Call us on 1300 794 893

The Experts

Shaneoliver_normal
Shane Oliver
Financial markets
+ About Shane Oliver

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

Trump's pro-business agenda remains on track

Monday, March 27, 2017

By Shane Oliver

Investment markets and key developments over the past week

The US share market finally saw a daily decline greater than 1% for the first time since last October and this dragged other share markets down to greater or lesser degrees over the last week. Chinese shares rose 1.3% over the week, but US shares fell 1.4%, Eurozone shares fell 0.2%, Japanese shares lost 1.7% and Australian shares fell 0.8%. Worries about whether President Trump will be able to pass his pro-business agenda of tax cuts, deregulation and infrastructure spending were the main drivers but high levels of short term investor optimism have left the market vulnerable. The risk off tone in markets saw government bond yields decline, credit spreads widen and commodities excepting gold weaken. The $US also fell, but this didn't stop a decline in the $A.

Will Trump's pro-business agenda pass Congress after the vote on a replacement for the Affordable Care Act (or Obamacare) was pulled? Can the Republicans get their act together? A common concern seems to be that if Trump and the Republicans can't pass their Affordable Care Act (or Obamacare) replacement, what hope have they got for the bigger measures around tax cuts, etc.? This reasoning is too simplistic. Obamacare had three key elements: Federal spending on healthcare subsidies; tax hikes to pay for them; and regulations imposed on health insurers. The Republican House leadership reasoned that if they reverse the spending increase and tax hikes then their Obamacare reform could pass through the Senate as part of the budget reconciliation process which just requires 51 votes (out of 100 Senators) which they have rather than the normal 60 votes (which they don’t have) if they push for removal of regulations as well. The sticking point was that the Freedom Caucus (a group of conservative tea party sympathetic Republicans in the House) wanted to remove the regulations too which would mean that any bill that passes in the House probably wouldn’t pass in the Senate. So the decision was taken that it’s all too hard and so the vote was pulled. This is good because it was just a distraction.

But a failure of the Obamacare reform does not mean that Trump’s pro-business reforms will be stalled. The Freedom Caucus, the broader Republican Party in Congress and Trump all want lower taxes and less regulation and would prioritise this as they want to “starve the beast” of government as they see it. The GOP also realise that given the risks around Trump's presidency (investigations around links to Russia, risk of eventual impeachment) and the risk they lose the Senate in next year's mid-terms mean that they only have a small window to get through the reforms they want. So they are not going to let the failure (so far) to repeal Obamacare get in the way of their small government agenda. The bottom line is that Trump’s pro-business agenda remains on track. Out of interest, note that on Friday Trump formally approved the Keystone XL pipeline, his third energy infrastructure project to be approved. 

The tragic events in London perpetrated by another deranged nutcase provide another reminder of the ongoing terrorist threat. But as has been the case with recent terrorist attacks the impact on investment markets was minor as investors have become accustomed to them (much as occurred a generation or so ago with the IRA and other terror attacks in Europe) and their economic impact remains insignificant.

In Australia, signs continue to point to an imminent fresh round of macro prudential controls to slow lending to property investors and further tighten home lending standards. The minutes from the RBA’s last Board meeting clearly indicate that it has become more concerned about a “build-up of risks associated with the housing market” and there is reportedly a special regulatory working group – composed of the RBA, APRA and ASIC – looking at the issue. Likely measures include a cut in the cap on annual growth in the stock of investor lending to 5-7% from 10% now (it’s been running at 8.5% lately) and tougher interest rate tests for borrowers. In fact, with out of cycle bank mortgage rate hikes heavily skewed to property investors (at around +25 basis points) as opposed to owner occupiers (at around +3 basis points) it’s clear that the regulators have already increased the pressure on banks to slow lending to investors. The last round of macro prudential measures combined with significant negative media publicity at the time worked very well in late 2015/early 2016 in slowing the Sydney and Melbourne property markets and would have kept working if they were tightened again around six months ago when it became clear that the initial impact was wearing off. Sure macro pru is second best to using rate hikes to slow property prices, but in the absence of more fundamental solutions it’s the best option at a time when its way too early to hike rates given the state of the overall economy and property markets outside of Sydney and Melbourne.

While strong population growth means that underlying property demand remains strong, the threats to the hot Sydney and Melbourne property markets are continuing to build: another round of macro-prudential measures looks on the way with regulators already putting pressure on banks to slow lending to property investors; the banks are raising rates out of cycle particularly for investors (with the CBA and ANZ joining the NAB and Westpac in hiking in the last week); the Federal, NSW and Victorian governments are swinging into gear to improve housing affordability; all at a time when the supply of units is surging; and prices are ridiculous. Expect a significant cooling in price growth in Sydney and Melbourne this year followed by 5-10% price falls commencing sometime in 2018.

Major global economic events and implications

US data was mostly good. Existing home sales and home prices were weaker than expected but durable goods orders were strong, new home sales surged, jobless claims remain historically low and while the manufacturing PMI fell it remains solid.

Eurozone business conditions PMIs rose more than expected in March to strong levels and point to a pickup in growth. Consumer confidence rose and is about as high as it ever gets. Europe is looking good for investors as growth looks set to pick up and this will boost profits, the ECB remains very supportive and Eurozone shares are relatively cheap in part due to overstated fears of a break-up of the Eurozone.

Japan’s manufacturing conditions PMI slipped in March but remains in a rising trend and continues to point to reasonable economic growth.

Australian economic events and implications

In Australia, official ABS home price data confirmed that the housing market has hotted up again after a soft patch in late 2015-16. Private data points to a further acceleration in the first few months of this year. Sydney and Melbourne remain the main culprits though with prices still trending down in Perth and Darwin and only seeing moderate growth in other cities. Meanwhile, September quarter data showed an uptick in population growth to a solid 1.5% year on year or 349,000 people highlighting a key source of underlying property demand.

What to watch over the next week?

In the US, no doubt the debate around the failure to reform Obamacare will remain a focus. But in our view it was just a silly distraction and President Trump and Congressional Republicans will just move on to the key elements of his pro-business agenda, notably tax cuts. On the data front, expect to see consumer confidence remaining high and continued growth in home prices (both Tuesday), a bounce back in pending home sales (Wednesday), modest growth in personal spending and core consumption deflator inflation remaining around 1.7% for the 12 months to February (Friday).

Eurozone economic confidence indicators (Thursday) are expected to remain solid and core inflation is likely to have remained unchanged at 0.9% year on year in March.

Japanese data for February to be released Friday is likely to show continued strength in the labour market, strong industrial production but weak household spending and core inflation remaining only just above zero.

The UK will likely trigger Article 50 of the Lisbon Treaty on Wednesday setting off a two year negotiation process to exit the EU. There will be a long way to go but the EU is likely to be a tough negotiator.

China’s manufacturing conditions index for March (Friday) is expected to slip back to 51.5 but retain most of its recent gains.

In Australia, expect credit growth (Friday) to remain moderate but the focus will likely be on a further acceleration in lending to property investors. Data on new home sales and job vacancies will also be released.

Outlook for markets

Shares remain vulnerable to a short term pull back of around 5% as investor sentiment towards them is very bullish and a lot of good news has been factored in which has left them vulnerable to any bad news as the uncertainty around Trump’s pro-business agenda showed over the last week. However, we would see any pullback as an opportunity to “buy the dips” as valuations are okay, global monetary conditions remain easy and global profits are accelerating on the back of stronger global growth. So shares are likely to continue to trend higher on a 6-12 month horizon.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. At present bond yields are still consolidating after last year’s rise, but a resumption of the bear market is likely at some point in the months ahead seeing a gradual rise in yields. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term.

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

For the past year the $A has been range bound between $US0.72 and $US0.78 and this may continue for some time yet. At some point this year though, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the Fed hikes 3 or 4 times and the RBA remains on hold).

Eurozone shares were flat on Friday and the US S&P 500 lost 0.1%. US shares had a bit of a roller coaster session - initially rising 0.4%, then falling 0.4% as the vote on replacing Obamacare was pulled only to end little changed as the focus moved on to tax reform. Reflecting the basically flat global lead ASX futures rose just 1 point (or 0.02%) on Friday night pointing to a basically flat open for the Australian share market on Monday morning.

| More

 

5 reasons why the RBA won't raise rates this year

Monday, March 20, 2017

By Shane Oliver

Global shares got a boost over the last week from a dovish rate hike from the Fed and relief that the Dutch election saw a rejection of far-right Eurosceptics. US shares gained 0.2%, Eurozone shares rose 1.2% and Chinese shares rose 0.5%. Reflecting the positive global lead, resources shares helped drive Australian shares 0.4% higher. Japanese shares slipped 0.4% though as the Yen rose. The Fed’s dovish hike also saw bond yields and the $US decline, which in turn helped commodity prices, emerging market shares and the $A.

The Netherlands election

The Netherlands election highlights, yet again, that the risk of a Eurozone break up is exaggerated, with Dutch voters turning out in large numbers to support pro-Euro parties. PM Mark Rutte’s Liberal Party won 33 seats in the 150 seat lower house of parliament against Geert Wilders’ Eurosceptic Freedom party which only received 20 (or just 13% of the vote). The Liberal Party will lead negotiations to form a centrist coalition government (which usually takes months) and Rutte will most likely remain PM. This is a blow to the Freedom party, which only a few weeks ago looked like it could get more votes than any other party. It’s the third election in the Eurozone in a row since Brexit – Spain, Austria and now the Netherlands – that has seen anti-Euro populists bomb out. The Europeans look to have seen Brexit and Trump and decided that’s not for them! Popular support for the Euro remains high and this is clearly working against populist/nationalist parties and is likely to do so too in the French elections too. This is positive for the Euro and leaves Eurozone shares and peripheral bonds looking attractive. (Adding in the West Australian election result, it wasn’t a good week for populists in Australia either!)

The US Federal Reserve

The Fed hikes, but continues to signal that future rate hikes remain conditional on improving growth and inflation and will likely remain gradual. It does not want to do anything to upset the recovery. The median dot plot of Fed officials’ interest rate expectations remained unchanged at three hikes for this year and another three hikes for next year, and the Fed continues to expect that future hikes will be “gradual”. This does not mean that the Fed poses no threat. Market expectations still look remarkably complacent and at some point in the next year, the focus will shift to the Fed allowing its balance sheet to start running down (by letting bonds roll off as they mature). This all points to a resumption of the bond bear market at some point.

 

Source: Bloomberg, Federal Reserve, AMP Capital

So far, share markets are following the pattern of the last twenty years where the initial Fed hike in a tightening cycle causes share market weakness (eg, June 2004, December 2015) but subsequent hikes have little impact as they are seen as consistent with stronger growth and profits, until monetary policy eventually becomes tight. With rates starting much lower and the process being far more gradual this time around, we still have a fair way to go before US monetary policy becomes tight enough to threaten the bull market in shares.

Of course, the US wasn’t the only country where interest rates were a focus in the last week. The People’s Bank of China increased key money market rates by 0.1% in a continuation of moves seen last month. However, the moves are very minor and look largely to be designed to stop growth from accelerating too far (given the commencement of a large number of infrastructure projects) rather than to slow the economy. The Fed’s move added to the case to move in order to minimise downwards pressure on the Renminbi.

By contrast, both the Bank of Japan and Bank of England left monetary policy on hold. In fact, the BoJ could be seen as being on autopilot, having committed to quantitative easing and keeping the 10-year bond yield at zero until inflation exceeds 2%. So the rest of the world still lags the US by a long way.

Finally, in Australia the National Australia Bank & Westpac raised rates for property investors and owner occupiers – the latter by 0.07% and 0.03% respectively. With global funding costs for banks having increased on the back of higher bond yields, out-of-cycle rate hikes for owner occupiers seemed likely at some point. Changes in investor rates have less impact on spending in the economy because they are tax deductible and investors are less sensitive to rate moves, but changes in owner occupier rates will cause more agitation. However, 3-7 basis point hikes are unlikely to have much economic impact and like the out-of-cycle rate hikes seen in November 2015 are likely to be ignored by the RBA. That said, if banks hike owner occupier rates by 25 basis points or more then the RBA may have to consider offsetting it with another cash rate cut. While the bank moves will lead to the usual waffle about whether the RBA still has much influence over lending rates it's noteworthy that out-of-cycle bank moves have been a regular occurrence since the GFC and yet this did not stop mortgage rates falling to record lows in response to RBA rate cuts. Changes in the cash rate remain the main driver of bank mortgage rates.

Source: RBA, AMP Capital

Major global economic events and implications

Most US data remains strong with small business confidence and regional business conditions indicators remaining robust, consumer sentiment up, manufacturing production up solidly, the NAHB’s home builders’ conditions index rising to its highest since 2005, housing starts up more than expected and labour market indicators remaining strong. Retail sales were softish though providing a brake on GDP growth (and the Fed). 

While President Trump’s budget proposals with massive spending cuts to pay for increased defence spending have caused much excitement, Congress drives the budget and will ultimately settle on a massively watered down compromise.

Chinese economic activity data for January/February indicated that solid growth momentum has continued into this year with industrial production and investment accelerating and real retail sales growth remaining strong. 

Australian economic events and implications

In Australia, two things happened over the last week. First, RBA Assistant Governor Bullock added to the message that more macro prudential measures could be on the way to cool down the Sydney and Melbourne property markets. This could include tougher interest rate tests and a reduction in the 10% growth cap for loans to property investors. Threats to the Sydney and Melbourne property markets are steadily building: state and Federal governments are shifting into gear to improve affordability; another round of macro-prudential measures looks on the way; the banks are starting to raise rates for owner occupiers out of cycle; all at a time when the supply of units is surging; and prices are ridiculous.

Second, economic data was mixed. Business conditions and confidence slipped but remain high according to the NAB survey. Consumer confidence edged up but remains around average. Jobs fell in February but full-time employment rose and leading jobs indicators point to solid jobs growth ahead. A rise in labour underutilisation to 14.6% is a concern though. 

Five reasons why the RBA won’t hike this year

Growth is still sub-par; labour underutilisation remains very high; underlying inflation is at risk of staying below target for longer; banks are raising lending rates out of cycle; and the $A has been going the wrong way. Another round of macro prudential controls to slow housing gives the RBA flexibility on this front. Our view remains no hike until the second half of 2018.

What to watch over the next week?

The G20 Finance ministers meeting will be watched for what it says on trade and currencies given the US focus on “fair trade” but is unlikely to have much market impact.

In the US, a speech by Fed Chair Yellen (Thursday) will be watched to see whether she seeks to temper the dovish market reaction to the Fed’s most recent meeting. On the data front, expect to see continued gains in home prices (Wednesday) but a fall back in home sales (also Wednesday and Thursday) after strong gains in January, February durable goods orders to show ongoing improvement and the March manufacturing conditions PMI (all Friday) to remain strong.

Eurozone business conditions PMIs for March (Friday) are also likely to remain at strong levels.

In Australia, the minutes from the last RBA Board meeting (Tuesday) are likely to confirm the RBA is comfortably on hold. But most interest will be around comments in relation to lending standards. Speeches by the RBA’s Ellis and Debelle will also be watched for any clues regarding rates and new macro prudential requirements. Expect ABS data to confirm a solid +2% gain in December quarter home prices (Tuesday).

Outlook for markets

Shares remain vulnerable to a short term pull back as investor sentiment towards them is very bullish and a lot of good news has been factored in – but there is a risk that any pullback may not come until seasonal weakness kicks in around May. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. They look to be starting their bear market again after a pause in the rise in yields since December. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

For the past year, the $A has been range bound between $US0.72 and $US0.78 and this may continue for some time yet. At some point this year though, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the Fed hikes 3 or 4 times and the RBA remains on hold). 

Eurozone shares rose 0.3% on Friday but the US S&P 500 slipped 0.1% despite solid economic data. The softish US lead saw ASX 200 futures fall 0.2% pointing to a 13 point decline at the open for the Australian share market on Monday morning.

| More

 

Fed on track for rate hike

Monday, March 13, 2017

By Shane Oliver

Investment markets and key developments over the past week

While US shares fell over the last week on nervousness ahead of a likely Fed rate hike, the loss was cut to 0.4% after the release of solid jobs data on Friday and most share markets rose with European shares up 0.3%, Japanese shares up 0.7%, Australian shares gaining 0.8% and Chinese shares flat. Bond yields pushed up in most regions – with yields in the US and Australia rising above their highs in December last year. Commodity prices were generally soft, with the oil price down 9% as US oil stockpiles rose with shale oil production looking like its offsetting OPEC production cuts. While the $US ended little changed, the $A fell to $US0.7544.

Solid US employment growth of 235,000 in February, a fall in unemployment and a slight rise in wages growth keep the Fed on track to raise interest rates again this coming Wednesday. By the same token, the pick-up in wages growth remains very gradual, and a likely rise in labour force participation will help keep it that way, which in turn, supports the view that future Fed rate hikes will be gradual too.

With short-term investor sentiment towards shares remaining very bullish, nervousness around a third Fed rate hike (along with worries around Trump, Eurozone elections or even North Korea) could help drive a correction in shares. However, with US monetary policy a long way from being tight, future rate hikes likely to be gradual and US economic data likely to be solid we don’t see it derailing the bull market in shares.

While I am not so worried about a Eurozone break up (support for the Dutch Freedom Party seems to be fading and Le Pen may have peaked in France at levels that won’t result in a victory in the second round), North Korea is worth watching. Tensions have clearly escalated, with North Korea’s latest missile test, South Korea employing the US THAAD missile defence system and China sanctioning both Koreas. This is likely to be just be another flare up in tensions to be followed by a cooling, but it’s a bit less certain than in the past, given North Korea’s nuclear capability and the US looking at “all options”. At least two things have been cleared up: despite pre-election rhetoric to the contrary, the US under President Trump is standing behind South Korea and Japan; and the upholding of President Park’s impeachment will see South Korea move forward on its political mess with new elections likely to see a new Democratic Party of Korea government take a less hard-line position towards North Korea.

The RBA stays put

RBA on hold at 1.5% for the seventh month in a row. As noted last week, we now expect the RBA to leave rates on hold for the rest of the year. Another rate cut is still possible, but it would require another leg down in underlying inflation. That said, talk of a rate hike this year is way too premature. Just because the US is hiking does not mean that the RBA will follow suit. The US is further into a growth recovery cycle than Australia, and since the Global Financial Crisis, RBA interest rate moves have diverged from those in the US - with the RBA hiking in 2009 and 2010 when the Fed was on hold and the RBA cutting rates last year when the Fed had increased rates.

More macro-prudential measures to slow housing may be on the way in Australia?

While I may be jumping at shadows, the latest post-meeting Statement from the RBA implied a bit of unease regarding lending to residential property investors and lending standards, probably on the back of the continuing surge in Sydney and Melbourne home prices. Most notably in the February Statement, it said that “supervisory measures have strengthened lending standards” whereas it's now saying that “supervisory measures have contributed to some strengthening of lending standards” which suggests the RBA thinks a further tightening in lending standards in relation to lending for housing may be required. More macro-prudential measures to slow property investment may be on the way, and this could take the form of lowering the threshold for growth in banks’ total lending to investors to say 7% year on year from 10% currently.

The past week saw the 100 year anniversary of the first Russian revolution (what a fizzer and waste of life the second one later the same year turned out to be!) and International Women’s Day. To help track the economic progress of Australian women, Financy (a women’s money website) and Data Digger (a data company) have produced an index that brings together six key indicators. What is interesting is that our biggest listed corporates are driving change at the very top with more women on boards and this is the main driver of the Financy Women’s Index since 2012. Hopefully, the realisation of the benefits of gender diversity on boards will trickle down through our workforce in the years ahead. 

Major global economic events and implications

US jobs data was strong, with payrolls up solidly, continuing very low jobless claims and a strong rise in imports driving a deterioration in the US trade deficit.

As expected, the ECB left monetary policy on hold, with President Draghi expressing a bit more confidence in the growth outlook but is yet to be convinced the rise in headline inflation is sustainable. He's still sounding dovish, albeit less so. We can't see the ECB announcing a tapering to its quantitative easing program for 2018 until after the French election is out of the way (and assuming Le Pen does not win).

Chinese macro-economic targets for 2017 from the People’s Congress contained few surprises – growth at 6.5%, inflation at 3% and the budget deficit as a percentage of GDP at 3% - and confirmed that the focus is on stability.

Chinese economic data was a bit mixed. While imports surged 38% year on year in February, pointing to strong domestic demand, exports surprisingly fell 1% year on year, which is contrary to evidence of stronger global growth. Both look a bit exaggerated and may reflect distortions due to the timing of the Chinese New Year holiday. Similarly, while producer price inflation accelerated further in February to 7.8% year on year, consumer price inflation fell, suggesting little pass through of the rise in producer prices. Again, holiday distortions may be playing a role. While it's clear that deflation has ended, producer price inflation is likely to slow going forward as the low base in commodity prices drops out of the annual calculation. Finally, credit growth slowed sharply in February. PBOC tightening may have played a role but the slowing largely reflects a reaction to the surge in January. Given the month to month volatility, it's best to take an average of the last two months, and it remains solid. Chinese data is consistent with further modest PBOC tightening, but it’s likely to remain gradual.

Australian economic events and implications

Australian retail sales bounced back in January after a couple of soft months, telling us that consumer spending has started 2017 on a solid note. While ANZ job ads fell in February, this followed a strong January and the trend points to solid jobs growth going forward. Finally, housing finance was stronger than expected in January due to another surge in lending to property investors – which is up nearly 28% from a year ago, highlighting that the dampening impact of APRA’s macro-prudential controls has worn off.

What to watch over the next week?

In the US, all eyes will be on the Fed, which on Wednesday is expected to announce its third rate hike for this cycle increasing the Fed Funds rate by 0.25% to a range of 0.75-1%. We have seen a run of solid economic data, the Fed is at or close to meeting its inflation and employment objectives, and such a move has been well flagged by Janet Yellen and others at the Fed.

As such, the money market is attaching a 100% probability to a hike on Wednesday. The main focus though will be the Fed’s commentary around the move which is likely to indicate that future moves will be conditional on continued economic improvement and that they will likely remain gradual. The so-called dot plot of Fed officials’ interest rate expectations could also shift up from showing three rate hikes this year to four. There may also be some discussion on when to start shrinking the Fed’s balance sheet, but the message is likely to remain that this will wait until the Fed Funds rate is closer to “normal” and that it will be achieved by letting maturing assets run off.

On the data front in the US, expect strength in small business optimism (Monday), a further rise in headline CPI inflation to 2.6% year on year, but a slight fall in core inflation to 2.2% year on year, a modest rise in retail sales and continued strength in the NAHB home builders’ index (all Tuesday), a rise in housing starts (Thursday) and a rise in industrial production (Friday). 

The main event in Europe will be the Dutch election on Wednesday. Recent polling points to a decline in support for the Geert Wilders' Eurosceptic Freedom Party from around 20% of the vote to less than 16%. It won't be able to form government which will ultimately come from a coalition of centrist parties. An outcome around these levels would be a positive sign for the Eurozone continuing to stay together and hence a positive for Eurozone shares.

The Bank of Japan (Thursday) is not expected to make any changes to monetary policy having committed in September to open ended quantitative easing until it exceeds its 2% inflation target, which at this stage, remains a long way away.

The BoE (Thursday) will probably make no changes to policy.

Chinese activity data for January/February (Tuesday) is expected to confirm that momentum in growth remained solid into 2017 with industrial production likely to pick up to 6.3% year on year (from 6% in December), retail sales likely to accelerate to 10.6% (from 10.4%) and fixed asset investment likely to accelerate to growth of 8.5% (from 8.1%).

In Australia, expect business conditions and confidence to remain at high levels according to the February NAB business survey (Tuesday), consumer confidence (Wednesday) to have risen slightly and February jobs data (Thursday) to show a 15,000 gain in employment and unemployment rising again to 5.8% on the back of higher participation.

Outlook for markets

Shares remain vulnerable to a short-term pull back as investor sentiment towards them is very bullish, the Fed is getting a bit more aggressive, Trump related uncertainty remains, various European elections could create some nervousness and North Korea is a potential risk factor as well. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. They look to be starting their bear market again after a pause in the rise in yields since December.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term.

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne and rising apartment supply hits.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

For the past year, the $A has been range bound between $US0.72 and $US0.78 and this may continue for some time yet. At some point this year though, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the Fed hikes three or four times and the RBA remains on hold).

Eurozone shares rose 0.2% on Friday, and the US S&P 500 rose 0.3% helped by a solid jobs report which points to the Fed hiking rates on Wednesday, but without having to get aggressive going forward. ASX 200 futures rose three points or 0.1%, pointing to a flat/mild positive start to trading for the Australian share market on Monday.

| More

 

US Fed on track for March rate hike

Monday, March 06, 2017

By Shane Oliver

The past week saw US shares rise 0.7%, European shares gain 2.6% and Japanese shares rise 1% helped by strong US forward looking data, signs that the Fed is increasingly confident in the US outlook and confidence that President Trump is in on track with his pro-business agenda.

By contrast, Australian shares fell 0.2% and Chinese shares fell 1.3%. Bond yields generally rose as the probability of a March Fed rate hike rose, and this also saw the $US rise slightly, which in turn put downwards pressure on some commodity prices and the Australian dollar, notwithstanding a reversal on Friday.

Despite much anticipation, President Trump’s Congressional address provided little detail on his pro-business policies, but he made plenty of references to deregulation, corporate and personal tax cuts and infrastructure spending and he sounded more presidential. As a result, share markets remained happy. Interestingly, the Trump administration also sent to Congress its trade policy agenda, which made reference to pursuing bilateral trade deals and renegotiating existing deals, but does not signal the widespread application of tariffs, which adds confidence to the view that a trade war will be avoided.  

The US Fed on interest rates

There was more interest in relation to the Fed, where comments by various Fed officials that it should move “soon” to raise rates again, and that the risks were “starting to tilt to the upside” (backed up by Fed Chair Yellen and Vice Chair Fischer) saw the money market’s implied probability of a March rate hike rise to 94%.

Given the run of strong US data and with Yellen, Fischer and New York Fed President Dudley confirming that a March hike is likely, we have moved our timing for the next Fed rate hike from May/June to March. If this were happening a year ago, share markets would have gone into a tailspin. But, because the US economy is stronger now, the Fed’s confidence in the outlook actually seems to be supporting the share market. After the strong gains since the US election, the likelihood of a short-term share market correction remains high. That said, the US share market seems to be following the pattern seen in previous rate hiking cycles, i.e. a pullback around the first hike (February 1994, June 2004 and December 2015) and then rallying into and through subsequent hikes because economic data is better. Back in the 2004-2006, tightening cycle rates were going up at every Fed meeting and it took 17 hikes to ultimately kill the bull market off.

A March hike would potentially open the door to four Fed hikes this year, but compared to the 2004-2006 rate hike cycle, this time around the tightening process is likely to be a lot slower reflecting still constrained GDP growth (so far March quarter growth looks like being below 2% again), still low wages growth and the strong and rising $US. Consistent with this, Janet Yellen indicated that she sees no evidence the Fed is behind the curve and continues to see rate hikes as being “gradual”, albeit faster than in the last two years.

Source: Bloomberg, AMP Capital 

Housing market risks 

The OECD is right to warn about Australian house prices, excessive household debt and the risk to the economy. Such risks are real, particularly with Sydney home prices up 73% over the last five years against wages growth of just 13%. Housing - both affordability and the nexus of excessive home price and household debt growth - remains Australia's Achilles heel. It's worth noting though, that such warnings have been issued continuously since 2003 and yet the property market keeps on keeping on. Our view remains that unit prices in some oversupplied areas will fall 15-20% at some point and that a 5-10% cyclical downturn in average home prices is likely once interest rates start to rise. But, it remains hard to see a generalised home price crash in the absence of: much higher interest rates causing a wave of defaults (but the RBA is not going to raise interest rates until it gets to that point); a surge in unemployment (of which there is no sign at present); and a continuing surge in supply (but building approvals look to have peaked). While the property market is proving even stronger than I thought, my views on the risk of a property crash are unchanged from those in this note.

Major global economic events and implications

US data was mixed – but where it counts in the forward looking indicators, it was strong. On the soft side, December quarter GDP growth was left unchanged at 1.9%, pending home sales fell, construction fell, real consumer spending fell in January and the trade deficit widened. But more importantly, consumer confidence rose to its highest since 2001, unemployment claims fell to their lowest since March 1973 and the ISM conditions indexes rose to strong levels near 58.  

In the Eurozone, economic confidence rose to a new six-year high, adding to the message from business conditions PMIs that growth is likely to accelerate. Meanwhile, headline inflation rose to 2% year-on-year in February on higher energy prices, but core inflation remained stuck at 0.9%. 

Japanese industrial production fell in January, but a rising trend in the manufacturing conditions PMI points to a rebound going forward. Labour market data was strong, but household spending was weak and core inflation remained low at 0.2% year-on-year – but at least it’s up from 0.1%. The BoJ remains a long way away from tightening. 

Chinese manufacturing conditions improved in February and services conditions held strong consistent with growth remaining solid.

Rising export momentum across Asia – with Korean exports up 20% year-on-year – is consistent with the stronger global growth theme. Even Indian GDP growth surprised on the upside in the December quarter, despite “demonetisation”.

Australian economic events and implications

The Australian economy saw some good news with December quarter real GDP rebounding by a greater than expected 1.1% quarter-on-quarter, robbing the doomsters from being able to declare a recession. The rebound in real growth was broad based across consumer spending, public demand, housing investment, business investment and trade. Nominal growth was also strong reflecting higher commodity prices which, in particular, supported profits. While growth will likely slow back a touch in the current quarter on slower consumer spending and trade, it’s likely to be close to 3% through 2017. In other data, the trade surplus fell sharply in January, but this looks to be due largely to temporary factors including the early timing of the Chinese New Year holiday and a slump in volatile gold exports. Building approvals rose slightly in January and new home sales fell slightly but the trend is down in both, pointing to a loss of momentum in housing investment. House price growth though stayed uncomfortably strong in Sydney and Melbourne in February according to CoreLogic, adding to RBA wariness about cutting rates again.

The Australian December half-profit reporting season wrapped up and left listed company profits on track for a 19% rise this financial year after two consecutive years of falls. The profit turnaround has all been driven by resources companies which are on track for a rise in profit of 150% this financial year, reflecting the benefits of higher commodity prices and volumes on a tighter cost base. Profit growth across the rest of the market is likely to be around 5% but it should accelerate in 2017-18 as economic growth improves.

What to watch over the next week?

In the US, February jobs data on Friday will be watched very closely as it’s the last major data release ahead of the Fed’s March 15 meeting. Payrolls are expected to rise by around 190,000 with unemployment falling back to 4.7% and wages growth edging up. Coming on the back of a run of solid data releases, this should keep the Fed on track for a rate hike on March 15. Meanwhile, expect the January trade deficit (Tuesday) to worsen slightly.

The European Central Bank is expected to make no change to monetary policy on Thursday. It has already committed to continue its €60bn a month asset buying program to year end and it’s premature to expect any announcement regarding a 2018 taper, particularly with risks around the French election and core inflation remaining well below target at 0.9% year-on-year. 

Chinese import and export growth for February (Wednesday) is likely to show a further acceleration, with imports up 18% year-on-year and exports up 14% year-on-year, and while CPI inflation (Thursday) is likely to drop back to 2% year-on-year, producer price inflation is expected to accelerate further to 7.5% year-on-year. The National People’s Congress that starts Sunday is likely to confirm a growth target of around 6.5% for this year.

The Reserve Bank is expected to leave interest rates on hold when it meets Tuesday. Economic growth bounced back nicely in the December quarter, recent economic data has been reasonable (particularly business conditions surveys), national income is rising again and growth in Sydney and Melbourne property prices is too strong for comfort. As a result, we expect the RBA to leave the official cash rate at 1.5% and we now expect the RBA to leave rates on hold for the rest of the year. Another rate cut is still possible, but it would require another leg down in inflation to get the RBA to cut again. On the data front, expect January retail sales (Monday) to bounce back by 0.4% after a slight fall but housing finance (Friday) to fall by 1.5%.

Outlook for markets

Shares remain vulnerable to a pull back as short term investor sentiment towards them is very bullish, the Fed is getting a bit more aggressive, Trump related uncertainty remains and various European elections could create nervousness in coming months. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds, reflecting higher yields and as the RBA is well behind the Fed in raising rates. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The Australian dollar could still see a retest of $US0.78 which, if broken, would likely see a run up to $US0.80. However, the downtrend in the $A from 2011 is likely to resume at some point this year as the interest rate differential in favour of Australia narrows (as the Fed hikes three or four times and the RBA remains on hold).

Eurozone shares gained 0.3% on Friday and the US S&P 500 rose 0.05% as Fed Chair Yellen and Vice Chair Fischer confirmed that another rate hike is likely at the Fed’s mid-March meeting, but with Yellen indicating that rate hikes will likely remain “gradual”. Following the slightly positive global lead, ASX 200 futures gained 0.4% pointing to a 21-point gain at the open for the Australian share market on Monday, reversing half of Friday’s 0.8% decline. 

| More

 

Shares at risk of short-term correction

Monday, February 27, 2017

By Shane Oliver

The past week saw shares rise 0.9% in the US, 1.5% in China and 0.3% in Japan helped by more good economic data, but Eurozone shares fell 0.3% and Australian shares lost 1.2% as profit results became more mixed towards the end of the profit reporting season. Bond yields generally fell and commodity prices were mostly up. The $A was little changed.

While shares have generally continued to push higher, they remain at risk of a short-term correction being technically overbought again and with short term investor sentiment at levels often associated with corrections. A major misstep on economic issues by Trump, worries about Eurozone politics, policy tightening in China or signs of faster Fed rate hikes could all be a trigger. Trying to time this remains difficult though and we just see it as a correction (say with a 5% decline) rather than something more severe with the profit outlook (both globally and in Australia) continuing to improve.

Business conditions PMIs remain strong in February, with Europe and Japan up but the US down slightly albeit remaining strong. This is good news for a continuation of the global profit recovery going forward, with profits needed to take over as a key driver of the bull market in shares as shares are no longer dirt cheap or under loved.

Eurozone break up risks continued to remain a focus over the last week with: the risks easing a little around the French election (as the prospects of combined Socialist/far left presidential bid receded, an investigation around Le Pen's use of European Union funds hotted up and centre-left candidate Macron and another centrist candidate agreed to work together); Greece edging towards a deal with the IMF and EU on its latest bailout review; but the risks around a break-up of the governing Democratic Party in Italy remaining. There is a long way to go on the Eurozone break up risk soap opera, so lots could go wrong (including more rioting in French suburbs boosting support for Le Pen), but a break up still seems far from imminent so spikes in fears around Europe should be seen as buying opportunities. Particularly with Eurozone shares still clearly cheap and underlying economic conditions in Europe looking good.

On the interest rate front in Australia, a speech and Parliamentary testimony by RBA Governor Philip Lowe has reiterated that the RBA is trying to balance the risks of inflation staying lower for longer versus the threat to financial stability that may flow from ever higher household debt if the RBA cuts rates again. Governor Lowe is clearly happy with another “period of stability” in rates and, in other words, is prepared to run a higher risk in terms of inflation remaining lower for longer to head off the risk of higher household debt. Fair enough. As this points to a relatively high hurdle to cutting rates again – e.g., worsening unemployment or a further leg down in inflation – the risk that we may not get the rate cut we have been looking for is high.

Two reasons why allowing first home buyers in Australia to access their super to buy a house is a really dumb idea. First, any boost in their home buying power will just be reflected in even higher home prices (as with first home buyer grants and lower interest rates). Second, it will mean they have less money for retirement as their lower super balances in the early years of their working lives will mean less for compound interest to work its magic on. So even less affordable housing and less in retirement. This idea gets floated every few years but its best forgotten.

Major global economic events and implications

The key message from the minutes from the Fed's last meeting was that the Fed is on track to raise interest rates again "fairly soon", providing economic data is in line with or better than their expectations. Of course, the term "fairly soon" is a bit vague and could mean any of its March, May or June meetings. Since the last Fed meeting though, strong payrolls data and CPI inflation suggest a risk of a March move but slow wages growth and a desire to remain consistent with three hikes this year point to a move around May or June. This is our base case but we see a 40% chance of a March hike. Meanwhile, data over the last week added nothing new with business conditions PMIs falling slightly in February but remaining strong, home sales rising strongly, home prices continuing to rise, consumer sentiment remaining strong and jobless claims remaining low.

Eurozone business conditions PMIs - both manufacturing and services - improved further in February pointing to acceleration in growth. For now, the ECB is committed to quantitative easing through to the end of the year at the rate of €60bn a month, but debate about when it will announce a taper will likely to continue to hot up. Nothing is likely to be announced until later this year though, at least not until after the French election is out of the way.

Japan's manufacturing conditions PMI also improved further in February continuing a recovery since May last year and pointing to stronger growth ahead.

Australian economic events and implications

The news on the Australian economy over the last week was, on balance, a little bit disappointing with wages growth remaining at a record low and investment coming in weaker than expected. Low wages growth adds to the risk that inflation will stay lower for longer and soft business investment data will constrain the expected rebound in December quarter GDP growth after the September quarter contraction. However, while investment plans for the financial year ahead are yet again below those of a year ago, the rate of decline has slowed (see the next chart) and it's all driven by mining investment (which is falling at the rate of around 30% pa) whereas plans for non-mining investment are about 7% stronger than was the case a year ago. What's more, the drag on overall growth in the economy from the mining investment slump is diminishing as it’s now a much smaller share of the economy and in any case it's getting back to levels that are close to as low as it ever goes.

 

Source: ABS, AMP Capital 

Cuts to penalty rates – good or bad? The Fair Work Commission’s decision to cut Sunday and public holiday penalty rates by 25% or so has created much contention. But it basically comes down to a trade-off between wages for those in relevant industries with jobs and the 1.8 million people without jobs, or who are underemployed. Yes, it will cut wage income for those affected and will weigh further on average wages growth, but against this, the decision partly reflects the fact that Sunday’s and public holidays are no longer sacrosanct like they used to be and it will make it possible for employers to employ more people or have them for longer hours (unless you believe that demand for something goes down when its price goes down). So, the decision is no disaster for the economy and, if anything, by injecting a bit more flexibility into the labour market it will help boost productivity and employment. It also maintains the hope that Australia can still get through a bit of economic reform, despite the scare campaign around any proposed economic reforms that dominates the media 24/7 now. 

The Australian December-half profit reporting season is now just over 90% done. Results remain consistent with a strong return to profit growth, but as always, we have seen more soft results as the reporting season has progressed. 46% of companies have exceeded earnings expectations compared to a norm of 44%, 59% of companies have seen profits up from a year ago and 59% have increased their dividends from a year ago. But reflecting the strong rally in the market ahead of the results, only 50% of companies have seen their share price outperform the market on the day they reported as a lot of good news was already priced in. Consensus profit expectations for the overall market for this financial year have been revised up by around 2% through the reporting season to a strong 19%. This upgrade has all been driven by resources companies which are on track for a rise in profit of 150% this financial year, reflecting the benefits of higher commodity prices and volumes on a tighter cost base. Profit growth across the rest of the market is likely to be around 5%, with mixed bank results and constrained revenue growth for industrials. Outlook comments have generally been positive, and as a result, the proportion of companies seeing earnings upgrades has been greater than normal. The focus has remained on dividends with 79% raising or maintaining their dividends.

 

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, President Trump’s address to Congress on Tuesday will be watched for details around his plans for tax cuts, infrastructure spending, etc. The focus will also be on the February ISM manufacturing index (Wednesday) and non-manufacturing conditions index (Friday) both of which are likely to remain strong. Speeches by Fed Chair Yellen and Vice-Chair Fischer (Friday) will be watched for clues as to whether to expect faster Fed rate hikes. Meanwhile, expect underlying durable goods orders to show further improvement and a rise in pending home sales (both Monday), a slight upwards revision to December quarter GDP growth to 2.1% annualised and continued strength in home prices and consumer confidence (all Tuesday), and a rise in inflation as measured by the core private final consumption deflator (Wednesday) to 1.8% year on year from 1.7% year on year. 

In the Eurozone, expect economic confidence indicators for February (Monday) to have remained strong, CPI inflation to edge a bit higher but core inflation to have remained around 0.9% yoy and unemployment (Thursday) to have fallen to 9.5%.

In Japan, expect a slight pull back in January industrial production (Monday), but continued strength in labour market indicators and a slight further improvement in household spending (Friday). Core inflation (also Friday) is likely to have remained around zero. 

Chinese manufacturing conditions PMIs for February (Wednesday) are expected to have remained around 51.

In Australia, December quarter GDP data is likely to show a bounce back in growth led by a stronger consumer, a rebound in dwelling investment and public spending, better trade volumes and bit less negative business investment. However, it looks likely to be only around 0.6% quarter on quarter, leaving annual growth at just 1.8% year on year. Ahead of the GDP release, expect a strong rise in December quarter company profits led by the mining sector (Monday) and net exports (Tuesday) to contribute 0.2 percentage points to GDP growth. Meanwhile expect continued momentum in February home prices (Wednesday), another big trade surplus (Thursday) and a small fall in building approvals (Thursday). 

The Australian December-half profit reporting season will wrap up on Monday and Tuesday with only 15 major companies left to report including QBE and Lend Lease. 

Outlook for markets

Shares remain vulnerable to a pull back as short term investor sentiment towards them is very bullish, Trump related uncertainty will be with us for a while and various European elections could create nervousness in coming months. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA is well behind the Fed in raising rates. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of Sydney and Melbourne and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The $A has had a short term bounce as the $US corrected from overbought levels. This could go further and see a retest of $US0.78 which if broken would likely see a run up to $US0.80. However, the downtrend in the $A from 2011 is likely to resume at some point this year as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. 

While Eurozone shares fell 0.9% on Friday, the US S&P 500 saw a late rally that pushed it up 0.1% perhaps in anticipation of President Trump’s address to Congress this coming Tuesday. Despite the basically flat US lead, ASX 200 futures fell 0.3%, pointing to a 16 point fall at the open for Australian shares on Monday.

| More

 

Eurozone risks to present buying opportunities

Monday, February 20, 2017

By Shane Oliver

Most major share markets continued to move higher over the past week, helped by more good economic and profit news and anticipation of President Trump’s pro-business policies. US shares gained 1.5%, Eurozone shares rose 1%, Chinese shares rose 0.2% and Australian shares gained 1.5%, but Japanese shares fell 0.7%. Bond yields generally rose as the reflation trade continued but commodity prices were mixed, with oil and metal prices down a bit but the iron ore price surging higher. The $A was little changed.

The resignation of President Trump’s National Security Adviser Mike Flynn and the ongoing investigations into links between Trump’s campaign and Russia highlights the political risks around this unusual administration. But as long as Trump continues on the path to implementing his pro-business agenda (and assuming Trump himself is not implicated) it’s just ongoing noise that investors have to get used to.

The focus on Eurozone breakup risk is continuing to hot up, with elections approaching in the Netherlands on March 15, France in late April/May and Germany in September. Our view remains that such risks are overstated, but any related market panic should provide an opportunity for investors. Looking at each in turn, based on current polling:

  • The populist Eurosceptic Party for Freedom will get more than any other party in the Dutch parliamentary elections but at around 20% of the vote and seats won’t be able to form government, with that likely to come from some combination of roughly ten centrist parties. 
  • Similarly, Marine Le Pen, whose policy is to leave the Eurozone, will “win” the first round of the French presidential election with around 25-30% of the vote but will most likely lose the second round to either the Republican Party’s Francois Fillon (by 15-20%) or more likely to the independent Emmanuel Macron (by 20-30%). Both Fillon and Macron are economic reformists which is exactly what France needs. The main risk is that the Socialist candidate, Benoit Hamon, manages to form a joint ticket with more leftist Jean-Luc Melenchon and the Green Party’s Yannick Jadot (which is a big ask given the differences between them) and then make it through to the second round against Le Pen where she would have a greater chance of defeating them.  
  • The German election is a long way away, but German Chancellor Angela Merkel is at some risk of losing to the centre-left Social Democrat Party whose new leader Martin Schulz is polling well. But Schulz is more pro Europe than Merkel, so even if he does win, it could actually mean a stronger Eurozone as he and the SPD are likely to end austerity in favour of some German fiscal reflation (which could help both Germany and peripheral Eurozone countries). The populist Alternative for Deutschland seems stuck at around 10% support. 
  • Ahhh, you say – but what about Brexit and Trump? Surely there is a risk of a populist upset? Yes there is – particularly in the Netherlands or France. But the polling against a populist forming government in these three countries is more decisive than was the case prior to the Brexit vote and US presidential election (where the polling was actually very close). More fundamentally, it can be argued that Europe is different. Support for the Euro remains high at around 70% and inequality is far less of an issue in most of Europe than in the UK or the US. And an abatement of the migration crisis is helping too. 
  • Perhaps the country at greatest risk is Italy, particularly with the governing Democratic Party showing signs of breaking up, but even here, if the Eurosceptic Five State Movement wins in their next election (possibly this year), it is likely to end up going down the path of Greece’s Syriza which has become just another European centrist party after it realised the cost to Greece of exiting the Euro. Speaking of which, Greece is at risk again facing tough negotiations with its creditors. These will probably be resolved but even if not and an early election ensues it’s noteworthy that the pro-Euro, pro-reform New Democracy party is polling well.
  • The bottom line is that Eurozone break up risks are overstated and if they intensify in the months ahead hitting Eurozone shares, bonds and other assets, it should be seen as a buying opportunity.

Major global economic events and implications

  • US economic data continues on the strong side, with a solid gain in retail sales, small business confidence remaining strong, very strong readings in the New York and Philadelphia regional manufacturing conditions surveys, continued strength in home builder conditions, strong readings for housing starts and permits and continuing ultra-low unemployment claims. Meanwhile, core consumer price inflation edged up more than expected to 2.3% year on year. Fed Chair Janet Yellen’s Congressional testimony on the rates front provided nothing new, signalling an intention to make haste gradually in raising rates this year and that all coming meetings are live for the next move providing the data behaves as expected. Our base case remains that the next hike will be in May or June, but the past week’s run of strong data points to a rising risk of a March hike (with the market currently putting the probability of such a move at 36%.) 82% of US S&P 500 companies have now reported December quarter profits, with 74% beating earnings expectations with an average surprise of +2.7% and 52% beating on revenue.
  • Japanese December quarter GDP growth disappointed at 0.2% quarter on quarter, or 1.6% year on year. But it marked four straight quarters of positive growth and business conditions indicators point to some acceleration ahead.
  • Chinese consumer and producer price inflation rose more than expected in January and combined with a surged in credit underpin the PBOC’s move to gradually tighten monetary policy. While a range of infrastructure projects should support growth in the near term and the Chinese Government unlikely to allow growth to slow much, the move to policy tightening and threat to growth will no doubt worry investors at some point later this year.

Australian economic events and implications

  • Australian economic data was good, with a further gain in business conditions and confidence in January according to the NAB survey, a rise in consumer confidence to around its long term average, stronger than expected jobs growth in January and a fall in unemployment. The main drag was a return to weakness in full time jobs, highlighting that the quality of jobs growth remains poor. This is partly structural reflecting the growing importance of the services sector in the economy and its preponderance towards part time jobs but it’s also partly cyclical and on this front it’s worth noting that job vacancies and business employment plans point to stronger employment growth ahead, which should help full time jobs.
  • Another big positive is the ongoing rise in the iron ore price which broke $US90/tonne in the last week for the first time since 2014. Softer structural growth in China and stronger supply warn this is not the start of a re-run of last decade’s commodity boom. But it's nevertheless a big positive for national income in Australia. The iron ore price at $US90, if sustained, will add around $9bn annually to Federal taxation revenue.

Source: Bloomberg, AMP Capital

  • At this stage our view remains that the RBA will cut rates again this year as inflation takes longer to move back to target. But if the positive news on growth and national income continues at a time when the Sydney and Melbourne property markets remain too hot then we will have to concede that the next move in rates is up – albeit not till later in 2018 – rather than down.
  • We are now a bit over 40% through the Australian December half profit reporting season. As is often the case after an initial flurry of good results, we have seen a few more misses over the last week. But so far the overall results remain good. 53% of companies to report so far have exceeded earnings expectations compared to a norm of 44%, 70% of companies have seen profits up from a year ago and 69% have increased their dividends from a year ago. But reflecting the strong rally in the market in anticipation of the results, only 44% have seen their share price outperform the market on the day they reported as a lot of good news was already priced in. Resource profits are on track to more than double this financial year and this is driving a return to overall profit growth for the market.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

  • In the US, expect business conditions PMIs for February (Tuesday) to remain strong and consistent with solid growth, a bounce back in existing home sales (Wednesday) and new home sales (Friday) and continued strength in house prices (Thursday). The minutes from the Fed's last meeting (Wednesday) are likely to confirm that the Fed sees itself as being on track to continue gradually raise interest rates.
  • In the Eurozone, business conditions PMIs for February (Tuesday) are also expected to remain strong, consistent with a pick-up in Eurozone economic growth.
  • Japan's manufacturing conditions PMI (Tuesday) is likely to show a further improvement.
  • Chinese property price data for January (Wednesday) is expected to show some further slowing in growth as property cooling measures continue to bite.
  • In Australia, expect the minutes from the last RBA Board meeting (Tuesday), a speech by RBA Governor Lowe (Wednesday) and his parliamentary testimony (Friday) to confirm that the RBA is comfortably on hold for now. On the data front, expect to see December quarter wages growth (Wednesday) remain at a record low of 1.9% year on year, December quarter construction data (also Wednesday) to show a 1% quarter on quarter bounce back after bad weather and a few other things affected the September quarter, but with mining construction still falling and December quarter business investment (Thursday) to also show a 1% quarter on quarter gain. Of most interest in the capex data will be investment intentions for this financial year and next which are expected to foreshadow some improvement in non-mining investment.\
  • The Australian December half profit reporting season will hit is biggest week with nearly 100 major companies reporting, including Worley Parsons, BHP, IAG, Woolworths and Qantas. Resource company profits are on track to more than double, but profit growth across the rest of the market is likely to be around 5%. Key themes are likely to be: a massive turnaround for resources companies; constrained revenue growth for banks and industrials; and an ongoing focus on dividends. 

Outlook for markets

  • Shares remain vulnerable to a short term pull back as sentiment towards them remains very high, Trump related uncertainty will be with us for a while and various European elections could create nervousness in coming months. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.
  • Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA is well behind the Fed in raising rates. 
  • Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 
  • National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne and rising apartment supply hits. 
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
  • The $A has had a short term bounce as the $US corrected from overbought levels. This could go further and see a retest of $US0.78 which, if broken, would likely see a run up to $US0.80. However, the downtrend in the $A from 2011 is likely to resume at some point this year as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 by year end.
  • Eurozone shares fell 0.2% on Friday as worries around the French election impacted, but the US S&P 500 rose 0.2%. Reflecting the positive US lead, ASX 200 futures rose 0.1% pointing to a modest five point gain at the open for the Australian share market on Monday.
| More

 

Trump's pro-growth agenda alive and well

Monday, February 13, 2017

By Shane Oliver

Most major share markets rose over the last week, helped by a combination of good economic data and profit news and announcements from President Trump progressing his deregulation and tax reform agenda. US shares rose 0.8%, Japanese shares rose 2.4%, Chinese shares gained 1.5% and Australian shares rose 1.8%. Eurozone shares slipped 0.1%. Bond yields mostly fell, though helped along by dovish comments from ECB President Draghi. Oil prices were flat but metal prices were up and the iron ore price rose to its highest since 2014. The $A rose slightly, despite a stronger $US.

The message from the first few weeks of Trump’s presidency is that, while he is generating a lot of noise, as long as he makes periodic announcements progressing his pro-growth policies – rolling back Dodd-Frank, working towards a “phenomenal” tax plan, making “life good” for airlines, etc – then share markets will respond positively. So, while all the noise around the travel ban, whether the Lindt Café siege was “underreported” (I was in Memphis on an Elvis pilgrimage at the time and the siege had plenty of coverage on US TV!), etc., is interesting, investors should turn down all this noise when making investment decisions. 

Adding to the positive tone were signs that Trump is taking a less antagonistic approach to China and Japan on trade, with Trump agreeing to respect the “One China” policy and reporting to have said he wants a “constructive relationship” and “mutual benefits” with China, and Trump and Japan PM, Abe, agreeing to start new trade and investment talks. 

While unwinding the Dodd-Frank financial regulations will take time and face constraints (as it will likely require the support of eight Democrat Senators, although it may be possible to find work-arounds), tax reform is likely to proceed more quickly as Congress has already done significant work on it and it can pass through the Senate using budget reconciliation rules that only require a simple Senate majority – which the GOP has.

It now looks likely that the Trump administration will submit a tax plan to Congress in a few weeks – this is almost certain to include a cut in the corporate tax rate (to 20% or so) and possibly also a cut to personal income tax rates. It’s less clear whether a “border adjustment tax” (rebating tax on exports and taxing imports) will be included. Taking the US corporate tax rate from 35% to 20% will put massive pressure on Australia at 30% and other countries to follow suit (the OECD average is around 25%).

In Australia, the Reserve Bank left interest rates on hold as expected, but in its Statement on Monetary Policy, made little significant changes to its growth and inflation outlook – seeing December quarter GDP growth rebound, growth averaging around 3% over the next few years and inflation heading back to 2% by the year's end. The Bank’s post-meeting statement, a speech by Governor Philip Lowe and the Statement on Monetary Policy, all presented a relatively upbeat assessment on the economic outlook. While we have a similar growth outlook, our view remains that it will take longer for inflation to return to target than the RBA is allowing, particularly with wages growth at record lows and the $A trending higher. As a result, we remain of the view that the RBA will likely cut rates again this year, probably in May after the next round of inflation data. Given the improving global growth and inflation outlook though and the desire to avoid adding to financial stability risks, our call for another RBA rate cut is a close one. 

Surprisingly, the RBA’s level of concern around the property market does not appear to have increased despite a further pick up in lending to property investors and rapid price growth in Sydney and Melbourne. This appears to partly reflect the RBA’s assessment that lending standards have tightened, the supply of property is set to rise with longer-than-normal lags and that part of the recent upswing in investor credit may reflect investors paying for properties bought off the plan some time ago. There still remains a case for a precautionary lowering in APRA’s 10% investor credit growth limit though.

Major global economic events and implications

US job openings and quits remained basically unchanged at relatively high levels, jobless claims fell to ultra-low levels and the trade deficit narrowed slightly in December. 72% of US S&P 500 companies have now reported December quarter profits, with 75% beating earnings expectations with an average surprise of +3.6% and 51% beating on revenue. Earnings are now expected to be up 6.3% from a year ago. 

Japanese data showed a slight fall in confidence and continuing weak wages growth but improved machinery orders, a rise in Japan’s leading index and an ongoing decline in bankruptcies and the first annual rise in producer prices since March 2015.

Chinese foreign reserves fell below $US3 trillion for the first time since 2011 as China continues to see capital outflows and is using its reserves to slow the decline in the Renminbi (are you listening President Trump?). Meanwhile, Chinese imports and exports rose much more than expected in December, which fits with stronger Chinese and global demand but may also reflect seasonal Lunar New Year distortions.

Australian economic events and implications

It's too early to read much into the December-half profit reporting season because less than 20 major companies have reported to date. But so far so good, with 67% exceeding earnings expectations compared to a norm of 44%, 67% of companies seeing profits up from a year ago and a stronger-than-expected result from Rio Tinto confirming that the turnaround in resources sector profits is on track. 

Source: AMP Capital

Source: AMP Capital

On the data front in Australia, December quarter retail sales volumes rebounded 0.9%, adding to confidence that consumer spending and hence GDP growth rebounded in the December quarter. While retail sales unexpectedly fell 0.1% in the month of December, this reflected a sharp fall in hardware, building and garden supplies (possibly reflecting the wind down of Masters) so is unlikely to mean much. Meanwhile, new home sales were flat in December according to the HIA but still appear to be tracing out a gradual downtrend since their high in 2015 and December housing finance commitments saw a slight swing back in favour of owner occupiers - but not much.

What to watch over the next week?

In the US, the focus is likely to remain on the noise coming out of Washington but also on Fed Chair Janet Yellen's Congressional testimony (on Tuesday and Wednesday) which is likely to repeat the message from the Fed's last meeting that it remains on track to hike further this year, but that the process is likely to be gradual. Her response to questions regarding the impact of the new president will no doubt be watched closely, but the Fed is basically in wait-and-see mode on that front. Expect headline CPI inflation (Wednesday) to have increased further to 2.4% year on year (yoy) in January, but core inflation to fall slightly to 2.1% yoy, solid growth in underlying retail sales in January, flat industrial production, continuing strength in the home builders' conditions index (all Wednesday) and flat housing starts (Thursday). December quarter earnings results will continue to flow.

Japanese December quarter GDP data (Tuesday) is expected to show growth at 0.3% quarter on quarter (qoq) or 1.8% yoy.

Chinese inflation data for January (Tuesday) is likely to show a further rise in CPI inflation to around 2.3% yoy and a further uplift in producer price inflation to 6.5% yoy as the slump in commodity prices a year ago continues to drop out.

In Australia, expect continued strength in business conditions according to the NAB's January survey, a bounce in consumer confidence (Wednesday) and January jobs data to show a 10,000 gain in employment but unemployment holding at 5.8%.

The Australian December half-profit reporting season will ramp up further with 61 major companies reporting (including JB HiFi, CBA, Wesfarmers, Origin and Telstra). Earnings upgrades for resources stocks on the back of the rise in commodity prices has seen the consensus expectation for 2016-17 earnings growth rise to 17%. Resource company profits are expected to more than double, but profit growth across the rest of the market is likely to be around 5%. Key themes are likely to be: a massive turnaround for resources companies, constrained revenue growth for banks and industrials, and an ongoing focus on dividends. 

Outlook for markets

Shares remain vulnerable to a short-term pullback as sentiment towards them remains very high, Trump-related uncertainty will be with us for a while, and various European elections could create nervousness in coming months. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA is well behind the Fed in raising rates. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term. 

National residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The $A has had a short-term bounce as the $US corrected from overbought levels. This could go further and see a retest of $US0.78. However, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 by year end.

Eurozone shares were flat on Friday and the US S&P 500 rose 0.4% to a new record high. Reflecting the positive lead from US shares along with rising prices for oil, metals and iron ore ASX 200 futures rose 0.2%, pointing to a 10 point gain at the open for the Australian share market on Monday.

| More

 

Trump jitters persist

Monday, February 06, 2017

By Shane Oliver

Despite good economic and profit news, Trump jitters dominated markets over the last week, but his plan to relax bank regulations and benign US jobs data saw US and Eurozone shares bounce back at the end of the week. This saw US shares rise 0.1% for the week, but Eurozone shares fall 0.8%, Japanese shares down 2.8% and Australian shares down 1.6%. Chinese shares lost 0.7% on the back of PBOC monetary tightening. Bond yields were mixed but the $US fell and this combined with news of a record trade surplus saw the $A rise.

Worries about Trump could be with us for a while yet as his belligerent approach, his team’s inexperience and fears about trade wars and US isolationism could dominate the pro-growth positives of his policies at times, as it will take a while to push through deregulation, tax cuts and increased infrastructure spending. That said, the pro-business focus is clearly there with Trump stopping the Obama “fiduciary rule” from taking effect and ordering a review of Dodd-Frank financial rules. One thing we have to get used to though is more noise coming out of Washington, but a lot of it is just that, i.e. noise!

Eurozone political risks will also feature this year. High on the list is France, which has presidential elections in April and May. Polling continues to show that populist Eurosceptic Marine Le Pen will make it into the second round polling more than any other candidate at around 27%, but that the independent former economy minister Emmanuel Macron (polling at 23%) or the Republican party’s Francois Fillon (polling 20%) will defeat her in the second round (at 65% to 35% and 59% to 41% respectively). Both Macron and Fillon are pro-Europe and reform oriented, but Fillon has been hit by a scandal involving the employment of his wife and children as parliamentary assistants (which is legal but the issue is whether they actually worked). Whether it's Macron or Fillon who makes the second round against Le Pen, it looks unlikely Le Pen will ultimately win. But then again, there is still several months to go and of course last year’s Brexit and Trump “upsets” can’t be ignored. As a result, investors will worry about it and so French bond yields have been rising against German yields.      

The 0.8% fall in Australian shares in January is not so positive in terms of the January barometer, which states that “as goes January so goes the year”. That said, negative January's are less reliable a guide to the year as a whole than positive January's. Just recall last year! Since 1980, a negative January in Australian shares has gone on to a negative year only 31% of the time. Perhaps more importantly, the US share market rose in January by 1.8% and since 1980 a positive US January has gone on to a positive year 86% of the time.

New US sanctions against Iran may provide a bit of short-term support for oil prices, but with global oil inventories above normal levels, it’s hard to see much impact short of a major disruption to Iranian oil flows.

Major global economic events and implications

Looking globally, business conditions PMIs continued to improve in January pointing to stronger global growth. Very different to a year ago when PMIs were heading down.

Source: Bloomberg, IMF, AMP Capital

US economic data was strong with solid business conditions, strong home price gains, solid consumer confidence and growth in personal spending, strong jobs data with a 227,000 gain in January payrolls and a rise in pending home sales. That said, a rise in labour force participation supports the view that there is still slack in the US jobs market, wages growth according to the employment cost index and average hourly earnings in January remains modest, and core personal consumption inflation remains stuck around the same levels it’s been at for a year.  

The Fed upgraded its comments regarding current conditions but there were no changes to the outlook and there was nothing pointing to a rate hike next month. With wages growth still weak and signs of ongoing slack in the US jobs market, we continue see the Fed remaining gradual with three Fed rate hikes this year with the first being in May or June.

55% of US S&P 500 companies have now reported September quarter profits with 74% beating earnings expectations and 50% beating on revenue. Earnings are now expected to be up 6% from a year ago taking them to a new high, highlighting that the earnings recession that began in 2014 is long over.

Eurozone economic data was also solid with a pick-up in December quarter GDP growth and confidence and manufacturing conditions PMIs at five-and-a-half year highs. While headline inflation rose solidly in December on the back of higher energy prices, core inflation remains stuck at 0.9% year-on-year, suggesting that the ECB won’t be rushing just yet to taper its quantitative easing program.

Japanese jobs data was good with stronger-than-expected readings for household spending and industrial production. Meanwhile, the BoJ left monetary policy on hold as expected.

Chinese manufacturing conditions PMIs fell in January but services conditions rose slightly, which points to continued solid growth for now. The PBOC’s move to raise short-term money market rates by 0.1% continues the incremental shift to tightening in China seen in recent months. With growth stabilising, the focus has returned to controlling credit growth, but the authorities are unlikely to tolerate sub 6% GDP growth.

Australian economic events and implications

Australian data was a mixed bag. The NAB business survey showed strong business conditions in December, adding to confidence that growth bounced back in the December quarter and the surge in iron ore and coal prices drove the trade balance to a record surplus in December. Against this, building approvals slipped further, adding to evidence that they have peaked. While the surge in commodity prices and the associated boost to national income won’t provide the same boost to the economy seen last decade (as tax cuts are less likely due to tougher budgetary conditions, the mining investment boom has already happened and its likely to be less durable), it’s better than falling national income and will provide some offset to the loss of momentum in dwelling construction. 

Meanwhile, a continuing surge in credit growth to property investors in December and a strong start to the year in home price growth adds to concerns that the Sydney and Melbourne property markets remain too hot. If the RBA is to have the flexibility to cut interest rates again, another round of macro-prudential tightening by APRA is likely to be needed.  

What to watch over the next week?

In the US, apart from what President Trump may do, the main focus in the week ahead will be on December quarter earnings reports, with over 100 major companies due to report. On the data front it will be pretty quiet, with December trade data (Tuesday) expected to show an unchanged deficit and consumer sentiment and import price data due Friday.

Chinese trade data for January is expected to show a strengthening in import growth to around 5% year-on-year and a return to positive growth for exports at around 2% year-on-year. 

In Australia, the focus will be back on the RBA (Tuesday) but it’s unlikely to make any changes to interest rates. While the low September quarter inflation reading leaves the door wide open for another rate cut, a move on Tuesday is unlikely as the inflation outcome was in line with the RBA’s own forecast and its likely to want to monitor the recent uptick in lending to property investors and see how the economy performs after the September quarter slump. As a result, all eyes will be on the post meeting Statement and the Statement on Monetary Policy to be released Friday. Of most interest will be any revisions to the RBA’s forecasts, where we expect a downwards revision to the growth and possibly inflation forecasts. Our assessment remains that - with record low wages growth, ongoing spare capacity, an increasing risk that low inflation will feed on itself and the $A remaining too high - the RBA will cut rates again around May. Also of interest will be what the RBA has to say about the resurgent Sydney and Melbourne property markets – are they embarking on another round of discussions with APRA?

On the data front in Australia, expect a 0.2% rise in December retail sales and a 0.8% rise in retail sales volumes for the December quarter (Monday) and 0.5% rise in December housing finance (Friday) again driven by property investors.

The Australian December half profit reporting season will ramp up, with 16 major companies reporting (including Rio, AMP, NewsCorp and Suncorp). Steady earnings upgrades for resources stocks on the back of the rise in commodity prices has seen the consensus expectation for 2016-17 earnings growth rise to 17% from around 7% last September. Resource company profits are expected to more than double, but profit growth across the rest of the market is likely to be around 5% led by retailers, utilities, telcos and building materials companies. Key themes are likely to be: a massive turnaround for resources companies, constrained revenue growth for banks and industrials and an ongoing focus on dividends. 

Outlook for markets

A further short-term consolidation or correction in shares is likely as sentiment towards them remains very high, Trump related uncertainty will be with us for a while and as we enter the seasonally weaker month of February. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA remains well behind the US in moving into a tightening cycle. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield, but this demand will wane as bond yields trend higher over the medium term. 

National capital city residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne markets and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The $A has had a short term bounce as the $US corrected from overbought levels. This could go further and see a retest of $US0.78. However, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 by year's end.

Eurozone shares rose 0.5% on Friday and the US S&P 500 gained 0.7% as financial shares were boosted as President Trump announced plans to roll back the Dodd Frank financial regulations and a benign jobs report indicated that the Fed can remain gradual in raising interest rates. Reflecting the positive global lead, ASX 200 futures gained 0.4% on Friday night pointing to roughly a 20-25 point rebound in Australian shares on Monday morning (depending of course on what sort of noise comes out of Washington in the interim!)

| More

 

Investors focused on Trump, US earnings and data

Monday, January 30, 2017

By Shane Oliver

Investment markets and key developments over the past week

The past week saw share markets break higher helped by solid global economic data, good US earnings results and optimism that Donald Trump’s policies will help boost the US economy. In particular the US share market rose 1%, pushing it out of a range it has been in since mid-December and propelling the Dow Jones index above 20,000. Eurozone shares rose 0.5%, Japanese shares rose 1.7% and Chinese and Australian shares both gained 1%. Bond yields rose as did oil and metal prices. The $A fell slightly.

Not too much should be read into the Dow crossing 20,000. Yes it creates a bit of short term excitement (like crossing from Victoria into NSW) and generates some headlines but its really just an arbitrary number for an index which only has 30 companies that are combined using a ridiculous price weighting system (so that Goldman Sachs gets a bigger weight than GE). And there is no evidence of higher than average returns after each 1000 point level has been crossed on the Dow anyway.

President Trump and his team’s announcements and comments have continued to create uncertainty but the negatives (e.g., the US’s withdrawal from the TPP, arguments about “alternative facts” and the floating of a 20% border tax to pay for the wall with Mexico) have been drowned out by the positives (Trump’s reiterating of his commitment to deregulation and tax cuts, moves toward approving the Keystone XL and Dakota Access oil pipelines and the construction boost from building the wall with Mexico). So investors have been left to mainly focus on the positives. And it’s not just Trump - fundamental news has been good too with good US earnings results and continuing strong business conditions readings in the US, Japan and Europe in January. So the pause in share markets as investors digested the rally that occurred since the US election may have run its course.

Two issues regarding President Trump’s policies are worth a mention. First, the US withdrawal from the TPP is no surprise (it would not have passed Congress anyway) and its loss is hardly a disaster for Australia, particularly with other regional trade deals likely to fill the gap. The real issue will be if Trump embarks on a trade war with China…but it’s looking more like Trump will go down the path of negotiation as opposed to unilateral measures at least initially. Secondly, talk of a “border tax” is heating up in the US. Quite what this means is debatable with the US Congress proposing shifting corporate tax to taxing only the value added of goods consumed in the US such that imports are taxed but exports receive a rebate (much as occurs under value added taxes or GSTs). This is commonly referred to as a “border adjustment tax”. Trump initially called this approach too complicated and his “border tax” concepts have thought to have been more direct but his recent comments suggest he could be warming to the idea (or just waving a stick at Mexico). There is a long way to go but if it does get up it would be a huge boost for US exporters (eg Boeing) and a huge negative for importers (eg Walmart) and would put significant upwards pressure on the value of the $US. 

Italy’s Constitutional Court’s ruling on the electoral law for its lower house has refocussed attention on political risk in Italy explaining why its share market fell and its bond yields rose more than most over the last week. By ruling against a two round electoral system the risk that the populist Five Star Movement attains power is somewhat reduced but the pressure for an early election remains. On current polling another grand coalition would be the likely outcome of an early election, but the risk of a 5SM led Government will rise for a later election if the economy continues to perform poorly. But note that even if 5SM ultimately win’s it would first require a constitutional change to call a referendum on Italy’s membership of the Euro and in any case a majority of Italian’s support remaining in it. Of course that won’t stop markets from having bouts of Itexit fears 

Major global economic events and implication

US economic data was mostly strong. Home sales fell in December and December quarter GDP growth was only 1.9% annualised but trade detracted 1.7 percentage points and final demand was strong at 2.6%. Meanwhile, underlying durable goods orders were strong, business conditions PMIs rose further in January, consumer confidence rose to a new 13 year high, the leading index rose and home prices continue to rise.

The US December quarter earnings reporting season is also looking impressive. Roughly one third of US S&P 500 companies have now reported with 74% beating earnings expectations and 52% beating on revenue.  Earnings are now expected to be up 5% from a year ago taking them to a new high, which is up from an expectation of 3.6% yoy highlighting that the earnings recession that began in 2014 is long over.

Eurozone business conditions PMIs remained strong in January pointing to a slight acceleration in economic growth.

Japan’s manufacturing conditions PMI continued its recovery in January pointing to stronger growth. Inflation remained stuck around zero but does seem to have bottomed.

Australian economic events and implications

Low December quarter consumer price inflation in Australia is consistent with another RBA rate cut as inflation remains well below target, but it’s hard to see a move in February. Annual inflation at 1.5% year on year in December was in line with the RBA’s own forecasts and its likely to want to monitor the uptick in lending to property investors and see how the economy performs after its September quarter slump before cutting rates again. However, our assessment remains that with record low wages growth and ongoing spare capacity in the economy along with the increasing likelihood that low inflation is feeding on itself via falling inflation expectations it will take longer to get inflation back to target than the RBA is allowing. As a result we continue to expect another RBA rate cut around May.

Meanwhile a big rise in export prices saw the third successive rise in Australia’s terms of trade in the December quarter. This will boost national income which in turn will help real economic growth but in the absence of another leg up in commodity prices we have probably seen the best for now.

What to watch over the next week?

In the US, the Fed is expected to leave interest rates on hold on Wednesday. Fed Chair Yellen has continued to stress that rate hikes will remain gradual, not enough has changed since the last rate hike in December to justify another move just yet and the Fed is still awaiting clarity on the size of any fiscal stimulus that President Trump plans to deliver. Rather the focus will be on whether the post meeting statement implies more rate hikes than the three suggested back in December for 2017.

On the data front in the US the focus will be on the January manufacturing conditions ISM index (Wednesday) which is expected to remain strong and jobs data (Friday) which is expected to show a 170,000 gain in payrolls and unchanged unemployment at 4.7%. Inflation according to the core private consumption deflator (Monday) is expected to rise to 1.8% year on year, the employment cost index (Tuesday) is expected to confirm a slight increase in wages growth and consumer confidence (Wednesday) is expected to have remained high.

US December quarter earnings reports will continue to flow with over 100 major companies due to report.

In the Eurozone, December quarter GDP (Tuesday) is expected to show a slight acceleration in growth to 0.4% quarter on quarter or 1.7% year on year. Meanwhile, economic confidence data (Monday) is likely to have remained strong and headline CPI inflation (Tuesday) is likely to have risen further to 1.5% yoy but core inflation is likely to have remained flat at 0.9% yoy.

The Bank of Japan (Tuesday) is not expected to make any changes to monetary policy having committed in September to open ended quantitative easing until it exceeds its 2% inflation target, which at this stage remains a long way away. Japanese data on the labour market, household spending and industrial production will be also be released.

The Bank of England (Thursday) could announce that asset purchases will not be extended beyond February.

Chinese manufacturing PMIs will be released on Wednesday and Friday and are expected to show little change.

In Australia, the NAB business conditions index will be watched for an improvement after recent deterioration, but expect to see continued moderate growth in credit (all Tuesday), building approvals are likely to fall slightly and the trade balance (both Thursday) is likely to show an even larger surplus on the back of higher commodity prices. Core Logic home price data will also be released on Wednesday.

The Australian December half profit reporting season will get underway with a handful of companies reporting (including Downer Tabcorp and James Hardie). After 2 years of falling profits this financial year is expected to see a return to growth and the December half results are likely to confirm that. Steady earnings upgrades for resources stocks on the back of the rise in commodity prices has seen the consensus expectation for 2016-17 earnings growth rise to 16% from around 7% last September. Resource company profits are expected to more than double, but profit growth across the rest of the market is likely to be around 5% led by food producers and retailers, utilities, telcos and building materials companies. Key themes are likely to be: a massive turnaround for resources companies; constrained revenue growth for industrials with the September quarter economic slowdown not helping; continuing constrained revenue growth for the banks; and an ongoing focus on dividends and cost control.

Outlook for markets

The risk of a short term consolidation or correction in shares remains as sentiment towards them remains very high, President Trump could still throw a curve ball at markets and as we enter the seasonally weaker month of February. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and the shift to rising profits in both the US and Australia.

Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA remains well behind the US in moving into a tightening cycle.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield, but this demand will wane as bond yields trend higher over the medium term.

National capital city residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne markets and rising apartment supply hits.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The $A has had a short term bounce as the $US corrected from overbought levels. However, the downtrend in the $A from 2011 is likely to resume as the interest rate differential in favour of Australia narrows & it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 but little change versus the Yen and Euro.

Eurozone shares fell 0.3% on Friday and the US S&P 500 dipped 0.1%. As a result of the softish global lead ASX 200 futures fell 0.2% pointing to around a 10 point decline in the Australian share market at the open on Monday morning.

| More

 

The uncertainty of President Trump

Monday, January 23, 2017

By Shane Oliver

Investment markets and key developments over the past week

The past week saw shares fall a bit, further correcting some of the large gains seen since November amid nervousness ahead of Donald Trump’s takeover as US President. US shares dipped just 0.1%, Eurozone shares fell 0.6%, Japanese shares lost 0.8% and Australian shares fell 1.2%. Chinese shares managed to rise 1.1% though helped by good economic data. Bond yields backed up a bit, commodity prices were mixed and the US dollar fell slightly which saw the $A rise slightly.

After large gains since the US election, shares, the US dollar and bond yields entered 2017 vulnerable to a correction or a consolidation with uncertainty about US policy under Donald Trump likely to provide a key trigger. This appears to be underway and may have further to run.

Donald Trump’s inauguration speech focussed on his broad campaign themes around “making America great again” and “America first”, highlighting that his administration will focus on increasing growth and jobs in the US. As expected, there was little in the way of policy detail, but President Trump did highlight infrastructure spending. 

Uncertainty remains high

Markets are now waiting for more evidence that Donald Trump will deliver on fiscal stimulus and deregulation but uncertainty remains high about what he will do on trade. The risk of a tit for tat trade war between the US and China is high, particularly if Trump formally brands China a currency manipulator (possibly in the week ahead).

I remain of the view that when it comes to actual policy moves as opposed to bluster, we will see more of Trump the pragmatist rather than Trump the populist. To be sure, he will adopt a tough line on trade given that it was a key election platform and this will initially cause bouts of market angst. But he also has a focus on jobs and won't want to threaten this, which ultimately suggests pragmatic outcomes. But one thing is clear: with Trump as President we will have to get used to more bluster and noise (including tweets) than has been the case from previous US presidents.

 

Source: AAP

Trumps comments on the US dollar and Europe are worth a mention. It’s understandable that he regards the US dollar as "too strong" given its huge gains. But unless the US economy slows relative to other countries and the Fed goes on another extended pause, the risk is that the trend in the US dollar remains up.

On one level, Trump's negative comments about the European Union are a bit amusing, because after all, it is just a less politically advanced version of the United States, with the integration of both driven by similar motivations (in fact their names suggest the same: United (States of) America, United Europe). Maybe the Europeans will start encouraging California towards a Calexit! In fact, America's relative decline geopolitically, which may accelerate under Trump, is a powerful reason for Europe to stay together!

Theresa May's Brexit talk

UK PM Theresa May's outline of Britain's Brexit terms suggest an element of the UK wanting to "eat its cake and have it too". Basically, Britain wants free trade with the EU, but at the same time, control of its borders, laws and no more huge contributions to the EU budget. In other words, all of the benefits of being in the EU but none of the obligations. It’s doubtful all or any of the other 27 EU members will agree to all of this, so a "hard" Brexit continues to look likely. That said, there is a long way to go (two years of negotiations after Britain formally notifies it wants to leave) and allowing Parliament a vote on the final deal could still mean a softer final outcome. So, Brexit is going to be background noise for investors for years to come. The key issue for global investors to remember however, is that the UK is only 2.5% of global GDP and what really matters is whether Brexit encourages other countries to leave the Eurozone. So far, there is not much evidence of that, with post Brexit elections in Spain and Austria seeing increased support for pro-Europe parties and Italy's referendum telling us nothing on the issue. A hard Brexit would probably make it even less likely that Eurozone countries will seek to leave.

Source: AAP

Putting aside political bluster and uncertainty over Trump’s policies, the world has entered 2017 on a strong note fundamentally, with strong readings on economic momentum - rising/solid business conditions PMIs, the OECD's leading economic indicators continuing to hook up, economic data surprising on the upside. And this is global, not just in the US - so it's more than just a Trump effect. Consistent with this, the IMF held its global growth forecasts unchanged (at 3.4% for 2017 and 3.6% for 2018) rather than downgrading them, which has been the norm for years.

There is also ongoing evidence that the threat of deflation is receding, with rising headline inflation readings in most regions. This is positive for nominal economic growth, corporate sales and hence profits. As a result, notwithstanding the likelihood of a further short-term pull back in shares, we remain positive on the outlook for them for this year.

Major global economic events and implications

US economic data remains solid. Business conditions in the New York and Philadelphia regions remain strong, housing starts are up strongly, home builder conditions remain strong, industrial production rose more-than-expected and jobless claims remain ultra low. Meanwhile, headline inflation continued to rise to 2.1% year-on-year in December on the back of the rebound in oil prices, but core CPI inflation remains stuck in the same range just above 2% year-on-year it’s been in for the last year. Consistent with all this, Fed Chair Yellen indicated that employment and inflation are near the Fed's goals and that rate hikes can remain gradual, noting that the Fed expects to raise rates a few times a year until by the end of 2019 when rates are back at the neutral rate of 3%. There is nothing really new here than what was foreshadowed by the Fed in December. Our base case is for three hikes this year, but fiscal stimulus could mean more.

It's early days in the US December quarter profit reporting season, but so far so good, with 75% of companies beating expectations.

There were no surprises from the European Central Bank (ECB) at its January meeting, which is basically on autopilot having committed in December to maintaining quantitative easing out to the end of 2017. ECB President Mario Draghi’s comments were dovish, indicating there were no signs yet of a convincing uptrend in underlying inflation. If growth continues to hold up, an ECB decision to start tapering its asset purchases in 2018 is likely, but not until around September, or even later this year.

Chinese GDP growth came in at 6.8% in the December quarter and 6.7% for 2016, pretty much as expected. Growth has clearly stabilised after the slowdown of recent years. December growth in industrial production and investment slowed slightly, but retail sales picked up slightly. Solid growth momentum allows Chinese policy makers to focus a bit more on slowing growth in debt and property prices. For 2017, we expect Chinese GDP growth of around 6.5%.

Australian economic events and implications

Australian data was a mixed bag over the last week with consumer confidence remaining soft, housing starts falling again in the September quarter but housing finance and employment coming in stronger than expected. The December jobs data was particularly noteworthy, as it was the third month in a row of solid jobs growth. Over the December quarter, monthly jobs growth averaged a strong 22,000 a month, a big improvement from average job losses of 5,000 a month in the September quarter, and most of it has been in full time jobs, all of which suggests that the jobs market has perked up a bit. While unemployment rose in December to 5.8%, this was only due to higher participation. 

What to watch over the next week?

In the US, the focus will likely be on Donald Trump's initial actions as President. On the data front, the first estimate of December quarter GDP growth (Friday) is likely to have been around 2.1% annualised, down from the 3.5% pace seen in the September quarter, but still okay. In other data, expect the January manufacturing conditions PMI (Tuesday) to remain solid, solid readings for existing and new home sales (Tuesday and Thursday respectively), a rise in home prices (Wednesday) and a continuing improving trend in underlying durable goods orders (Friday). US December quarter earnings reports will continue to flow and are expected to show profits up by around 4.3% year on year.

Eurozone business conditions PMIs for January (Tuesday) are also likely to have remained solid.

Japan's manufacturing conditions PMI (Tuesday) will be watched for a continuation of the recent improving trend and inflation data will be released Friday.

In Australia, the big focus will be on December quarter consumer price inflation data due Wednesday as a guide to what the RBA may do next on rates. We expect the CPI to rise 0.6% quarter on quarter as higher prices for petrol and a tobacco excise increase offset seasonal softness in prices for utilities, health and education. This will push the annual inflation rate up to 1.5% from 1.3% year-on-year in the September quarter and a low of 1.1% year-on-year in the June quarter. Underlying inflation is expected to remain low at 0.5% quarter-on-quarter or 1.5% year-on-year. While this is in line with the RBA's own forecasts, it’s well below the 2-3% target and if, as we expect, the RBA revises down its growth and inflation forecasts at its February meeting, it may contribute to another rate cut. This could come as early as February but we suspect a cut around May is more likely as the RBA is likely to prefer to wait to get more clarity on how the economy is going.

Outlook for markets

Shares remain vulnerable to a further correction/consolidation in the next month or so as excessively positive short term sentiment towards them is worked off, as we enter the seasonally weaker month of February and as nervousness around what President Trump will do in relation to tax cuts, deregulation and US-China relations lingers. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and the shift from falling to rising profits for both the US and Australia.

Still, low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds, reflecting higher yields and as the RBA remains well behind the US in moving into a tightening cycle. 

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield, but this demand will wane as bond yields trend higher over the medium term. 

National capital city residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne markets and rising apartment supply hits. 

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

The Australian dollar is in the midst of a short-term bounce as the US dollar corrects from overbought levels. However, the downtrend in the Australian dollar from 2011 is likely to resume, as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 but little change versus the Yen and Euro.

| More

 

MORE ARTICLES

What to watch over the week

Bad news is good news for the stock markets

Will interest rates rise in 2017?

What to watch over the next week

Trump the pragmatist, or protectionist?

3 things you need to know about Donald Trump's victory

3 things you need to know about Donald Trump's victory

How the US election result could impact the markets

Why has the Australian market slipped?

3 reasons not to fear the Fed

7 reasons not to worry about a Fed rate hike

What to watch over the week

Weekly economic and market update

Shares rally on central bank moves

Are central banks out of bullets?

Could this market correction have further to run?

What to watch this week: Aussie growth numbers

What to watch this week: reporting season ends

What to watch over the week

Another rate cut in November?

Reporting season ramps up

What to watch this week: Reporting season

Signs are pointing to an August rate cut

8 reasons for the market rebound

Will Brexit ever happen?

Will we see a post-election rally?

Keeping Brexit in perspective

Is the Brexit frenzy justified?

Brexit blues

Has Janet Yellen lost her nerve?

Why a Brexit is a bad idea

Will Janet Yellen pull the trigger on interest rates?

Two more rate cuts on the cards

Global growth worries return

RBA expected to cut and budget preview

Share recovery continues

Rising risk to Australia’s AAA rating?

Global growth worries return

Bank worries still weighting on share market

Fed officials still upbeat

Rising $A is a concern

The ECB delivers and shares rebound

Australia keeps on keeping on

Will Australian property prices crash?

Shares bounce as companies deliver good results

Volatility feeding itself

Outlook for the markets

Decent investment yield matters in volatile times

Central banks more dovish

Good chance of a short-term bounce

Another volatile week ahead

7 reasons not to be too concerned

A poor start to the year

What to watch over the next two weeks

Shares poised for Santa Claus rally

A constrained year for investors

Fed on track to hike

Market focus on central banks

Share markets bounce back

Santa Claus rally likely

Solid gains for global shares

What to watch over the next week

The ECB signals further monetary easing

Pressure mounts on the RBA

The great rebound

US Congress showdown to grip markets

US rate hike expectations shift to 2016

Rough ride ahead

Falling dollar to provide boost for economy

From goodbye to good buy

Is this 1997-98 all over again?

Reporting season so far

Cost cutting focus of earnings reports

The week in review and what's ahead

Global focus returns to the US

Is the short-term correction over?

Uncertain times

Volatility to continue, but bull market not over yet

The RBA's clear easing bias is back

Greek negotiations drag on

RBA not expected to cut...yet

US GDP and Eurozone confidence

What's happening at the Fed?

The lessons of the last Budget

What to watch over the next week

The Fed is the focus

A full week of US earnings results

What to watch over the next week

What to watch over the next week?

The economic week ahead

All eyes on the Fed

Shares at risk of a correction

What to watch over the next week

What to watch over the next week?

Earnings numbers and the week ahead

What to watch over the next week?

What to watch over the next week

What to watch over the next week?

What to watch

A list of lists for the economy and shares

Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300