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

What to watch over the next week

Monday, November 28, 2016

By Shane Oliver

The past week saw the rally in shares continue to be helped by good global data, rising commodity prices and ongoing optimism regarding President elect Trump’s stimulus plans. US shares rose 1.4%, Eurozone shares rose 0.9%, Japanese shares rose 2.9%, Chinese shares rose 3% and Australian shares gained 2.8%. The main drag though is the continuing rise in the $US which has broken out to its highest level against an average of major currencies since 2003.

Despite this, commodity prices rose, making the latest bout of $US strength more positive than seen in 2014. Higher prices for bulks, metals and energy saw resources shares lead the charge higher in Australian shares over the last week. Despite the rising $US, the $A rose, helped along by higher commodity prices. Bond yields continued to rise in the US and Australia. 

Is Europe different?

Brexit, Trump, Le Pen … or is Europe different? Naturally, after the recent experience in the UK and US, which is indicative of a resurgent nationalist backlash against the pro-globalisation establishment, there is a fear that Europe will go the same way. But there are several reasons for thinking that Europe is different – that a populist driven break up won’t happen.

First, Europe does not have the same issues with inequality that has driven the "leftist" backlash in the UK and US. It has always been well to the left of Anglo countries.

Second, the maximum risk point in the Eurozone was arguably just after the Eurozone debt crisis a few years ago when austerity and unemployment were at their peak.

Third, despite the media excitement, the increase in support for the Euro-sceptic populists following Brexit, Trump, etc, has not really been overwhelming. Support for Le Pen and the National Front in France has been stuck around 25%. The Five Star Movement in Italy looks to have peaked in the polls and polls less than the governing party. Alternative for Deutschland only gets about 15% support.

Finally, support in mainland Europe for the EU and Euro is high. Perhaps the two main pressure points in Europe are the migration crisis and austerity - but the migration crisis is abating and austerity looks to be over with the European Commission even recommending recently that member countries adopt a more expansionary stance. Risks are high though and the December 4 Austrian presidential election and Italian Senate referendum could add to fears about a break up. But the evidence suggests that Europe is not the same as the UK and the US and that bouts of share market weakness on Eurozone breakup fears should be seen as buying opportunities.

Australia's soap opera

The soap opera about Australia’s AAA sovereign rating is back on again, but does it really matter? While the surge in bulk commodity prices should boost corporate tax revenue this looks like being offset by lower personal tax collections due to lower wages growth, so yet another budget blow out is possible. Meanwhile, S&P has Australia on negative outlook and has warned of a downgrade if there is any further delay in return to balance by 2020-21. Given the continuous delays of recent years and Australia’s continuing dependence on foreign capital, the odds of a downgrade are high. But would it matter?

First, based on other countries that have been downgraded it’s 50/50 as to whether borrowing costs would actually rise in response to a downgrade. Italy and Spain have lower ratings than Australia and yet have lower borrowing costs. And in any case, if mortgage rates do rise in response to a downgrade, the RBA can always cut the official interest rate in order to bring them back down to where it wants them. In fact, the main blow from a downgrade would be what it tells us about the deterioration in the quality of economic policy making in Australia.

Mortgage rates

Australian mortgage rates on the way back up? The past week has seen several lenders raise fixed rate mortgage rates. This is a natural reaction to the back up in bond yields which drive the funding costs for fixed rate mortgages. Major bank variable rates are at risk of out of cycle increases but it’s hard to see them rising significantly any time soon as we don’t see the RBA raising the cash rate until 2018 (see below). 

Major global economic events and implications

US economic data remained solid. The Markit manufacturing conditions PMI, consumer sentiment, durable goods orders and existing home sales all rose more than expected and the services PMI remained strong. December quarter GDP growth is tracking around 3% annualised and the US money market is pricing in a 100% probability of a December Fed rate hike.

Eurozone business conditions PMIs also rose further in November and are tracking at levels consistent with a pick-up in GDP growth to around 2%. Consumer confidence also rose. 

Japan’s manufacturing PMI slipped but remains well up from mid-year lows, and inflation rose but remains weak. 

Australian economic events and implications

An upbeat RBA versus a possible slump in September quarter GDP growth ... what gives? Assistant RBA Governor Kent painted a relatively upbeat view of the economic outlook similar to that portrayed by Governor Lowe the week before. By contrast, September quarter construction activity fell much more than expected and along with likely weak net export volumes and soft retail sales points to weak, possibly even slightly negative, September quarter GDP growth, which if reported in early December will no doubt reinvigorate concerns about the Australian economy. However, while the RBA may be a bit too upbeat, I wouldn’t read too much into likely soft September quarter GDP, because it will be payback for much stronger-than-expected growth over the year to the June quarter of 3.3%.

And looking forward, the ramp up in resource export volumes has further to go, approvals data point to a bounce back in dwelling construction and strengthening non-dwelling investment, mining investment is getting close to a bottom with engineering work back to around its long term trend (see chart), recent retail sales data have improved and the rebound in commodity prices tells us that the income recession is over. Given the possible September quarter soft patch in growth and downside risks in inflation we are still allowing for one more interest rate cut next year, but overall growth is likely to be around 3% in 2017 which will help set the scene for a likely RBA rate hike in 2018.

What to watch over the next week?

  • OPEC, US payrolls, the Austrian presidential election and Italian Senate referendum and Australian capex data will likely be the main focus points in week ahead.
  • It’s a close call, but our assessment is that OPEC (Wednesday) will probably reach agreement on a production cut as inventories are rising, Iran is at maximum capacity and Saudi Arabia wants to re-establish its position as the leader of OPEC. This should help the oil price but don't get too excited - it may not get much higher as US shale oil production looks like it’s ramping up again, lighter energy sector regulation under a Trump administration will likely also add to US oil production and OPEC discipline around any cut will be debatable. But it will add to the case that it’s bottomed.
  • In the US, expect a solid rise in the ISM manufacturing conditions index (Wednesday) for November and solid payroll employment growth (Friday) of 180,000 to support expectations for another Fed rate hike in December. The jobs data is likely to show unemployment unchanged at 4.9% and wages growth holding at 2.8%. Meanwhile, expect a rise in consumer confidence and further gains in home prices (both Tuesday), solid personal spending but the core personal consumption deflator remaining around 1.8% year-on-year and little change in pending home sales (all Wednesday). 
  • In the Eurozone, all eyes will be on the Austrian presidential election and Italian senate referendum to be held on Sunday December 4. Opinion polls point to a victory by the right wing Eurosceptic candidate in Austria and a “No” vote in Italy both of which will lead to an increase in Eurozone break up fears. But there will be a long way to go before either country will have a referendum on Eurozone membership (if indeed they do) and as we have seen with Greece a majority of the population support staying in the Euro. On the data front, economic confidence indicators (Tuesday) are expected to show further strength and core inflation (Wednesday) is likely to have remained around 0.8% year-on-year. 
  • Japanese jobs data for November is likely to have remained strong but household spending (both Tuesday) is expected to have remained soft and industrial production (Wednesday) relatively subdued.
  • Chinese manufacturing PMIs (Thursday) for November may slip back a bit but are likely to remain in a rising trend.
  • In Australia, September quarter business investment data (Wednesday) is expected to show continued mining driven weakness but with signs that mining investment is getting close to the bottom and that non-mining investment plans may be improving. Meanwhile, expect a bounce in building approvals and continued moderate credit growth (both Wednesday) and a 0.2% gain in October retail sales (Friday).

Outlook for markets

Shares are now overbought and due for a pause and event risk could cause short term volatility with policy uncertainty remaining high in the US, Eurozone break up risks coming back into focus with the Italian Senate referendum and Austrian presidential election re-run and ECB and Fed meetings in December. Bond yields could also see more upside in the short term. However, we anticipate shares to be higher by year's end as seasonal strength kicks in (the “Santa rally”) and see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australia. 

Sovereign bonds are now very oversold and due for a pullback in yield. But still low bond yields point to a poor medium term return potential from them. The abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the long term decline in yields since the early 1980s is probably over. Expect the trend in bond yields to be up.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors though as these two asset classes never fully adjusted to the full decline in bond yields. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the $A remain down.

Eurozone shares gained 0.2% on Friday and the US S&P 500 rose 0.4% despite a 4.2% fall in the oil price on scepticism OPEC will reach an agreement to cut output. Despite the gains in US shares the ASX 200 futures contract was flat, perhaps weighed down a bit by the fall in the oil price, pointing to a flat start to trade for the Australian share market on Monday.

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Trump the pragmatist, or protectionist?

Monday, November 21, 2016

By Shane Oliver

The past week saw US shares gain 0.8% and Japanese shares gain 3.4% as bond yields and the $US continued to push higher as investors focussed on prospects for fiscal stimulus and deregulation under a Donald Trump presidency. However, Chinese shares were flat, Eurozone shares slipped 0.3% and Australian shares fell 0.2% after their 3.7% surge in the previous week. Emerging market shares remained under pressure from the rising $US and commodity prices were mixed. The rising $US saw the $A fall below $US0.74 which is good news for the RBA. 

Pragmatic Trump?

It’s still early days, but the past week provided a bit more evidence that we are more likely to see a pragmatic Donald Trump as president (focussed more on positive measures to boost growth - tax cuts, infrastructure spending and deregulation) rather than a protectionist populist. To be sure, some of the appointments to his team have raised question marks and some action on the trade front looks inevitable but his appointment of a Republican establishment figure as his Chief of Staff and his watering down of commitments around the Affordable Care Act, the wall with Mexico and deporting illegal immigrants suggest he is likely to be more moderate than his campaign rhetoric suggested. As such, while risks on the trade front are high, we remain of the view that his stimulatory policies on balance are likely to be neutral to positive for advanced country equities, positive for commodities, positive for the $US as the Fed is likely to tighten by more and negative for bonds and some emerging share markets (as a rising $US creates dollar funding concerns). Of particular note though:

  • The last two big cyclical surges in the $US in 1981-85 and 1997-2001 were actually good for US shares with the S&P 500 index up 50% and 80% respectively.
  • European and Japanese equities will be particular beneficiaries of a rising $US - maybe not so much Europe in the short term given short term risks around Italy and Austria (see below) but particularly Japanese shares which get the benefit of a falling Yen but are not seeing the same upwards pressure on bond yields because of the Bank of Japan's commitment to cap JGB yields at zero which in turn is amplifying downwards pressure on the Yen.
  • Upwards pressure on bond yields (made worse by an unwinding of long bond positions) and the $US is likely to pause and then become more gradual as the rise in the $US at a time when other central banks are a long way from tightening will help limit how quickly the Fed will raise rates.
  • The falling Chinese Renminbi (RMB) is a strong $US, not weak Renminbi story. Over the last week, as $US index (DXY) rose 2.3% against a basket of currencies, the RMB fell 1.2% against the $US but its trade weighted basket is basically flat. In fact, the fall in the RMB against the $US is mild compared to that of other currencies, eg. over the last week the Euro fell 2.4%, the Yen fell 3.9% and the $A fell 2.5%. So it’s not a case of China artificially devaluing their currency ahead of a feared protectionist Trump presidency. 
  • Cyclical share market sectors are likely to continue to outperform bond proxies such as REITs. 

Will President Trump replace Janet Yellen?

There is much talk he will replace her with a more hawkish “hard money” chairperson. However, she is answerable to Congress not the president and her current term does not end until the end of January 2018 (until which she has indicated she intends to stay) but by which time Trump may well conclude that it’s in his own interest to retain a more dovish Fed leader for fear that a more hawkish Fed would offset the benefits of his stimulus program via even higher interest rates, bond yields and a $US. So it’s premature to conclude he will replace Yellen.

Focus shifts to Europe

The geopolitical focus is now shifting back to Europe, with the upcoming referendum on reducing the power of the Italian Senate and the Austrian presidential election both on December 4 refocussing attention on Eurozone break up risks. Opinion polls in Austria are pointing to the election of the Euro-sceptic right wing candidate - and although the president is largely ceremonial his election could add to anxiety about the threat to Europe. Italy is more significant though - the Senate referendum coming on the back of reforms to the lower house of Italy's parliament are designed to make Italy more governable and clear the way for long needed economic reforms (just what Australia needs!)

Opinion polls are now leaning to a "No" vote. A "No" vote would probably see PM Matteo Renzi resign with fears that this will lead to an early election with the Euro-sceptic Five Star Movement (5SM) winning, calling a referendum on Italy's membership of the Eurozone which would then see Italy move to leave. As a result, bond yields in Italy have blown out on fears that at some point Italian debt will be redenominated into a less valuable currency. These fears are likely exaggerated though: the referendum's failure would just mean messy politics as normal in Italy, it's unlikely there will be an election before the due date in 2018, even if there was it’s not clear that 5SM would win (its poll support is no longer rising and its below support for the governing party) and even if it did and called a referendum on Italy's membership of the Euro a majority of Italians support staying in the Euro. That said, markets may still worry about what would happen if there is a "No" vote. So it could cause short-term volatility but I suspect another bout of share market weakness on Eurozone break up fears would prove to be yet another buying opportunity just like over the last five years. 

Major global economic events and implications

US data was mostly solid. Retail sales rose more than expected in October and were revised up for September indicating that the consumer is kicking into gear, while industrial production was soft in October regional manufacturing conditions indexes suggest little reason for alarm, solid home builder conditions and strong housing starts point to solid housing investment and jobless claims remain low. Meanwhile, headline consumer price inflation continues to rise as the impact of the fall in energy prices falls out, but producer price inflation and core CPI inflation was softer than expected. Finally, Janet Yellen's testimony provided no surprises indicating rates will likely rise "relatively soon" but that the process of rate hikes would remain "gradual". Bottom line: US growth looks to be running around 3% in the current quarter consistent with the Fed hiking rates in December, for which the money market is now attaching a 98% probability.

Eurozone GDP growth remained moderate at 0.3% quarter on quarter/1.6% year-on-year (yoy) in the September quarter as widely expected. Business conditions PMI's and confidence readings point to some pick-up in growth ahead. 

Japanese GDP growth surprised on the upside for the September quarter with strength in exports, housing investment and public spending. Last year's volatility has given way to more steady growth this year with stronger consumer spending likely to help growth going forward. 

Chinese economic activity indicators were mixed in October with slower retail sales (albeit 10% yoy ain't bad), steady industrial production at 6.1% yoy and a pick-up in fixed asset investment helped by property investment. Having just returned from China, the one thing that struck me is that it’s as busy as ever. If you are waiting for the hard landing long predicted by the China bears it’s a bit like "waiting for Godot". 

Australian economic events and implications

In Australia, the minutes from the RBA's last Board meeting offered nothing new and a relatively upbeat speech by Governor Lowe indicated that the Bank is happily on hold for now, but labour market softness highlights that’s it still too early to rule out another interest rate cut next year. Employment rose in October, driven by a gain in full time jobs but left in place a very weak trend for full time jobs consistent with continuing very high underemployment. This in the September quarter resulted in a new record low for wages growth of just 1.9% yoy. The risk is that this in turn will result in lower inflation than the RBA is allowing for, and combined with a slowing in the housing sector, upwards pressure on bank mortgage rates from rising funding costs and a still too high $A will drive another rate cut. Bottom line: while global bond yields are on the rise on prospects for stronger US growth and a tighter Fed and this will likely see the Australian interest rate cycle turn up in 2018, we are still allowing for another RBA rate cut in the first half of next year. 

What to watch over the next week?

In the US, the manufacturing conditions PMI (Wednesday) is likely to have remained around solid levels. Expect flat existing home sales (Tuesday) and new home sales (Wednesday) after solid gains in September, continued modest growth in home prices and a bounce in durable goods orders (both Wednesday) but with little change in underlying orders. The Minutes from the last Fed meeting (also Wednesday) will be very dated.

In Europe, manufacturing and services conditions PMIs (Wednesday) are expected to have remained solid at around 53.5, consistent with a slight pick-up in economic growth.

Japan's manufacturing conditions PMI (Thursday) will be watched for further signs of improvement. Inflation data (Friday) is expected to show continuing headline deflation.

In Australia, a speech by the RBA’s Kent (Tuesday) will be watched for clues on the interest rate outlook. September quarter construction data (Wednesday) is likely to show an ongoing decline in mining engineering investment.

Outlook for markets

While the US election is out of the way, event risks could still cause short term volatility in share markets with policy uncertainty remaining high in the US (watch the senior appointments to Trump’s team), Eurozone break up risks coming back into focus with the Italian Senate referendum and Austrian presidential election re-run (both on December 4) and ECB and Fed meetings in December. Bond yields could also see more upside in the short term. However, despite continuing volatility, we anticipate shares to be higher by year end and to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets. 

Sovereign bonds are now very oversold and due for a bounce in price (or pullback in yield). But still low bond yields point to a poor medium term return potential from them. The abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the long term decline in yields since the early 1980s is probably over. Expect the trend in bond yields to be up.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors though as these two asset classes never fully adjusted to the full decline in bond yields. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the $A remain down.

Eurozone shares fell 0.7% and the US S&P 500 lost 0.2% in quiet trade on Friday. Despite the soft global lead ASX 200 futures rose 0.1% so I expect a 5 to 10 point gain at the open for the Australian share market on Monday. Perhaps of more interest is the $A which fell to $0.7325 on Friday night its lowest since June after hitting a six month high just before Donald Trump’s election victory. Expectations for a narrowing in the interest differential in favour of Australia as Fed tightening swings into view are clearly weighing on the $A, which is good news for Australian companies that have to compete internationally.

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

Monday, November 14, 2016

By Shane Oliver

The past week has all been about the US presidential election with share markets first falling and bonds and gold rallying on news of Donald Trump’s likely victory as investors initially worried about a global trade war and policy uncertainty, only to see a sharp reversal (and then some) as investors focussed on the stimulatory aspects of his policy platform. The key turning point appears to have been Donald Trump’s conciliatory victory speech which appeared to drive a focus on the more positive aspects of his policy platform (including tax cuts, deregulation and infrastructure spending) which could boost growth, inflation and interest rates in the US. Reflecting this, major share markets saw strong gains for the week overall, but with emerging market shares falling, bond yields rose sharply on expectations for higher inflation and interest rates and the $US rose, and this, along with sharp falls in Asian currencies weighed on the $A despite sharp gains in prices for metals and iron ore. For the week, US shares rose 3.8%, Eurozone shares rose 2%, Japanese shares rose 2.8%, Chinese shares rose 1.9% and Australian shares rose 3.7%.

Sectors to benefit from a Trump Presidency

US share market sectors that will benefit from deregulation and infrastructure spending under Trump – like industrials, financials, healthcare, energy and materials – rose the most, but bond yield sensitive REITs and utilities struggled. This pattern was also reflected in the Australian share market, but with resources stocks doing particularly well.

While US financials stand to benefit from plans to dismantle the US Dodd-Frank financial sector law that cracked down on banks post the GFC, global and Australian banks have rallied too on the basis that what happens in the US often goes global and that the shift back to financial sector deregulation in the US will take the wind out of the sails for further global regulatory moves under the Basle framework.    

Three key points on Donald Trump's election

Three key points on Donald Trump’s election as President of the United States.

  1. First, Trump’s victory adds impetus to the backlash against economic rationalist policies, and specifically, globalisation, that got kicked off by the Brexit vote. On the face of it, this is a threat to global growth and investment returns if it ushers in a period of lower productivity. However, with Trump, there is a twist. While his trade policies could be bad for productivity and global growth, his proposed tax cuts, infrastructure spending and industry deregulation will likely boost productivity and growth. So it could all turn out to be positive.  
  2. Second, what ultimately matters is whether we get Trump the pragmatist focussing on the fiscal stimulus (tax cuts and infrastructure spending) and industry deregulation aspects of his program, or Trump the populist, focussing particularly on aggressive protectionism. The populist is what we saw in the election campaign, but economic and political realities usually force politicians to become more pragmatic once in office. Trump’s conciliatory victory speech provided a bit of confidence that he will be more pragmatic as does his business background.  
  3. Finally, Trump’s victory adds impetus to the “great policy rotation” from relying solely on monetary policy to boost growth, to a greater reliance on fiscal stimulus (tax cuts and infrastructure spending) and structural reform (deregulation). While House Republicans are likely to want to limit any budget deficit blow out, expect agreement between Trump and Congress to be reached pretty quickly. This will likely all mean stronger growth, higher inflation, more upwards pressure on bond yields and more upwards pressure on the Fed. In the absence of much negative fallout in investment markets from Trump’s victory, the Fed remains on track to hike in December (with the US money market pricing in an 84% probability), but assuming the $US does not push too high, we could see three to four rate hikes next year rather than the one hike that the money market has priced in.

In summary, this is neutral to positive for shares (with stronger economic and profit growth offsetting the negative impact from faster Fed tightening), mostly positive for commodities (with US infrastructure spending adding to China’s), negative for bonds and positive for the $US. Emerging market shares could be relative losers though on trade fears, and the risk of a dollar funding crisis if the $US continues to rise and yield sensitive share market sectors, like REITs and utilities, are likely to be under pressure for longer as bond yields rise with cyclical sectors outperforming.

What does it mean for Australia?

For Australia, the impact of Trump’s victory also comes down to whether we get Trump the populist, as US tariffs on Chinese imports will likely invite retaliation and see Australia caught in the cross fire with a fall in demand for our exports – or Trump the pragmatist – as stronger US growth and the avoidance of a debilitating trade war will ultimately be good for Australia.

I have a leaning towards the latter. In the meantime, with little negative fallout in investment markets from Trump’s victory, there are little in the way of implications for the RBA regarding Australian interest rates in the short term. Looking out further, if Trump’s policies help drive stronger US growth and inflation, then the beneficial impact on Australia could help eventually help drive higher interest rates here – but that’s a 2018 story at the earliest.

Major global economic events and implications

US data remained good, with a rise in small business optimism, job openings and hiring remaining strong, jobless claims remaining low and a reported easing in bank lending standards to households. Meanwhile, the mortgage delinquency rate for US households has fallen to its lowest since 2006. 

Japanese wages growth remained very weak in September and machine orders fell, but bank lending and the Eco Watcher’s economic confidence index rose more than expected and corporate bankruptcies are down 8% year-on-year (yoy).

Chinese import and export data for October remained weak but consumer price inflation rose slightly to 2.1% yoy (from 1.9%) and producer price inflation rose to 1.2% yoy which is up from -5.9% a year ago. The upswing in producer prices is driven by stronger commodity prices and a stabilisation in Chinese economic growth and is positive for nominal economic growth and profits in China.

Australian economic events and implications

In Australia, housing finance unexpectedly rose in September, led by strength in lending to investors, and ANZ job ads rose by 1% but business and consumer confidence fell slightly leaving them slightly above or around their long term averages. Nothing to get too excited about here, but the reinvigoration of lending to property investors at a time when Sydney and Melbourne price growth and auction clearance rates remains robust is a bit of a concern. 

What to watch over the next week?

In the US, the consumer will be back in focus with October retail sales data (Tuesday) expected to show solid growth, although election uncertainty may have acted as a bit of a drag. Meanwhile, expect modest growth in industrial production (Wednesday), continued strength in home builder conditions (also Wednesday) and a rebound in housing starts (Thursday) and core inflation remaining around 2.2% yoy.

In Japan, September quarter GDP growth (Monday) is expected to come in around 0.2% quarter on quarter (qoq) (unchanged from the June quarter).

Chinese activity data for October (Monday) is likely to show a slight rise in industrial production to 6.2% yoy (from 6.1%), but retail sales growth is expected to remain unchanged at 10.7% yoy and investment at 8.2% yoy.

In Australia, wages (Wednesday) are expected to rise 0.6% qoq, leaving annual growth at a record low of 2.1% yoy. Meanwhile, October jobs data (Thursday) is expected to show a 30,000 bounce in employment with unemployment rising to 5.7% (from 5.6%) as participation bounces back after recent falls. The Minutes from the last RBA Board meeting and a speech by Governor Lowe are likely to confirm that the RBA has a neutral bias on interest rates for now.

Outlook for markets

While the US election is out of the way, event risks could still cause short term volatility in share markets, with policy uncertainty remaining high in the US (watch the senior appointments to Trump’s team in the weeks ahead), Eurozone break up risks likely coming back into focus with the Italian Senate referendum and Austrian presidential election re-run (both on December 4) and ECB and Fed meetings in December.

Bond yields could also see more upside in the short term. However, despite continuing volatility, we anticipate shares to be higher by year end and to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets. 

Sovereign bonds are now very oversold and due for a bounce in price (or pullback in yield). But still, low bond yields point to a poor medium-term return potential from them. While it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks, the abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the cyclical decline in bond yields (and likely too the long term decline since the early 1980s) is probably over. Expect the trend in bond yields to be up.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors though, as these two asset classes never fully adjusted to the full decline in bond yields. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the $A remain down. 

Eurozone shares fell 0.5% and the US S&P 500 fell 0.1% on Friday as investors paused to digest Donald Trump’s election victory and the oil price fell. The soft global lead saw ASX 200 futures fall 0.3% so I expect the Australian market to open down 15 points or so on Monday morning. With the ASX 200 rising 3.7% over the last week some short term pull back is to be expected.

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

Monday, November 14, 2016

By Shane Oliver

The past week has all been about the US presidential election with share markets first falling and bonds and gold rallying on news of Donald Trump’s likely victory as investors initially worried about a global trade war and policy uncertainty, only to see a sharp reversal (and then some) as investors focussed on the stimulatory aspects of his policy platform. The key turning point appears to have been Donald Trump’s conciliatory victory speech which appeared to drive a focus on the more positive aspects of his policy platform (including tax cuts, deregulation and infrastructure spending) which could boost growth, inflation and interest rates in the US. Reflecting this, major share markets saw strong gains for the week overall, but with emerging market shares falling, bond yields rose sharply on expectations for higher inflation and interest rates and the $US rose, and this, along with sharp falls in Asian currencies weighed on the $A despite sharp gains in prices for metals and iron ore. For the week, US shares rose 3.8%, Eurozone shares rose 2%, Japanese shares rose 2.8%, Chinese shares rose 1.9% and Australian shares rose 3.7%.

Sectors to benefit from a Trump Presidency

US share market sectors that will benefit from deregulation and infrastructure spending under Trump – like industrials, financials, healthcare, energy and materials – rose the most, but bond yield sensitive REITs and utilities struggled. This pattern was also reflected in the Australian share market, but with resources stocks doing particularly well.

While US financials stand to benefit from plans to dismantle the US Dodd-Frank financial sector law that cracked down on banks post the GFC, global and Australian banks have rallied too on the basis that what happens in the US often goes global and that the shift back to financial sector deregulation in the US will take the wind out of the sails for further global regulatory moves under the Basle framework.    

Three key points on Donald Trump's election

Here are three key points on Donald Trump’s election as President of the United States.

  1. First, Trump’s victory adds impetus to the backlash against economic rationalist policies, and specifically, globalisation, that got kicked off by the Brexit vote. On the face of it, this is a threat to global growth and investment returns if it ushers in a period of lower productivity. However, with Trump, there is a twist. While his trade policies could be bad for productivity and global growth, his proposed tax cuts, infrastructure spending and industry deregulation will likely boost productivity and growth. So it could all turn out to be positive.  
  2. Second, what ultimately matters is whether we get Trump the pragmatist focussing on the fiscal stimulus (tax cuts and infrastructure spending) and industry deregulation aspects of his program, or Trump the populist, focussing particularly on aggressive protectionism. The populist is what we saw in the election campaign, but economic and political realities usually force politicians to become more pragmatic once in office. Trump’s conciliatory victory speech provided a bit of confidence that he will be more pragmatic as does his business background.  
  3. Finally, Trump’s victory adds impetus to the “great policy rotation” from relying solely on monetary policy to boost growth, to a greater reliance on fiscal stimulus (tax cuts and infrastructure spending) and structural reform (deregulation). While House Republicans are likely to want to limit any budget deficit blow out, expect agreement between Trump and Congress to be reached pretty quickly. This will likely all mean stronger growth, higher inflation, more upwards pressure on bond yields and more upwards pressure on the Fed. In the absence of much negative fallout in investment markets from Trump’s victory, the Fed remains on track to hike in December (with the US money market pricing in an 84% probability), but assuming the $US does not push too high, we could see three to four rate hikes next year rather than the one hike that the money market has priced in.

In summary, this is neutral to positive for shares (with stronger economic and profit growth offsetting the negative impact from faster Fed tightening), mostly positive for commodities (with US infrastructure spending adding to China’s), negative for bonds and positive for the $US. Emerging market shares could be relative losers though on trade fears, and the risk of a dollar funding crisis if the $US continues to rise and yield sensitive share market sectors, like REITs and utilities, are likely to be under pressure for longer as bond yields rise with cyclical sectors outperforming.

What does it mean for Australia?

For Australia, the impact of Trump’s victory also comes down to whether we get Trump the populist, as US tariffs on Chinese imports will likely invite retaliation and see Australia caught in the cross fire with a fall in demand for our exports – or Trump the pragmatist – as stronger US growth and the avoidance of a debilitating trade war will ultimately be good for Australia.

I have a leaning towards the latter. In the meantime, with little negative fallout in investment markets from Trump’s victory, there are little in the way of implications for the RBA regarding Australian interest rates in the short term. Looking out further, if Trump’s policies help drive stronger US growth and inflation, then the beneficial impact on Australia could help eventually help drive higher interest rates here – but that’s a 2018 story at the earliest.

Major global economic events and implications

US data remained good, with a rise in small business optimism, job openings and hiring remaining strong, jobless claims remaining low and a reported easing in bank lending standards to households. Meanwhile, the mortgage delinquency rate for US households has fallen to its lowest since 2006. 

Japanese wages growth remained very weak in September and machine orders fell, but bank lending and the Eco Watcher’s economic confidence index rose more than expected and corporate bankruptcies are down 8% year-on-year (yoy).

Chinese import and export data for October remained weak but consumer price inflation rose slightly to 2.1% yoy (from 1.9%) and producer price inflation rose to 1.2% yoy which is up from -5.9% a year ago. The upswing in producer prices is driven by stronger commodity prices and a stabilisation in Chinese economic growth and is positive for nominal economic growth and profits in China.

Australian economic events and implications

In Australia, housing finance unexpectedly rose in September, led by strength in lending to investors, and ANZ job ads rose by 1% but business and consumer confidence fell slightly leaving them slightly above or around their long term averages. Nothing to get too excited about here, but the reinvigoration of lending to property investors at a time when Sydney and Melbourne price growth and auction clearance rates remains robust is a bit of a concern. 

What to watch over the next week?

In the US, the consumer will be back in focus with October retail sales data (Tuesday) expected to show solid growth, although election uncertainty may have acted as a bit of a drag. Meanwhile, expect modest growth in industrial production (Wednesday), continued strength in home builder conditions (also Wednesday) and a rebound in housing starts (Thursday) and core inflation remaining around 2.2% yoy.

In Japan, September quarter GDP growth (Monday) is expected to come in around 0.2% quarter on quarter (qoq) (unchanged from the June quarter).

Chinese activity data for October (Monday) is likely to show a slight rise in industrial production to 6.2% yoy (from 6.1%), but retail sales growth is expected to remain unchanged at 10.7% yoy and investment at 8.2% yoy.

In Australia, wages (Wednesday) are expected to rise 0.6% qoq, leaving annual growth at a record low of 2.1% yoy. Meanwhile, October jobs data (Thursday) is expected to show a 30,000 bounce in employment with unemployment rising to 5.7% (from 5.6%) as participation bounces back after recent falls. The Minutes from the last RBA Board meeting and a speech by Governor Lowe are likely to confirm that the RBA has a neutral bias on interest rates for now.

Outlook for markets

While the US election is out of the way, event risks could still cause short term volatility in share markets, with policy uncertainty remaining high in the US (watch the senior appointments to Trump’s team in the weeks ahead), Eurozone break up risks likely coming back into focus with the Italian Senate referendum and Austrian presidential election re-run (both on December 4) and ECB and Fed meetings in December.

Bond yields could also see more upside in the short term. However, despite continuing volatility, we anticipate shares to be higher by year end and to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets. 

Sovereign bonds are now very oversold and due for a bounce in price (or pullback in yield). But still, low bond yields point to a poor medium-term return potential from them. While it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks, the abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the cyclical decline in bond yields (and likely too the long term decline since the early 1980s) is probably over. Expect the trend in bond yields to be up.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors though, as these two asset classes never fully adjusted to the full decline in bond yields. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the $A remain down. 

Eurozone shares fell 0.5% and the US S&P 500 fell 0.1% on Friday as investors paused to digest Donald Trump’s election victory and the oil price fell. The soft global lead saw ASX 200 futures fall 0.3% so I expect the Australian market to open down 15 points or so on Monday morning. With the ASX 200 rising 3.7% over the last week some short term pull back is to be expected.

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How the US election result could impact the markets

Monday, November 07, 2016

US election uncertainty really hit financial markets over the past week as news of the FBI’s intervention saw average opinion poll support for Clinton over Trump decline to 1 to 2 points. This along with falling oil prices saw most share markets fall. While Chinese shares rose 0.4%, US shares fell 1.9%, Eurozone shares fell 4%, Japanese shares fell 3.1% and Australian shares fell 2%. Bond yields in major countries declined and gold rose on safe haven demand. While prices for metals and iron ore rose, oil fell on a strong US oil inventory build and fears OPEC won’t implement its deal to cut production. The $US fell on the back of election uncertainty and this along with higher metal prices saw the $A rise.

If the US election result is to be reasonably decisive – a big if! – we should have an idea who won by around 1-2pm (Sydney time) on Wednesday. What can we expect from investment markets? I tend to think the median American voter will reject misogynism, racism and narcissism and this combined with the Democrats natural advantage in the Electoral College favours a Clinton win, but following the narrowing in the polls over the past week it is now a very close call. Even if Clinton wins there is close to zero chance of the Democrats retaking control of Congress in a clean sweep. The last few weeks have seen shares sell off when developments favoured Trump and rally when developments favoured Clinton and get the jitters when there is talk of a Democrat clean sweep – suggesting investors favour a Clinton victory as long as it’s not a clean sweep. With US shares down 5% and Australian shares down 7% from August highs it seems investors have factored in maybe a 50/50 bet on the election outcome. Given all this:

  • A Trump victory would likely trigger a further initial bout of “risk off” with shares down by 5% or so (both in the US and globally) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares would be particularly vulnerable to this given our high trade exposure (exports are 21% of GDP in Australia against 13% in the US). While the Fed would be less likely to hike in December if Trump wins the $A would likely still suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war may also increase the chance of another RBA rate cut in Australia.
  • Beyond the initial reaction, share markets could then settle down and get a boost to the extent that his stimulatory economic policies look like being supported by Congress, but much would ultimately depend on whether we get Trump the pragmatist (who backs down on his more extreme policies, eg around protectionism) or Trump the populist. Congress along with economic and political reality can probably be relied on to take some of the edge of Trump’s policies to some degree, but this would take time.
  • A Clinton/Democrat clean sweep of the Presidency and Congress would likely also trigger a further bout of nervousness in US shares as it would be easier for Clinton to implement less business friendly tax and regulatory policies that would weigh particularly on US health, energy and financial stocks. This would likely be more focussed on US shares though with less of an impact on global/Australian shares. However, this scenario is now very unlikely.
  • The best outcome for shares would be a Clinton victory but with Republicans retaining control of at least the House as this would be seen as “more of the same”. This would likely see a decent relief rally in US, global and Australian share markets – particularly given that they are already technically oversold. While there may be concerns about her policies on income and capital gains tax and regulation, these would have little chance of getting through a Republican Congress. The downside is that if her win is narrow a Clinton presidency is likely to be weak with a poor mandate, ongoing controversy around the FBI investigation of her emails, issues around the Clinton Foundation and very low popularity. Against this background Congressional Republicans are unlikely to be particularly cooperative in implementing sensible policy changes. Historically, since 1927 US total share returns have been strongest at an average 16.7% pa when there has been a Democrat president and Republican control of the House, the Senate or both.

Source: Bloomberg, AMP Capital

Of course there is the question of what will happen if the result is unclear - either with no candidate winning the necessary 270 Electoral College votes or the result being so close that it’s contested as occurred in 2000 between Bush and Gore. Either result will likely see shares under pressure short term. In the first scenario, the House of Representatives will decide with one vote to each group of state representatives and since it will almost certainly have a Republican majority Trump will win. But get this: the Senate then chooses the vice-president from top two candidates so we could have Vice-President Clinton to President Trump! In the second scenario, the 2000 experience saw US shares fall about 8% and safe havens rally until a result was declared - but prior to the 2000 election shares had rallied (whereas now they have fallen) and the falls were likely affected by the tech wreck recession around that time.

Finally, while all this sounds a bit messy – just recall the fears around Brexit, which after a few days saw global markets move on to focus on other things with shares rebounding. And at least this time around there is less complacency ahead of the event. Global and Australian shares rallied into the Brexit vote, whereas this time around they have already fallen 3-5% over the last two weeks to price in maybe a 50% chance of a Trump victory and are already technically oversold and primed for a rebound if the news is good or uncertainty is reduced.

Looking beyond the boulder in the investment road that is the US election… the news over the last week or so has actually been reasonably good. This is most evident in business conditions PMIs, which rose in most countries in October both for services and manufacturing and are trending up after a soft patch earlier this year. This is good for profits and hence share markets. While it keeps the Fed on track to raise interest rates in December it’s a far more positive back drop (US election uncertainty aside) than was the case a year ago.

Source: Bloomberg, AMP Capital

Major global economic events and implications

US data was good. Personal spending saw solid growth in September, the ISM manufacturing conditions index rose adding to evidence that the manufacturing sector is healthier and the non-manufacturing conditions ISM remained strong, the trade deficit narrowed and October saw payroll employment growth of 161,000 new jobs, a fall in unemployment and a further pick up in wages growth. While faster wages growth (albeit from a low base) is bad for profit margins it’s actually good for profits as it boosts household income, consumer spending and hence corporate revenue. Meanwhile there were no surprises from the Fed which left interest rates on hold as expected but expressed more confidence on the economy and inflation and indicated that the case for a hike has continued to strengthen. The solid October jobs report provides another green light for the Fed. Bottom line: barring a shock (eg. a Trump win or bad data) the Fed remains on track to hike in December.

Revenue growth and better margins have driven an end to the profit recession in the US. The US profit reporting season is now over 80% done with 75% of companies beating on earnings and 55% beating on sales. Profits are on track to be up in the quarter, up on a year ago and up relative to the last high in 2014.

Eurozone growth continued in the September quarter at a moderate pace of 1.6% yoy with a rising trend in business conditions PMIs and confidence readings pointing to a possible pick up ahead. However, with core inflation remaining low at 0.8%, headline inflation just 0.5% and unemployment remaining high at 10% pressure on the ECB to extend it quantitative easing program beyond March next year remains.

The UK High Court’s requirement that the British parliament approve the triggering of Brexit is unlikely to stop it but reduces the chance of a hard Brexit. Meanwhile the Bank of England is now on hold. Both are short term positive for sterling.

There was no surprise from the Bank of Japan which left monetary policy unchanged. It’s already doing open ended quantitative easing anyway until inflation exceeds its 2% target.

Chinese manufacturing and services PMIs rose in October and are actually trending up adding to confidence that Chinese growth has stabilised.

Australian economic events and implications

In Australia, as expected the RBA left interest rates on hold with inflation in line with expectations and its inflation and growth expectations little changed from three months ago as confirmed in its Statement on Monetary Policy. Short of a shock – eg financial turmoil in response to a Trump victory or a run of very soft economic data - it’s hard to see the RBA cutting interest rates at its December meeting. However, with housing construction likely to slow next year, an expected slowing in house price momentum leading to fading wealth effects, falling full time jobs a concern for consumer spending, credit growth slowing, inflation risks skewed to the downside and the likely need to offset regulatory driven pressure on banks to raise mortgage rates, we are allowing for another interest rate cut in the first half of next year.

Australian economic data was a mixed bag. On the strong side the trade deficit fell sharply driven by the surge in coal prices, non-residential building approvals are rising solidly, business conditions PMIs rose in October and September retail sales saw a decent gain. But against this, retail sales volumes were soft in the September quarter, home building approvals fell sharply and credit growth is slowing. Momentum in Sydney and Melbourne home prices remains strong according to CoreLogic but its weak to moderate elsewhere and the Melbourne Institutes’ Inflation Gauge showed weak inflation continuing into the current quarter. Bottom line: the risks remain skewed to rate cuts.

What to watch over the next week?

Globally, all eyes will be on the US election, but apart form that it will be a relatively quiet week with Chinese trade and inflation data and Australian confidence data being the main areas of interest.

In the US, small business confidence (Tuesday) and consumer sentiment (Friday) may show an election related dip but data for job openings (Tuesday) is likely to remain solid.

Chinese trade data for October (Tuesday) is expected to show some improvement in exports and imports and consumer price inflation (Wednesday) is likely to edge up to 2.1% year on year and producer price inflation is expected to rise further to 0.9% yoy as higher commodity prices feed through.

In Australia, business conditions and confidence as measured by the NAB survey (Tuesday) are expected to hold at above average levels, but consumer confidence (Wednesday) may dip slightly. Housing finance (Thursday) is expected to continue to slow falling another 3% or so. Speeches by RBA officials Ryan and Debelle will be watched for any clues on interest rates.

Outlook for markets

We remain cautious on shares in the short term as event risk is high given the US election, the Italian Senate referendum & Austrian presidential election re-run (both on December 4) and ECB and Fed meetings in December. Bond yields could also see more upside in the short term. However, after any further short term weakness, we anticipate shares to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets.

Still ultra-low bond yields point to a poor medium term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns.

The outlook for the $A has become murky. A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend remain down and the $A normally overshoots on the downside after the bursting of commodity price booms and this remains our base case. But against this, the stabilisation and rising trend in some commodity prices and the continued gradual nature of Fed rate hikes suggest ongoing upside risks in the short term. The danger is that the latter will threaten the rebalancing of the economy and the best defence against this is for the RBA to revert to a clear easing bias even if it never acts on it.

Eurozone shares fell 0.7% on Friday and the US S&P 500 fell 0.2% as US election uncertainty continued to weigh along with a further fall in oil prices. Reflecting the weak global lead ASX 200 futures fell 0.6% so I expect another weak open for the Australian share market on Monday driven by US election fears with the ASX 200 likely to fall 25 to 30 points.

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Why has the Australian market slipped?

Monday, October 31, 2016

By Shane Oliver

Investment markets and key developments over the past week

Shares were mixed over the last week, with Japanese shares up 1.5% and Chinese shares up 0.4%, but Eurozone shares flat, US shares down 0.7% and Australian shares down 2.7%. US shares were hit late on Friday by renewed election uncertainty, as the FBI announced it was reopening its investigation into Hillary Clinton’s use of a private email server while Secretary of State. Bond yields continued to back up as prospects for a December Fed rate hike continue to firm and as stronger UK growth diminished prospects for a further Bank of England easing. Commodity prices were mixed with oil down but metals up and the $A fell slightly despite a fall in the $US. 

Why the recent poor performance from Australian shares?

While global shares have been range bound over the last few months (with Eurozone and Japanese shares benefitting from falls in their currencies and the US share market down a bit) Australian shares are down 5% from their August high. This relative underperformance reflects a combination of:

  • concerns about the Fed and the US election that seem to be weighing on most share markets at present; 
  • a reversal of the huge bond rally that had helped the higher dividend paying Australian share market and sectors like real estate investment trusts up to mid-year; 
  • a soft patch in consumer spending weighing on retailers; 
  • and stock specific issues. 

Of these, the turn up in bond yields is perhaps most significant, taking a huge toll on defensive high-yield sectors like REITs. With the Fed on track to hike again in December and the RBA likely to be on hold for now, a further back up in bond yields is likely into December. However, while the bond bull market is likely over as global inflation bottoms, the back up in yields generally is likely to be gradual as global growth is set to remain constrained, the Fed is likely to remain gradual in raising interest rates and other major central banks including the RBA are likely on hold or skewed to easing further. Meanwhile, defensive yield sectors are getting very oversold and due for a bounce and cyclical sectors have more upside if as we expect that global and Australian economies continue to see moderate growth. Bottom line – it’s just another correction.  

Spain is moving out of limbo with the focus shifting to Italy. The political impasse that has hung over Spain following inconclusive elections in December and June looks likely to be resolved with the Socialist party voting to abstain from voting in a parliamentary confidence vote that will then see Mariano Rajoy confirmed as PM. However, political risk in Europe has shifted to Italy and Austria. Italy will see a referendum on reducing the power of its Senate on December 4 with PM Matteo Renzi seeking to reduce its power in order to proceed with economic reform (something maybe Australia should think about!) and threatening to resign if the referendum is not passed, which would then provide a boost to the mostly anti-Euro Five Star Movement. On the same day, Austria will see a re-run of its presidential election with the far right candidate being anti-Euro. So, if these go the wrong way, we could see another bout of Eurozone break up fears. Either way I remain of the view that the Eurozone will continue to hang together – mainland Europeans are far more attached to the EU and Eurozone than the UK ever was, much of the recent rise in populists in Europe is really a backlash against austerity than necessarily the Euro (which remains popular). What’s more, European shares remain very undervalued.

Based on history, the best outcome for US shares will be a Clinton victory, but with the Republicans retaining control of at least the House of Representatives. Since 1927, US total share returns have been strongest at an average 16.7% pa when there has been a Democrat president and Republican control of the House, the Senate or both. By contrast, the return has only averaged 8.9% pa when the Republicans controlled the presidency and Congress. 

Source: Bloomberg, AMP Capital

A Trump victory would likely trigger an initial bout of “risk off” with shares down (both in the US and globally), bonds rallying and the $US up as investors fret about his economic policies, particularly his protectionist trade policies triggering a global trade war. Australian shares and the $A would be particularly vulnerable to this, given our high trade exposure. But a Clinton/Democrat clean sweep of the Presidency and Congress would likely also trigger a bout of nervousness in US shares as it would be easier for Clinton to implement less business friendly tax and regulatory policies that would weigh on US health, energy and financial stocks. This would likely be more focussed on US shares though with less of an impact on global/Australian shares. The best outcome for shares would be a Clinton victory, but with Republicans retaining control of at least the House, as this would be seen as more of the same. While Clinton was ahead in the latest polls by an average 5.2 points, these were taken before the FBI reopened an investigation into her use of a private email server while Secretary of State, which adds to uncertainty going into the final week of the election campaign. In any case, there is no sign of a wave of support going towards the Democrats that will see them win the necessary 30 seats to take the House.

Major global economic events and implications

US data was mostly good. Manufacturing and services conditions PMIs are up solidly, home sales are strong and home prices continue to rise and unemployment claims remain low. September quarter GDP growth accelerated to 2.9% annualised, as the inventory cycle turned and trade contributed strongly to growth offsetting softer growth in consumer spending. Durable goods orders are trending sideways though and consumer confidence fell but this looks to be related to election uncertainty. This is all consistent with a December rate hike assuming a Clinton victory in the upcoming election. But continued soft wages growth (with the Employment Cost Index up only 2.3% year-on-year in the September quarter) and constrained economic growth will keep likely the Fed gradual through 2017.

Despite a few high profile misses, the US September quarter profit reporting season is actually looking pretty good … the profit recession looks to have ended. Of the 299 S&P 500 companies to report so far, 78% have beat on earnings and 59% have beat on sales. Profits are now expected to be up 4% on the June quarter and up 15% from their March quarter low and to surpass their 2014 high. A 4% year-on-year gain in revenue is a key driver. 

Eurozone business conditions PMIs also rose strongly in October as did economic confidence pointing to continued moderate growth.

Japanese data was also solid with stronger manufacturing conditions, a rise in small business confidence, an improvement in household spending and solid labour market indicators. Deflation continued in September though with core inflation falling to zero.

Chinese industrial profits slowed in September to 7.7% year-on-year, but consumer confidence spiked higher in October.

Australian economic events and implications

Inflation remains very low, but maybe not low enough to trigger another RBA rate cut just yet. While September quarter CPI inflation at 0.7% quarter-on-quarter was a bit higher than expected, this was mainly due to prices for fruit and vegetables, electricity, tobacco and property rates while underlying inflation at 0.3% quarter-on-quarter was a bit lower than expected, with ongoing evidence that deflationary pressures are still working through the economy. However, on balance it is probably not enough to trigger an immediate rate cut as inflation is in line with the RBA’s own expectations, economic growth looks to be reasonable and rising commodity prices are set to boost national income. The latter was reflected in the second rise in the goods terms of trade in row in the September quarter with a further rise likely in the December quarter as higher coal and iron ore prices feed through. Meanwhile new home sales rose again in September and remain strong and producer price inflation remains very low.

What to watch over the next week?

In the US, the Fed (Wednesday) is very unlikely to raise interest rates, particularly with a “risky” election just six days later but the post meeting statement is likely to confirm that the Fed is on track to raise rates in mid-December (the market probability is just 17% for a November hike and 69% for a December hike). Meanwhile, September quarter earnings reports will continue to flow with around 100 S&P 500 companies due to report, the October ISM manufacturing conditions index (Tuesday) is likely to show a further improvement and jobs data (Friday) is expected to show continued solid jobs growth of around 170,000, a slight fall in the unemployment rate to 4.9% but continued modest wages growth. Meanwhile, core inflation according to the private consumption deflator (Monday) is likely to have remained unchanged at 1.7% year-on-year in September.

In the Eurozone, September quarter GDP data (Monday) is expected to show continued moderate GDP growth and expect a further rise in October CPI inflation (Monday) as the fall in oil prices from a year ago drops out but core inflation to remain around 0.8% year-on-year.  

Japanese industrial production for September (Monday) is expected to show continued growth and the Bank of Japan (Tuesday) is unlikely to make any changes to monetary policy after the further easing announced a month or so ago.

Chinese manufacturing conditions PMIs for October (Tuesday) are likely to pause or slow slightly but remain consistent with a stabilisation in growth.

In Australia, it’s a close call but the RBA is expected to leave interest rates on hold at its monthly Board meeting (Tuesday). September quarter inflation was low on an underlying basis but probably not low enough to trigger another cut just yet, as it is in line with the RBA’s own expectations, economic growth in Australia looks reasonable with the worst of the mining investment slump behind us and a rise in commodity prices is starting to boost national income again. As such, the RBA can afford to be patient in waiting for inflation to head back to target and thereby avoid the risk of adding to financial instability (read a further acceleration in Sydney and Melbourne home price gains) with another rate cut for now. Overall, we think that the RBA will leave rates on hold at its Melbourne Cup Day meeting, but that with inflation remaining very low, the $A still uncomfortably high and jobs data softening lately, it's premature to close the door on another rate cut but that’s more likely to be a 2017 story. The Reserve Bank’s Statement on Monetary Policy (Friday) will likely see little change to the RBA’s growth and inflation forecasts.

On the data front, expect credit growth (Monday) to remain moderate, CoreLogic home price growth (Tuesday) to remain solid, building approvals (Wednesday) to fall 6%, the trade deficit (Thursday) to show a further decline as higher coal prices flow through and retail sales (Friday) to grow 0.2% in September but just 0.1% in the September quarter in real terms.

Outlook for markets

We remain cautious on shares in the short term as event risk is high for the months ahead including ongoing debate around the Fed and ECB, the US election on November 8 and the Italian Senate referendum and Austrian presidential election re-run (both on December 4). Bond yields could also see more upside in the short term. However, after any short term weakness, we anticipate shares to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets. 

Still ultra-low bond yields point to a poor medium-term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

The outlook for the $A has become murky. A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend remain down and the $A normally overshoots on the downside after the bursting of commodity price booms and this remains our base case. But against this, the stabilisation and rising trend in some commodity prices and the continued gradual nature of Fed rate hikes suggest ongoing upside risks in the short term. The danger is that the latter will threaten the rebalancing of the economy and the best defence against this is for the RBA to revert to a clear easing bias even if it never acts on it. 

Eurozone shares fell 0.1% on Friday and the US S&P 500 lost 0.3% giving up an earlier gain of 0.4% as the FBI announced it had reopened an investigation into Hilary Clinton’s use of a private email server. The weak global lead saw ASX 200 futures fall 0.1%, so I expect Australian shares to open down around 5 points on Monday morning – although this may be affected by whether there is more news regarding the FBI investigation of Clinton’s emails and the outcome of an OPEC meeting regarding oil production in Vienna.

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3 reasons not to fear the Fed

Monday, October 24, 2016

By Shane Oliver

Global share markets rose over the past week, helped by generally good economic data, more evidence US earnings have bottomed, confidence that the Fed will be gradual in raising interest rates and dovish comments from ECB President, Mario Draghi. US shares rose 0.4%, Eurozone shares gained 1.6%, Japanese shares rose 1.9% and Chinese shares rose 0.7% but Australian shares fell 0.1%. Bond yields generally fell, helped by Draghi’s comments, the oil price rose 1.2% but metal prices fell and the $US rose further. While the Aussie dollar briefly made it above $US0.77, it fell back after the release of soft jobs data. 

Three big differences compared to last year’s Fed scare

While expectations for a December Fed rate hike are continuing to build, investment markets seem to be taking it a bit better than was the case in the run up to last December’s eventual rate hike. At its core, there are three big differences between now and last year.

1. The global and US growth outlook is more positive now.

2. US earnings now look to have bottomed, whereas a year ago they were falling.

3. And thirdly, the uncertainty around where the Renminbi will go and Chinese capital outflows is a lot less. While event risk is high at present – with the Fed, the US election, Eurozone risk and the ECB – and this could drive short term volatility or a correction in global and Australian shares – the broad trend in shares is likely to remain up.

Trump v Clinton

Hillary Clinton is maintaining her lead but the Democrats still unlikely to take the House. While Trump's performance in the final presidential debate may have been his best for the three debates, it was not a knock out and polls had Clinton as the winner (e.g. the CNN poll had Clinton at 52% and Trump at 39%).

According to the Real Clear Politics average of major polls, Clinton is ahead by 6.2 points and the Mexican Peso (perhaps the best guide to market expectations regarding the election outcome) is up 6% since the first debate. However, there's still no evidence of a huge wave of support flowing to the Democrats that will be sufficient to see them pick up the necessary 30 seats to win a majority in the House of Representatives. So my base case remains a 70% probability of a Clinton victory, but with the Republican’s retaining control of the House (with maybe a loss of 10-15 seats). This would be a “more of the same” outcome for investment markets. Meanwhile, Trump’s comments that the election is rigged (yeah right!) and that he may not accept the result unless “ … I win” coming on the back of his comments about women, Hispanics, Muslims, China, invitations to Russia to hack into America, etc, along with his short fuse and erratic nature add to the concern that he is not fit to be president. The sooner the Republicans can recover from this mess, reunite and return to being the GOP that gave the world Lincoln and Reagan, the better.

In Australia, a speech by RBA Governor Philip Lowe, along with the minutes from the RBA’s last Board meeting, add to expectations that the RBA is not in a hurry to cut rates again, with Lowe more comfortable with the growth outlook and not wanting to push inflation quickly back to target if it risked financial instability. While his comment about the importance of September quarter inflation data for the interest rate outlook and the need to guard against inflation expectations falling too far leave the door to another rate cut open, the hurdle to do so at this stage looks to be relatively high. 

Major global economic events and implications

US data was generally OK. Jobless claims remain very low and existing home sales, the leading index and industrial production all rose. However, manufacturing conditions in the New York and Philadelphia regions were mixed. While housing starts fell sharply in September, this was all due to volatile starts of multi-dwelling buildings and permits to build new homes and home builder conditions were strong, indicating that housing activity will remain solid. Meanwhile, the Fed’s Beige book continued to point to “modest to moderate” economic growth, “tight” labour market conditions but “modest” wage growth and “mild” inflation. The latter was confirmed by the September CPI, which showed rising headline inflation as the oil price plunge falls out, but a slight fall back in core inflation to 2.2% year-on-year. All of this is consistent with the Fed hiking in December (with the money market attaching a 68% probability) but remaining gradual thereafter in raising rates. 

It’s still early days in the US September quarter profit reporting season, but so far so good. Of the 116 S&P 500 companies to report so far, 81% have beat on earnings and 66% have beat on sales. Profits are on track to be to up for the second quarter in a row and are likely to be up year-on-year.

The European Central Bank (ECB) leaves monetary policy on hold, but looks on track for some sort of extension to its quantitative easing program. President Draghi’s comments were mostly dovish setting up for a likely extension (and widening of the assets it can buy) at its early December meeting. However, it may opt to move towards a more flexible approach where the amount of monthly QE is varied depending on bond yields and expectations regarding inflation. Meanwhile, the ECB’s September quarter bank lending survey showed strong demand for loans across the board which is a good sign, but while lending standards eased for households they were unchanged for corporates.

Chinese growth remains stable, with September quarter GDP growth unchanged at 6.7% year-on-year and improvements in growth for retail sales and investment. While industrial production slowed slightly, this may be due to G20 factory shutdowns and one less working day this September. Meanwhile, growth in money supply and credit was generally strong adding to confidence that growth has stabilised although the problem of high debt growth (flowing from too much saving) remains.

Australian economic events and implications

Soft Australian jobs data likely payback for unbelievably strong growth last year. Employment fell for the second month in a row in September, full time employment is now negative year-on-year, hours worked are weak and only falling participation is stopping unemployment from rising. The soft jobs data keeps alive the prospect of another RBA rate cut, but the monthly jobs survey remains of dubious quality and the recent weakness could be just payback for last year's too-good-to-be-believed jobs surge. In other words, more noise than signal and so the RBA is likely to look through it.

What to watch over the next week?

In the US, the main focus is likely to be on September quarter earnings reports, with over 100 S&P 500 companies due to report, September quarter GDP growth (Friday) which is expected to show a modest improvement in economic growth to 2.5% annualised after three quarters around 1% and September quarter employment costs (also Friday) which are expected to remain subdued around 2.3% year-on-year growth. In other data, expect the Markit manufacturing conditions PMI (Monday) to remain modest at around 51.5, home price data to show continued growth and consumer confidence to fall back a bit on election uncertainty (all Tuesday), new home sales (Wednesday) to fall slightly but pending home sales (Thursday) to bounce back and little change in durable goods orders (also Thursday). Overall, this won’t be enough to deliver a surprise rate hike in November but will leave the Fed on track to hike in December.

In the Eurozone, expect October business conditions indicators (Monday) and economic confidence indicators (Friday) to remain consistent with moderate growth. 

Japanese data for September to be released on Friday is expected to show continued labour market strength, but weak household spending, ongoing CPI deflation and a further fall in core inflation to around 0.1% year-on-year.

In Australia, the focus will be on September quarter inflation data (Wednesday) which will be the main driver of whether the RBA cuts rates again at its November meeting. Thanks to higher prices for fruit and vegetables, utility charges and rates and an increase in tobacco excise only partly offset by lower petrol prices headline inflation is expected to be up 0.6% quarter-on-quarter taking annual inflation to 1.3% (from 1%). The underlying measures of inflation (the average of the trimmed mean and weighted median) are expected to be around 0.5% quarter-on-quarter or 1.6% year-on-year. We have been allowing for another RBA rate cut in November but given recent solid economic data, evidence that the terms of trade and hence national income has bottomed and signs that the new RBA Governor would prefer not to cut rates again, underlying inflation would probably need to be 0.3% quarter-on-quarter or less to clearly bring on another rate cut in November. 

Australian data for September quarter export and import prices (Thursday) will likely provide further evidence that the terms of trade has bottomed and producer price inflation and new home sales data will be released Friday.

Outlook for markets

We remain cautious on shares in the short term as event risk is high for the months ahead including ongoing debate around the Fed and ECB, issues around Eurozone banks, the US election on November 8 and the Italian Senate referendum and Austrian presidential election re-run (both on December 4). However, after any short-term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets. 

Ultra-low bond yields point to a soft medium-term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

The outlook for the $A has become murky. A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend remain down and the $A normally overshoots on the downside after the bursting of commodity price booms and this remains our base case. But against this, the stabilisation and rising trend in some commodity prices and the continued gradual nature of Fed rate hikes suggest ongoing upside risks in the short term. The danger is that the latter will threaten the rebalancing of the economy and the best defence against this is for the RBA to revert to a clear easing bias even if it never acts on it.

Eurozone shares and the US S&P 500 were both flat on Friday. Reflecting this the ASX 200 futures contract fell just 1 point, so I expect a flat start to trade for the Australian share market on Monday morning.

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7 reasons not to worry about a Fed rate hike

Monday, October 17, 2016

By Shane Oliver

Share markets were mixed over the last week, with US shares down 1% on the back of a some soft US earnings reports and nervousness ahead of a likely Fed rate hike in December. Meanwhile, Australian shares were down 0.6%, but Japanese shares were basically flat, Eurozone shares were up 0.8% and Chinese shares were up 1.6%. Bond yields rose, oil prices rose but metal prices fell, and the $A rose despite a stronger $US. 

Seven reasons why a Fed rate hike in December, and the $US breaking higher, are unlikely to cause a re-run of the market scare we saw late last year/early this year.

The US money market is now pricing in a 66% probability of a December Fed rate hike, and this is putting renewed upwards pressure on the value of the $US and on bond yields, with the latter weighing on defensive high-yield share market sectors like REITs and listed infrastructure. While this could contribute to a corrective pull back in shares in the short term, a return to the turmoil seen through the second half of last year and into early this year is unlikely. 

  • First, the global growth outlook is a bit more positive now. 
  • Second, there is now a greater level of understanding and confidence that the Chinese Renminbi is not going to crash, as the Chinese are targeting a relatively stable trade weighted level for the Renminbi, and capital outflows from China have not accelerated. 
  • Third, last year poor supply/demand dynamics and a rising $US were causing a double whammy for commodity prices, which in turn, was weighing on commodity producers. Now, commodity prices appear to have bottomed. This in turn is adding to confidence that the profit recession in both the US and Australia has likely ended.
  • Fourth, worries about a $US funding crisis in the emerging world have receded as commodity prices have stabilised and emerging market growth is looking a bit healthier.
  • Fifth, the back-up in bond yields is likely to remain gradual as global growth remains subdued, the Fed will likely remain gradual in hiking rates, and any handover from monetary to fiscal policy will also be gradual.
  • Sixth, the Fed has made it clear that it is aware of the impact of US rate hikes globally, and that a stronger $US does part of its job, so there should now be greater confidence that it won't just blindly hike interest rates to the point that it threatens US/global growth. 
  • Finally, while defensive yield share market sectors may see more downside, cyclical share market sectors are likely to strengthen with this rotation already evident.

From worries about a Trump presidency, to worries about a Clinton/Democrat clean sweep

With the Trump campaign falling into disarray again as his fitness for presidency is once again called into question their support, there is now an increasing risk that a backlash against Republicans could see them lose not just their Senate majority but also control of the House of Representatives. Such a scenario would worry investors to the extent that it would make it easier for less business friendly tax and regulation policies to be put in place that might weigh on health, energy and financial companies.

The polls are clearly moving in Clinton's favour again, but it’s doubtful that it’s enough to generate a wave of support strong enough to see the Democrats take both houses of Congress. While there is a good chance the Democrats will gain a majority in the Senate (but not necessarily the 60 seat control) it’s hard to see them winning the 30 seats necessary to control the House. Current polling suggests they will pick up only around 10 seats. Sure, Obama's victory in 2008 saw a Democrat clean sweep, but back then the Democrats already had small minorities in both houses of Congress which they built on, whereas this time around they are starting well behind and don't have the GFC to help them. So while the probability of Clinton becoming president has gone up (from around 55% a few weeks ago to now around 70%), a Democrat clean sweep is possible, but I would only raise the probability of it occurring from 5% to 10%. History shows that the best combination for shares is a Democrat president and a Republican House.

Finally, there is more good news on the commodity price front for Australia, with the more than doubling in average coal prices flowing through to coal contract negotiations with Japan. While coal prices may not ultimately settle at current high levels, they do look to have bottomed and the rise in coal prices is another sign that the terms of trade and national income have seen the worst. Higher bulk commodity prices, if sustained, will also see a big improvement in the Federal budget deficit and could eliminate the trade deficit. Given this, along with reasonable economic growth and the rising prospect of a December Fed rate hike taking upwards pressure off the $A, the probability of a November RBA rate cut is rapidly collapsing. 

Major global economic events and implications

The minutes from the Fed's last meeting reinforced the impression that the Fed is on track to hike rates in December. But by the same token, the minutes were not really hawkish with ongoing reference to "few signs of emerging inflation pressures". Dovish comments by Fed Chair Yellen regarding the case to let the economy run hot for a while to help fix damage caused by the GFC add to the impression that the Fed expects to remain gradual in raising rates.

US data releases were mixed, with a stronger-than-expected rise in producer price inflation and headline retail sales, but underlying retail sales growth remaining soft, consumer sentiment down, a slight fall in small business optimism and mixed readings on the jobs market. Its early days in the September quarter earnings reporting season, with only 34 S&P 500 companies reporting so far, but while Alcoa kicked off with disappointment 79% of companies have so far surprised on the upside.

Chinese export and import data for September were weaker than expected, after several months of improvement. It’s a bit too early to tell whether this is a concern. In other activity, data power consumption slowed to 6.9% year-on-year in September, but auto sales rose 26% year-on-year. Meanwhile, consumer price inflation picked up to 1.9% year-on-year mainly due to higher food prices and producer prices rose 0.1% year-on-year, their first rise in over four years. The improvement in producer price inflation is suggestive of stronger nominal growth in China and consistent with global deflationary pressures receding.

Australian economic events and implications

Both consumer and business confidence are now above long term average levels, which is consistent with ongoing reasonable economic growth. Meanwhile, housing finance was soft in August which appears to contrast with strong auction clearance rates, but its noteworthy that while auction clearances are high it is on declining volumes so maybe they are not as strong as they appear.

The RBA’s Financial Stability Review indicated some lessening in concern regarding household debt as lending standards have strengthened and credit growth has slowed, but it does appear to be increasingly (and understandably) concerned around the risks flowing from large increases in the supply of apartments. Overall though, it sees Australian banks as remaining resilient to shocks. 

What to watch over the next week?

In the US, the focus is likely to remain on the election, with the final presidential debate on Wednesday, consumer price inflation data will likely remain consistent with a December Fed rate hike and September quarter earnings reports will start to flow in earnest. On the data front in the US, expect to see a partial bounce back in September industrial production (Monday), a further rise in CPI inflation (Tuesday) to 1.5% year-on-year as the plunge in the oil price drops out but core inflation remaining around 2.3% year-on-year, continued strength in home builder conditions (also Tuesday) and gains in housing starts (Wednesday) and existing home sales (Thursday). Manufacturing conditions surveys for the New York and Philadelphia regions will also be released, along with the Fed’s Beige Book of anecdotal evidence on the economy.

In Europe, the focus will be on the ECB meeting (Thursday) but no change in policy is likely. A decision on extending its quantitative easing program beyond its March 2017 expiry is unlikely until the December meeting. Inflation is below target, but with growth okay and the current program still having a while to run there is no reason for the ECB to decide now.

Chinese economic data is expected to remain consistent with a stabilisation in growth. September quarter GDP growth is expected to be unchanged at 6.7% year-on-year and September data is expected to show a slight pick-up: in industrial production to 6.4% year-on-year (from 6.3%), in retail sales to 10.7% (from 10.6%) and for fixed asset investment to 8.2% (from 8.1%).

In Australia, the minutes from the last RBA Board meeting and a speech by Governor Lowe (both Tuesday) will be watched for any clues regarding the outlook for interest rates but are likely to reinforce the impression that the RBA is comfortably on hold for now. On the data front, expect a 20,000 gain in employment for September but the unemployment rate to rise back to 5.7% from 5.6%.

Outlook for markets

October is often a rough month for shares and we remain cautious on shares in the short term as event risk is high for the months ahead including ongoing debate around the Fed and ECB, issues around Eurozone banks, the US election on November 8 and the Italian Senate referendum and Austrian presidential election re-run (both on December 4). However, after any short term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions and moderate global economic growth. 

Ultra-low bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns. 

Increasing confidence that the Fed will hike rates again by year end has taken some pressure off the $A in the short term and we continue to see the longer term trend remaining down as the interest rate differential in favour of Australia narrows as the RBA continues cutting rates and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

Eurozone shares rose 1.5% on Friday but the US S&P 500 ended basically flat, with mixed US retail sales and dovish comments by Janet Yellen but a stronger than expected rise in producer prices supporting the case for a December Fed rate hike. ASX 200 futures fell 0.2% pointing to a 5-10 point decline in Australian shares at the start of trade on Monday morning.

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What to watch over the week

Monday, October 10, 2016

By Shane Oliver

Shares were mixed over the last week, with US shares down 0.7% and Eurozone shares down 0.1%, but Japanese shares up 2.5% and Australian shares up 0.6%. Bond yields rebounded on ECB taper talk and increased expectations for a December Fed rate hike. As a result of the latter, the $US rose and appears to be breaking higher which pushed the $A lower. This was despite a further rise in the oil price on the back of falling US crude stockpiles.

US non-farm payrolls growth of 156,000 in September tells us that the US jobs market remains solid and keeps the Fed on track for a December rate hike. But rising labour force participation, which pushed the unemployment rate up to 5% and indicates that there is still more slack in the labour market along with slow wages growth is consistent with the process of raising US interest rates gradually. Firming prospects for a December hike are taking pressure off the $A, which fell below $US0.76 over the last week. 

Another taper tantrum?

The ECB tapering its quantitative easing program is inevitable, but it’s likely to be extended first. The past week saw global bond yields pushed higher by more talk that the ECB will taper (or gradually slow) its bond purchases once its quantitative easing (QE) program ends. ECB tapering is inevitable, but it’s more likely to extend QE beyond March 2017 at the current rate of €80bn a month first given that growth is fragile, inflation is below target and political risk is high. The minutes from the last ECB meeting and comments from ECB officials remain dovish. Taper talk will likely continue though and global bond yields are poor value regardless of whether the ECB tapers sooner or later. The risk is that a 2013 style taper tantrum - if it causes a sharp rise in peripheral Eurozone bond yields - will result in QE for longer.

Global business conditions PMIs point to okay global growth. The global manufacturing PMI rose in September – with notable gains in Brazil, Japan, Europe, the UK, the US and even Australia - continuing a mild rising trend seen over the last six months.

Source: Bloomberg, AMP Capital

Consistent with this, the IMF’s global growth forecasts have stabilised. After the usual downwards revisions to the IMF’s 2016 and 2017 global growth forecasts they have now stabilised relative to the IMF’s last update in July at 3.1% and 3.4% respectively. The IMF’s 2016 growth forecast has followed the same pattern of the last few years – starting towards 4% and then ending around 3%. The 2017 forecast is likely to fall to around 3% too. 3% global growth is good for investors as it’s enough to support modest profit growth, but not so strong as to invite aggressive monetary tightening.

Source: IMF, AMP Capital

Trump v Clinton

While Hillary Clinton enjoyed a bit of a poll boost post the first presidential debate taking her lead to around 3-4%, the vice-presidential debate looks to have been won by Mike Pence, albeit its impact is usually minor, and the election outcome remains close. The focus now shifts to the next presidential election debate. Our view remains that a November 8 victory by Clinton would simply mean more of the same in the US, as Democrats would not control Congress.

But a Trump victory (or anticipation of it) would be initially negative for shares on policy uncertainty and trade war worries, push up bond yields as the US budget deficit is likely to widen and US interest rates would move higher and therefore be positive for the $US. After an initial negative reaction, shares are likely to rebound if Trump’s Reaganesque policies (tax cuts, increased infrastructure and defence spending, and deregulation) predominate over his protectionist policies. For Australian assets, a Trump victory would mean an initial share sell-off followed by a rebound, potentially higher bond yields and a lower $A.

A flash crash in the British pound (down 6% then up 5% on Friday in the Asian time zone), provided lots of interest for traders but should just be noise for well diversified long term investors. The real issue is that the UK increasingly looks headed for a hard Brexit (with Britain paying a price for border control in the form of curtailed export access to the EU). The EU is keen to discourage other countries from following Britain out, but it likely means more downside for the pound which should limit the fall-out for the British economy.  

The RBA

The RBA on hold and neutral. With no major economic developments in the last month, September quarter inflation due later this month and new Governor Philip Lowe presumably wanting to demonstrate a degree of policy continuity, it was no surprise to see rates left on hold at 1.5%. However, we remain of the view that the RBA will cut rates again at its November meeting when it reviews its economic forecasts after the release of the September quarter inflation data, particularly with the $A remaining too high. However, with economic growth holding up well, commodity prices and national income looking like they have bottomed and the new Governor perhaps preferring a period of stability, this is a close call and is critically dependent on seeing a lower September quarter inflation result. 

Major global economic events and implications

US economic data was mostly good, leaving the Fed on track for a December rate hike. The ISM business conditions indexes rebounded in September to reasonable levels, particularly for non-manufacturing which is strong, durable goods orders were revised up, the four-week moving average of jobless claims fell to its lowest since 1973, payroll employment was solid (albeit less than expected) and better employment readings in the ISM surveys point to reasonable jobs growth ahead. The trade deficit widened in August though.

Japanese data was mixed with lacklustre conditions according to the Bank of Japan Tankan’s survey, a slight improvement in September’s manufacturing conditions PMI, but a worsening in the services PMI and stronger consumer confidence.

The Reserve Bank of India surprised with a 0.25% rate cut, highlighting that global monetary conditions are still easing.

Australian economic events and implications

Australian economic data was mostly solid with a stronger-than-expected gain in August retail sales after three soft months, building approvals remaining around record levels pointing to a stronger-for-longer housing construction cycle, a rebound in September business conditions PMIs (albeit to still soft levels) and a further decline in Australia’s trade deficit (which now looks to have seen the worst). Home prices continued to rise solidly in September, with Sydney and Melbourne remaining uncomfortably strong (particularly with the supply of units surging). Finally, the Melbourne Institute’s Inflation Gauge rose solidly in September, but has been soft in the quarter as a whole with the trimmed mean measure of underlying inflation falling to just 0.8% year-on-year.

What to watch over the next week?

In the US, expect the minutes from the Fed’s last meeting (Wednesday) and a speech by Fed Chair Yellen (Friday) to repeat the message that the Fed will remain gradual in raising rates and expects to hike rates again at its December meeting. On this front, an expected 0.4% month-on-month gain in September retail sales after two weak months will be important in indicating whether the Fed is on track or not. Data on job openings (Tuesday), small business optimism (Wednesday) and producer prices (Friday) is also due. 

The US third quarter earnings reporting season will also kick off with Alcoa reporting Monday. While total earnings for S&P 500 companies are expected to be down 1.5% from a year ago, they are expected to be up slightly on the June quarter continuing an earnings recovery that has been helped by a stabilisation in the US dollar and rising trend in the oil price.

In China, expect September export growth to remain negative but import growth to slow slightly (Thursday), consumer price inflation to remain low at around 1.6% year-on-year, producer price deflation to continue to fade (both Friday) and total credit to slow after the August surge.

In Australia, expect the NAB business survey (Tuesday) to show business confidence and conditions remaining above long term average levels, housing finance (also Tuesday) to bounce back after a fall in July and the Westpac/MI survey (Wednesday) to show that consumer confidence remains around average levels. The RBA’s six monthly Financial Stability Review (Friday) will be watched mostly for more colour around the state of the housing market.  

Outlook for markets

While the period for seasonal share market weakness (August to October) so far has passed without a major mishap, we remain cautious on shares in the short term as event risk remains high for the months ahead including ongoing debate around the Fed and ECB, issues around Eurozone banks, the US election on November 8 and the Italian Senate referendum and Austrian presidential election re-run (both on December 4). However, after any short-term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions and moderate global economic growth. 

Ultra-low bond yields point to a soft medium-term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up.

Cash and bank deposits offer poor returns.

Increasing confidence that the Fed will hike rates again by year end has taken some pressure off the $A in the short term and we continue to see the longer term trend remaining down as the interest rate differential in favour of Australia narrows as the RBA continues cutting rates and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

Eurozone shares lost 0.9% on Friday and the US S&P 500 fell 0.3% as reasonable September jobs growth in the US kept the Fed on track for a December rate hike and the oil price dipped after recent gains. Despite the soft global lead, ASX 200 futures rose 0.1% and so I expect a modest 5-10 point gain at the open for the Australian share market on Monday.

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Weekly economic and market update

Tuesday, October 04, 2016

By Shane Oliver

Shares had a volatile week, with support from higher oil prices, but weakness in banks led by concerns around Deutsche Bank with most share markets ending lower, although Australian shares were little changed.

Bond yields also fell, continuing to reverse the back up in yields seen a few weeks ago. Commodity prices were little changed, except oil, which rose 7% on the back of OPEC’s reported agreement to reduce output. The $US was little changed, as was the $A.

The main issues around Deutsche Bank appear to relate to the size of a US Department of Justice penalty relating to mortgage-backed securities (where the DoJ’s opening position is $US14bn, but the final settled outcome may be closer to $US8-9bn) and whether it will require a capital raising. This appears to be affecting sentiment around banks generally, although many US banks have already settled with the US Department of Justice. It seems whenever there are issues with banks these days, investors start to fear a re-run of the GFC.

OPEC’s agreement to cut oil production for the first time in eight years adds to confidence we have seen the low in the oil price. The reported agreement will see production cut to around 32.5 to 33 million barrels per day from around 33.25 mbd in August, but the details and individual country targets won’t be agreed until OPEC’s next meeting in late November.

The deal, if stuck to, could signal better cooperation between Saudi Arabia and Iran and a return to discipline by Saudi Arabia. Time will tell, but it adds to confidence that we have seen the low in the oil price. That said, while the oil price has bounced 6% or so on the news, it’s just normal volatility and the oil price remains below its June high of $US53 a barrel.

Expect a bit of an upwards drift in the oil price but constrained demand growth, the prospect of shale oil production picking up again as the oil price pushes through break-evens for such producers of around $US50-$US60, and the ongoing switch to alternatives and efficiencies should to limit the upside in the oil price, probably to around $US0.60. 

For the time being, it’s hard to see a big flow on to Australian petrol prices as the bounce in the oil price around the OPEC news has only been around $US3/barrel which would translate to about three cents a litre at the bowser in Australia, and in any case, the petrol price is still averaging around 10-20 cents a litre above levels normally implied by current oil prices suggesting wider than normal margins.

More broadly to the extent that the OPEC deal reflects better supply discipline and is consistent with the bottoming in commodity prices seen generally over the last nine months and energy in particular, it’s positive for Australia and adds to a lessening in downwards pressure on the RBA to cut interest rates again. The only complication is the $A which briefly rose above $US0.77 and is at risk of re-test of April’s high of $US0.78. 

Has global trade peaked?

A World Trade Organisation report downgrading its estimate for global trade growth to 1.7% this year from 2.8% and five years of low or stagnant trade growth obviously begs the question that global trade may have peaked. This is a risk, but the recent stagnation appears to owe more to a return to trend after the trade boom of the 2000s, slower demand driven growth due to slower growth in Europe, the end of the commodity price boom and a shift in China’s growth from industrial production to services (which is less trade oriented).

That said, all the talk of protectionism (eg. from Donald Trump and the stalling of the Doha trade round) is a concern.

The first presidential debate between Hilary Clinton and Donald Trump has kicked off market focus on the November 8 election. While the general conclusion was that Clinton won and she reinforced her key strength of being more “presidential”, there was no knockout blow and it’s unclear whether it will really change the outcome which looks close, but with a slight lean to Clinton. Financial markets appeared to like Clinton’s performance. There are still two presidential debates to go on October 9 and 19 and a debate between the vice presidential candidates on October 4. See this for an analysis of the coming US election.

The Bank of Japan’s latest moves are more profound than first appeared. There has been much debate as to whether the BoJ actually did anything of substance at its meeting a week or so ago. There was no big increase in quantitative easing or change in interest rates. But by the same token if it actually does what it says, it really could be a big thing. Put simply, the BoJ has committed to pumping cash into the Japanese economy until inflation rises above its 2% target and stays there. If it actually does this, then inflation expectations will rise and investors will naturally want to sell bonds. But the BoJ has committed to keeping the 10-year bond yield at zero and if private investors start selling bonds it will have to buy even more bonds to keep the yield at zero. Which all means that real yields will fall, which will encourage spending and push the Yen down, all of which will reinforce the pick-up in inflation. At the same time, the commitment to keep the 10-year bond yield at zero is an open invitation to the Government for more fiscal stimulus. This is all kind of heavy, but if the BoJ actually does what it says – even though I suspect it may need a bit of helicopter money along the way - then what it has announced is actually quite profound. Time will tell, but I suspect that the BoJ under Kuroda should be given some benefit of the doubt.

Major global economic events and implication

US economic data was mostly better-than-expected. Consumer confidence rose to its highest level since 2007 in September (despite election uncertainty), the Markit services conditions PMI rose in September resulting in overall business conditions continuing their rising trend, regional business conditions surveys rose, durable goods orders were stronger-than-expected, jobless claims remained low, the goods trade deficit narrowed, new home sales were stronger-than-expected and home prices continue to see modest growth. Various Fed speakers offered nothing new, with Yellen reiterating that the current environment calls for a gradual increase in rates and that a majority of Fed officials see a rate hike as likely this year.

Eurozone economic data was good, with a rise in the German IFO business conditions survey to its highest since May 2014, a rise in overall Eurozone economic confidence to an eight-month high and stronger growth in bank lending all of which points to continuation of moderate economic growth at least.

Japanese labour market indicators remained strong in September and industrial production rose, but household spending slowed sharply and headline inflation remained in deflation with core inflation falling to 0.2% year-on-year highlighting the BoJ has a lot of work to do to get inflation above its 2% target.

Chinese industrial profits rose 19.5% year-on-year in August helped by less severe producer price inflation, the Caixin manufacturing conditions PMI rose a bit further and consumer confidence rose to its highest since June, all of which is consistent with a stabilisation in Chinese economic growth. 

Australian economic events and implications

In Australia, job vacancies rose solidly in the three months to August which is consistent with continued solid jobs growth. Growth in private sector credit decelerated further with credit to property investors slowing further to 4.6% year-on-year, which is well below APRA’s 10% threshold. So APRA can claim a victory, although it does look like monthly growth in property investor credit may have bottomed and the Sydney and Melbourne property markets remain uncomfortably hot.

What to watch over the next week?

In the US, September data for the ISM manufacturing conditions index (Monday) and payroll employment (Friday) will be the main focus for the week ahead.

Regional manufacturing conditions surveys and the Markit PMI already released suggest a recovery in the ISM to around 50.5 (from 49.4 in August). Payroll employment is likely to be solid at 180,000 new jobs but unemployment is likely to remain around 4.9% and wages could edge up to 2.6%. All up, this should keep the probability of a December Fed rate hike around 60%. 

In Japan, the September quarter Tankan survey (Monday) will provide a guide to business conditions and confidence.

In Australia, the RBA is expected to leave interest rates on hold for the second month in a row at 1.5%. Not enough has changed since the last rate cut in August, most recent commentary from the RBA including from Governor Lowe has expressed a broadly neutral tone regarding rates, and the RBA is likely waiting for the release of the September quarter inflation data in late October as a guide to whether it will cut in November.

Governor Lowe has already stressed the importance of “what the next inflation data look like” as a determinant of whether another rate cut occurs and it will be interesting to see whether the post-meeting Statement makes reference to this as it did three months ago ahead of the release of June quarter inflation data. Our view remains that the RBA will cut again at its November meeting, but this assumes another low September quarter inflation result and the $A remaining uncomfortably high. Given recent solid growth data, we would have to admit that getting another rate cut is a close call.

On the data front in Australia, manufacturing and services sector conditions PMIs (due Monday and Wednesday respectively) are likely to show a bounce after hard-to-explain falls in August, CoreLogic home price data (Monday) is expected to show continued strength in Sydney and Melbourne for September, building approvals (Tuesday) are likely to fall 9% or so after an 11% bounce in July driven by volatile apartment approvals, retail sales (Wednesday) are expected to gain 0.3% month-on-month after several weak months and the trade deficit (Thursday) will also be released.  

Outlook for markets

While the period for seasonal share market weakness (August to October) so far has passed without a major mishap, we remain cautious on shares in the short-term as event risk remains high for the months ahead including ongoing debate around the Fed, issues around Italian banks and Deutsche Bank, the Italian Senate referendum, the US election and global growth generally. However, after any short-term weakness, we anticipate shares to trend higher over the next 12 months, helped by okay valuations, continuing easy global monetary conditions and continuing moderate global economic growth. 

Ultra-low bond yields point to a soft medium-term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors. 

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up.

Cash and bank deposits offer poor returns. 

There is a high risk that the $A will re-test its April high of $US0.78 as the Fed continues to delay, presenting challenges for the RBA.

Beyond the short term though, we see the longer-term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, commodity prices remain low and the $A sees its usual undershoot of fair value.

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