The Bank of Japan is not expected to make any changes to monetary policy when it meets Thursday, with core CPI inflation (Friday) likely to remain stuck around 0.4% yoy and providing one reason why this is likely to remain the case for a long while yet.
The Bank of England is also expected to leave its cash rate at 0.75% when it meets Thursday with Brexit uncertainty likely to weigh heavily on its thinking.
In Australia, the Mid Year Economic and Fiscal Outlook to be released on Monday is likely to show that the Federal budget is running around $9bn per annum better than expected – thanks to higher than expected commodity prices and employment driving stronger tax revenue only partly offset by fiscal easing measures. This year’s budget deficit projection is likely to fall to around -$6bn (from a projection of -$14.5bn in the May Budget) and the 2019-20 surplus on unchanged policies will be projected to be around +$11bn (up from $2.2bn in May) with future surpluses looking even stronger. This is likely to enable the Government to announce around $9bn in income tax cuts and other pre-election goodies ahead of next May’s election and still maintain a surplus projection for 2019-20. The big risk of course is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows, and wages growth remains weak. The Government’s growth forecast for this financial year of 3% is expected to remain unchanged but it may lower forecasts for 2.25% inflation and 2.75% wages growth as both look too optimistic.
The minutes from the RBA’s last meeting (Tuesday) will likely repeat the mantra that it expects the next move in rates to be up although there is no strong case for a near term move, but investor interest is likely to be on what the Bank has to say about the housing market and credit conditions with recent speeches suggesting that it may be getting a bit more concerned about the risks. On the data front expect November labour force data (Thursday) to show a 10,000 gain in jobs and unemployment remaining at 5%. June quarter population data (also Thursday) will likely show some slowing in population growth to around a still strong 1.5%yoy.
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