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Shane Oliver
Financial markets
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Shane Oliver is head of investment strategy at chief economist at AMP Capital.

Delays in US tax reform

Monday, December 11, 2017

Investment markets and key developments over the past week

  • Shares had a few wobbles early in the past week with a bit of profit taking partly triggered by the US Senate’s tax reform bill delaying the corporate tax rate cut until 2019 and its retention of the alternative minimum tax for corporates which could mean higher than intended tax for some companies. But most major share markets still ended up for the week, with US shares up 0.4% helped by another “goldilocks” jobs report, Eurozone shares up 1.7% and Chinese and Australian shares both up 0.1% and Japanese shares down less than 0.1%. Bond yields were mostly little changed, but commodity prices fell. The Australian dollar fell to around $US0.75 in response to softish GDP growth, a sharp fall in the trade surplus and a stronger $US.
  • Combining the House and Senate tax reform bills is now the main focus in the US, but this should be resolved by year end. Amongst other things this is likely to repeal the alternative minimum corporate tax that the Senate left in as a last minute saving measure and bring forward the corporate tax cut to a 2018 start but with the rate going down to 22% rather than 20% to limit the blowout in the budget deficit. The pressure on the GOP to get tax reform done is now immense and having ticked off all the boxes so far (passing a 2018 budget, support in the House and the Senate) the tax reform package looks likely to be passed into law by year end.
  • Meanwhile, Congress has passed a two-week government funding extension, so no partial Federal Government shutdown from December 9, and a shutdown from December 23 is unlikely too. Because of the large number of outstanding issues on both sides of politics and amongst various factions (eg around defence spending, spending caps, protection for children of illegal immigrants, etc) a longer term solution was unlikely just yet. However, a December 23 shutdown is unlikely because Congressional Republicans and Democrats are well aware after the 2013 experience of the blame they will take if a shutdown happens, particularly if it’s over Christmas/New Year. It’s also worth noting that there have been 12 shutdowns since 1981 and their economic impact tends to be modest. In fact, US economic growth accelerated around the last shutdown in December quarter 2013.
  • Bitcoin mania continues with another 43% gain over the last week, making for a whopping 16.4-fold increase year to date. While the announcement by the Australian Stock Exchange that it will use blockchain to replace its CHESS clearing and settlement system highlights the huge benefits of blockchain, bitcoin’s price surge continues to look like another speculative mania with huge price gains and stories of instant riches drawing attention to it, which is in turn encouraging more and more people to pile onto the bandwagon, which in turn pushes prices even higher, encouraging even more investors to pile in. And futures trading in bitcoin is on the way making it easier to trade which will only suck in more buyers. As John Maynard Keynes pointed out, “the market can remain irrational for longer than you can remain solvent” so it’s impossible to know how high it will get and for how long, so shorting it would be very high risk. But while its enthusiasts celebrate its freedom from government involvement and regulation, it will be ironic if they clamour for government help if/when it eventually crashes.
  • Why bitcoin mania might be good for shares? Because it’s helping to suck up euphoria that might otherwise go into shares - why invest in boring US shares that are only up 18% year to date when bitcoin is up 1543%! Less euphoria in shares can allow a longer cyclical bull market.

Major global economic events and implications

  • US data remains consistent with solid growth and “goldilocks”. While the non-manufacturing conditions ISM index fell in November this may be due to hurricane related distortions and in any case it remains very strong. Meanwhile, jobs data indicated that payrolls rose a stronger than expected 228,000 in November with unemployment remaining very low at 4.1% and looking like it will push below 4% in the months ahead. But it was another case of “goldilocks” with wages growth coming in weaker than expected at 2.5% year on year. While the Fed remains on track to continue hiking (because the tight labour market will eventually boost wage inflation) it can remain gradual compared to past cycles.
  • While the UK and EU have finally reached a deal to allow divorce negotiations around issues like trade to start there is a long way to go yet. The risk of a referendum on a final deal seeing a rejection and even a reversal of Brexit is significant.
  • Japanese GDP growth for the September quarter was revised up to 0.6% quarter on quarter from 0.3%, helped by stronger business investment and adding to evidence that the Japanese economy is a lot stronger these days. That’s the same growth rate as Australia but note Japan’s population is falling and Australia’s is still rising strongly.
  • The Chinese Caixin services conditions PMI rose in November and export and import growth was robust and stronger than expected consistent with continuing solid growth this quarter.

Australian economic events and implications

  • The Australian economy saw okay growth in the September quarter with good news on investment but a very weak consumer. The uncertainty around the Australian consumer has been apparent for some time and was highlighted in the September GDP data showing just 0.1% growth in consumer spending, its weakest since the GFC. With the national accounts showing continuing very weak average wages growth (just 0.6% over the last year), energy price hikes cutting into spending power, slowing house price gains in Sydney and Melbourne reducing positive wealth affects and ongoing concerns about high household debt, consumer spending is likely to remain constrained for a while yet. At the same time the housing construction cycle is slowing. Fortunately, non-mining business investment looks to be picking up at last, the growth drag from slumping mining investment is fading, public infrastructure investment is strong and export volumes are likely to rise solidly helped by a further ramp up in LNG exports all of which should be enough to keep the economy growing and eventually help support a pick up to around 3% growth on a more sustained basis next year. But for now underlying growth is still subdued at around 2.5% and while good October retail sales may help consumer spending a bit in the current quarter a slump in the October trade surplus suggests this may be offset by weak net exports.
  • Meanwhile, housing finance slowed again in October adding to evidence that the property market is still cooling.
  • While it was no surprise to see the RBA leave interest rates on hold this month our view remains that the risks around the consumer, weak wages growth and weak inflation mean it shouldn’t and won’t start raising interest rates until late 2018 at the earliest and another cut still can’t be ruled out.

What to watch over the next week?

  • In the US, apart from noise around tax, the focus will be on the Fed (Wednesday) which is expected to raise interest rates again for the third time this year and for the fifth time in this cycle. However, this is largely factored in – with a 98% probability according to the US money market - so will be no surprise. While the Fed and current Chair Yellen is likely to express concern about ongoing sub target inflation it is likely to reiterate that this is expected to be temporary, particularly with growth running strong and likely to receive a further boost next year from tax cuts. In fact, while the Fed is likely to reiterate that interest rate increases will remain gradual the “dot plot” of Fed officials’ expected interest rate increases for next year is likely to move up from three hikes to four.
  • On the data front in the US, the key to watch will be CPI inflation on Wednesday, which is expected to show a rise in headline inflation to 2.2% year on year but core inflation staying at 1.8% yoy, and retail sales data on Thursday which is likely to show a solid gain of 0.3%. Meanwhile, expect continuing strong or solid readings for job openings (Monday), small business confidence (Tuesday), business conditions PMIs (Thursday) and industrial production (Friday).
  • The ECB (Thursday) is likely to express continuing confidence in Eurozone growth but with inflation remaining well below target its unlikely to make any changes to monetary policy having already extended its QE program out to September and committed to not raising rates until after it ends. Eurozone business conditions PMIs for December to be released Thursday are likely to remain strong.
  • In Japan expect the Tankan business survey (Friday) to show a further improvement in business conditions.
  • Chinese economic activity indicators to be released Thursday are expected to show retail sales growth remaining around 10.3% year on year, industrial production growth stuck at 6.2% and investment slowing to 7.1%. Money supply and credit data will also be released.
  • In Australia, expect ABS data for the September quarter to be released on Tuesday to confirm a sharp slowing in national home price growth to around 0.7% quarter on quarter, the NAB business survey (Tuesday) to show continued strength in business conditions and confidence, consumer confidence (Wednesday) to remain sub-par and labour market data (Thursday) to show a 20,000 gain in jobs and unemployment remaining unchanged at 5.4%. A speech by RBA Governor Lowe (Wednesday) will be watched for any clues on the interest rate outlook.

Outlook for markets

  • With the direction setting US share market not having had a negative total return month so far this year (a very unusual feat historically) the risk of a decent short term correction in global shares led by the US is high. Uncertainty around US tax reform and government shutdown risk could provide a trigger but given positive seasonality with “Santa Claus” related strength usually kicking in from mid-December a correction is likely to wait till next year. Looking beyond short term correction risks though, we remain of the view that the broad trend in shares will remain up because we are still in the sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions.
  • Australian shares are likely to continue to participate in the global share rally albeit remaining a relative laggard thanks to a more constrained earnings outlook.
  • Low starting point government bond yields and a likely rising trend in yields will likely drive poor returns from bonds.
  • Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.
  • The Sydney and Melbourne residential property markets are likely to slow further over the next year or two with prices likely to fall by around 5-10%. But Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
  • Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or more and the Fed on track to hike in December with another four hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.
  • Eurozone shares rose 0.6% on Friday and the US S&P 500 gained 0.6% too helped by another “goldilocks” jobs report in the US. Following the positive global lead ASX 200 futures rose 23 points or 0.4% pointing to a positive start to trade Monday that will probably push the ASX 200 back above the 6000 level.
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US tax reform possible by year end

Monday, December 04, 2017

By Shane Oliver

Investment markets and key developments over the past week

US shares rose 1.5% over the last week to new record highs helped by progress on tax reform and Jerome Powell confirming that he would opt for less onerous financial regulation at the Fed. Japanese shares also rose 1.2%, and Australian shares rose 0.1% but Eurozone shares fell 1.1% and Chinese shares lost 2.6%. Oil prices fell 1.1% in a case of “buy on the rumour and sell on the fact” as OPEC extended production cuts to the end of next year, but the iron ore price rose 3.2%. The $A was little changed at around $US0.76.

US Senate passes tax reform 51-49, with a good chance it will now be in place by year end. With the Senate passing its tax bill it now moves to a House-Senate conference to resolve differences between the House and Senate tax bills – for example the House bill sees the corporate tax cut to 20% commence in 2018 whereas the Senate bill delays it to 2019 – ahead of a final vote in both houses. Having gotten so far tax reform is now more than 90% likely in the US and the GOP is likely to want to wrap it up by year end to avoid the risk that its final passage through the Senate may be adversely affected by the outcome of the special Senate election in Alabama (where the new Senator will sit from January).

At a big picture level, tax reform in the US will mean a boost (maybe 0.5%) to 2018 GDP growth, a likely additional Fed rate hike (four hikes in 2018 rather than three) and more upwards pressure on US bond yields and the $US. For Australia, US tax reform will mean a lower than otherwise $A, more flexibility for the RBA and more pressure to lower our 30% corporate tax rate for large companies (given the risk some companies may choose to relocate their headquarters to the US).

News that former US National Security Adviser Mike Flynn has pleaded guilty (to lying about his Russian contacts) and will cooperate with the Mueller inquiry into the links between the Trump campaign provides a reminder of the cloud hanging over the Trump administration and the potential for Trump’s resignation or impeachment. This could cause bouts of volatility (as we saw briefly on Friday with US shares down 1.5% on the Flynn news before largely recovering) next year and just adds to the likelihood that the GOP will lose control of the House in the November 2018 mid-term elections. However, we remain of the view that it does not change prospects for tax reform (it’s already nearly there) and in fact just highlights the pressure on Congress to get it done. We also remain of the view that unless there is clear evidence of wrong doing Republicans will not impeach Trump. The Democrats may try post the mid-terms but they are unlikely to get the necessary votes in the Senate again unless there is clear wrong doing. In any case even if Mike Pence replaces Trump it’s doubtful the administration’s economic policy direction will change much (less tweets though!). The main risk is that if the pressure on Trump mounts he may lash out with more populist policies (like protectionism) to shore up his support base.

Bitcoin to infinity and beyond with a surge through $US10,000 in the last week! Crypto currencies and block chain technology could revolutionise currency and payment systems. But bitcoin’s price surge increasingly looks to have more to do with speculative investor demand as rapid price gains and stories of millions being made on it with headlines like “Bitcoin mania sweeps into Manhattan” and “Bitcoin leaves sceptics behind” attract more attention to it. Which in turn draws in more investors - as evident in a spike in “how to buy bitcoin?” Google searches - fuelling more exponential price gains as it becomes self-perpetuating. As such it has all the elements of a classic bubble but there is no way to reliably value it as it produces no income so it’s impossible to tell how far it could go up before the music stops. But what goes up rapidly can come down just as rapidly and the volatility seen over the last week (where bitcoin rose to just below $11,500 only to fall back to near $9000 before rebounding again) provides a reminder that it’s not great at providing a reliable store of value which is a key characteristic of a currency. My views on it are unchanged from those expressed here.


North Korea’s latest missile test keeps the risk of military conflict alive but has not increased it. The US knows that a military response will result in thousands of deaths in South Korea and the North Korean regime does not want to push so far that it threatens its survival. Military conflict with North Korea is best regarded as a tail risk – worth keeping an eye on (including looking for appropriate portfolio protection where it’s cheap) but not enough to change our base case which is positive on the global outlook.

Major global economic events and implications

US data remains strong with a 17-year high in consumer confidence, another strong ISM manufacturing conditions reading, solid growth in construction activity, strong gains in home sales, rising house prices and an upward revision to September quarter GDP to 3.3%. While the Fed’s Beige Book sees economic growth, wages growth and inflation as all being “modest to moderate” it did note widespread labour market tightness and skill shortages and Fed Chair Yellen noted broad based growth and that gradual rate hikes remain appropriate as did Powell. With inflation in the core private consumption deflator rising to 1.4% year on year (or 1.447% to be precise), the Fed remains on track to hike again this month and three (or four) more times next year. Market expectations for the Fed remain too dovish.

Eurozone economic confidence rose to a 16-year high in November and unemployment fell again in October but core inflation remained low at 0.9% year on year keeping the ECB cautious.

Good Japanese activity data but ongoing low inflation. Industrial production bounced back in October (with solid business conditions PMIs pointing to continued strong growth), the labour market remains very tight and household spending was stronger than expected. However, with core inflation remaining weak at just 0.2% year on year the Bank of Japan will remain stimulatory for a long while yet.

Chinese data was solid with industrial profit growth remaining strong and business conditions PMIs remaining reasonable on average in November (with the Caixin PMI down slightly but the official PMIs up) suggesting that growth has remained solid into year-end. Measures aimed at reducing financial risk point to some softening in growth into next year though.

Australian economic events and implications

CoreLogic data for November showed a 0.1% decline in capital city property prices resulting in annual price growth dropping to 5.5%. Sydney prices are continuing to fall (down another 0.7%) and Melbourne prices are continuing to slow, but prices in Perth look to be bottoming as the slump in mining related employment bottoms out.




The Sydney and Melbourne property boom is fading thanks to APRA’s tightening measures (higher rates for investors and interest only borrowers, etc), rising supply and weakening expectations. Sydney auction clearance rates have already fallen into the mid-50s, a level that points to price declines on an annual basis on the back of the experience in 2008 and 2012. (This didn’t happen in 2016 because the auction slowdown then was too brief.) 

Our view remains that average residential property prices in Sydney and, with a lag, Melbourne will fall 5-10% into 2019. Perth is bottoming and should start to see moderate price gains by 2019, with Darwin following too. Brisbane, Adelaide and Canberra are likely to see continuing moderate gains over the next few years with some acceleration possible and Hobart will remain strong.

However, for those worried about what will keep the economy growing after the Sydney and Melbourne property boom ends there was good news over the last week.

  • First, after years of disappointment the business investment cycle in Australia is finally on the mend. Not only did investment rise in the September quarter (providing a boost to September quarter GDP growth) but investment plans for the current financial year are up on those made a year ago for the first time since 2012-13 (see the next chart). While business investment intentions point to a further 20% or so fall in mining investment, it’s now close to where it was as a share of the economy before the mining boom started and its drag on growth has collapsed to around 0.4% from around 1-1.5% a few years ago. More significantly non-mining investment plans point to a gain of around 12% this financial year with even the manufacturing sector looking to boost investment. The diminishing drag from falling mining investment and the improving outlook for non-mining investment (along with ongoing strength in export volumes and public infrastructure spending) has come just in time to offset the downturn in the housing cycle and the weak consumer.

  • Second, manufacturing conditions PMIs from both the AIG and CBA surveys were strong in November adding to evidence that manufacturing is doing well.
  • Finally, while building approvals are down from their 2015-16 highs, they remain strong suggesting a slowing in housing construction but not a collapse (at least for now).

What to watch over the next week?

Next week is going to be a busy one in the US with the House and Senate needing to start work on a common tax bill, agreement needed on a spending bill to head off a partial government shutdown on Friday and November payroll data to be released Friday which will be the last big economic release ahead of the Fed’s mid-December meeting. On the shutdown risk there remains a number of outstanding issues including funding for Trump’s wall and it’s doubtful that Congress is ready to agree a long term funding deal just yet so another last minute deal is likely that pushes the issue out another few months. Meanwhile, expect payroll growth to be a solid 200,000 with unemployment unchanged at 4.1% and wages growth edging up (after hurricane related distortions to 2.7%. Meanwhile expect the trade balance (Tuesday) to worsen and the non-manufacturing conditions ISM (also Tuesday) to remain solid at 59.

In China expect November trade data to show export growth remaining around 7% year on year and import growth to slow a bit to 14% year on year.

In Australia, it will be a big week with the RBA meeting (Tuesday) and September quarter GDP data (Wednesday) to provide an update on how the economy is performing. For the RBA we expect more of the same – on hold. While strong business conditions, solid jobs growth, improving global growth and the RBA’s own forecasts for a pick-up in growth argue for an eventual rate hike, ongoing low inflation, record low wages growth, uncertainty around consumer spending, signs that the housing cycle is slowing and the still strong $A argue against a rate hike. We remain of the view that the RBA will leave the cash rate on hold until a probable rate hike late next year at the earliest.

On the data front in Australia, expect September quarter GDP growth to show a rise of 0.7% quarter on quarter which will take annual growth to 3% as the 0.4% GDP contraction of the September quarter last year drops out. While consumer spending and housing investment are likely to be soft this should be more than offset by business investment, net exports and public spending. Meanwhile expect a solid rise in September quarter public spending and a 0.1% gain in October retail sales (both Tuesday), the October trade surplus (Thursday) to fall to around $1.4bn and housing finance (Friday) to be flat. Data for ANZ job ads, September quarter profits and services and construction sector conditions PMIs will also be released.

Outlook for markets

While the risk of a decent correction in global share markets is high (particularly given the risks of setbacks around US tax reform and the December 8 debt ceiling and government shutdown deadlines), we are now in a favourable part of the year for shares seasonally and remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions. We remain of the view that the broad trend in share markets will remain up.

Australian shares are likely to continue to participate in the global share rally albeit remaining a relative laggard thanks to a more constrained earnings outlook. The uncertainty that will come with a Royal Commission into Australian banks and the financial sector and the possibility of more regulation to follow adds to this assessment – Australian banks will remain great for income thanks to their high dividend yields but banks in Europe and the US are likely to be outperformers as their economies accelerate and particularly with the US heading towards less onerous financial regulation under Trump and Powell at the Fed.

Low starting point government bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

The Sydney and Melbourne residential property markets are likely to slow further over the next year or two with prices likely to fall by around 5-10%. But Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or more and the Fed on track to hike in December with another three or more hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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Are tax cuts really on the cards?

Monday, November 27, 2017

By Shane Oliver

Investment markets and key developments over the past week

While Chinese shares fell 0.4% over the last week, US shares rose 0.9% helped by retailers and oil shares, Eurozone shares also gained 0.9%, Japanese shares rose 0.7% and Australian shares rose 0.4%. Bond yields were flat to down helped by ongoing concerns about low inflation in the US and this also weighed on the $US. Commodity prices rose and this along with a weaker $US and a reiteration of RBA Governor Lowe’s view that the next move in Australian interest rates will be up saw the $A rise.

The failure of attempts to form a “Jamaica” coalition government in Germany over disagreements around immigration won’t threaten the German economy or the Euro. The Social Democrats have indicated that they are open to talks on backing a Merkel led government and failing that another election will likely take place next year which could see support for Angela Merkel increase as Germans’ opt for stability. In the meantime, the German IFO business conditions index is at a record high, no major economic decisions are awaiting the formation of a new government and with over 80% of Germans supporting the Euro there is no threat to its survival. Eurozone shares remain cheap and very attractive given improving growth & profits and a highly supportive ECB.

In Australia, it’s no surprise to see the Government talking of tax cuts ahead of the next election but it’s doubtful this will change the outlook for the economy or interest rates over the year ahead. Tax cuts are expensive (a 1% across the board cut to marginal tax rates would cost around $7 billion per annum), but make some economic sense to the extent that the household sector is weak, the RBA is reluctant to cut interest rates again and it would return bracket creep. However, while they could be announced in the May budget next year: it’s unlikely they’ll commence until July 2019 so it will be a while before they impact; while the budget is currently running better than projected, budget savings would still likely have to be found to be confident of keeping the return to surplus for 2020-21 on track which will reduce their impact; and they will be further offset by the July 2019 0.5% increase in the Medicare levy.

Major global economic events and implications

US data remains strong. While lower aircraft orders pulled durable goods orders down in October, core investment orders remain in a solid rising trend pointing to stronger business investment. Meanwhile consumer sentiment remains around its highest since 2000, existing home sales rose more than expected, business conditions PMIs fell slightly but remain strong and jobless claims remain ultra low.

While the minutes from the Fed’s last meeting and comments by Fed Chair Yellen highlight ongoing concerns about low inflation our view remains that disappearing spare capacity and the very tight US labour market will see core inflation head up towards the 2% target next year but it (and Fed rate hikes) will be gradual and we will remain in the “sweet spot” of the cycle (good growth/low inflation/benign central banks) for a while yet which is positive for shares. In the meantime, the Fed is on track for a December hike.
Eurozone business conditions PMIs rose further in November and are near as high as they ever get. Consumer sentiment also rose to a 20-year high. Very strong business and consumer sentiment point to further growth acceleration. In fact, based on business conditions readings and inflation the Eurozone is in an even better “sweet spot” than the US.


China saw another restructuring move with average import tariffs across a range of consumer goods to fall from 17.3% to 7.7%, providing a further boost to consumer spending and sending another signal its committed to free trade.

Australian economic events and implications

In Australia, construction data for the September quarter surged for the second quarter in a row sparking excitement that maybe an investment boom has arrived. But yet again it was due to a distortion associated with the installation of imported LNG equipment, so alas there won’t be any big flow through to GDP growth. Dwelling construction was also soft but private non-residential building rose, adding to signs non-mining investment is on the mend and public construction continues to surge on the back of the infrastructure boom.

Nothing really new from the RBA. The minutes from the RBA’s last board meeting were consistent with recent messages from the Bank: it remains confident that growth will pick up and that this will eventually boost growth in wages and inflation resulting in the next move in interest rates being up, but for now rates will remain on hold. While growth is likely to improve a bit, high underemployment, very low wages growth, the disinflationary impact of technological innovation (with Amazon’s expanded arrival in Australia likely to take 0.2% or so off inflation in 2018), below target underlying inflation and the risk that the Australian dollar, will remain too high mean that the RBA won’t be able to raise interest rates anytime soon. So our view remains that rates will be on hold out to the end of 2018 at least and it may be well into 2019 before rates start to rise. Meanwhile, the risk of another rate cut remains.

Meanwhile, with the housing market in Sydney and to a lesser extent Melbourne slowing, APRA has indicated its now looking into how banks assess living expenses and the total debt of borrowers. After the focus on slowing lending to investors and interest only borrowers this could be the next leg in an ongoing tightening in lending standards adding to the likelihood that the housing market won’t simply bounce back again next year, like it did in 2016 after slowing in 2015 after APRA’s first round of tightening measures.

What to watch over the next week?

In the US, the focus is likely to be a Senate vote on its tax reform bill. The GOP has 52 senators out of 100 so can only afford to lose two senators and still pass the bill with the Vice President’s casting vote. After more tweaks around contentious issues, we think it will pass – but it will clearly be close. Meanwhile, key data is likely to point to a slight lift inflation and continuing strength in business conditions. On Thursday the Fed’s preferred inflation measure, the core private consumption deflator is likely to show a slight lift in inflation to 1.4% year on year and on Friday the ISM manufacturing conditions index is likely to show that business conditions remain robust with a reading around 58.4. In other data expect to see a pullback in new home sales (Monday), continued gains in home prices and ongoing strength in consumer confidence (both due Tuesday), a rise in pending home sales and an upwards revision to September quarter GDP growth to 3.2% (both Wednesday) and a solid rise in personal spending for October (Thursday). Fed Chair Janet Yellen will deliver a speech that will no doubt be watched for any clues on US interest rates (both Wednesday).

 

In the Eurozone, expect economic confidence for November (Wednesday) to remain strong, unemployment for October to fall to 8.8% but core inflation for November to rise to just 1% year on year (both Thursday).

In Japan, expect industrial production (Thursday) to bounce back, and data on Friday to show a modest rise in household spending, a slight improvement in household spending and a slight rise in core inflation to 0.3% year on year.

Chinese manufacturing conditions PMIs (due Thursday and Friday) are likely to remain solid at around 51-52 and the non-manufacturing conditions PMI is expected to remain around 54.

OPEC’s meeting on Thursday will be watched closely with an extension in production cuts beyond their current expiry of March next year likely to be announced. If not, expect a sharp fall back in oil prices which have partly run up in anticipation.

In Australia, the key focus will be on September quarter business investment data (Thursday) which will provide an input in GDP estimates and a guide to the investment outlook. Expect a slight gain in business investment reflecting stronger non-residential building and a slight upgrade to the outlook for non-mining investment plans. Meanwhile expect continued moderate growth in credit and a 2.5% decline in building approvals (both Thursday) and CoreLogic data for November to show a further slowing in national home price growth (Friday) with further falls in prices in Sydney.

Outlook for markets

While the risk of a decent correction in global share markets is high (particularly given the risks around US tax reform and the December 8 debt ceiling and government shutdown deadlines), we are now in a favourable part of the year for shares seasonally and remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions. So we remain of the view that the broad trend in share markets will remain up. Australian shares are correcting their recent break above the 6000 level, but are likely to continue to participate in the global share rally albeit remaining a relative laggard thanks to a more constrained earnings outlook.

Low starting point government bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

The Sydney and Melbourne residential property markets are likely to slow further over the next year or two with prices likely to fall by around 5-10%. But Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or more and the Fed on track to hike in December with another three or more hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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Should we be concerned about a collapse in the Chinese economy?

Monday, November 20, 2017

By Shane Oliver

While Chinese shares rose 0.2% over the last week, US shares fell 0.1%, Eurozone shares fell 1.1%, Japanese shares lost 1.3% and Australian shares fell 1.2% with a bit of profit taking. Bond yields fell slightly as inflation news remained weak. While gold and copper prices rose slightly, iron ore was flat and the oil price fell slightly. Although the $US slipped back a bit the $A fell as weaker than expected wages growth further pushed out expectations for any RBA rate hike.

Uncertainty around US tax reform prospects and rising nervousness in the run up to the December 8 debt ceiling and shutdown deadline may impact markets ahead. However, both are likely to be resolved favourably providing a renewed boost to share markets when they are. Progress on US tax reform continues, but there is a way to go yet. The past week saw the House pass its tax reform bill, the Senate will then vote on its tax bill after Thanksgiving and, assuming it passes, the Senate and House must then agree on a combined bill. I have been assuming this will take into early next year but the risks for the GOP around the Alabama Senate election on December 12 may see it sped up. Either way, there is still a long way to go, but our view remains that - thanks to the immense pressure on the Republicans to get either tax reform or simple tax cuts done ahead of the 2018 mid-terms (after which they may not be able to) - there is a 70% chance they will be passed by March next year. While some senators have indicated concerns, these are likely to be resolved as part of the bargaining process. At the very least, tax reform or tax cuts will provide a big boost to high tax paying US companies, investors in which look to have given up on tax reform/cuts.

Resolution of the December 8 debt ceiling and shutdown deadline could cause a short delay in progress on tax reform – and several issues remain to be resolved including funding for Trump’s wall - but no side of politics wants to see a shutdown or debt default so the issue will be resolved even if its last minute and/or another case of kicking the can down the road.

Should Australia be concerned about a collapse in the Chinese economy as some are warning yet again? China is Australia’s number one trading partner so its more vulnerable to the Chinese economy than in the past. But warnings of a Chinese collapse have been around for years now and I continue to regard it as unlikely. The most common concerns about high and rising debt miss the reality that China’s high debt growth reflects its high saving rate which in turn gets largely channeled through the banking system as its capital markets remain underdeveloped. China does not rely on foreign capital (in fact its the opposite) and to slow its debt growth its needs to save less and spend more! Similarly concerns about its property market and commodity demand are misplaced. The “ghost cities” stories of a few years were literally just scary stories and much of China continues to have a housing shortage at the same time that many of the apartments built twenty years ago are now substandard and need to be replaced. Similarly, much of China remains under developed in terms of infrastructure, so peak raw material demand from China is a long way off. Yes, Chinese growth could slow towards 6% over the next few years but I doubt a hard landing any time soon. Certainly there was no sign of any hard landing in China when I visited it again in the last week - things were just as frantic as ever!

Its been another tumultuous weak on the citizenship front for Australian politicians with more resigning and increasing concerns about the Government’s majority and the risk of an early election. This is a mess…

…but at least we are making progress on getting one issue resolved with the Yes vote winning in the same sex marriage survey. Of course it’s about much much more than just material economics, but once its passed into law marriage equality in Australia will likely provide a boost over time to the economy. I must admit it’s very hard to estimate the magnitude of any such boost and its unlikely to be enough to prompt me to revise up my short term growth or interest rate forecasts. But the economic impact over a few years is far more likely to be positive than negative and easily exceed the $122 million cost of the ABS same sex marriage survey. An obvious beneficiary will be the marriage industry (as same sex couples marry here rather than overseas) and maybe the tourist industry from a possible increase in inbound tourism from LGBT people. More fundamentally though, just like earlier moves to extend the right to vote to women in 1902 and the 1967 referendum on citizenship for first Australians, extending the same marriage rights to all citizens will contribute to a more inclusive society in which all feel equally accepted and amongst other things able and motivated to contribute their best. Along with the productivity benefits of greater workplace diversity this provides, one outcome is likely to be stronger economic conditions over time than would otherwise be the case. If anyone thinks I have just gone flakey sprouting “luvvie economics” (as someone accused me of on Twitter) please see this which looks at “The Relationship Between LGBT Inclusion and Economic Development”.

Major global economic events and implications

US data remains strong with solid retail sales growth pointing to strong December quarter consumer spending, a big (partly hurricane related) jump in housing starts and permits, a very strong rise in industrial production in October, strong readings for small business confidence and regional manufacturing indexes and continuing very low unemployment claims. While a continued pick up in producer price inflation points to rising inflationary pressure this is yet to show up in CPI inflation where core inflation rose to just 1.8% year on year in October. Sure core inflation surprised on the upside in October but only if you go to the second decimal place – it was 0.22% month on month as opposed to market expectations for 0.2%!

Japanese September quarter GDP growth was a bit weaker than expected at 0.3% quarter on quarter or 1.7% year on year with a strong contribution from trade but weaker than expected consumer spending and business investment. Various confidence surveys and business conditions PMIs point to continuing good growth though.

Chinese economic data for October was a little bit softer, consistent with a moderation in economic growth to around 6.5%. Growth in retail sales, industrial production, investment, money supply and credit all slowed compared to September, suggesting that growth has moderated a bit after the slight acceleration seen over the last year, particularly as the property sector has slowed again. However, the softening in activity indicators was only modest, it may have been affected by the Party Congress, retail sales may have been affected by “Singles Day” in November and credit growth remains very strong at over 14% year on year. So don’t get too excited.

Australian economic events and implications

Australian data was the usual mixed bag providing something for the optimists and pessimists alike. On the upside, according to the NAB business survey business conditions rose to an (unbelievable) record high and business confidence remains strong and while jobs growth slowed to a crawl in October, full time jobs growth remains strong and unemployment fell further to 5.4%. On the downside, wages rose a less than expected 0.5% in the September quarter or 2% year on year which when adjusted for the bigger increase in the minimum wage this year means that underlying wages growth slowed to a record low of 1.8% year on year. The weakness in wages growth goes a long way to explaining why consumer confidence (which fell again in November) is so low relative to business confidence and together with still high underemployment and rising energy costs will act as an ongoing drag on consumer spending. We seem to be locked in the opposite of the 1970s upwards wage-price spiral where now low wages growth and low inflation are feeding on each other. The continued strength in jobs growth and falling unemployment holds out the prospect that sooner or later wages will accelerate and the downwards spiral will be broken. But for now we are still waiting and given the downside risks to consumer spending and inflation from weak wages growth it all means that the RBA will have to keep interest rates on hold at a record low for longer – probably into 2019 – and that the risk of another rate cut remains significant.

What to watch over the next week?

In the US, expect the minutes from the Fed’s last meeting (Thursday) to confirm that the Fed remains on track to raise interest rates by another 0.25% at its mid-December meeting. On the data front existing home sales (Tuesday) are likely to see a modest rise, the trend in durable goods orders (Wednesday) is likely to remain up pointing to ongoing strength in business investment and the Markit business conditions PMIs (Friday) are likely to remain solid.

Eurozone business conditions PMIs (Thursday) are expected to remain strong, consistent with ongoing strong economic growth.

In Australia, speeches by RBA Governor Lowe (Tuesday) and officials Kearns and Kohler (Monday) along with the minutes from the last RBA board meeting (Tuesday) will be watched for clues regarding the interest rate outlook. September quarter construction data (Wednesday) is expected to show a decline after a strong rise in the June quarter, but should show some evidence of improvement in non-mining investment and will provide input to September quarter GDP forecasts. Skilled vacancy data (Wednesday) will also be released.

Outlook for markets

The risk of a further short term correction or volatility in share markets is high given recent strong gains and risks around US tax reform and the December 8 debt ceiling and government shutdown deadlines. US shares have not had a decent correction since a near 5% pull back into the US election last year. But looking beyond the short term risk of a pause or correction we are now in a favourable part of the year for shares seasonally and remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions. So we remain of the view that the broad trend in share markets will remain up. Australian shares are likely to continue to participate in the global share rally, but remain a relative laggard thanks to a more constrained earnings outlook.

Bond yields look to be starting to break higher again, led by US bonds. Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.
Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne looks to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or more and the Fed on track to hike in December with another three or more hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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US tax cut conundrum

Monday, November 13, 2017

By Shane Oliver

Investment markets and key developments over the past week

Share markets were mixed over the last week with US shares down 0.2%, not helped by tax reform uncertainty and Eurozone shares down 2.3%, Japanese shares getting hit by profit taking but still managing a 0.6% rise and Chinese up 3% and Australian shares up 1.2%. Bond yields rose except in Japan. Oil, gold and iron ore prices rose but copper prices fell. The US dollar fell back a bit but the $A was little changed.

Uncertainty around US tax reform ramped up over the last week and will remain for a while yet, but the pressure on Republicans to get it or simple tax cuts done is intensifying. With the Senate releasing its version of tax reform with several differences versus the House version - notably around mortgage interest and state and local tax deductions and the start date for reducing the corporate tax rate - it’s clear that there is a long way to go yet before its agreed with the House (by which time the Senate’s proposed one-year delay to the corporate tax rate cut probably won’t survive because the House and Trump won’t support it). But this was always going to be the case, particularly given the need to constrain the cost to $US1.5 trillion over ten years. Going by the relative performance of US high tax paying companies, the US share market is now factoring in little prospect of tax reform or tax cuts. However, our view remains that it’s on track.

  • First, unlike Obamacare reform, lower tax rates are core to Republican belief. It’s what they do – think Reagan and Bush.
  • Second, political pressure to get it done has intensified. Strong Democrat support in the Virginian elections and President Trump’s low popularity indicate the GOP is on track to lose control of the House in the November 2018 mid-term elections. So, the pressure on Republicans to get tax reform (or cuts) done to boost their chances in the mid-terms and make sure it’s out of the way before they can’t do it anyway – is immense.
  • Third, if reform of deductions proves too hard politically the GOP can always revert to just delivering tax cuts, albeit the headline rates won’t be able to come down as much.
  • Finally, some Democrat senators may support it (12 did with GW Bush’s first tax cuts and three did with the second round). (And this may be necessary if the GOP loses the December 12 Alabama Senate election where their candidate is now embroiled in a scandal.)

As such, we remain of the view that the chance of US tax reform or simple tax cuts by March 2018 is 70%. The next step is for the House to vote on their plan probably in the week ahead, then for the Senate to vote possibly before Thanksgiving (Nov 23) but this could slip until after the December 8 debt ceiling and government shutdown issues are resolved. By the time the House and Senate are able to resolve all their issues it will be early next year.

More fundamentally, while there is much interest in US tax reform, there is a danger in overemphasising its importance to the US economy in the short term. At most it might add 0.1% to US GDP growth a year over ten years, maybe a bit more in initially. So some might argue its much ado over nothing much.

It’s too early to expect a negative impact on growth from rising oil prices, but they will likely put some renewed upwards pressure on headline inflation. Recent gains reflect a combination of stronger global growth driving stronger oil demand, constrained supply and worries that tension between Sunni Saudi Arabia and Shia Iran is intensifying again. However, the Saudi Arabia/Iran issue has flared up several times in recent years only to settle back down again. Our assessment remains that direct confrontation cannot be ruled out but ongoing proxy wars are more likely. But whatever, it all supports oil prices which could have more short term upside as global growth continues to improve, before supply starts to ramp up again (including from shale oil) to put a cap on prices. At this stage the rise in oil prices is not enough to threaten global growth - historically its only when the oil price rises 80% or more over a year that it causes major problems whereas at present its up only 15% year on year. But it may start to push inflation rates up again. And it’s good for energy related shares.

Australia is a net oil importer but net energy exporter so it will benefit from higher energy prices (as oil prices flow through to gas prices). It’s not so good for Australian consumers though. Petrol prices may have another 2-3 cents a litre upside as recent oil price increases flow through and this, combined with any further upside in gas prices, will be another constraint on consumer spending. (Note in the next chart that for the last three years Australian petrol prices have been running around 10 cents a litre higher than their normal relationship with oil prices would suggest – this appears to reflect higher refining margins.)



In Australia, the citizenship issue may become an increasing drag on confidence. While it was hoped that the High Court decision would resolve the issue this has not been the case with questions about new politicians continuing to be raised, with the possibility of more by-elections adding to the risk regarding the Government’s majority. The sense of malaise in Canberra that’s been the norm since 2010 continues.

Just as we saw the All Ords push through the 6000 level, the ASX 200 has now followed suit. Correction risks aside, our view remains that the share market has more upside ahead thanks to rising profits and benign monetary policy. The headline effect of the share market making it back through the 6000 level may also help boost interest in shares amongst ordinary Australian investors where share market scepticism has been running high. However, while the Australian share market has finally made it back above the 6000 level it has significantly underperformed global shares since 2009, this remains the case this year (with Australian shares up 6% or so but global shares up 14%) and is likely to remain the case for some time as global earnings growth is now running around 15-20% compared to underlying earnings growth in Australia of around 5-6%.

Major global economic events and implications

US data was a bit light on but job openings, hiring and workers quitting for new jobs all remain very strong and unemployment claims remain ultra low, consistent with a tight labour market and rising wage pressures. Meanwhile, the September quarter earnings reporting season is now largely complete with 91% of S&P 500 companies having reported. Companies have continued to surprise on the upside with 77% beating on earnings and 67% beating on sales. Earnings growth for the quarter has come in around 7% year on year, which is up from 4% a month ago and would have been closer to 10% were it not for the hurricanes.

Japanese wages growth picked in September but only to 0.9% year on year and it’s just back to where it was 18 months or so ago, so there is a fair way to go to be able to call it a sustained inflation driving pick up. Meanwhile, Tokyo office vacancies fell to an ultra-low 3% in October.

Chinese export and import growth slowed slightly in October but remains consistent with solid growth and foreign exchange data implies that capital outflow remains under control. Chinese consumer and producer price inflation came in a bit stronger than expected but not alarmingly so – core CPI inflation of 2.3% year on year is still low for an emerging country. It’s consistent with no PBOC easing though and points to solid nominal growth in China. Meanwhile, the announcement of a significant expansion in foreign access to the Chinese financial sector highlights that reform momentum is ramping up post the Party Congress.

Australian economic events and implications

RBA on hold and revises down its inflation forecasts yet again. While the RBA’s Statement on Monetary Policy remains relatively upbeat and still sees 3% plus growth by the end of next year, it slightly downgraded its growth forecasts and revised down its inflation forecasts by 0.25% to 0.5% seeing underlying inflation remaining below target for longer. The downwards revision to the RBA’s inflation forecasts reflects the ABS’s new CPI weights that correct for “substitution bias” (which sees increasing spending on things that fall in price like computers and reduced spending on items that go up a lot in price like tobacco), but regardless it all means that inflation is expected to take longer to get back to target, which in turn runs the risk that low inflation expectations will just get further entrenched, making it even harder to get inflation back up again and increasing the risk of deflation the next time the economy slows down. All of which means low interest rates for longer. Improving global growth and the RBA’s own forecasts for stronger growth along with solid business conditions and employment growth continue to argue against rate cuts. But ongoing low inflation and wages growth, uncertainty around consumer spending, signs that the housing cycle is slowing and the still strong $A argue against a rate hike. We remain of the view that the RBA will leave the cash rate on hold until a probable rate hike late next year. The risk is that rates won’t start rising until 2019 though.

On the data front in Australia, ANZ job ads showed good growth in October suggesting the labour market remains solid, but a further 6% plunge in housing finance commitments to investors in September highlights that APRA tightening measures are continuing to bite. Falling investor housing finance, falling auction clearance rates along with anecdotal evidence are consistent with an ongoing slowing in the Sydney property market and to a lesser extent in Melbourne. Expect more price declines in Sydney and eventually Melbourne ahead. The good news is that there is more room now for first home buyers whose share of housing finance has risen to a five year high.

What to watch over the next week?

In the US expect to see more solid readings for: small business optimism (Tuesday); retail sales (Wednesday); industrial production and the NAHB homebuilders’ conditions index (Thursday); and housing starts (Friday). The New York and Philadelphia manufacturing conditions indexes are also likely to have remained strong for November. Against this though, core CPI inflation (Wednesday) is expected to remain at 1.7% year on year.

Japanese GDP growth for the September quarter is expected to slip back to 0.4% quarter on quarter (from 0.6%), but annual growth is likely to pick up to 1.7% yoy.

Chinese activity data for October (due Tuesday) is expected to show continuing solid growth with retail sales up 10.4% year on year, industrial production slowing to 6.4% and fixed asset investment around 7.5%.

In Australia, the key focus is likely to be wages growth (Wednesday) which should show a bit of an acceleration, to 0.7% quarter on quarter or 2.2% year on year reflecting the 3.3% increase in the minimum wage, but beyond this underlying wages growth is likely to have remained weak. Meanwhile, jobs data (Thursday) is expected to show a 10,000 decline in employment after a long period of strength and unemployment rising to 5.5%. The NAB business conditions survey (Tuesday) and the Westpac consumer sentiment index (Wednesday) will also be released.

Outlook for markets

The risk of a short term share market correction is high given recent strong gains and this may have already started in Europe and Japan. US shares have not had a decent correction since a near 5% pull back into the US election last year. Australian shares are also short term overbought after their recent break higher. But looking beyond the short term risk of a pause or correction we are now in a favourable part of the year for shares seasonally and remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions. So we remain of the view that the broad trend in share markets will remain up. Australian shares are likely to continue to participate in the global share rally, but remain a relative laggard thanks to a more constrained earnings outlook.

Bond yields look to be starting to break higher again, led by US bonds. Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne looks to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or so and the Fed on track to hike in December with another three or so hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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9 lessons from the GFC

Monday, November 06, 2017

By Shane Oliver

Given the 10-year anniversary of the start of the GFC in terms of its share market impact, which saw 50% plus plunges in share markets its worth recalling the lessons it provided for us as investors. Here is a list of the main ones:

  1. At a time when many were talking of the “great moderation” and the death of the business cycle it reminded us that the economic and investment cycle lives on;
  2. The collapse of higher returning investments – including high yielding “yield funds” - provided a reminder that higher returns come with higher risk.
  3. It showed yet again that investor sentiment can push markets to extremes – eg, by early 2009 when shares had become substantially undervalued and underloved.
  4. It provided a reminder to be sceptical of investments that are hard to understand – remember CDOs?
  5. It provided a reminder of the dangers of too much gearing and debt of the wrong sort (like margin loans).
  6. It provided a reminder of the importance of having assets that provide true diversification to shares like government bonds as opposed to assets that may be lowly correlated to shares in good times (commodities and high yield debt) but highly correlated in bad times.
  7. The post GFC recovery showed that fiscal and monetary policy do work but that it can take longer to return to normal after major financial crises.
  8. It highlighted the importance of asset allocation as opposed to agonising about stock picking and manager selection.
  9. And finally, stuff happens! History tells us another financial crisis is inevitable at some point as each new generation forgets the lessons of the past and has to (re)learn them.

Investment markets and key developments over the past week

While Chinese shares fell 0.7% over the last week, US shares gained 0.3%, Eurozone shares rose 1.1%, Japanese shares gained 2.4% and Australian shares rose 1% helped by a combination of good global economic growth and earnings news.

The Australian All Ords index even managed to push above the 6000 level for the first time since early 2008. Bond yields fell helped by President Trump’s nomination of Jerome Powell to succeed Janet Yellen as Fed Chair and a fall back in Eurozone inflation. Oil and copper prices rose but the iron ore price fell slightly. The $US was flat against a basket of currencies but the $A was hit by very weak retail sales data.

Global share markets have been boosted by a number of positives over the last few weeks: strong economic growth and profits news; ongoing low inflation; progress on US tax cuts; the nomination of Jerome Powell as Fed Chair; confirmation that the ECB will continue quantitative easing next year and remains dovish; the continuation of Abenomics post Abe’s election victory; and the removal of uncertainty around China’s Communist Party Congress. This avalanche of positive news and removal of uncertainties has pushed global shares higher and dragged the Australian All Ords index above the 6000 level.

As expected, the Fed left monetary policy on hold and remains on track for a December rate hike. The Fed upgraded its characterisation of growth from “moderate” to now “solid” and it continues to regard recent inflation softness as temporary and likely to give way to a move back towards its 2% target as a result of falling spare capacity and faster wages. The October jobs report in the US likely keeps the Fed on track for a December hike – wages growth fell back to 2.4% year on year but this looks distorted by the hurricanes and meanwhile employment rebounded by 261,000, previous months’ payrolls were revised up by 90,000 and unemployment fell further to just 4.1%, indicating a labour market that is getting quite tight.

Continuity for monetary policy at the Fed under Jerome Powell. President Trump’s nomination of current Fed Governor Jerome Powell to replace Janet Yellen as Chair when her term expires in February next year signals more of the same at the Fed. Naturally, there may be a bit of market nervousness around the time of the handover and particularly around his first meeting in March next year (assuming he is approved by the Senate). But since becoming a Governor in 2012 Powell has been supportive of the Fed’s approach to monetary policy and is pragmatic and non-ideological and is likely to be a consensus builder as Chair. Barring any significant shocks Powell is most unlikely to alter the Fed’s current path of letting its balance sheet run down in line with the process announced in September and raising rates three times next year. So given Trump liked Yellen why did he even make the change? First, he wanted to leave his mark. Second, Powell appears supportive of taking a more relaxed approach to financial regulation than Yellen was.

The first indictments in the Mueller investigation into the links between the Trump campaign and Russia are unlikely to impact tax reform. First, two of the indictments don’t appear to be linked to Trump or the campaign and second, tax reform is a wider Republican objective that goes well beyond Trump. The investigation poses an ongoing risk and source of uncertainty regarding Trump and of course those indicted may seek to reveal something more damning regarding Trump, but unless there is ultimately a finding of clear criminal wrong doing by Trump the Republican controlled House of Representatives is very unlikely move to impeach him. Of course a Democrat House post the 2018 mid-terms may try – but by then tax reform/tax cuts should be passed. Meanwhile momentum continues on the tax reform front with the House releasing its tax reform bill. There were no great surprises with a 20% corporate tax rate, 12% deemed repatriation tax rate on corporate overseas cash and reduced personal tax rates. There is still a long way to go to iron out the details but we continue to expect it to be passed (with a 70% probability) by the March quarter next year.

The Australian All Ordinaries Index finally broke back above 6000 again in the last week – but its still well below its November 1 2007 peak of 6854 whereas the US share market surpassed its 2007 high back in 2013. Why the big lag? First the Australian share market rose very strongly into the 2007 peak on the back of the mining boom, whereas the US share market just spun its wheels last decade after first getting smashed by the tech wreck. So the 2007 high was a much higher high for our market and hence a higher hurdle to get back to. Second, Australian resource shares have been hit by the collapse in commodity prices since 2011. Third, Australian shares have also been hit by a bit of foreign investor scepticism regarding the outlook for China and perennial fears about a crash in property prices. Fourth, US and many global markets benefitted from zero interest rates and money printing whereas Australia has had neither. Finally, it should be noted that Australian companies pay higher dividends than US and foreign companies and once dividends are allowed for the Australian share market has surpassed its 2007 peak, albeit it’s still underperformed global shares in the period since the GFC.

Major global economic events and implications

US data remained strong and points to 4% or so growth this quarter. The manufacturing ISM fell but remains very high at 58.7, the non-manufacturing ISM rose to a very strong 60.1, consumer confidence rose to its highest since 2000, personal spending was very strong in September, payroll employment rebounded by 261,000 in October and previous months’ payrolls were revised up by 90,000, unemployment fell further to 4.1% and home prices continue to rise. While core private consumption deflator inflation remained low at 1.3% year on year in September, the September quarter Employment Cost Index confirmed some acceleration in wages growth. Wages growth in October fell back to 2.4% year on year from 2.8% but this looks distorted by the hurricanes. Meanwhile, September quarter earnings reports have continued to surprise on the upside with 77% beating on earnings and 67% beating on sales. While GE and hurricane affected earnings results have weighed on earnings growth in the quarter, estimates for the quarter have now pushed back up to 5% year on year after originally starting at 4%.

Eurozone data was remarkably strong with economic sentiment at its highest since 2001, GDP growth rising to its fastest since 2011 and unemployment falling to 8.9% - still high but that’s down from 12% just a few years ago! But despite this core inflation slipped back to just 0.9% year on year highlighting the ongoing lack of inflationary pressure and why the ECB will remain very gradual in slowing monetary stimulus.

The Bank of England raised interest rates by 0.25%, but only to 0.5% and its concerns around Brexit suggest it’s not hawkish.

The Bank of Japan left monetary policy on hold as expected with quantitative easing and the zero 10-year bond target to remain in place for a long time yet given ongoing core inflation near zero. Meanwhile, Japan’s economic data was mixed with strong labour market indicators, weak household spending and some slowing in industrial production. A solid PMI reading and rising consumer confidence suggests growth should remain reasonable in Japan.

China business conditions PMIs were mixed for October but are in their recent ranges and consistent with 6.5-7% growth.

Australian economic events and implications

Australian economic activity data was messy. On the one hand business conditions PMIs were mixed but point to okay growth, home building approvals remain solid, non-residential building approvals are pointing up and net exports look set to contribute around 0.3% to September quarter GDP growth. Against this credit growth slowed, home sales are falling, pointing to slower building approvals ahead and, most importantly, retail sales growth stalled in the September quarter with flat volumes and falling prices highlighting the ongoing pressure on households from weak wages growth, high underemployment and surging energy costs. Growth in consumer services and other parts of the economy, including trade volumes, will likely have kept the economy growing in the September quarter but overall Australian growth is likely to remain sub-par in contrast to the strengthening we are seeing globally.

Meanwhile, evidence continues to build that the property price boom in Sydney is over with CoreLogic data showing a further decline in prices in October. Auction clearance rates in Sydney are now falling towards levels around 55% that are normally associated with price declines on an annual basis and we expect Sydney home prices to fall around 5-10% over the next year or so. Across Australia the picture is very mixed: Perth is showing signs of bottoming; Adelaide, Brisbane and Canberra are seeing moderate growth; Melbourne is cooling a bit; and Hobart is rising solidly.



Source: Domain, CoreLogic, AMP Capital

What to watch over the next week?

It will be a quiet week on the data front in the US, although data on job openings and hiring (Tuesday) will likely show continued labour market strength and the preliminary November reading for consumer sentiment (Friday) is likely to show that consumer confidence remains strong. US September quarter earnings results will continue to flow.

Chinese trade data (Wednesday) is likely to show exports up 8% and imports up 18%, inflation data (Thursday) is expected to show CPI inflation rising to 1.7% but PPI inflation dipping to 6.7%. Credit data will also be released.

In Australia, the RBA (Tuesday) is expected to leave interest rates on hold for the 15th month in a row. The RBA’s forecasts for stronger growth along with solid business conditions and employment growth argue against rate cuts, but ongoing low inflation, record low wages growth, uncertainty around consumer spending as highlighted by very weak retail sales, signs that the housing cycle is slowing and the still strong $A argue against a rate hike. We remain of the view that the RBA will leave the cash rate on hold until a probable rate hike late next year at the earliest. The RBA’s quarterly Statement on Monetary Policy (Friday) is likely to see the RBA revise down its inflation forecasts reflecting the lower than expected

September quarter outcome, ongoing signs of weak pricing power and the latest CPI re-weighting. A shift to providing point forecasts is also likely to highlight a slower than expected path for inflation and maybe also growth. This along with likely ongoing RBA wariness regarding the outlook for wages and inflation is expected to reinforce the RBA’s short term neutral bias on interest rates.

On the data front in Australia, ANZ job ads (Monday) may be worth watching given a softening in job vacancies seen recently and September housing finance data (Thursday) is expected to show modest growth.

Outlook for markets

US shares remain overdue a correction, but looking beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. Australian shares are likely to continue to participate in the global share rally, but remain a relative laggard thanks to a more constrained earnings outlook.

Bond yields look to be starting to break higher again, led by US bonds. Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne looks to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or so and the Fed on track to hike in December with another three or so hikes next year under Jerome Powell the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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Trump to announce new Fed chair

Monday, October 30, 2017

By Shane Oliver

Global share markets rose over last week helped by solid earnings and economic data.
US shares rose 0.2% with strong gains in tech stocks, Eurozone shares gained 1.2% helped by a dovish ECB, Japanese shares rose 2.6% as Abenomics continues following the Japanese election and Chinese shares gained 2.4%.

Australian shares fell 0.1% not helped by political uncertainty at the end of the week after the High Court’s citizenship decision. Bond yields rose in the US and UK but fell elsewhere. While iron ore prices fell, oil prices rose. The $US had another leg higher on strong US data and ECB dovishness and this, along with lower than expected Australian inflation, saw the $A fall below US0.77.

As widely expected the ECB announced a further extension of its quantitative easing program at the reduced rate of €30bn a month from January 2018 for nine months and “beyond, if necessary” with ECB President Draghi saying it won’t suddenly stop next October. In doing so the ECB reiterated that interest rates will not be raised until “well after” QE ends, which implies not until 2019 at the earliest. Continuing QE and low rates in the Eurozone are a big positive for Eurozone shares and, at a time when the Fed is undertaking rate hikes and quantitative tightening, points to downwards pressure on the Euro. The continuation of QE in Europe when Japan remains locked on QE and zero 10-year bond yields, and the US is only tightening gradually, also highlights that global monetary conditions will remain easy for a long while yet. This, along with strong economic growth and earnings, largely explains why global share markets are so strong.

China’s Communist Party Congress saw an enhanced authority for President Xi Jinping as evident in the new seven-member leadership team, the absence of any heir appointed in the team and his “Thoughts on Socialism with Chinese Characteristics for a New Era” being enshrined in the Party’s constitution. However, we continue to expect a continuation of the recent direction in policy rather than a big shift in direction.

Is President Xi “recklessly building China on a foundation of sand” as a well-known US hedge fund manager suggested, presumably as a reference to rising debt? Not that I can see. Yes, debt levels have gone up rapidly but it borrows from itself, it hasn’t blown it on reckless consumption and it is aware of the problem. If anything it saves too much and has the problem that a big chunk of that saving is recycled through its banking system (which means it gets called debt). Yes, it has problems with unequal development and pollution – but so have all rapidly developing economies. Is it fair to criticise China on the grounds that “true developed economies do not impose severe capital controls or move short term interest rates hundreds of basis points overnight in attempts to manipulate their own currency” as the same hedge fund manager also said? Again I don’t think so – China is still a developing economy and most developed economies (the US and Australia included) have had phases of heavy market regulation often well after China’s current level of development.

Progress continues towards tax reform in the US with the House passing the Senate’s 2018 budget which will allow tax reform to proceed under the so-called budget “reconciliation” process. Our assessment is that it now has a 70% chance of getting up by early next year. The biggest risk is that the package loses the support of more than two GOP senators (for ideological reasons, feuds with Trump, poor health or a loss to the Democrats in the Alabama special senate election). Trump’s fights with various Republican senators highlight this risk but it must be remembered that tax cuts/reform are a fundamental Republican objective (ie, it’s much more than Trump) and Republican’s need a big win on something like tax reform ahead of the 2018 mid-term Congressional elections. (It’s worth noting though that some Democrat senators may support tax reform – as they did in relation to the Bush era tax cuts.) There is also uncertainty about the size of the fiscal stimulus tax reform will provide – eg will it rely on a growth dividend (called “dynamic scoring”) to make it revenue neutral over time or will the tax cuts expire after ten years like the Bush era tax cuts? Out of interest the Senate budget allows for a $1.5 trillion net deficit increase due to tax reform over ten years which, if spread evenly, is about 0.1% of GDP a year but it is likely to be more front loaded.

But at a big picture level, tax reform in the US will mean a small boost (maybe 0.2% to 0.3%) to 2018 GDP growth, a likely additional Fed rate hike (four hikes in 2018 rather than three) and more upwards pressure on US bond yields and the $US. For Australia, US tax reform would mean a lower than otherwise $A, more flexibility for the RBA and more pressure to lower our corporate tax rate (given the risk some companies may choose to relocate their headquarters to the US).

In Australia, the High Court’s disqualification of four senators and the Deputy PM from sitting in parliament due to their dual citizenship has led to an increase in political uncertainty. The four senators will be replaced by people from their own party but the Deputy PM must face a December by-election which if he loses will mean the Government will lose its majority. However, initial polling suggests he is likely to retain his seat and even if he doesn’t it’s unlikely that all four independent members will vote with the ALP and Greens. So the Government is likely to retain power but only just, which prevents a risk should the Government face another by-election. The risk is that increased political uncertainty damages business confidence and adds to downwards pressure on the $A.

Major global economic events and implications

US data remains strong with strong business conditions PMIs, a rebound in new home sales, solid gains in durable goods orders pointing to solid business investment and ultra low jobless claims. While GDP growth came in at 3% annualised in the September quarter, private demand growth slowed partly due to the hurricanes but looks likely to bounce back strongly in the current quarter. September quarter earnings reports have continued to surprise on the upside with 79% beating on earnings and 68% beating on sales.

Eurozone business conditions PMIs remain strong (up for manufacturers and down for services) and the German IFO has almost reached its highest level since 1969.

Japanese core inflation remained at 0.2% year on year in the September quarter which is well below the Bank of Japan’s 2% target, ensuring its ultra easy monetary policy will continue.

Chinese home prices were flat in September under the influence of property cooling measures, but industrial profits surged 27.7% consistent with strong growth.

Australian economic events and implications

Australian inflation surprised again on the downside in the September quarter, producer prices were weak and import prices fell – RBA rate hikes are still a way off. Our view remains that the RBA won’t raise interest rates until late next year as it will take a while for a gradual pick-up in economic growth to flow through to wages growth and higher underlying inflation. RBA Deputy Governor Debelle’s reference to sizeable spare capacity in the labour market and flat Phillips curves implies ongoing RBA concern about low wages growth.

What to watch over the next week?

In the US, the Fed (Wednesday) is expected to leave interest rates on hold but indicate that recent weakness in inflation is likely to be temporary given strong indications regarding growth and that as such it remains on track to raise interest rates again in December and that quantitative tightening is proceeding as planned. On the data front, the main focus will be on October jobs data (Friday) which is expected to show a 300,000 rebound in payrolls to make up for the hurricane driven 33,000 decline seen in September. Unemployment is expected to remain around 4.2% but wages growth may also slip back a bit to 2.7% year on year. Meanwhile, expect to see strong growth in personal spending but continued low core inflation for September (Monday), ongoing gains in home prices, solid consumer confidence and an edging up in employment costs (all Tuesday), continued strength in the ISM manufacturing index (Wednesday) and a slight worsening in the trade deficit (Friday). September quarter earnings results will also continue to flow.

President Trump will likely also announce his nomination for Fed Chair – it seems to have come down to a choice between existing Chair Yellen, current Fed Governor Jerome Powell and academic John Taylor. Yellen and Powell would be more of the same and Taylor may be seen as a bit more hawkish albeit he has said that his Taylor rule should not be applied mechanically. However, it’s doubtful the choice will change the tightening path the Fed takes over the next year, but Taylor may be slower to respond in the event of a deflationary crisis.

Eurozone data is expected to show continued strong readings for economic confidence (Monday), a fall in unemployment to 9%, a rise in September quarter GDP growth of 0.6% quarter on quarter or 2.5% year on year and underlying inflation (all Tuesday) remaining at 1.1% year on year.

Japanese data is expected to show continued labour market strength, a pick up in household spending growth and some slowing in industrial production (Tuesday). But reflecting ongoing near zero core inflation the Bank of Japan, which also meets on Tuesday, is expected to continue quantitative easing and keep the 10-year bond yield around zero.

China’s manufacturing conditions PMIs (Tuesday and Wednesday) are expected to point to continued solid growth.

In Australia, expect continued moderate growth in credit (Tuesday), CoreLogic data (Wednesday) to show further evidence of a moderation in home price growth, a 1% fall in building approvals (Thursday) and a 0.3% gain in September retail sales (Friday) after two months of falls. September quarter real retail sales data is expected to show a sharp slowing.

Outlook for markets

US shares are overdue a correction, but looking beyond short-term uncertainties, we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. Australian shares are likely to continue to participate in the global share rally, but remain a relative laggard thanks to a more constrained earnings outlook.

Bond yields look to be starting to break higher again, led by US bonds. Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne looks to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

With the RBA on hold for the next year or so and the Fed on track to hike in December with another three or four hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

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Progress on US tax reform

Monday, October 23, 2017

By Shane Oliver

Investment markets and key developments over the past week

Share markets mostly rose over the last week helped along by continuing good economic data. US shares gained 0.9% boosted by progress towards tax reform, Japanese shares rose 1.4%, Chinese shares rose 0.2% and Australian shares gained 1.6%. Eurozone shares were flat though with Spanish shares slipping as the Spanish Government looks to be moving towards taking over the Catalan Government. Australian shares are continuing to play catch up after underperforming significantly year to date with utilities, financials, consumer staples, IT, resources and health stocks all seeing good gains over the last week. Bond yields rose in the US and Europe but fell in the UK and Australia. Oil and metal prices rose but the iron ore price was flat. The $A fell as the $US rose on the back of progress towards US tax reform.

Given the 30th anniversary of the 1987 share market cras,: the prior 12 month gains have been far more modest today and valuations are now far more reasonable once lower inflation and bond yields are allowed for. All of which suggests the circumstances are very different now. The 1987 crash was also a bit of an oddity because it was unrelated to any economic downturn at the time or afterwards. While it may have been triggered by rising inflation and tightening monetary conditions in the US its severity owed much to “portfolio insurance” which saw declines trigger more selling and further declines. While circuit breakers introduced after the 1987 crash are designed to limit vertical falls, the growth of high frequency trading, ETFs and possibly investment programs driven by artificial intelligence all mean that we can’t rule out another crash like 1987 at some point. At the end of the day though we also have to bear in mind that crashes and bear markets are part and parcel of share investing and ultimately the price we pay for higher long term returns from the asset class compared to say bank deposits.

Chinese President Xi Jinping’s opening address at the Communist Party Congress referred to “a new era of socialism with Chinese characteristics”. However, it sounded more likely a continuation of the recent direction in policy rather than a big shift in direction. More focus on quality growth, less on growth for growth’s sake, ongoing reform and more emphasis on pollution and equality (both global themes). While there may be less emphasis on growth targets, the objective to double 2010 GDP by 2020 implies GDP growth of 6-6.5% pa. So expect growth to remain solid, albeit we may see a bit of fine tuning towards more economic reform.

Progress continues towards tax reform in the US with the Senate passing a 2018 budget with the House likely to vote on the budget and probably pass it too in the next week or so. The passage of a 2018 budget is a critical step because it allows tax reform to proceed under the so-called budget “reconciliation” process which means Republicans would only require 51 votes to pass it though the Senate rather than requiring Democrat support to get to 60 votes. Congressional tax writing committees are planning to release draft tax reform legislation by early November with the aim of enacting tax reform by year end (or it could be early next year). The main risks relate to the Republicans’ making sure they lose no more than 2 senators in terms of support for tax reform (as it would still pass with Vice President Pence’s vote) - an Alabama Senate special election presents some risk on this front as polls currently show the GOP and Democrat candidates tied (in Alabama of all places! – not so good for Trump). We remain of the view that tax reform or tax cuts will get up (with a 60% or so probability). The poor performance of high tax paying companies suggest that tax reform is not priced into US shares.

While the first round of NAFTA talks have ended with no agreement and Mexico and Canada seemingly at loggerheads with a now protectionist US, the fear that the US will just withdraw has been eased by an extension of the talks into next year. So it looks like the US would still prefer a deal. So trade wars still yet to happen under Trump. Our base case remains some sort of deal will be reached.

New Zealand has a new coalition Government with NZ First agreeing to support Labour and the Greens.
The risk is that it will take a bit of a populist bent in contrast to the rationalist National Party Government it replaces, reflecting similar pressures to those seen in recent elections in the UK, US and Australia, putting downwards pressure on the $NZ.

The Australian Government unveiled its long awaited energy policy with a focus on both reliability and emissions reduction. This is designed as a way out of the surge in prices that has occurred in response to gas shortages, unsettled climate change policy and a surge in intermittent renewable power without storage. Although I am a bit unsure as to why it should necessarily drive lower prices, the dual focus does make sense. It still must pass Federal parliament though (with bilateral support essential if industry is to take it seriously) and needs state agreement. So a way to go yet.

Major global economic events and implications

US data remains solid. While housing starts and permits remained depressed by the hurricanes in September, a bounce back in the home builders’ conditions index points to a rebound this month. And the lowest level in jobless claims since 1973, and strong regional manufacturing conditions index readings for October, point to strong underlying economic growth. With Fed Chair Yellen expressing on going confidence that inflation will rise, the Fed remains on track for another hike in December (with the money market seeing an 84% probability) and likely another three hikes next year (whether its Powell or Taylor or whoever appointed to be next Fed Chair). Meanwhile, although consensus profit growth expectations for September quarter earnings growth are relatively subdued at 4.3% year on year (weighed down by insurers after the hurricanes) results to date have been solid with 82% of results beating on earnings and 75% beating on sales. That said, only 88 S&P 500 companies have reported so far.

Chinese economic activity data for September provided no surprises with a fractional slowing in GDP growth to 6.8% year on year, slight lifts in growth in retail sales and industrial production but a slight fall in investment growth. It basically tells us that Chinese growth has stabilised at a solid rate. Monetary policy will not be eased much going forward but nor will it be tightened. Rather it remains a case of continued fine tuning with maybe a bit more post Congress emphasis on reform, bringing credit growth under control and more property cooling measures but only to the extent growth remains solid.

Australian economic events and implications

Australian jobs data surprised on the upside yet again in September with annual jobs growth of 3.1% at its highest since 2008 and unemployment continuing to trend down. Our jobs leading indicator remains strong, pointing to continued solid jobs growth. This is all good news and should lead to faster wages growth eventually – but the US experience (with still low wages growth despite 4.2% unemployment) along with ongoing high levels of job insecurity, suggest we may have a way to go yet. So while the strong jobs data taken in isolation points to the risk of an earlier than expected RBA rate hike, the ongoing weakness in wages growth, along with risks around the consumer and the still high $A, argue against a near term rate hike. On this front the latest RBA minutes add little that is new but it did reiterate that there is no mechanical link between higher interest rates overseas and Australian interest rates, with domestic economic conditions being the key driver of local interest rates. Out of interest: looked at Tasmania lately? – its unemployment rate has fallen below that of Queensland!

What to watch over the next week?

In the US, expect October Markit business conditions readings (Tuesday) to remain solid at around 53-55, the trend in durable goods orders to remain up and further gains in home prices (both Wednesday) but hurricanes may have continued to dampen new home sales (also Wednesday) and pending home sales (Thursday). Similarly, the hurricanes are likely to have resulted in September quarter GDP growth (Friday) slipping slightly to 2.5% annualised from 3.1% in the June quarter, but a bounce back is likely in the current quarter. September quarter earnings results will continue to flow.

In the Eurozone, the focus is likely to be on the ECB which is likely to announce that quantitative easing will be continued for another 9 months from January 2018 at the reduced rate of €30bn a month with a reaffirmation of forward guidance that rates won’t be raised until “well past” the ending of QE. Perhaps the main interest though will be on whether the ECB indicates that this will likely be it for QE or whether the door will be left open for another extension if needed. On the data front, expect October business conditions PMIs (Tuesday) to remain strong at around 56-58 pointing to continuing solid economic growth

In China the focus will be outcomes from the Communist Party Congress but it’s doubtful that it will signal anything unexpected. Property price data will be released Monday and industrial profit data on Friday.

In Australia, expect higher energy prices only partly offset by lower petrol prices to push CPI inflation (Wednesday) up to 0.8% in the September quarter or 2% year on year. However, underlying inflation is likely to have remained soft at 0.5% quarter on quarter thanks to ongoing pricing softness in response to constrained demand, weak wages growth and the rise in the value of the $A. This should still take underlying inflation back to 2% year on year though which is at the bottom of the RBA’s target range (after 1.8% yoy in the June quarter). Data for skilled vacancies and producer prices will also be released.

Outlook for markets

While we are moving into a more favourable part of the year for shares from a seasonal perspective, North Korean risks remain high, Trump related risks remain and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This has already helped drag Australian shares up out of their June to September range bound malaise.

Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne looks to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.

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China will be the main focus globally

Monday, October 16, 2017

By Shane Oliver

While Eurozone shares were flat over the last week and US shares only rose 0.2% (with good data but uncertainty about tax reform and President Trump’s end to Obamacare related health insurance subsidies acting as constraints), Japanese shares rose 2.2%, Chinese shares rose 2.2% and Australian shares had a good 1.8% rebound from the bottom of the range they have been in for the last few months. Partly reflecting another weak US inflation reading, bond yields fell in the US, Europe and Australia. The $A rose as commodity prices rose & the US dollar slipped after several weeks of gains.

Reflecting the ongoing improvement in the global growth outlook the IMF yet again revised up its global growth forecasts for 2017 and 2018, highlighting how the global growth story has switched from disappointment over the 2012 to 2016 period to upside surprises more recently. This is supporting profits and hence growth assets like shares.

Rising female participation in the economy is good for growth as it will boost the workforce and a more gender diverse workforce is good for productivity. The latest Financy Women’s Index (which can be found here) shows that women are continuing to make economic progress both in absolute terms and relative to men, particularly in terms of workforce participation and wages. This is great news but there is much further to go. Boosting female workforce participation to that of males could add up to 8% to the size of the economy or $147bn to annual GDP and help offset the impact of the aging population. There would likely be an additional boost to the extent that greater female participation will result in increased workplace diversity which in turn will contribute to a more productive workforce – as Australian company boards are starting to recognise.

Major global economic events and implications

US data remains solid. Retail sales surged in September and were revised up for August, consumer confidence rose to a 13 year high, small business optimism remained high in September, August readings for job openings, hiring and quits were all strong, initial jobless claims are continuing to unwind their hurricane related boost and producer price inflation is continuing to trend up. While core inflation disappointed yet again in September and remained at 1.7% year on year, we remain of the view that an uptick in US inflation is still on the way, thanks to strong growth and the tight labour market. As such, the Fed is still likely on track for a rate hike in December. Meanwhile, the Goldilocks combination of good growth and low inflation keeps the Fed benign for now which is good for shares.

Eurozone industrial production rose by more than expected in August. But with ECB President Draghi saying “we’re still not there yet” in terms of wages and sticking to the commitment to only raise interest rates “well past” the conclusion of its quantitative easing program - which we think will be extended at the rate of €30 billion a month from January for another 6-9 months – means that as things currently stand the ECB is unlikely to raise interest rates until well into 2019.

Japan saw strong readings for machine orders and economic sentiment. Reflecting strong economic conditions, Tokyo’s office vacancy rate has fallen to just 3.17%.

Chinese foreign exchange reserves rose again in September, highlighting that capital outflows remain under control and the fact export and import growth accelerated is telling us that global and domestic demand remains strong.

Australian economic events and implications

Australian data was more upbeat over the last week with continuing strength in business conditions, a slight rise in business confidence and an improvement in consumer confidence. September quarter home price data from Domain added to evidence that the Sydney property market has rolled over with significant price declines. It would be wrong to read too much into just one quarter’s data but price softness is consistent with a sharp fall in auction clearances and anecdotal evidence. Housing finance data showing a surge in lending to first home buyers indicates that recent NSW and Victorian government moves to increase stamp duty concessions for first home buyers have worked which, along with still strong population growth and various other factors, highlights why a property crash is unlikely.

The RBA’s Financial Stability Review saw the Australian financial system as being strong with low non-performing loans but continues to see the main risks as relating to household debt and the housing market. However, the Bank does note slower growth in riskier types of lending and signs of easing in the Sydney and Melbourne property markets. The RBA also announced that it will be conducting bank stress tests which is surprising given that’s normally the role of APRA. Early conclusions suggest the banks are resilient except in extreme shocks. Its possible such tests could be used to justify a further tightening of macro prudential standards at some point.

What to watch over the next week?

China will likely be the main focus globally in the week ahead with the commencement of the Communist Party Congress on Wednesday and September inflation and economic activity data due for release. The Congress is almost certain to see President Xi Jinping continue as General Secretary and Li Keqiang remain as Premier, but the leadership team will be renewed around them with President Xi seeing his authority enhanced. Post the Congress we may see a refocus on reform but it’s doubtful that there will be an abrupt policy change and as we have seen over the first five years of President Xi’s leadership, there will be a careful balancing of reform and maintaining growth.

On the data front in China, September inflation data (Monday) is likely to show a fall back in CPI inflation to 1.6% year on year and producer price inflation is expected to fall slightly to 6.2% yoy. More importantly, economic activity data (Thursday) is expected to show a modest slowing in GDP growth in the September quarter to 6.8% yoy, September industrial production growth is expected to pick up to 6.5% yoy, retail sales growth is likely to remain at 10.1% yoy and investment is likely to slow to 7.6% yoy. None of which will cause much excitement in financial markets or at the PBOC.

In the US September industrial production (Tuesday) is likely to see a return to growth and October home builder conditions (also Tuesday) are likely to bounce back up a bit but September housing starts (Wednesday) and existing home sales (Friday) are likely to remain subdued thanks to the hurricanes. Regional manufacturing conditions indicators for October are likely to remain strong. The Fed will also release its Beige Book of anecdotal indicators (Wednesday) and Fed Chair Yellen in a speech on Friday may reiterate the case for another rate hike in December. The September quarter profit reporting season will also start to ramp up and will likely show another increase in profits from a year ago, although the hurricanes may have temporarily dampened things later in the quarter.

Japan’s election (Sunday October 22) is likely to see PM Abe’s LDP led coalition comfortably returned with poll support for the new Party of Hope declining. Abenomics will continue! (although I suspect it would have anyway but under a difference name if the Party of Hope were to win.)

In Australia, the minutes from the RBA's last board meeting (Tuesday) are unlikely to add anything new and will continue to imply that the RBA retains a neutral short term bias with respect to interest rates. September jobs data (Thursday) is likely to show a 10,000 fall in jobs but with unemployment unchanged at 5.6%.

Outlook for markets

This is still a seasonally volatile time of the year for shares, North Korean risks remain high, Trump related risks remain and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This should eventually drag Australian shares up from their range bound malaise.

Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne is likely to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.

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Global share markets climb wall of worry

Monday, October 09, 2017

By Shane Oliver

Investment markets and key developments over the past week

Despite uncertainty about who will chair the Fed and tax reform in the US, 59 shot dead and over 500 injured in another terrible US mass shooting in Las Vegas, a political crisis in Spain and the ongoing issue around North Korea, global share markets continued to climb the classic wall of worry over the last week. Why? Put simply the global economy is looking stronger and stronger and this is driving profits all at a time when inflation and central banks remain relatively benign. US shares rose 1.2% over the last week with gains being pared on Friday after North Korean tensions flared up again, Eurozone shares rose 0.2% and Japanese shares gained 1.6%. Australian shares rose 0.5% but remain big underperformers year to date reflecting a relatively less positive growth and profit outlook. Bond yields were mixed: up in the US, flat in Japan and Germany but up in Spain and Italy after the Catalan mess and down in Australia. While metal and iron ore prices rose, oil and gold prices fell. The $A also fell back below $US0.78 as the $US continued to recover.

Expect increasing focus on who will be the next Fed Chair as President Trump will reportedly make an announcement on his choice in the next couple of weeks. But it’s doubtful it will make much difference to what the Fed does in the next year or so. The list of people reportedly being considered for chair includes some monetary policy hawks (John Taylor who advocates a rules based approach for the Fed and Kevin Warsh who was a relative hawkish Fed Governor over 2006 to 2011) and some who are likely to be neutral/dovish (current chair Janet Yellen, current Fed Governor Jay Powell and Trump economic adviser Gary Cohn). In the interest of having one less source of instability I would argue it’s in Trump's interest to reappoint Janet Yellen, but her views on financial regulation may work against that. However, with the Fed already on a tightening path (it has already announced a schedule for reducing its balance sheet and is on track for more interest rate hikes) it’s doubtful that whoever is appointed will take a significantly different direction for US monetary policy over the next year or two compared to what would occur under Janet Yellen. The real test may come during the next crisis when a hawkish Fed Chair may be slower to react.

The upcoming Communist Party Congress in China (starting October 18) is generating much anticipation. President Xi Jinping is almost certain to continue as General Secretary and Premier Li Keqiang will likely continue as well, but leadership will be renewed around them with the popular President Xi seeing his authority enhanced. Post the Congress we may see a refocus on reform but it’s doubtful that there will be an abrupt policy change and as we have seen over the first five years of President Xi’s leadership there will be a careful balancing of reform and maintaining growth.

Major global economic events and implications

US data remains strong. September jobs data was hit by the hurricanes but a rebound is likely this month, the ISM business conditions indexes rose to very strong levels in September (no hurricane dip here) with very strong readings on employment plans and auto sales surged in September (although this may reflect hurricane replacement demand). This is all consistent with another Fed rate hike in December with the money market probability of a December move now at 79%.

Japanese data was strong with further gains in the Tankan business conditions indexes, okay readings in business conditions PMIs and a rise in consumer confidence.

Details from the People’s Bank of China regarding a cut in bank required reserve ratios for lending to small business, start-ups and agricultural businesses indicate that most banks will benefit. While it should really be seen as a targeted measure to encourage entrepreneurship and innovation as opposed to being a monetary easing, it highlights that the Chinese authorities wish to maintain decent growth.

Australian economic events and implications

As expected, the RBA left interest rates on hold for the 14th month in a row and retained a basically neutral short term bias on rates. Improving global growth, strong business confidence and jobs growth, the RBA’s own expectations for a growth pick up and already high levels of household debt argue against a rate cut. But record low wages growth, low underlying inflation, the impending slowdown in housing construction, risks around the consumer and the strong $A argue against a rate hike. The next move in rates is likely to be up, but for now the downside risks are still significant and as such we remain of the view that it’s way too early to start raising rates just yet and don’t see a rate hike until late next year.

Data releases over the last week are consistent with the RBA remaining on hold. Trade data is pointing to an ongoing contribution to growth from trade volumes and business conditions PMIs fell in September but remain solid. Against this though, building approvals and new home sales point to a declining trend in dwelling construction albeit gradual and a sharp fall in August retail sales indicate that the weak consumer has returned. Meanwhile, further evidence of a loss of momentum in home prices for September suggests that this year’s tightening in lending standards is working,

What to watch over the next week?

In the US, the minutes from the Fed’s last meeting (Wednesday) are unlikely to add much that’s new with quantitative tightening underway and the Fed likely on track for another rate hike in December (with a 70% probability according to the US money market). On the data front expect continued strength in small business confidence (Tuesday) and job openings (Wednesday), a rise in September core CPI inflation to 1.8% year on year from 1.7% (Friday) and a 1.2% rebound in retail sales (also Friday) for September after the hurricane depressed fall in August.

It’s pretty quiet on the data front in Europe but there may be some noise ahead of Austrian parliamentary elections on October 15 with current polling suggesting the currently governing Social Democrats will lose to conservative People’s Party who may form a coalition with the nationalist Freedom Party. Such an outcome would likely add to a tougher line on immigration across Europe and may slow European integration a bit as the German election outcome may, but is unlikely to threaten the Euro with the People’s Party supportive of the Euro and Freedom Party dropping demands to ditch it.

Chinese trade data for September is likely to show an acceleration in export growth to 10% year on year reflecting the strong global economy and a slight rise in import growth to 15% yoy. Money supply and credit data will also be released.

In Australia, the NAB business survey (Tuesday) will be watched for any slippage in business conditions, consumer confidence (Wednesday) is expected to remain relatively subdued and housing finance (Thursday) is expected to rise 0.5%. The RBA’s semi-annual Financial Stability Review will be watched for how the RBA views recent progress in reducing financial stability risks around the property market.

Outlook for markets

This is still a seasonally volatile time of the year for shares, North Korean risks remain high and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This should eventually drag Australian shares up from their range bound malaise.

Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

Residential property price growth in Sydney and Melbourne is likely to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.

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