Call us on 1300 794 893

The Experts

Shaneoliver_normal
Shane Oliver
Financial markets
+ About Shane Oliver

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

What’s pushing the political pendulum to the left?

Friday, March 15, 2019

When I was in my early 20s, I thought socialism might be the way to go. Two things happened. One I studied economics, which led me to the conclusion that socialism/heavy state intervention doesn’t lead to the best outcome in terms of living standards for most. Second, I had the benefit of a trip to the USSR before it and the eastern bloc disintegrated. It must have been Paul McCartney’s faux Beach Boys’ “Back in the USSR” that got me interested!

Sure, the history and scenery were fantastic and I like the fact that I saw it before the wall came down – but economically it was a mess. And trying to spend excess roubles before we left the USSR was a struggle (nothing but off chocolate to spend them on). “Socialism” seemed to work a bit better in the Deutsche Democratic Republic - but not really and it was a relief to come through Checkpoint Charlie knowing decent food (McDonald’s!) was waiting.

So I ended up gravitating to the centre with the view that the best approach is to allow a market economy with the government providing a good safety net, education and intervening where there are market failures. But a wise man told me when I was young that it’s best to start off on the left when you are young otherwise you will end being like Attila the Hun, as you move to the right as you age. Given the tendency for the young to start off on the left, it’s no surprise to see younger generations favour a bigger role for government in what The Economist magazine has dubbed “millennial socialism”.

If the millennials and Gen Z follow the normal pattern, they will shift to the right as they age like their forebears. So nothing new! Well maybe but there is a big difference now compared to the 1980s. Back in the 1980s, the political pendulum (or technically the median voter) was moving to the right. So my ageing was in tune with a big picture political cycle. Now the pendulum is swinging left. Since then it’s become more evident. What’s driving it and what does it means for investors?

Political cycles beyond elections

Just as the weather, economies and financial markets go in cycles so it is with politics, even beyond standard electoral cycles. This has been clearly evident over the last century:

1930s-1970s - the Great Depression gave rise to a fear of deflation and high unemployment and a scepticism of free markets. The political pendulum swung to the left and culminated in the economic disaster of the high tax, protectionism, growing state intervention and the welfare state of the late 1960s and 1970s that gave rise to stagflation.

1980s-2000s – stagflation and the failure of heavy government intervention gave rise to popular support for the economic rationalist/right of centre policies of the 1980s. Thatcher, Reagan and Hawke and Keating ushered in a period of deregulation, freer trade, privatisation, lower marginal tax rates, tougher restrictions on access to welfare, measures to reign in budget deficits and other supply side economic reforms designed to boost productivity. The middle class didn’t support higher taxes on the rich because they aspired to be rich. This was all helped along by the collapse of communism and the integration of the old USSR and China into global trade. The political pendulum swung to the right and there was talk of “The End of History” with general agreement that free market democracies were the way to go.

2010 - ? – but post the global financial crisis (GFC) it seems the pendulum is swinging to the left again and support for economic rationalist policies seems to be fading if not reversing.

What’s pushing the political pendulum to the left?

This reflects a range of factors, in particular:

  • the feeling that the GFC indicated financial de-regulation had gone too far;
  • constrained and fragile economic growth in recent years;
  • stagnant real wages and incomes for median households;
  • high household debt levels preventing individuals from taking on more debt as a way to boost living standards;
  • rising levels of inequality and perceptions that “it’s unfair”;
  • the perceived failure of the baby boomer generation of political leaders to do much about climate change;
  • examples of big business doing the wrong thing;
  • a backlash against immigration in some countries; and
  • a backlash against globalisation.

Of course, it’s being aided by a dimming of memories of stagflation of the 1970s and its causes and the failures of socialism as highlighted by the USSR (although Venezuela provides a current example). So government related solutions or socialism seem more attractive. Allied to this are economic theories like Modern Monetary Theory (or rather, Magic Mushroom Theory) that contends governments can borrow and spend freely in the current environment of spare capacity globally spurred along by the crazy argument that quantitative easing did not cause hyper inflation and higher interest rates so why should bigger budget deficits.

Of these, rising inequality and perceptions of stagnant living standards are the big ones.

The political response

In this environment (often populist) politicians have been able to easily tap into voter anger and argue the case for greater public sector involvement in the economy.

  • This was evident in support for self-declared socialist Bernie Sanders and Donald Trump in the US in 2016 (although Trump’s focus on deregulation and tax cuts look like a temporary deviation right). It’s now even more evident in the Democrats with the Green New Deal (that plans to rid the US of carbon emissions – and planes & cows – in a decade) and 2020 Democrat presidential aspirants adopting variations of Bernie Sanders’ policies, with proposals for wealth taxes and a 70% tax rate for income above $10 million (which is supported by 59% of Americans). It’s also evident in less US public concern about rising public debt.
  • It’s been evident in the Brexit vote in the UK which represented a backlash against globalisation and the left wing turn in the British Labour Party under Jeremy Corbin.
  • In Australia, we are seeing an intensification of the left right divide not seen since 1970s. The ALP is far from the economic rationalist policies of Hawke and Keating. Policies of higher taxes for the “big end of town” (bringing back the Budget Repair Levy and winding back various tax concessions), significantly increased spending on health and education, some regulation of the labour market and talk of raising the minimum wage to become a ‘living wage’ all suggest a populist focus reflecting a change in voter preferences. The same pressures are also evident in some ways in proposed intervention in the energy sector.

Qualifications

Of course, there are various qualifications to this leftward shift. First, it’s most evident in Anglo countries because it's here that the swing to the right and economic rationalism was most pronounced in the 1980s and 90s and where inequality is more of an issue. Europe never fully bought into the supply side revolution of Thatcher and Reagan and inequality has not risen much. In fact, France under Macron looks to be embarking on its own version of Thatcherism (with the yellow jacket protests proving nothing more than that Macron is actually doing something) which should augur well for its long-term prospects if Macron stays the course. Second, it’s arguable that if the Democrats are to win the US presidential election next year they have to win the mid-west and a socialist presidential candidate may not cut it there. Third, even many on the left are sceptical of ever larger budget deficits – e.g. in Australia the ALP has been talking of a stronger budgetary position. Finally, there is an argument that a modest move left is necessary to curb the rise in inequality and so save capitalism – much as Keynesian economics “saved” it after the Great Depression.

But what does it all mean for investors?

The risk over time is that a more left leaning electorate will mean a tendency towards bigger government, bigger budget deficits, more regulation, higher effective top marginal tax rates, less globalisation and tougher rules on immigration in some countries. Or it may just mean a stalling in economic reforms. The risk is that it will act as another constraint on productivity and economic growth and eventually see higher inflation if the supply side of the economy suffers.

It's worth putting this in context. The swing in the political pendulum to the right and the economic rationalist/supply side policies – of deregulation, privatisation, smaller government, tax cuts, low inflation, globalisation - that followed along with the peace dividend from the collapse of communism and attractively high starting point dividend yields and bond yields created a powerful tail wind that drove strong returns in shares and bonds starting in the early 1980s.

Now the environment is very different. Starting point investment yields are ultra-low for most assets and a reversal of economic rationalist policies in favour re-regulation, higher taxes and more government risk slowing productivity growth and eventually resulting in higher inflation.

The key point is that the powerful tailwind from the economic rationalist policies (deregulation, smaller government and globalisation) is now behind us and is contributing along with a range of other factors to a much more constrained return environment for investors. Our medium-term projection for the investment return from a balanced mix of assets have been steadily declining in recent years and is now running around 6.4% pa, which is down from over 10% a decade ago.

In this environment, there is a strong case to focus on investment strategies targeting the achievement over time of goals defined in terms of returns, investment income or whatever is required and using a flexible approach to do so as opposed to relying solely on set and forget strategies that depend heavily on market-based returns. There is also a case to look out for assets that may buck the trend of constrained returns as support for economic rationalist policies recede. French shares may be worth looking at!

| More

 

A decent year for shares

Monday, February 18, 2019

Further progress in US/China trade talks and the avoidance of a return to the partial government shutdown in the US are both positive to the extent that they help dial down the political risk that weighed on investors last year. The latest trade talks in Beijing ended with President Xi noting “important progress” and US Trade Negotiator Lighthizer saying “we have made headway” and reports that the US and China had reached consensus on the main issues. The talks will continue in Washington in the week ahead but are unlikely to be finalised until President’s Xi and Trump meet probably next month.  If the March 1 tariff deadline is delayed, as appears probable, it’s likely that the US auto tariff threat will also be delayed as Trump has been inclined to avoid multiple battles at once. Avoiding a return to the shutdown – even as Trump goes down the contentious path of declaring a National Emergency to get Wall funding - is good news as it removes a threat to the economy and adds a bit to confidence that a debilitating battle over the need to raise the debt ceiling from March will be avoided.

Some lessening in political threats (for now) along with a swing to more dovish/stimulatory economic policy globally are consistent with our view that this will be a decent year for share markets. However, with share markets having run hard from their December lows and technically overbought and economic data still weak the risk of a short term pull back is high. The Australian share market particularly looks to have run ahead of itself. Earnings results have been better than feared but economic growth looks to be slowing, the earnings outlook is constrained, and RBA rate cuts are still a way off.

Australian economic events and implications

The Australian December half earnings reporting season has been better than feared but shows a slowdown in growth and caution regarding the outlook. So far about a third of results have been released. 60% of companies have seen their share price outperform on the day of reporting (which is above a longer term norm of 54%) and 45% have surprised analyst expectations on the upside which is around the long term average, but a more than normal 33% have surprised on the downside, the proportion of companies seeing profits up from a year ago has fallen and only 55% have raised their dividends which is a sign of reduced confidence in the outlook – six months ago it was running at 77%. Concern remains most intense around the housing downturn and consumer spending.

Source: AMP Capital   

Source: AMP Capital

Source: AMP Capital

What to watch this week

In the US, expect the minutes from the Fed’s last meeting (Thursday) to confirm that the Fed remains upbeat but that it is waiting patiently to decide what to do next in terms of interest rates and that it might end its quantitative tightening process earlier than previously expected. On the data front expect a slight rise in the National Association of Homebuilders’ conditions index (tomorrow), a modest rebound in underlying durable goods orders, business conditions PMIs for February to remain around 54-55 and existing home sales (all due Thursday) to rise slightly.

In Australia the minutes from the last RBA board meeting (tomorrow) will confirm the shift to a neutral bias in terms of the immediate outlook for interest rates and Governor Lowe’s parliamentary testimony on Friday will be watched for further clues in terms of how the RBA is seeing the outlook for the economy. On the data front, expect December quarter wages growth (Wednesday) to hold around 0.6% quarter on quarter or 2.3% year-on-year as the lift in the minimum wage increase to 3.5% continues to feed through. January jobs data is expected to show a 5000 gain in employment and a rise in unemployment to 5.1%. Data for skilled vacancies and the February CBA business conditions PMIs will also be released.

70 Aussie companies reporting this week

The Australian December half earnings results season will see its busiest week with 70 major companies reporting including Ansell, Brambles and Coles (Monday), BHP, Bluescope and Cochlear (Tuesday), Fortescue, Stockland, Seven Group and Woolworths (Wednesday), and Coca-Cola Amatil, Nine and Wesfarmers (Thursday). 2018-19 consensus earnings growth expectations are around 4% for the market as a whole. Resources, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained.

Outlook for shares and property   

Shares are likely to see volatility remain high with the high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.

National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government. 

| More

 

What’s my take on the Aussie economy?

Thursday, February 14, 2019

Our view on global and Australian share markets hasn’t changed. They have run hard and fast since their December lows and some sort of short-term pull back is likely. Australian shares look to have run too far too fast – economic growth looks to be slowing and while we expect the RBA to cut rates, that’s probably still a way off.

But as global policy swings to being more stimulatory and growth indicators improve, shares should perform well for the year as a whole. Key to watch for will be further policy support globally and rate cuts in Australia, a decisive end to the US government shutdown dispute and signs the US debt ceiling will be raised relatively smoothly, a bottoming in profit revisions and good earnings reporting seasons globally and in Australia, stronger than expected economic data and a bottoming in PMIs and share markets breaking through resistance on strong breadth.

We continue to see the RBA cutting the cash rate this year and it’s now moving in this direction, but there is still a way to go yet. We thought the first easing was likely to be around August, but it could come as early as June. Our view remains that the cash rate will be cut to 1% by year end in two moves of 0.25% each.

One worry from the Royal Commission recommendations is in relation to mortgage brokers – they have played a huge roll in injecting competition into the mortgage market by making it possible for small lenders without a big shopfront presence to take mortgage business away from the big banks via the mortgage brokers. Moving to having borrowers pay for the services of mortgage brokers at a time when they are cash strapped is likely to significantly reduce competition in the mortgage market, which would be bad for borrowers. So it’s understandable that the Government is not so sure about this recommendation. 

Australian economic events and implications

Australia has just seen yet another week of soft data with a further sharp fall in home building approvals, very weak retail sales, a sharp fall in the services sector conditions PMI, a fall in job ads and the Melbourne Institute’s inflation gauge showing continuing weak inflation in January. Sure the December trade surplus was much better than expected but this was due to a slump in imports. Retail sales and trade look like making a zero contribution to December quarter GDP growth suggesting another quarter of weak GDP growth. The bottom line is that the housing construction cycle is turning down, the downturn in house prices looks to be weighing on retail sales, the labour market appears to be starting to slow and inflation remains MIA.

 

Source: ABS, AMP Capital    

What to watch here this week

Expect a further fall in our housing finance tomorrow. The NAB business survey (tomorrow) and the Westpac Melbourne Institute’s consumer confidence survey (Wednesday) are expected to remain softish.

The flow of Australian December half earnings results will start to pick up, with 44 major companies reporting, including JB HiFi and GPT (yesterday), Transurban and Amcor (today), Cochlear and CSL (tomorrow), South32, Woodside and AMP (Thursday) and Sonic Healthcare (Friday). 2018-19 consensus earnings growth expectations have fallen to around 4% for the market as a whole not helped by slower growth globally as well as locally with a large number of Australian companies warning of tough trading conditions, with resources profit growth running around 8% and the rest of the market around 2%. Resources, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained. Key issues will be around the impact of the housing downturn, possible changes to franking credits and how the consumer is holding up. 

Outlook for investment markets   

Shares are likely to see volatility remain high with the high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.

Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.

Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.

National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government. 

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.

The $A is likely to fall into the $US0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.

| More

 

Going up or down?

Wednesday, February 06, 2019

This month’s RBA Board meeting saw interest rates left on hold for a record 27th meeting in a row. No surprises there.

Since its December meeting the RBA has become less upbeat - acknowledging that downside risks have increased globally, revising down its Australian growth forecasts from “around 3.5%” to “around 3% for this year and a little less in 2020”, acknowledging the threat to consumer spending from falling house prices, revising down its inflation forecasts yet again to 2% this year (from 2.25%) and sounding a bit more concerned about the downturn in house prices. 

However, despite its growth and inflation downgrades and increased downside risks, it retains the view that “further progress in reducing unemployment and having inflation return to target is expected” implying that it still believes that the next move in rates will be up rather than down.  

This probably explains why the $A bounced from around $US0.72 around the time of the rates announcement to around $US0.726 an hour or so later. 

Tomorrow’s address by Governor Lowe and Friday’s Statement on Monetary Policy may provide greater clarity as to whether it retains its “next move is more likely to be up” bias on interest rates.

Nevertheless, our view is that RBA is underestimating the impact of the housing downturn on the economy – both directly via reduced housing construction and also indirectly via reduced consumer spending – and as a consequence we see weaker growth and lower inflation than the RBA is forecasting. Consistent with this we have seen a string of soft economic data releases this year including for business conditions, business conditions PMIs, consumer confidence, retail sales, housing approvals and housing starts, house prices and job ads. As a result our view remains that the RBA will cut the cash rate to 1% by year end.

| More

 

6 reasons why markets will be higher by year’s end

Thursday, January 17, 2019

While the recent rebound in shares has come on good breadth (i.e. strong participation across sectors and stocks) and is confirmed by markets like credit and a rally in “risk on” currencies, it’s too early to say that we have seen the lows. Global growth could still slow further in the short term and there is a bunch of issues coming up that could trip up markets, including US December quarter profit results, trade negotiations, the US government shutdown, the need to raise the US debt ceiling, the Mueller inquiry, Brexit uncertainties, the Australian election, etc. So markets could easily have a retest of the December low or make new lows in the next few months.

However, our view remains that the falls in share markets – amounting to 18% for global shares, 20% for US shares and 14% for Australian shares from their highs last year to their December lows – and any further falls to come in the next few months are unlikely to be the start of a deep (“grizzly”) bear market like we saw in the GFC and that by year end share markets will be higher. The main reason is that we don’t see a US, global or Australian recession any time soon, as monetary conditions are not tight enough and we haven’t seen the sort of excesses in terms of debt, investment or inflation that normally precede recessions. In relation to this, the following points are also worth noting: 

1.     The US share market has seen six significant share market falls ranging from 14% to 34% since 1984 that have not been associated with recession & saw strong subsequent rebounds.

2.     Each of these have seen some sort of policy response to help end them and on this front recent indications from the Fed including Fed Chair Powell about being patient, flexible and using all tools to keep the expansion on track are consistent with it pausing its interest rate hikes this year, Chinese officials are continuing to signal more policy stimulus including cutting banks’ required reserve ratios and we expect the ECB to provide more cheap bank funding.

3.     Negotiations between the US and China on trade look to be proceeding well although they are still at early stage and won’t go in a straight line. China in particular announced more tariff cuts and a commitment to treat foreign firms equally.

4.     President Trump wants to get re-elected in 2020 so he is motivated to do whatever he can to avoid a protracted bear market and recession and this includes seeking to resolve the trade dispute and ending the partial government shutdown before it causes too much damage.

5.     While the oil price has bounced off its lows it’s still down 30% from its high taking pressure off inflation and providing a boost to spending power.

6.     A year ago investors were feeling upbeat about 2018 on the back of US tax cuts, stronger synchronised global growth and strong profits and yet 2018 didn’t turn out well. So, it may be a good sign for 2019 from a contrarian perspective that there is now so much uncertainty and caution around.

Australian economic data over the last three weeks has been soft, with weak housing credit, sharp falls in home prices in December, another plunge in residential building approvals pointing to falling dwelling investment (see chart), continuing weakness in car sales, a loss of momentum in job ads and vacancies and falls in business conditions PMIs for December. Retail sales growth was good in November but is likely to slow as home prices continue to fall. Anecdotal evidence points to a soft December and reports of slowing avocado sales – less demand for smashed avocado on rye? – may be telling us something. Income tax cuts will help support consumer spending, but won’t be enough so we remain of the view that the RBA will cut the cash rate to 1% this year.

Source: ABS, AMP Capital

Another blowout in bank funding costs is adding to the pressure for an RBA rate cut. The gap between the 3-month bank bill rate and the expected RBA cash rate has blown out again to around 0.57% compared to a norm of around 0.23%. As a result, some banks have started raising their variable mortgage rates again. This is bad news for households seeing falling house prices. The best way to offset this is for the RBA to cut the cash rate as it drives around 65% of bank funding. 

Source: Bloomberg, AMP Capital

| More

 

Jobs, jobs, jobs

Friday, December 21, 2018

Employment rose by 37,000 in November, well above market expectations for a 20,000 gain. The unemployment rate rose to 5.1%, as participation rose to 65.7%. Annual jobs growth slowed but to a still strong 2.3%, albeit it’s down from a high of 3.6% in January. The quality of jobs growth was poor with 6,400 less full time jobs and full time jobs growth falling to 2.1% year on year compared to part time jobs growth of 2.7%. Reflecting the fall in full time jobs, hours worked fell -0.2% month on month and slowed to 1.1% year on year.

Overall, the Australian jobs market remains strong but it has slowed down a bit and the quality of jobs growth has deteriorated a bit in the last month.  

Source: ABS, AMP Capital

Mainly reflecting slowing growth in job ads, our Jobs Leading Indicator – based on job vacancies, job ads and hiring plans - points to moderating but still solid employment growth.

Source: ABS, Bloomberg, AMP Capital

Labour market underutilisation rose in November as unemployment rose to 5.1% and underemployment rose to 8.5% resulting in an increase in the total labour market underutilisation rate to 13.6% (from 13.3%). This continues to contrast with the US, and remains a constraint on wages growth even though September quarter Enterprise Bargaining Agreements showed a rise in wages growth in new agreements (mainly in the public sector).

Source: ABS, Bloomberg, AMP Capital

Finally, ABS data showed that population growth in Australia remained strong over the year to the June quarter at 391,000 or 1.6% with roughly 60% of this coming from net immigration. Strong population growth remains an underlying source of support for housing demand and is one argument against a property price crash, although it would be weakened if immigration is cut significantly. Population growth is strongest in Victoria and the ACT (both at 2.2%yoy), followed by Queensland (+1.7%yoy) and NSW (+1.5%yoy) but its falling in the NT (at -0.1%yoy). 

Implications for interest rates

Solid jobs growth will benefit consumers through higher aggregate household income, as well as boosting consumer sentiment. However, there are some signs in job advertisements that have slowed substantially that jobs growth will slow going forward and there is still a large amount of labour market slack, which will act as an ongoing constraint on wages growth. Meanwhile, the Australian consumer continues to face headwinds, due to the ongoing housing market correction and a savings rate that is already extremely low. 

There is no change to our view that the RBA will cut interest rates next year but not until the second half.

| More

 

Surplus and tax cuts here we come

Tuesday, December 18, 2018

As widely expected the Government’s Mid-Year Economic and Fiscal Outlook saw a further improvement in budget projections, with this year’s deficit projection cut to -$5.2bn or -0.3% of GDP (from -$14.5bn in the May Budget)and the 2019-20 surplus projected to be around +$4.1bn or +0.2% of GDP (up from +$2.2bn in May), with future surpluses looking even stronger. This was due to stronger-than-expected tax collections (helped by higher commodity prices and employment and lower outlays), partly offset by fiscal easing measures since the May Budget.

The surplus on current policy is projected to reach $19bn or +0.9% of GDP by 2021-20.

After years of consecutive deterioration seen in the budget deficit projections, which has seen a record run of budget deficits, the improvement seen in recent budget updates is continuing. This is good news.

Source: Australian Treasury, AMP Capital 

The improved budget outlook provides some scope for the Government to announce somewhat bigger and earlier income tax cuts (than already legislated following the May Budget) and other pre-election goodies ahead of next May’s election. This looks to have been partly allowed for with the MYEFO putting aside $3bn in “decisions taken, but not yet announced”, but looks to be smaller than we have been allowing for. Earlier tax cuts from July next year will likely help households, but are only likely to be a partial offset to the drag from a negative wealth effect as house prices continue to fall. 

The big risk of course is that revenue growth is weaker than the 7.9% that the Government is projecting for this financial year (and the 5.6% pa on average projected over the next four years), as slower Chinese growth weighs on commodity prices, jobs growth slows, and wages growth remains weak. In this regards the Government’s economic projections for 2019-20 of 3% GDP growth, 2.25% inflation and 3% wages growth are a bit on the optimistic side. 

Overall, today’s budget update is good news and confirms that the budget is moving in the right direction after a record run of deficits. However, the risks to the growth and wages outlook along with the prospect for fiscal stimulus next year suggest that it may not get a lot better than this.

The projected improvement in the budget outlook is not enough to change the RBA’s view on the economy – of most interest will be the size of any pre-election fiscal stimulus in next April’s budget. There is nothing here to alter our view that the next move by the RBA will be to lower interest rates in the second half of next year.

| More

 

Have we seen the bottom?

Monday, December 17, 2018

With US and Australian shares falling below their October/November lows over the last week and concerns about global growth still intensifying, it’s still too early to say we have seen the low in shares. Here’s a possible road map though. Shares have a possible Santa rally over the next two weeks or so, but we get more weakness in early 2019, as global growth indicators remain softish. Which in turn prompts more stimulus in China, the Fed to pause, the ECB to provide more cheap bank funding and a bit of fiscal stimulus out of Europe (was Macron’s concession over the last week to the “yellow shirts” a sign of things to come for fiscal stimulus in Europe?). US/China trade negotiations make progress. Shares then bottom around March. Economic data starts to improve, and it looks like 2015-16 all over again (albeit a bit more compressed in time). Who knows for sure. But while I remain confident that a “grizzly bear” market (where shares fall 20% only to be down another 20% or so a year later) is unlikely because a US/global recession is unlikely anytime soon, a further leg down in shares turning the correction we have seen so far (with global shares down 11% from their September high and Australian shares down 13% from their August high) into a “gummy bear” market (down 20% or so from top to bottom but up a year later) is a high risk.

Speaking of the Santa rally, it normally kicks in around mid-December on the back of festive cheer and new year optimism, the investment of any bonuses, low volumes and no capital raisings. Over the last 10 years, the period from mid-December to year end has seen an average gain of 1% in US shares with shares up in this two-week period seven years out of 10, albeit it’s been less reliable in the last few years. In Australia, over the last 10 years, the average gain over the last two weeks of December has been 2.2% with shares up eight years out of 10, including in all of the last six years. Which is why December is normally a strong month. 

Source: Bloomberg, AMP Capital

Australian economic data releases over last week were nothing to get excited about. The ABS reported that house prices fell 1.5% in the September quarter, but this just confirmed declines already reported by private sector surveys, which show an intensification over the last two months. Housing finance rose in October, but this could just be a statistical bounce after several weak months. Consumer confidence was little changed in December, but business confidence continued to slip below consumer confidence after running above it since the 2013 election. The problem is that neither are particularly strong and with house prices falling and wages growth likely to remain weak, it’s hard to see consumer confidence rising much and a continuing slide in business confidence may threaten business investment. Finally, the CBA’s December business conditions PMIs slowed to still okay levels but are well down on last year’s highs.

Residential vacancy rates for the September quarter highlight the divergent pressures on the Australian property market. In Sydney, vacancy rates are above their long-term average and rising reflecting surging supply and this is driving falling rents. But in Melbourne they are below their long term average and stable as is the capital city average. And in Perth they are falling sharply. The key takeout is consistent with Sydney being most at risk in terms of property price falls.

Source: REIA, AMP Capital

Meanwhile the regular quarterly meeting of the Council of Financial Regulators (RBA, ASIC, APRA and the Treasury) noted the importance of lenders continuing to lend, but made no move to ease the credit tightening that is impacting the economy.

What to watch...

In Australia, the Mid-Year Economic and Fiscal Outlook to be released on Monday is likely to show that the Federal budget is running around $9bn per annum better than expected – thanks to higher than expected commodity prices and employment driving stronger tax revenue only partly offset by fiscal easing measures. This year’s budget deficit projection is likely to fall to around -$6bn (from a projection of -$14.5bn in the May Budget) and the 2019-20 surplus on unchanged policies will be projected to be around +$11bn (up from $2.2bn in May) with future surpluses looking even stronger. This is likely to enable the Government to announce around $9bn in income tax cuts and other pre-election goodies ahead of next May’s election and still maintain a surplus projection for 2019-20. The big risk of course is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows, and wages growth remains weak. The Government’s growth forecast for this financial year of 3% is expected to remain unchanged but it may lower forecasts for 2.25% inflation and 2.75% wages growth as both look too optimistic.

The minutes from the RBA’s last meeting (Tuesday) will likely repeat the mantra that it expects the next move in rates to be up although there is no strong case for a near term move, but investor interest is likely to be on what the Bank has to say about the housing market and credit conditions with recent speeches suggesting that it may be getting a bit more concerned about the risks. On the data front, expect November labour force data (Thursday) to show a 10,000 gain in jobs and unemployment remaining at 5%. June quarter population data (also Thursday) will likely show some slowing in population growth to around a still strong 1.5% year-on-year.

| More

 

Will interest rates rise or fall in 2019?

Thursday, December 13, 2018

Australian economic data was weak, and we now see the RBA cutting interest rates in the year ahead. September quarter GDP came in at just 0.3% q-o-q, driven by very weak growth in consumer spending, which saw annual growth fall back to just 2.8%, which is well below the RBA’s expectation for growth around 3.5%, building approvals continue to trend down, retail sales rose modestly but the previous month was revised down, momentum in job ads is continuing to slow pointing to slower employment growth ahead, the trade surplus fell slump in home prices accelerated in November led by Sydney and Melbourne. And to cap it off, the Melbourne Institute’s Inflation Gauge showed even slower inflation in November.

Growth is nowhere near as strong as the RBA is expecting and it’s likely to revise down its forecasts. Yes, public spending is strong, business investment is looking healthier and export earnings are doing well but the housing construction cycle is turning down and falling house prices will weigh on consumer spending. As such growth is likely to be constrained around 2.5-3% over the year ahead. Given the combination of falling house prices, tight credit conditions and constrained growth, which will keep wages growth weak and inflation below target, we see the next move being a rate cut. However, it will take a while to change the RBA’s thinking, so we don’t see rates being cut until second half next year, but won’t rule out an earlier move if things are weaker earlier than we are expecting. By end 2019 the cash rate is likely to have fallen to 1%.

Sure, the RBA is repeating the mantra that the next move in rates is more likely up than down, but just not yet (with the latest being Deputy Governor Debelle’s speech this week), but RBA commentary won’t always tell us what it might soon do (remember the February 2015 rate cut!) and the RBA has recently indicated that it is getting a bit more focussed on the risks around credit and Deputy Governor Debelle has pointed that the RBA has more to go to the bottom of the easing barrel (i.e. 150 basis points on rates and quantitative easing if needed).

What to watch over the next week?

Expect to see another fall in housing finance in Australia of around 1%, ABS data to show a 1.7% fall in house prices for the September quarter consistent with private sector surveys and soft readings for business and consumer confidence.

Outlook for markets

Shares remain at risk of further short-term weakness, but we continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Beyond any further near-term bounce as the Fed moves towards a pause on rate hikes next year, the $A likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.

| More

 

The week ahead

Monday, December 03, 2018

Two weeks ago, I noted three potential positives for shares: a Fed pause, the oil price crash extending the cycle and some hope on the trade front. Oil prices have since fallen even further, providing a boost to consumers and comments over the last week from Fed Chair Powell and Vice-Chair Clarida along with the minutes from the last Fed meeting have added confidence to the prospect of a pause in rate hikes next year. The key message from the Fed is that it remains upbeat on the US economy – consistent with another hike in December, but that rates are now "just below…neutral" and it needs to be aware of potential headwinds to growth including the lagged response in the economy to past monetary tightening and that there are no major excesses to deal with, which is all consistent with the Fed being open to a pause and slower pace of rate hikes next year.

Following a hike in December, the Fed is likely to lower its “dot plot” of rate hikes for 2019 and replace the reference to “further gradual [rate] increases” in its post meeting statement, with a reference to being more data dependent. A pause on rates in the first half of next year is now highly likely, particularly if core inflation continues to remain benign. A slower more cautious Fed would be positive for markets as it would reduce fears of a US downturn and take some pressure off the $US, which would provide some relief for emerging markets and commodity prices. 

I have a leaning towards some sort of positive outcome from the Trump/Xi meeting – as both sides want a deal, but it’s a close call. I remain of view that Trump will want to resolve this issue sometime in the next six months before the tax/tariff hikes wipe out all of the remaining fiscal stimulus next year and start to act as a drag on US economic growth pushing up prices at Walmart and pushing up unemployment threatening his re-election in 2020.

Stronger Australian budget position likely to see the Government announce tax cuts ahead of next year’s Federal election. PM Morrison’s announcement that next year’s budget will be brought forward to April 2 is clearly designed to clear the way for an election in May (on either May 11 or May 18). Meanwhile, the Mid-Year Economic and Fiscal Outlook report to be delivered on December 17 is likely to show that Federal budget is running around $9bn per annum better than expected – thanks to higher than expected commodity prices and employment driving stronger tax revenue only partly offset by fiscal easing measures. This suggests this year’s budget deficit projection is likely to fall to around -$6bn (from a projection of -$14.5bn in the May Budget) and the 2019-20 surplus on unchanged policies will be projected to be around +$11bn (up from $2.2bn in May) with future surpluses looking even stronger. This is likely to enable the Government to announce $9bn in income tax cuts and other pre-election goodies starting in July 2019 and still maintain a surplus projection for 2019-20. The big risk of course is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows and wages growth remains weak. The upside of bigger and earlier income tax cuts is that it will inject a bit of spending power into household budgets providing a partial offset to what looks like being an intensifying negative wealth effect from falling house prices on consumer spending next year. So, while we see pretty constrained consumer spending growth next year it’s not all doom and gloom.

Around the globe

US data releases over the last week were mixed. On the weak side home prices rose only slightly in September, home sales fell in October, the goods trade deficit deteriorated again in October and jobless claims rose again (although they remain very low). But against this, growth in consumer spending and income was solid in October, consumer confidence fell slight in November but remains around an 18-year high and Black Friday retail sales look to have been strong. Meanwhile, core inflation fell back to 1.8% year on year in October suggesting inflation may have peaked and providing plenty of scope for a Fed rate pause at some point next year.

Chinese official PMIs softened further in November and momentum in industrial profits continued to slow in October which is all consistent with a further gradual slowing in growth and points to a more vigorous ramp up in policy stimulus.

Down under

Australia data released over the last week was messy, with a sharp fall in September quarter construction activity that was broad based across residential and non-residential building and engineering activity, a fall in September quarter private new capital expenditure and continuing softness in credit growth. There was good news though in that business investment plans for the current financial year continue to improve with capital spending plans compared to a year ago growing at their fastest in six years as the slump in mining investment slows but non-mining investment improves. So, business investment should help provide an offset to the downturn in the housing cycle.  

Source: ABS, AMP Capital

Credit growth remained soft in October with credit to property investors growing at its slowest on record and owner occupier credit continuing to slow. Fortunately, business credit growth has picked up possibly reflective of stronger investment.

Source: RBA, AMP Capital

What to watch over the next week?

In the US, jobs data to be released Friday will be the focus. Expect to see another solid gain in payrolls of around 200,000, unemployment remaining at 3.7% and wages growth rising to around 3.2% year on year. In other data, expect the November ISM manufacturing conditions index (today) to edge down to a still strong 57.5, the non-manufacturing conditions ISM index (Wednesday) to edge down to 59.5 and the trade deficit (Thursday) to widen slightly, Another speech by Fed Chair Powell (Wednesday) will likely reinforce the impression that its becoming open to a pause in rate hikes next year and the Fed’s Beige Book of anecdotal comments will be released the same day.

There is also another bout of shutdown risk in the US in the week ahead with the need for another “continuing government funding resolution” to avoid another US government shutdown from December 7 - this could create a bit of noise given Trump’s past threats to shut down the government if he doesn’t get funding for his wall – but ultimately an extended shutdown in the run up to Christmas is in neither sides interest. And a lot of spending measures have already been approved so the scale of any shutdown will be small with little economic impact.

China’s Caixin manufacturing conditions index (today) will likely remain soft.

OPEC’s meeting on Thursday is likely to agree to production cuts designed to end the rout in oil prices since early October.

In Australia the RBA will leave rates on hold for the 26th meeting in a row. The RBA remains between a rock and a hard place on rates. Strong infrastructure spending, improving non-mining investment, a lessening drag from falling mining investment, strong export earnings and a fall in unemployment to 5% are all good news. But against this the housing cycle has turned down, this will act as a drag on housing construction and consumer spending via a negative wealth effect, credit conditions are tightening, wages growth remains weak, inflation is below target and share market volatility is highlighting risks to the global outlook which is a potential threat to confidence and export earnings. So yet again the RBA will remain on hold. We remain of the view that rates will be on hold out to second half 2020 at least with a rising risk that the next move will be a cut before a hike.

On the data front expect a continuing slide in home prices for November and a 1% decline in building approvals for October (both due Monday), trade data (Tuesday) to show a 0.2% contribution from net exports to September quarter GDP growth, September quarter GDP growth (Wednesday) to come in at 0.6% quarter on quarter or 3.3% year on year helped by solid net exports and public demand but soft consumer spending and dwelling investment and weak business investment, October retail sales to rise by 0.3% and the trade surplus to fall back to $2.9bn (both due Thursday).

Outlook for markets

Shares remain at risk of further short-term weakness, but we continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.

Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit at a slower rate next year).

Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.

National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

Having fallen close to our target of $US0.70 the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound and the Fed moves towards a pause on rate hikes. However, beyond a near term bounce the $A likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory. Being short the $A remains a good hedge against things going wrong globally.

| More

 

MORE ARTICLES

No grizzly bears in this market

The story of the three bears

3 reasons why shares rallied after the US midterms

Is it bottom up from here?

Is there a doctor in the house?

Is this a story about a scary bear market?

Ah, what’s going on?

Property & shares: where are markets heading?

Can’t help falling

Risky business

Not going up

Is a property crash 60 minutes away?

Is there a Democrat in the House?

Are we on the down side of the roller coaster ride?

Rates on the rise

Where in the bloody hell are we?

Always on my mind

Turkey currency crisis triggers contagion fears

Economic update: Another Goldilocks US jobs report

Economic update: US growth rebounds

Economic update: Cutting through Trump white noise

Economic update: Trade skirmish escalating

US-China trade tensions remain high

The week in review: Trade war threat ramps up again

Week in review: Trade war threat still remains

Week in review: Turmoil in Italy and US trade

Week in review: No trade war but still no trade peace

Week in review: US-China trade and rising oil

Week in review: Rising share markets and the Federal Budget

Week in review: 'Goldilocks' jobs report and Australian data

Weekly economic update: Strong US data and geopolitical news

Economic update: Syria strike fears and US inflation

Week in review: Another volatile week for the market

The week in review: Are the trade war risks exaggerated?

Weekly economic update: Franking credits and trade war with China

Goldilocks returns in the US but Australia still muddles along

Weekly economic and market update : The Fed and Trump's Tariffs

Week in review: US inflation and the Fed

Share market bounce back - where to now?

This looks more like a correction than a major bear market

Shane Oliver’s freakishly well-timed prediction

Global growth outlook continuing to brighten

Are global economic conditions so good that they're bad?

US tax reforms likely to provide a bigger boost than many expect

Delays in US tax reform

US tax reform possible by year end

Are tax cuts really on the cards?

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

US tax cut conundrum

9 lessons from the GFC

Trump to announce new Fed chair

Progress on US tax reform

China will be the main focus globally

Global share markets climb wall of worry

Keep an eye on the RBA

Australian share market should eventually be dragged up

Markets resilient in face of bad news

Some good news from reporting season

Take Trump seriously not literally

Political mayhem continues in the US

3 ways the North Korean issue could unfold

Another "Goldilocks" US jobs report

Is there more upside for the Aussie dollar?

Is it too early to write off Trump's tax reform agenda?

US shares helped by another "Goldilocks" jobs report

Taper tantrum 2.0

Lower oil prices a bonus for consumers

'Super flows' likely helping Australian shares

Weak or negative GDP growth?

Will Aussie shares continue to underperform?

Trump crisis likely to speed up US tax reform

Weekly economic and market report

Budget preview: 3 key focus areas

'Risk on' thanks to France and Trump's tax plan

Macron to face Le Pen: A good outcome for investment markets

Weekly economic and market update

Will APRA's move cool Sydney and Melbourne property?

Trump's pro-business agenda remains on track

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

Fed on track for rate hike

US Fed on track for March rate hike

Shares at risk of short-term correction

Eurozone risks to present buying opportunities

Trump's pro-growth agenda alive and well

Trump jitters persist

Investors focused on Trump, US earnings and data

The uncertainty of President Trump

What to watch over the week

Bad news is good news for the stock markets

Will interest rates rise in 2017?

What to watch over the next week

Trump the pragmatist, or protectionist?

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

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

How the US election result could impact the markets

Why has the Australian market slipped?

3 reasons not to fear the Fed

7 reasons not to worry about a Fed rate hike

What to watch over the week

Weekly economic and market update




Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300






-->