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

China will be the main focus globally

Monday, October 16, 2017

By Shane Oliver

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

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

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

Major global economic events and implications

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

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

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

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

Australian economic events and implications

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

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

What to watch over the next week?

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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Global share markets climb wall of worry

Monday, October 09, 2017

By Shane Oliver

Investment markets and key developments over the past week

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

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

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

Major global economic events and implications

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

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

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

Australian economic events and implications

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

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

What to watch over the next week?

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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Keep an eye on the RBA

Monday, October 02, 2017

By Shane Oliver

Investment markets and key developments over the past week

Global share markets pushed higher over the last week as solid economic data and ongoing talk of US tax reform more than offset continuing North Korea worries. US shares rose 0.7%, Eurozone shares gained 1.3% and Japanese shares rose 0.3%. Chinese and Australian shares were flat though. Bond yields generally rose but commodity prices were mixed with oil and copper up but gold and iron ore down. The $A fell, reflecting a stronger $US and a falling iron ore price.

September saw US shares up 1.9%, Eurozone shares up 4.4% and Japanese shares up 3.6% compared to a 0.6% decline in Australian shares. Softer earnings prospects are likely to see Australian shares remain a relative underperformer for a while yet.

Don’t exaggerate the significance of the German election. The election result which saw reduced support for Angela Merkel's Christian Democrat Union (CDU) led coalition and the Social Democrats in favour of the far right anti Euro Alternative for Deutschland and the pro Europe Free Democrat Party has led to concerns about what it means for Europe.  A so called "Jamaica coalition" with the CDU/CSU, Free Democrat Party and the Greens looks doable but will take months to negotiate (they always do) and the FDP may seek to hold European integration back. However, there is a danger in exaggerating all this. First, the AfD only got 12.6% of the vote - this is not Brexit or Trump! Second, the AfD's support largely owes to the 2015 immigration crisis which has already subsided and Merkel will likely undertake a further strengthening of border controls. Third, the very pro-EU Greens will act as a counterbalance to the FDP in a coalition government. Finally, Germans are very pro Euro with 81% support for it so talk of a threat to the Euro is grossly exaggerated. Move on to the next issue!

Speaking of elections, Japan's PM Shinzo Abe confirmed an election for October 22. Early strong poll support for the new Party of Hope with which the Democrat party is now merging, suggests that Abe and the LDP are not guaranteed of victory. However, it’s doubtful the new party will have enough time to fully get its act together so Abe is most likely to win but with a reduced majority. Abe has already announced that part of the 2019 consumption tax increase will be used to finance new spending and more fiscal easing is likely. If Abe is returned as we expect it’s unlikely to change the relative attractiveness of Japanese assets (positive on shares, negative on the Yen).

Finally, again on elections, the October 1 Catalan independence referendum - to the extent that it even occurs given Spanish Government moves to block it - is unlikely to be of significant relevance to global investors. It’s essentially a Spanish issue with not much relevance to the Eurozone. Under the Spanish constitution the referendum is illegal (hence the moves to stop it by the Spanish Government) and opinion polls show that around 56% of the Catalan population view it as such. Polls also show that less than 35% of Catalans support independence, down from nearly 50% in 2012 and around 55% would prefer to stay in Spain with more autonomy – although there is a risk the Spanish Government moves to stop the referendum will boost pro-independence support. But given all these issues and that the disrupted referendum won’t be able to be interpreted as providing any mandate, independence is a long way off if at all and even if it is eventually achieved Catalonia wants to stay in the Euro, so the whole issue has little to do with the survivability of the Euro.

Major global economic events and implications

US activity data was mostly solid, but core inflation remains weak. August home sales were down on hurricane effects and low inventory levels and the hurricanes dampened August household spending, but home prices are rising solidly, consumer confidence remains strong, August durable goods orders were robust and regional manufacturing conditions indexes are strong. While core private consumption deflator inflation surprised on the downside for August at 1.3% year on year, it is likely to pick up a bit by year end. Fed Chair Yellen provided balanced comments on monetary policy, reiterating the case to be gradual in raising rates but not too gradual. This is consistent with our view that the Fed will hike rates again in December, all of which is positive for the US dollar. More details were provided of US tax reform plans - they have a long way to go to make it through Congress but our view remains that ultimately some form of tax cuts will be passed early next year. Which would also add to upwards pressure on the $US.

Strong Eurozone activity data but still low inflation. Eurozone economic confidence rose again in September, supporting the view that growth in Europe has picked up. Against this inflation remains well below target, with core inflation falling to 1.1% yoy (from 1.2%), suggesting that the ECB will remain cautious in moving to slow money printing.

Strong Japanese activity data but still low inflation (too). Japanese labour market indicators and industrial production remained strong in August and household spending growth picked up. Core inflation rose to 0.2% yoy, but it’s still well below the Bank of Japan's 2% objective. So don't expect any early exit from ultra easy monetary policy in Japan.

Chinese profit growth accelerated in August to 24% year on year (from 16% in July) and while the Caixin manufacturing PMI fell slightly in September, the official manufacturing and services PMIs rose, suggesting any growth slowdown is mild.

Australian economic events and implications

It was a relatively quiet week on the data front in Australia. ABS job vacancies for August remained strong, pointing to continuing solid jobs growth and credit growth remained moderate with an ongoing moderation in the growth of credit to property investors relative to owner occupiers. Two things are particularly worth highlighting though from the last week.

First, for the first time in years the latest Federal budget update showed an improvement with the final 2016-17 underlying budget deficit coming in $4.4 billion lower than had been estimated in the May Budget. This is good news, but wages growth needs to pick up for the improvement to continue.

Second, population growth remained robust at 389,000 people or 1.6% over the year to the March quarter, with immigration offsetting slowing natural growth. All of which provides a strong support for economic growth, helps slow the ageing of the population compared to other countries and underpins strong underlying demand for housing. The latter in turn helps reduce the risk of a property price crash. This is particularly the case in Victoria where the population is growing by a whopping 2.4% year on year or by nearly 150,000 in contrast to population growth in NSW of 1.6% yoy or 123,000. Its little wonder that the Melbourne property market is holding up better than Sydney's and if this continues its likely that Melbourne property prices will rise relative to those in Sydney.

In terms of unit supply it’s worth noting that Rider, Levett, Bucknall residential crane count rose further in September to 551 (compared to 128 three years ago) with Sydney rising to 298 cranes and Melbourne rising to 124. Falls in building approvals suggest that we are at or close to the peak but there is clearly still a big pipeline of work to be completed.

Source: RLB Crane Index, AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on September jobs data (Friday) which is likely to have been temporarily distorted by the impact of hurricanes Harvey and Irma, so expect payrolls to be up by a relatively subdued 90,000. Unemployment is likely to have remained at 4.4% though and wages growth is likely to be rise slightly to 2.6% year on year. Meanwhile expect the September ISM manufacturing conditions index (Monday) and the non-manufacturing conditions index (Wednesday) to remain strong. Fed Chair Yellen has another speech on Wednesday.

In the Eurozone, expect unemployment (Monday) to have fallen to 9% in August.

In Japan, the September quarter Tankan business conditions survey is expected to show continued strength.

In Australia the RBA is expected to leave interest rates on hold for the fourteenth month in a row. Improving global growth, strong business confidence and jobs growth, the RBA’s own expectations for a growth pick up and already high levels of household debt argue against a rate cut. But record low wages growth, low underlying inflation, the impending slowdown in housing construction, risks around the consumer and the strong $A argue against a rate hike. We agree that the next move in rates is likely to be up, but for now the downside risks are still significant and as such we remain of the view that its way too early to start raising rates just yet.

On the data front in Australia, expect CoreLogic home price data (Monday) to show some continued moderation in Sydney (and hopefully Melbourne) property price growth in September, building approvals to rise 1% (Tuesday), retail sales to show modest growth of 0.2% and the trade surplus (both Thursday) to improve. Business conditions PMIs are likely to remain solid.

Outlook for markets

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

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

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

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

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

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

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Australian share market should eventually be dragged up

Monday, September 25, 2017

By Shane Oliver

Investment markets and key developments over the past week

Global share markets rose over the last week with Japanese shares up 2.5%, Eurozone shares up 0.7%, Chinese shares up 0.2% and US shares up 0.1%. Australian shares fell 0.2% though, on rate hike fears and falls in the iron ore price. Bond yields rose as global data remained solid and the Fed continued its process of monetary tightening. Oil and metal prices rose but the iron ore price fell 12%. The $A fell after RBA Governor Lowe pushed back against talk of an early rate hike in Australia.

Bonds resumed their upswing as the Fed provides a jolt to investor complacency. A big surprise this year has been the extent of the pull back in bond yields in the US and to a lesser extent elsewhere and a big driver of this was low US inflation and expectations that this will see less tightening from the Fed. However, the Fed clearly sees things differently. Not only is it moving to start letting its holdings of bonds and mortgage backed securities start to rundown from next month but it has also maintained its expectation for another rate hike in December. This is all understandable given the strength of US economic data and the likelihood that at some point this will start to push inflation up. So, after hitting a low around 20% early this month the US money market's probability of a December Fed rate hike has rebounded to 67%. And it’s hard to see a reduction in the Fed's bond holdings not imparting some upward pressure on bond yields.

The bottom line is that while the Fed remains benign and gradual in undertaking monetary tightening, it’s not quite as benign and gradual as many had been assuming. This is likely to see further upwards pressure on bond yields and the US dollar – after both sagged this year partly in response to lower than expected US inflation and expectations that the Fed may not raise rates as much as had been flagged. Equities should be able to withstand ongoing Fed tightening (short term gyrations aside) because they are still cheap versus bonds, the Fed is only tightening because growth is stronger and US monetary policy is a long way from tight.

Of course, what Yellen and others at the Fed say comes with a bit less authority at present with Trump set to select the chair, vice chair and up to five governors (if Yellen also resigns her governorship if she does not remain as chairperson) in the next few months. But this is unlikely to slow the quantitative tightening process and could go either way on interest rates, so for now Fed commentary and the dots remain the best guide to its thinking.

Trump is still Trump - threatening to wipe out North Korea in the last week (but don’t forget to take him seriously, not literally!) - and I am not a political analyst (although economists like to pretend they are). But it does seem that Trump may have hit a low inflection point a few weeks ago in the aftermath of Spicer, Priebus, the Mooch and Bannon leaving the White House team and after Trump’s Charlottesville comments. Trump the pragmatist seems to be in control of Trump the populist, his White House team seems a lot more disciplined now and he is cutting pragmatic deals with Democrats and moderate Republicans to get things done. Some of this may be aimed at upping the pressure on the Republican's in Congress to get tax reform done (where progress is continuing). The hurricanes may also have helped but the sense of crisis around Trump looks to have receded a bit. Along with the Fed reasserting itself this adds to the positives for the US dollar.

Major global economic events and implications

US data remains strong, abstracting from the impact of hurricanes. While August readings for home builders' conditions, starts and existing home sales were all dampened by the hurricanes, permits to build new homes are up and initial jobless claims are already falling again. What’s more, the Markit business conditions PMI and manufacturing conditions in the Philadelphia region remained strong this month and the US leading index is also strong. Based on past experience the hurricane impact will be temporary and is best looked through.

Eurozone business conditions PMIs rose in September to very strong levels – with gains in manufacturing and services – pointing to stronger growth ahead.

UK PM May’s seeking of a two-year post Brexit transition with EU benefits and obligations would if accepted by the EU push out a Brexit cliff to 2021 and buy more time for a better deal. It would potentially support a more hawkish BoE and the pound.

The Bank of Japan made no changes to monetary policy and remains on auto pilot with quantitative easing and its zero target for the 10-year bond yield continuing until it gets inflation above 2% and right now we are a long way from that. With the Fed on track with tightening and the BoJ firmly on hold the Yen is in decline again which has helped Japanese shares rebound to their highest since 2015.

While China’s credit rating was downgraded to A+ from AA- by Standard and Poors on the back of strong credit growth, my view is that Chinese credit risks have declined a bit over the last year or so with stronger corporate earnings, reduced capital outflows and regulatory moves to slow credit growth. The S&P downgrade just follows a similar Moody’s downgrade in May. More broadly it’s odd to think that China is a huge creditor nation with a current account surplus, borrows from itself, saves too much (46% of GDP), consumes too little and has a weaker credit rating than Australia.

Australian economic events and implications

In Australia, the minutes from the RBA’s last Board meeting didn’t add anything new and nor did RBA speeches – but the latter still caused a few gyrations. While some may have been confused by the seemingly more upbeat comments of Assistant Governor Lucy Ellis and the more balanced comments of Governor Philip Lowe, it’s worth noting Ellis was mainly focussed on the global economy where it’s easier to sound more upbeat whereas Lowe was focussing on Australia where it’s more mixed. Lowe is upbeat about growth consistent with the RBA’s own forecasts but is well aware of the risks around wages and household debt and repeated that “a rise in global rates has no automatic implications for Australian rates.” We agree with Lowe that the next move in rates will likely be up but it’s still likely to be some time away.

For those who want to know “where the increase in jobs is coming from” the chart below shows a breakdown for the twelve months to August. Healthcare, construction and education are the big drivers.


Source: ABS

What to watch over the next week?

In the US, a speech by Fed Chair Janet Yellen (Tuesday) will no doubt be watched for clues on the interest rate outlook but probably won’t add much to what we learned in the last week. Expect continuing modest gains in July home price data but a slight hurricane related pull back in September consumer confidence (both Tuesday), a hurricane related pull back in August pending home sales (Wednesday), continued strength in underlying durable goods orders (also Wednesday) but only a modest gain in August personal spending (Friday). Following recent CPI data, the August core private consumption deflator (Friday) may be a bit stronger at 0.2% month on month, but with the annual inflation rate remaining still low at 1.4%.

In Germany, the focus will shift to who Angela Merkel’s Christian Democratic Union will form a coalition with in the aftermath of the election. Expect Eurozone economic confidence readings for September (Thursday) to remain robust but core inflation to remain low at 1.2% year on year.

In Japan, expect August data on Friday to show continued labour market strength, solid growth in industrial production and some improvement in household spending but core inflation remaining depressed but rising slightly to 0.2% yoy.
Chinese business conditions PMIs (due Friday and Saturday) for September are likely to remain consistent with only a modest edging down in growth.

In Australia, March quarter population data (Wednesday) is expected to show population growth remaining strong at around 1.6% year on year led by Victoria, August ABS job vacancy data (Thursday) is likely to show continued strength and credit data (Friday) is likely to show continued moderate growth with a further slowing in property investor credit.

Outlook for markets

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

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

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

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

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

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

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Markets resilient in face of bad news

Monday, September 11, 2017

By Shane Oliver

Investment markets and key developments over the past week

Share markets mostly fell over the last week as worries around North Korea continue, combining with concern about the impact of hurricanes on US growth, albeit most markets remain in the range they have been in for a while and have proven quite resilient in the face of bad news thanks to solid global growth and supportive monetary policy. While Eurozone shares rose 0.1%, US shares lost 0.4%, Japanese shares fell 2.1%, Chinese shares fell 0.1% and Australian shares fell 0.9%. Bond yields fell further helped by dovish comments from ECB President Draghi, a downwards revision to the ECB’s inflation forecasts and worries about the impact of hurricanes on the US. However, the Euro rose as President Draghi wasn’t seen as dovish enough resulting in a new down leg in the $US which also saw the $A push back above $US0.80. Oil and gold prices rose but iron ore fell.

We thought Hurricane Harvey made a US Government shutdown and debt ceiling crisis this month very unlikely and this has proved to be the case with President Trump and Congress agreeing to extend government funding and raise the debt ceiling out to mid-December.
So no shutdown and no debt default for now. This continues the period of budget and spending stability that has been in place since the 2013 “crisis”. Uncertainty will rise again in December but a shutdown/debt default is also unlikely then. At the margin the move adds to confidence that tax reform will happen.

Trump’s threatening tweets – eg, that he will stop all trade with countries trading with North Korea (read China) – create great media headlines but just remember that the trick with Trump is to take him seriously but not literally.
His approach is all about setting up tough a negotiating stance, getting some movement in his direction and then settling. So yes he is trying to put more pressure on China regarding North Korea but don’t expect the US to cease trade with China.

North Korean risks continue to escalate. Our view remains that the risk of a skirmish or war has grown – particularly due to a miscalculation by either side in the conflict, but that a diplomatic solution remains most likely as North Korea is not quite so stupid to set off a war in which it will be annihilated and the US and its allies are aware of the potential huge loss of life in South Korea and potentially Japan that would flow from a pre-emptive military response. But we are a long way from a diplomatic solution yet. So the issue is likely to escalate further posing the risks of triggering further downside in share markets and demand for safe havens.

What about Bitcoin? Crypto currencies led by Bitcoin are generating much interest. They and the block chain technology underpinning them seem to hold much promise but there is reason to be cautious. Lots of them are popping up, the ascent of Bitcoin’s share price looks very bubbly (although its potential ramifications if it bursts are nowhere near as significant as the other bubbles shown on the chart) and regulators are starting to take a closer look. I also still struggle to fully understand how it works and one big lesson from the GFC is that if you don’t fully understand something you shouldn’t invest (who really understood CDOs? – obviously not many!)

Major global economic events and implications

It was a quite week for US data, but the ISM non-manufacturing conditions index rose in August to a strong reading of 55.3 and the trade deficit widened less than expected. Jobless claims rose 62,000 but this reflects the impact of Hurricane Harvey with Texas up 52,000. Hurricane Katrina saw a 100,000 rise in claims over three weeks but after eight weeks they were back to where they started. Houston is much bigger than New Orleans and Hurricane Irma will impact too so the rise this time may be greater, but Houston is recovering quicker so again the impact is likely to be temporary.

The ECB made no changes to monetary policy. It revised up its growth forecasts but revised down its inflation forecasts and President Draghi was dovish and the ECB effectively tied a decision on what it will do about its quantitative easing program for 2018 (to be announced in October) to what the Euro does. The surprise was that Draghi was not more forceful in expressing concerns about the rising Euro, but if it continues it will likely see the ECB taper its asset buying at a slower rate, eg initially cutting it to say €50 billion a month rather than say €35 billion.
China’s Caixin services conditions PMI rose and import growth accelerated indicating Chinese growth is remaining strong.

Australian economic events and implications

Australian data was the usual mixed bag. GDP growth bounced back nicely in the June quarter driven by consumer spending, investment and trade and ANZ job ads continue to grow strongly pointing to ongoing labour market strength. With the drag from mining investment slowing, non-mining private investment picking up, strong public capital spending and an ongoing contribution to growth from trade volumes growth is likely to improve further. However, July retail sales and trade were off to a soft start for the current quarter, and with continuing low wages growth (with average wages -0.1% in the June quarter and up just 0.1% over the last year) constraining consumer spending and dwelling construction topping out the rebound in growth will remain constrained relative to the RBA’s expectations for 3% plus growth. Which in turn means that the risks to underlying inflation remain on the downside.

So despite RBA Governor Lowe sounding upbeat, we remain of the view that the RBA will leave rates on hold out to late 2018 at least before starting to gradually raise rates. If the $A continues to rise – with it back above $US0.80 over the last week – then any hike could be pushed further out.

What to watch over the next week?

In the US, expect small business confidence and job openings (both Tuesday) to remain strong, solid growth in underlying retail sales and a modest rise in industrial production (both Friday). Jobless claims are likely to see a further spike reflecting hurricane disruption. While headline CPI inflation (Thursday) is expected to rise to 1.8% year on year (from 1.7%) core inflation is expected to fall to 1.6% yoy (from 1.7%) keeping the Fed gradual in undertaking monetary tightening.

Chinese activity data for August due Thursday is expected to show a slight rise in both retail sales growth to 10.5% year on year and growth in industrial production to 6.7% yoy, but stable growth in fixed asset investment at 8.3% yoy. Money supply and credit data for August will also be released.

In Australia, expect the August NAB survey (Tuesday) to show continuing solid levels for business confidence, the Westpac consumer confidence index (Wednesday) to remain soft and August employment (Thursday) data to show jobs up 10,000 but with unemployment rising to 5.7%

Outlook for markets

Share markets remain at risk of a further consolidation or short-term correction, particularly with North Korean risks remaining high and seasonal weakness around September and October. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets remaining in place into 2018.

Low yields point to ongoing low returns from bonds.

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

National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.

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

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed tightens and the RBA holds.

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Some good news from reporting season

Monday, September 04, 2017

By Shane Oliver

Investment markets and key developments over the past week

The key implication of Hurricane Harvey for global investors is that there is now less chance of a US shutdown/debt ceiling crisis. US Federal Government agencies like the Federal Emergency Management Agency will be central to the assistance and rebuild effort and Texas voted for Trump. Given this, it's inconceivable that Trump and Congress will countenance a Government shutdown and debt ceiling crisis in the immediate aftermath of a disaster. So maybe a bit of noise in late September/early October but I would put the shutdown risk at just 5-10% and debt ceiling risk at less than 5%. In fact, to speed an increase in the debt ceiling President Trump is reportedly considering tying it to a request for Hurricane Harvey relief funding and has already backed away from tying a shutdown to Mexican wall funding. More broadly at the margin Harvey may help galvanise Republicans in Congress to get moving on their agenda - with tax reform high on the list and infrastructure in there as well.

After a two week lull North Korean risks escalated again. Our view remains that the risk of a skirmish or war has grown – particularly due to a miscalculation by either side in the conflict, but that a diplomatic solution remains most likely as North Korea is not quite so stupid to want to set a war off knowing its regime would be wiped out and the US and its allies are aware of the potential huge loss of life in South Korea and potentially Japan that would flow from a military response. But we are a long way from a diplomatic solution yet and both sides obviously want to keep the threat level up in order to achieve a successful outcome from their own perspective. So the issue is likely to escalate further posing the risks of triggering further downside in share markets and demand for safe havens.

Major global economic events and implications

US economic data remains strong. June quarter GDP growth was revised up to 3% annualised (from 2.6%) thanks to stronger business investment and consumer spending, the August manufacturing conditions ISM rose to a very strong reading of 58.8, consumer confidence rose in August to around its highest since 2000 (despite all the Trump related political noise), consumer spending rose solidly in July and home prices are continuing to rise. While payrolls growth was less than expected in August, this looks like noise with most other jobs indicators, including jobless claims and employment plans in the ISM survey, all very strong. All of this will keep the Fed on a tightening path, but continuing low inflation at just 1.4% on a core basis in July and wages growth of just 2.5% will keep it gradual.

Eurozone economic data is also strong with confidence rising in August to levels last seen before the GFC, driven by both consumer and business confidence. It's even up and solid in Italy! However, unemployment remains very high at 9.1% in July and core inflation remained well below the 2% "target" at 1.2% in August. All of which will keep the ECB “patient”.

Japanese jobs data remained strong in July with the ratio of job vacancies to applicants at its highest since 1974 (helped by Japans falling workforce) but household consumption data was weak. Industrial production fell in July but after a strong June and annual growth remains around 5%.

Chinese business conditions were mixed in August - up for manufacturers, down a bit for services - and profit growth slowed a bit in July all consistent with some slowing in Chinese growth in the current quarter, but not much.

As always – it’s not all good news globally. The Indian economy has slowed (to 5.7% year on year in the June quarter) with the July GST start up also impacting. That said a rebound in its manufacturing Conditions PMI in August is a positive sign that GST disruption is short lived.

Australian economic events and implications

At last, some good news on the non-mining investment front. Australian data over the last week was mixed. Credit growth remains moderate with credit to housing investors showing a continuing slowdown to well below APRA's 10% speed limit, residential construction didn't bounce as expected in the June quarter and with building approvals and new home sales well down on peak levels, the contribution to growth from dwelling investment looks to have ended. But against this business conditions PMIs are strong and business investment looks to have increased modestly in the June quarter (albeit not as much as construction data would suggest owing to a distortion from the largely imported Prelude LNG platform) and most importantly the outlook for non-mining investment is looking better.

Capex plans for the current financial year point to a further slight fall in investment of around 3-4%. But while mining investment is still falling sharply (likely to be down around 22%), as a share of GDP its already collapsed to 2% from a high around 6-7% so its drag on growth is diminishing and it looks to be close to the bottom. More importantly, non-mining investment plans point to a rise of around 8%, but which could be even stronger if sectors such as agriculture, healthcare and education (which are not included in the capex survey) are allowed for. The point is that just as housing’s contribution to growth starts to slow and reverse it will be offset by a diminishing drag from mining investment and stronger non-mining investment. Which in turn should help growth lift a bit from the dismal pace of the last year.

Home prices slow. Core Logic data for August showed that while the Melbourne property market remains strong, Sydney has cooled, price growth remains moderate in Adelaide and Brisbane, prices are still falling in Perth and Darwin but Hobart is now a star performer as the boom in Melbourne has forced buyers to look elsewhere. Our view remains that Sydney and Melbourne will slow, Perth and Darwin are close to bottoming and price growth will improve a bit in other cities.

The June half earnings reporting season in Australia is now done. The good news is that profits and dividends are up with 67% of companies reporting higher profits than a year ago (see the first chart below) and 64% increasing dividends from a year ago, which is a good sign regarding the quality of earnings. Overall earnings per share growth for 2016-17 looks to have come in around 17.7% which is a huge improvement after two years of declines. However, looking beneath the surface it’s not quite so good.
First, the huge upswing in earnings owes to a 124% rise in resource sector profits and there is no doubt that the turnaround here is impressive and reflecting this they have increased their dividends substantially. However, profit growth in the rest of the market is more modest at around 6%. What’s more, only 39% of companies have surprised on the upside (which is less than normal and the weakest since 2013) and 31% have surprised on the downside. Outlook guidance has also been a bit soft. All of which partly explains why the share market fell fractionally in August. 55% of companies saw their share price outperform the market the day they reported but beneath the surface there has been intense volatility with some very sharp declines in share prices for companies who disappointed (eg Dominos, Telstra, Suncorp, QBE, Bluescope, Healthscope, Harvey Norman) either in terms of the result, outlook comments or dividends. The problem of course is that PEs are relatively high and so much had already been factored in. As a result, expectations for earnings growth for the current financial year have been revised down a bit to 2.3%, although again it’s worth noting that profit growth for the market excluding resources is expected to remain relatively stable at around 4.3%. Key themes have been: large caps doing better than small caps; resources stocks back to strength; constrained revenue growth with the domestic economy just okay with housing still strong but retailing mixed; some disappointment from foreign earners; dividends (ex Telstra) continuing to roar ahead; and indications of stronger business investment.

While underlying profit growth for Australian listed companies (ie, excluding the volatility in resources earnings) at around 6% is all right – it’s well below that in the US (at around 11%) and Europe and Japan (at around 30% lately) so it’s another reason to maintain a bias towards global shares over Australian shares.

 

 

 

 Source: AMP Capital

 

What to watch over the next week?

In the US, expect the ISM non-manufacturing conditions index for August to remain solid and the July trade balance to worsen a bit (both Wednesday). Initial jobless claims (Thursday) will likely show a sharp rise due to Hurricane Harvey. The Fed’s Beige Book of anecdotal evidence (Wednesday) will also be released.

The ECB on Thursday is very unlikely to make any immediate changes to monetary policy and is likely to stress that monetary policy should remain accommodative. While its edging closer to announcing a reduction in its quantitative easing program for 2018 from €60bn a month to maybe €35bn a month its unlikely to do it just yet as it remains in “patient” mode given low inflation and for fear of adding to Euro upside. In fact, the ECB may not provide a detailed announcement of its plans until December. Some sort of reduction for 2018 has been talked about for so long though that when it is announced it should not come as a surprise to anyone.

Chinese trade data for August (Friday) is expected to show import growth slowing to around 10% year on year and export growth slowing to around 6% year on year.

In Australia the RBA is expected to leave interest rates on hold for the 13th month in a row. Basically the RBA and rates are stuck between a rock and a hard place. Strong business confidence and jobs growth, the RBA’s expectations for a growth pick up and worries about reigniting the Sydney and Melbourne property markets argue against a rate cut. But record low wages growth, low underlying inflation, the impending slowdown in housing construction, risks around the consumer and the rise in the $A argue against a rate hike. So it makes sense to leave rates on hold at 1.5% and this is likely to remain the case out to late next year at least. Speeches by RBA Governor Lowe on Tuesday and Friday will also be watched for any clues on the rate outlook.

On the data front in Australia, most interest is likely to be on June quarter GDP data to be released Wednesday. Our expectation is for 0.5% quarter on quarter with strong retail sales driving a boost to consumer spending and a slight rise in business investment, but a flat contribution from net exports. This will see annual growth slip to 1.5%. June quarter data on wages, company profits and inventories on Monday and for net exports which are expected to be flat and public demand on Tuesday will help firm up GDP estimates. Expect July data to show a 0.2% gain in retail sales (Thursday) and a slight rise in housing finance (Friday).

Outlook for markets

Share markets remain at risk of a further consolidation/short term correction. Although the risk of a US Government shutdown and debt ceiling crisis have receded a bit, US politics generally, North Korea and central banks remain potential triggers and we remain in a seasonally weak part of the year. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets likely to resume through the December quarter and into 2018.  

Low yields point to ongoing low returns from bonds. 

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

National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.

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

While further short-term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the interest rate differential in favour of Australia is likely to continue to narrow as the Fed hikes rates and the RBA holds.

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Take Trump seriously not literally

Monday, August 28, 2017

By Shane Oliver

Investment markets and key developments over the past week

Trump is continuing to throw curve balls, adding to the risk but maybe not as bad as it looks. From North Korea, to Charlottesville, to a revolving door team in the White House and now the approaching budget/debt ceiling negotiations, the political mayhem in the US continues with President Trump at the centre of it. His comments to a rally of his supporters that he might terminate NAFTA and use the threat of a Government shutdown to get funding for his wall have naturally kept investor nervousness alive around US policy and particularly the issue of a debt default if Congress and the President fail to agree on a bill to increase the debt ceiling by late September/mid-October. This is because funding to avoid a shutdown may be pared with a bill to increase the debt limit by late September. US Government funding will run out on September 30 and the debt ceiling will be reached sometime between then and mid-October.
 
As we saw in the last US Government shutdown between October 1-16 in 2013 the economic impact was minor, so another short shutdown would not be a major problem but a failure to raise the debt ceiling in time would be: although the US Treasury would avoid defaulting on its debt initially, it would be forced to stop making some entitlement payments – and this may trigger a broader downgrade to America’s credit rating which, as we saw in 2011, caused a mini financial panic. However, there are several points to note in relation to this: 
 
1. Trump should be taken seriously but not literally. He can go from Trump the populist rabblerouser to Trump the pragmatic businessperson within the same day to the point he looks schizophrenic so there is a danger in reading too much into what he says.

2. Related to this his comments on shutting down the Government and building the wall naturally appeal to his base but so did his comments about declaring China a currency manipulator and imposing 35% tariffs on Chinese imports and they haven't happened. His comments on both NAFTA and the shutdown are likely both just part of a negotiating ploy.

3.  Congressional Republicans (and Democrats) are well aware of the blame they will take if welfare payments are stopped. The American public tended to blame Congressional Republicans for the 2013 shutdown and debt ceiling delay and they would probably do the same again which would not be good ahead of the 2018 mid-term Congressional elections.

4.  Consistent with this, House Speaker Ryan has indicated that they are not interested in a shutdown, the chair of the conservative tea party group in the House has said “we will raise the debt ceiling and there shouldn’t be any fear of that” and Senate Majority Leader McConnell has said earlier this week that there is “zero chance, no chance, we won’t raise the debt ceiling.”

5. With the departure of political adviser Stephen Bannon the populist influence around Trump in the White House has been dramatically reduced (almost wiped out).

6. Finally, indications in the last week are that the White House and congressional leaders are making good progress on tax reform. The desire to achieve something by the 2018 mid-terms is a big driving force behind congressional Republicans’ in terms of tax reform.
 
As a result, our view remains that the debt ceiling will be raised in time and some form of tax reform will take place. However, unlike in the 2011 and 2013 debt ceiling debates the President is no longer calm and cool and has become a third force in the negotiations. So the risk is high that there will be lots of market disturbing argy bargy and last minute brinkmanship ahead of signing a new funding resolution and an increase in the debt ceiling. The worst case could be a two-week shutdown from October 1 which focusses public pressure ahead of a debt ceiling increase just before the ceiling is reached. Just like in 2013.
 
Political uncertainty ramped up a notch in Australia with the High Court unlikely to rule on the citizenship issue of five (soon to be at least seven) Federal parliamentarians until October/November with a significant risk to the Government’s ability to govern and the risk of an early election if the Court takes a literal view of the Constitution.
 

The prospect of six prime ministerships in just over 10 years is not a good look. The risk of an early election has yet to impact Australian financial markets. But it would likely weigh on business confidence which has been surprisingly upbeat since the 2013 change of government to the Coalition which in turn could adversely affect employment and investment. A change of government would also have significant implications for banks (with the Labor Party committed to a bank royal commission) and property prices (with the ALP committed to restricting negative gearing and cutting the capital gains tax discount).

Major global economic events and implications

 US data remains solid with the composite business conditions PMI rising solidly in August to a strong reading of 56 driven by strength in the services sector. Underlying capital goods orders and shipments are strong, jobless claims remain low and home prices are continuing to rise. Home sales fell in July though.
 
The Eurozone composite business conditions PMI also rose in August to a strong reading of 55.8 driven by manufacturing. Consistent with this the German IFO and French Insee business conditions/confidence readings were strong. Consumer confidence is about as strong as it ever gets.
]Japan's manufacturing conditions PMI rose in August to a solid reading of 52.8. Core inflation remained around zero in July though highlighting that it will be a long time before the Bank of Japan can consider an exit from ultra easy money policy.

Australian economic events and implications

Australian data was light on but skilled vacancies rose in July indicating that the jobs market remains solid.
 
We are now about 85% through the Australian June half earnings reporting season and results have remained a little disappointing. At a high level profits look good: they are up with 70% of companies reporting higher profits than a year ago (see the first chart below) which is the strongest since 2010, 69% have increased dividends from a year ago which is a good sign regarding the quality of earnings and overall earnings per share growth for 2016-17 is coming in at around 17.5% which is a huge improvement after two years of declines. However, dig beneath the surface and it’s not quite so good. First, the huge upswing in earnings owes to the rebound in the fortunes of the big resources stocks with resource sector profits up around 130%. There is no doubt that the turnaround here is impressive and reflecting this they have increased their dividends substantially.
 
However, profit growth in the rest of the market is more modest at around 5-6%. What’s more only 38% of companies have surprised on the upside (which is less than normal and the weakest since 2012) and 32% have surprised on the downside. Outlook guidance has also been a bit soft. While the market as a whole has been relatively stable through the reporting season – it’s basically flat for August to date - and a roughly equal number of companies have seen their share prices outperform and underperform the market on the day they released results, beneath the surface there has been intense volatility with some very sharp declines in share prices for companies that disappointed (eg Dominos, Telstra, Suncorp, QBE, Bluescope and Healthscope) either in terms of the result, outlook comments or dividends.
 
The problem of course is that PEs are relatively high and so much has been factored in. As a result, expectations for earnings growth for the current financial year have been revised down a bit to 1.8%, although again it’s worth noting that profit growth for the market excluding resources is expected to remain relatively stable at around 5%. Key themes have been: large caps doing better than small caps; resources stocks back to strength; constrained revenue growth with the domestic economy just okay with housing still strong but retailing mixed; some disappointment from foreign earners; and dividends (ex Telstra) continuing to roar ahead.
 
While profit growth for Australian listed companies ex the miners at around 5% is all right – it’s well below that in the US (at around 11%) and Europe and Japan (at around 30% lately) so it’s another reason to maintain a bias towards global shares over Australian shares.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on Friday data releases for the ISM manufacturing conditions index for August which is expected to remain solid at around 56.3 and payroll employment which is expected to be up by a solid 180,000 with unemployment remaining low at 4.3% but wages growth remaining soft at around 2.5% year on year. In terms of other data, expect a modest rise in home prices and a slight dip but still strong consumer confidence (both Tuesday), a slight upwards revision to June quarter GDP growth (Wednesday) to 2.7%, solid growth in personal spending for July but with core personal consumption inflation remaining soft at 1.5% yoy (Thursday).
 
In the Eurozone economic confidence for August (Wednesday) is likely to remain solid consistent with recent PMI readings and already released consumer confidence data.
 
In Japan, labour market data (Tuesday) is expected to remain solid, household spending (also Tuesday) may slow a bit but industrial production (Wednesday) is likely to see solid annual growth.
 
Chinese business conditions PMIs (due on Thursday and Friday) are likely to remain around solid levels.
 
In Australia, June quarter data on construction work done (Wednesday) and capital spending (Thursday) will help firm up expectations for June quarter GDP data to be released on September 6th. Construction work is expected to have risen by 1.7% quarter on quarter helped along by a rebound in dwelling construction after weather affected weakness in the March quarter.
Capex is also expected to have risen in the June quarter but intentions for future investment are likely to remain subdued.
 
In other data, expect a fall in building approvals (Wednesday) after an 11% bounce in June and moderate growth in credit (Thursday). Data on new home sales and the manufacturing PMI will also be released and August CoreLogic home price data will be watched for a further loss of momentum as a result of the property tightening measures announced early this year.
 
The Australian June half profit reporting season will wrap up with around 40 major companies reporting including Lendlease (Monday), Blackmores, Mantra, Caltex and Downer EDI (Tuesday), Ramsay Health and Boral (Wednesday) and Harvey Norman (Thursday).

Outlook for markets

Share markets are at risk of a correction with signs of short term investor complacency and diminishing breadth in the US share market and various potential triggers including risks around North Korea, US politics and the Fed. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets likely to resume through the December quarter and into 2018.  
 
Low yields point to ongoing low returns from bonds.
 
Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield,
but this will wane eventually as bond yields trend higher.
 
National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.
 
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
 
While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the interest rate differential in favour of Australia is likely to continue to narrow as the Fed hikes rates and the RBA holds.
 
Eurozone shares fell 0.2% on Friday as the Euro rose further, but the US S&P 500 gained 0.2% helped by positive signs regarding tax reform. Reflecting the positive US lead and a slight rise in the iron ore price, ASX futures gained 6 points or 0.1% pointing to a flat to marginally positive start to trade for the Australian share market on Monday.

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Political mayhem continues in the US

Monday, August 21, 2017

By Shane Oliver

Share markets were mixed over the last week, with a rebound early on as North Korea decided against shooting a missile towards Guam but renewed mayhem around President Trump and a terror attack in Barcelona weighing on markets later in the week. US shares fell 0.6% and Japanese shares fell 1.3%, but Eurozone shares rose 1.2% (after losing 2.6% the week before), Chinese shares rose 2.1% and Australian shares rose 0.9%. Bond yields were flat to up slightly, commodity prices were mixed with oil and gold down but metals and iron ore up and the $A was up slightly.

Political mayhem continues in the US. So far, it’s unlikely to impact the GOPs tax reform agenda but the risks are rising. While President Trump had a bad week back in May, it seems like he is having one bad week after another lately. While the war of words between North Korea and the US receded over the last week (for now), the mayhem around President Trump seems to be going from bad to worse with the disbanding of two business councils as US business leaders resigned in protest over Trump’s response to racist violence in Charlottesville and rumours that Trump’s top economic adviser Gary Cohn may resign too. This is clearly all disconcerting and highlights the divisions in the US that appear to be widening under Trump (including between Trump and key Republicans).

Image: President Donald Trump speaks to the media in the lobby of Trump Tower. On the far left is National Economic Council Director, Gary Cohn. Source: AAP.

Next month, the political noise in the US will escalate, with the need to pass a 2017-18 budget, approve funding to avoid a government shutdown and raise the debt ceiling by late September ahead of moving on to tax reform. However, while there will likely be another bout of brinkmanship around avoiding a shutdown and debt default that could cause volatility in financial markets, ultimately, a last minute solution remains most likely as the 2013 experience highlighted that it’s in neither party’s interest to allow a shutdown and neither want a debt default. And, while it all looks messy, it’s doubtful that the disbanding of the business councils has reduced the chance of tax reform. Business groups will still want tax reform and lobby for it and it’s the Republicans in Congress who are driving the agenda on tax reform now (not Trump) and they want a win on taxes ahead of the November 2018 mid-term elections. The removal of alt-right adviser, Stephen Bannon, may help steady the White House, but the risks will grow if Trump can’t start to heal the divisions he is creating (including with Congressional Republicans).

Meanwhile, Trump provided no surprises in announcing a directive to consider whether Chinese practices around US intellectual property should be formally investigated. This is process oriented and will have a long way to go with plenty of opportunities for win/win compromises along the way. Trump is a long way from the imposition of huge tariffs from day one that was talked about in the election campaign.

Political uncertainty is on the rise in Australia. While the key issues seemingly troubling Australian politicians at present – marriage equality and the “foreigners stealing Aussie politicians’ jobs” debacle – may seem trivial compared to what most Australian’s worry about, the first highlights the problem Australia seems to have these days in achieving reforms that other countries seem to have no problem in doing (e.g. New Zealand) and the citizenship issue risks bringing on an early election to the extent it is threatening the Government’s lower house majority. Investors have yet to focus on the implications of an early election, but a change of government could have significant implications for some sectors – e.g. banks (with the Labor Party committed to a bank royal commission) and real estate (with the ALP committed to restricting negative gearing and cutting the capital gains tax discount).

Our view remains that shares are at high risk of a short-term correction led by the US share market, where low volatility readings and high levels of investor sentiment until recently are a sign of complacency, and participation by sectors and shares in recent gains has narrowed sharply, which is often a sign of impending weakness. The trigger for a correction is always hard to know: but there are plenty of candidates out there including around North Korea, US politics and possibly the Fed later this year. 

Terrorism reared its ugly head again in Barcelona over the last week and my thoughts are with all those affected. It’s worth noting though that the impact of terrorist attacks in recent times on share markets has been relatively minor and short lived as invariably there is little economic impact from them.

Finally, the past week was disappointing for those of us in the US and Australia who value and celebrate diversity and respect for our fellow humans and detest discrimination and bigotry. But seeing American business leaders and most Australian Senators taking a strong stand against bigotry was heartening.

Major global economic events and implications

US economic data remains mostly solid. Retail sales rose strongly in July, with an upwards revision to June, manufacturing conditions in the New York and Philadelphia regions remain strong, jobless claims remain low, leading indicators are strong and while housing starts fell in July, strength in the NAHB’s home builders’ conditions index suggest that the starts should remain solid going forward. The minutes from the Fed’s last meeting were balanced with the implication being that the tight labour market justified further tightening but low inflation means that it should be gradual.

 The minutes from the ECB’s last meeting highlighted the need for “patience, persistence & prudence” in getting inflation back to 2% and concern about the Euro overshooting on the upside. Expect easy money to continue, albeit with lower quantitative easing next year.

Japanese June quarter GDP growth was much stronger than expected at 1% quarter on quarter and 2% year on year, driven particularly by consumer spending and business investment.

Chinese data points to a slowing in growth in July. Retail sales, industrial production, investment (particularly property related investment) and M3 growth all slowed a bit in July, consistent with earlier mixed readings from business conditions surveys and slower export and import growth. This likely suggests that recent policy tightening may be starting to impact. But it’s worth noting that total credit growth actually accelerated in July and any growth slowdown looks to be modest leaving growth around or above the 6.5% GDP target for this year.

Australian economic events and implications

Australian data was the usual mixed bag. While the composition of jobs growth was poor in July, overall jobs growth remains solid and leading labour market indicators indicate it will remain so. Hopefully, the strength in employment growth will lead to stronger wages growth and this will boost consumer confidence and support consumer spending. But, with June quarter wages growth remaining at a record low of 1.9% year on year, there is as yet little evidence of this. And with the boost to growth from housing construction set to reverse, underlying inflation remaining below target and a rising $A threatening lower growth and inflation, it remains best for the RBA to keep interest rates unchanged at 1.5%.

We are now about 45% through the June half earnings reporting season and results remains mixed. 41% of results have exceeded expectations, which is the weakest since 2013 (see the first chart below), outlook guidance has been a bit soft and reflecting this, only 50% of companies have seen their share price outperform the market on the day they reported. Against all this of course, earnings are up with 73% of companies reporting higher profits than a year ago and 71% have increased dividends from a year ago – although Telstra’s cut to future dividends was taken as a huge disappointment. 2016-17 earnings growth is on track to come in at around 18% with resources up 132% (down a bit from initial expectations) and the market excluding resources up 6% (which is a bit above initial expectations). Expectations for the current financial year have been revised down a bit to 1.6% though. Key themes have been: large caps doing better than small caps; moderate revenue growth with the domestic economy just okay; some disappointment from foreign earners; and dividends (ex-Telstra) continuing to roar ahead.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, expect a further gain in home prices (Tuesday), continued strength in August business conditions PMIs (Wednesday), small gains in new home sales (also Wednesday) and existing home sales (Thursday) and a continuing rising trend in durable goods orders (Friday). The Fed’s annual central bankers’ symposium (Thursday), where the topic this year is “Fostering a Dynamic Global Economy” , will be watched for clues on monetary policy both in the US and globally, particularly with ECB President Draghi due to speak and possibly likely to issue further warnings about a rising Euro.

In the Eurozone, expect August business conditions PMIs (Wednesday) to remain strong.

Japanese inflation data for July is expected to show core inflation stuck at zero, providing a reminder that it’s a long way from the Bank of Japan’s 2% target and hence that the BoJ is a long way from starting to exit easy money.

In Australia it will be a quiet week on the data front but the focus will remain on the profit reporting season which will see its biggest week with around 100 major companies reporting including Fortescue and BlueScope on Monday, Oil Search, BHP and Amcor on Tuesday, Worley Parsons, IAG and Woolworths on Wednesday, Scentre Group and South 32 on Thursday and Qantas on Friday.

Outlook for markets

Share markets are at risk of a correction, with signs of short-term investor complacency and diminishing breadth in the US share market and various potential triggers including risks around North Korea, US politics and the Fed. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets likely to resume through the December quarter and into 2018.  

Low yields point to ongoing low returns from bonds

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

National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.

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

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the interest rate differential in favour of Australia is likely to continue to narrow as the Fed hikes rates and the RBA holds.

Eurozone shares fell 0.5% on Friday and the US S&P 500 fell 0.2% after a brief rise on news of Stephen Bannon’s exit from the White House. ASX 200 futures fell 4 points or 0.1% pointing to a flat to soft start for the Australian share market at the open on Monday.

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3 ways the North Korean issue could unfold

Monday, August 14, 2017

By Shane Oliver

Share markets fell over the last week on the back of escalating fears around conflict with North Korea. US shares fell 1.4%, Eurozone shares lost 2.6%, Japanese shares fell 1.5%, Chinese shares lost 1.6% and Australian shares fell 0.5%. Bonds benefitted from a flight to safety and continuing low inflation readings in the US, pushing yields down slightly. Commodity prices were mixed though, with oil down but copper, iron ore and gold up. While the $US fell against the Yen and the Euro, the $A fell against all three.

North Korean risks ramp up

North Korean risks have clearly ramped up significantly over the last week, as the UN Security Council agreed on more sanctions; reports suggested it may already have the ability to put a nuclear weapon in an intercontinental ballistic missile; President Trump threatened it with “fire, fury and, frankly, power..” only to add a few days later that that “wasn’t tough enough” and that “things will happen to them like they never thought possible”; and North Korea talked about plans to fire missiles at Guam.

Source: AAP

This all reminds me of something out of James Bond (or rather Austin Powers) except that its serious and naturally has led to heightened fears of an imminent military conflict. Of course it could all de-escalate again, but given North Korea's growing missile and nuclear capability, it does seem that the North Korean issue after years of escalation and de-escalation may come to a head soon. In thinking about the risks around North Korea, it’s useful to think in terms of three scenarios as to how it could unfold:

1. Diplomacy/no war – sabre rattling would likely intensify further before a resolution is reached, during which share markets could correct maybe 5-10% before rebounding once it becomes clear that a peaceful solution is in sight. An historic parallel is the Cuban Missile Crisis of October 1962 that saw US shares fall 7% before a complete recovery after the crisis was resolved. 

2. A brief and contained military conflict - perhaps like the 1991 and 2003 gulf wars proved to be, albeit without a full-on ground war or regime change. In both gulf wars, while share markets were adversely affected by nervousness ahead of the conflicts, they started to rebound just before the actual conflicts began.

3. A significant military conflict – a contained gulf war style military conflict is unlikely as North Korea would most likely launch missile attacks against South Korea (notably Seoul) and Japan, causing significant loss of life. This would entail a more significant impact on share markets with say 20% or so falls before it became clear that the US would prevail. 

Diplomacy remains by far the most likely path. The US is aware of the huge risks in terms of the potential loss of life in South Korea and Japan that would follow if it acted pre-emptively against North Korea and it is not interested in regime change there. And North Korea appears to only want nuclear power as a deterrent. In this context, Trump’s threats along with the US’ show of force earlier this year in Syria and Afghanistan are designed to warn North Korea of the consequences for them of an attack on the US or its allies, not to indicate that an armed conflict is imminent. Rather, US officials are still working on a diplomatic solution.

As such, our base case remains that there is a diplomatic solution, but there could still be an increase in uncertainty and share market volatility in the interim and the risk is significant (particularly given the volatile personalities of Kim Jong-un and Donald Trump). Key dates to watch are North Korean public holidays on August 15 and 25 and September 9, which are often excuses to test missiles, and US-South Korean military exercises starting August 21.

More broadly, the intensification of the risks around North Korea comes at a time when there is already a significant risk of a global share market correction. The recent gains in the US share market have been increasingly concentrated in a few stocks; volatility has been low and short-term investor sentiment has been high indicating a degree of investor complacency; political risks in the US may intensify as we come up to the need to avoid a government shutdown and raise the debt ceiling next month (which will likely see the usual brinkmanship ahead of a solution); market expectations for Fed tightening look to be too low (with only a 25% probability of a hike priced by December); tensions may return to the US-China trade relationship; and we are in the weakest months of the year seasonally for shares.

While Australian shares have already had a 5% correction from their May high, they are nevertheless vulnerable to any US/global share market pull back. However, absent a significant and lengthy military conflict with North Korea (which we think is unlikely) we would see any pullback in the next month or so as just a correction rather than the start of a bear market. Share market valuations are okay – particularly outside of the US, global monetary conditions remain easy, there is no sign of the excesses that normally presage a recession and profits are improving on the back of stronger global growth. As such, we would expect the broad rising trend in share markets to resume through the December quarter and into 2018.  

Major global economic events and implications

US data remains solid with small business optimism rising in July and around as high as it ever gets, job openings rising to a record and jobless claims remaining ultra low. All at the same time, producer and consumer price inflation remains soft, with the core CPI stuck at 1.7% year-on-year (yoy) in August. Strong growth readings keep the Fed on track to continue tightening, with a start to winding back quantitative easing next month, but low inflation will keep it gradual.

The US June-quarter earnings reporting season is now 90% done, with 78% beating on earnings, 68% beating on sales and earnings up around 11% yoy. 

Earnings growth seen in the June quarter is even stronger in Europe at 35% yoy and Japan at 37% yoy.

Chinese export and import growth slowed a bit more than expected in July but remains consistent, with GDP growth running around 6.5-7% year on year. Inflation data for July was benign with 1.4% yoy consumer price inflation and 5.5% yoy producer price inflation, neither of which have any significant implications for monetary policy.

Australian economic events and implications

RBA Governor Lowe’s Parliamentary testimony provided no real surprises and basically repeated the themes of RBA commentary released over the last two weeks. However, he highlighted the issues around low wages growth, noted that the RBA is continuing to watch consumer spending and the housing markets in Sydney and Melbourne very closely and reiterated his warning that the appreciation in the Australian dollar is weighing on inflation and growth and that a lower $A would be “helpful”.

RBA Governor, Philip Lowe. Source: AAP.

While Lowe indicated that the next move in rates is more likely to be up than down, he also indicated that this won’t be for some time. Our view remains that rates will remain on hold ahead of a rate hike late next year, but if the $A continues to rise, rate hikes will be even further delayed and the next move could turn out to be a cut. At this stage, Governor Lowe appears to be happy with the tightening in mortgage lending standards, but with a further cooling in Sydney and Melbourne still needed, we think additional measures cannot be ruled out. 

Australian economic data

Australian data was the usual mixed bag, with solid readings for ANZ job ads, and business conditions and confidence according to the NAB business survey for July, and a slight rise in housing finance commitments but a further decline in consumer confidence. The gap between upbeat business confidence and down beat consumers is widening and remains a bit perplexing. The combination of record low wages growth, rising energy costs, increases in some mortgage rates and worries about having too much debt are all weighing on Australian households.

While low wages growth may be good for profits and business, subdued consumer confidence will weigh on consumer spending going forward. Better jobs growth should help eventually push up wages growth and hence consumer confidence, but as we have seen globally, the lags are long these days. All of which supports the case for the RBA to keep interest rates down for some time to come.

Source: NAB, Westpac/Melbourne Institute, AMP Capital

Reporting season

It's early days in the June-half earnings reporting season, as only 25 or so major companies have reported, but so far it’s been mixed. 45% of results have exceed expectations, which is around the long term norm of 44% (see the first chart below), but 72% have reported profits higher than a year ago and 82% have increased dividends from a year ago. But, reflecting the mixed results so far, 50% of companies have seen their share price outperform the market on the day they reported and 50% have seen underperformance. It’s worth noting though that there is a tendency for the quality of results to tail off a bit as the reporting season proceeds. Consensus earnings expectations for 2016-17 have been revised down by 0.4% to 17.7% over the last week, but mainly due to resources stocks.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, the minutes from the Fed’s last meeting (Wednesday) are likely to firm expectations that the Fed will announce the start of letting its balance sheet run down next month (basically quantitative tightening) but signal that sub target inflation means a degree of uncertainty around the timing of the next interest rate hike (which we expect to be in December). On the data front, expect gains in retail sales and the NAHB home builders’ conditions index (both Tuesday), housing starts (Wednesday) and industrial production (Thursday) and solid readings for the New York and Philadelphia manufacturing conditions indexes.

Japanese June quarter GDP data (Monday) is expected to show a bounce in growth to 0.6% quarter on quarter or 2.5% year on year driven by consumer spending and investment.

Chinese activity data for July is expected to show a slight slowing after the acceleration seen in June, with retail sales growth slowing to 10.8% year, industrial production slowing to 7.2% and fixed asset investment unchanged at 8.6%.

In Australia, the minutes from the RBA’s last board meeting (Tuesday) are likely to show the Bank firmly on hold with most interest likely remaining on how the RBA sees the recent rise in the Australian dollar. Speeches by RBA officials Kent and Ellis will be watched for any additional clues on interest rates. On the data front, the focus will be on the labour market with June quarter wages data (Wednesday) expected to show that wages growth remains soft at 0.5% qoq or 1.9% yoy and July labour force data (Thursday) expected to show a 10,000 gain in jobs and unemployment remaining around 5.6%.

The August profit reporting season will speed up in the week ahead, with around 60 major companies reporting including Bendigo Bank, Ansel and JB Hi Fi on Monday, GPT on Tuesday, Westfield, Origin, Fairfax, Seek and Woodside on Wednesday and Wesfarmers, QBE and Telstra on Thursday. 2016-17 profits for the market as a whole are likely to have increased by around 18%, driven by a huge 133% gain in resources profits on the back of the rebound in commodity prices. Profit growth for the rest of the market is likely to be around 5.5% led by retailers, utilities, healthcare stocks and financials. Dividends and outlook statements will remain the key focus.

Outlook for markets

Share markets are at risk of a short-term correction, with signs of short-term investor complacency in the US share market and various potential triggers including risks around North Korea, US politics and the Fed. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets likely to resume through the December quarter and into 2018.  

Low yields point to ongoing low returns from bonds.  

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

National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne. 

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

While further short term upside in the $A is possible, our view remains that the downtrend from 2011 will ultimately resume as the interest rate differential in favour of Australia is likely to continue to narrow as the Fed hikes rates and the RBA holds.

Eurozone shares fell 0.9% on Friday, but the US S&P 500 rose 0.1% reflecting some stabilisation after several days of falls on North Korean worries. ASX 200 futures fell just 3 points or 0.1% on Friday night, pointing to a broadly flat start to trade Monday after a 1.2% decline on Friday.

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Another "Goldilocks" US jobs report

Monday, August 07, 2017

By Shane Oliver

US and European share markets got a boost on Friday with another “Goldilocks” (not too hot, not too cold) jobs report in the US. As a result, US shares gained 0.2% over the last week and Eurozone shares were up 1.2%. Thanks to gains earlier in the week, Australian shares rose 0.3%, but Japanese shares were flat and Chinese shares lost 0.4%. Global economic and earnings news remains good, but this is partly being offset by the noise around Trump and the risks around US-China trade. Bond yields fell over the week and commodity prices were mixed, with oil down but iron ore up. The $US rose, helped by the solid US July payroll report and this, along with a bit of RBA jawboning, saw the $A fall.  

Trump led US-China trade risk went up another notch. As we noted a few weeks ago, while the risk of a trade war between the US and China went into abeyance during the early part of Trump's Presidency, it’s now on the rise again, partly in response to tensions around North Korea and reflecting a lack of progress in US-China trade negotiations so far. Initially, the focus was on steel, but it looks to be moving on to a review of China's perceived violations of US intellectual property, which has long been a sore point, which could end in tariffs. Our view remains that cool heads will ultimately prevail, but it’s a risk worth keeping an eye on, and one that may escalate if Trump's political woes continue to mount. Even support for Trump amongst his core Republican base is starting to slip a bit, so a ramped up populist “make America great again” campaign around trade could create a useful distraction!

US President, Donald Trump. Source: AAP.

Consistent with its comments over the last few weeks, the RBA has further ramped up its jawboning against the rise in the Australian dollar. It made no significant changes to its growth and inflation forecasts in its latest Statement on Monetary Policy – still seeing a shift to growth a bit above 3%, but with the timing pushed out a bit, and revising its headline CPI inflation forecasts up slightly on the back of rapid utility price increases, but making no changes to its expectation that underlying inflation will be around 2%.

However, it has clearly become concerned that the rising $A poses a threat to both its growth and inflation forecasts. We have been of the view that rates are on hold ahead of a rate hike late next year, but if the Australian dollar continues to trend higher (in contrast to our view for a move lower), it will deliver a further de facto monetary tightening, and further push out the timing of rate hikes (and may even put rate cuts back on the agenda). Of course, continued strength in Sydney and Melbourne property prices would work in the opposite direction, but with the RBA constrained in raising rates to deal with this, the pressure will simply fall back on APRA to deliver another round of measures to further tighten property lending standards.

A couple of things stand out in the latest HILDA report - on household income and labour dynamics in Australia - that has tracked roughly 7000 households since 2001. First, despite all the political noise, income inequality (allowing for taxes and welfare) as measured by the Gini coefficient has changed little since 2001. But, the main driver of the building angst in recent years has been a stagnation in real median household income since 2009 – which, in part, can be traced to record low wages growth. When your own living standard is clearly on the rise as it was for most of last decade, you don’t worry so much about those better off than you, but when you feel like you are stagnating, claims about rising inequality start to resonate.

Second, homeownership rates for 18-39 year olds have fallen by roughly 10 percentage points from 35.7% in 2002 to 25.2% in 2014. Of course, this partly owes to changed demographic trends where we start everything later in life (leaving home, leaving full time study, starting work, getting married, etc) and millennial scepticism about the benefits of home ownership and having a mortgage. But poor and ever-worsening housing affordability is a big factor and must be addressed if we want to avoid rising social tensions – between the “haves” and “have nots” when it comes to owning a patch of the Australian dream. Trouble is that this issue has been brewing since early last decade and it’s only this year that governments have started to really take it seriously.

Major global economic events and implications

US data was solid. Business conditions ISM readings slipped in July but along with the Markit PMIs remain solid, pending home sales rose, payroll employment rose by a stronger-than-expected 209,000 in July and unemployment fell to 4.3%. But inflation pressures remain weak, with wages growth remaining stuck at just 2.5% year on year in July and core inflation in June remaining well below target at 1.5% year on year. The strong US labour market leaves the Fed on track to continue tightening monetary policy, but weak wages growth will keep it gradual.

US June-quarter earnings results remain strong. Of the 420 S&P 500 companies to have reported, 77% have beaten earnings expectations and 68% have beaten on revenue. Earnings look like coming in around 12% yoy, which is almost double the initial expectation.

Eurozone economic growth picked up in the June quarter to 2.1% year on year, its fastest since 2011 and unemployment fell to 9.1% - which is high but down from a high of around 12%. Core inflation rose in July but only to 1.2% yoy.

Chinese business conditions PMIs were mixed in July - down slightly according to the official PMIs but with the Caixin manufacturing PMI up slightly and services PMI down slightly. But the moves are neither here nor there and their levels are consistent with GDP growth remaining around 6.5 to 7%.

Japanese industrial production rose in July and is up 4.9% year on year, with PMIs pointing to reasonable growth ahead.

The Reserve Bank of India cut its official cash rate by 0.25% to 6%, providing a reminder that major central banks are going in different directions with monetary policy. This is consistent with lower inflation. Indian business conditions PMIs also fell sharply in July, although this likely reflects distortions to the July 1 start-up of the goods & services tax. 

Australian economic events and implications

Australian data was a mixed bag. Business conditions PMIs remained solid consistent with other readings of business confidence. Building approvals bounced strongly in June but this was mainly driven by volatile apartment approvals and a fall in new home sales to their lowest since 2013 suggests that the trend will remain down. Retail sales rose more than expected in June and real retail sales rose strongly in the June quarter, providing confidence that GDP growth will bounce back from the softness seen in the March quarter. On the flip side, the trade surplus fell back sharply in June and net exports look to be a flattish contributor to June quarter GDP growth. The Melbourne Institute's Inflation Gauge showed low inflation in July, whereas I would have expected a higher rise in headline inflation on the back of higher electricity prices, suggesting that underlying inflationary pressures remain very weak.

Australian home prices continued to bounce back in July after their soft patch in April and May, particularly in Melbourne. While auction clearance rates and investor lending looks to have slowed, it’s still not clear that the tightening measures announced earlier this year are having a big enough impact so, given the RBA's inability to raise interest rates, further action by APRA may still be necessary.  

Finally, it’s too early to draw any conclusions from the start of the June-half earnings reporting season, as only a few companies have reported. But RIO's result has confirmed a huge upswing in 2016-17 earnings on the back of the bounce in iron ore and other commodity prices and announced a large dividend hike. That said, it came in a little below expectations, so the good news had already been discounted.

What to watch over the next week?

In the US, expect small business optimism to remain solid and job openings to remain strong (both due Tuesday), headline CPI inflation (Friday) to rise to 1.8% year on year in July from 1.6%, but core inflation to remain unchanged at 1.7%. US June quarter earnings results will also continue to flow.

Chinese growth in exports and imports (Tuesday) are expected to remain strong and inflation data for July (Wednesday) is expected to show a dip in CPI inflation to 1.4% year on year and producer price inflation slipping to 5.3% as the earlier surge in commodity prices continues to drop out.

In Australia, Parliamentary testimony by RBA Governor Lowe (Friday) will be watched for further clues on the interest rate outlook, but is unlikely to add much to the just released Statement on Monetary Policy. On the data front, expect the NAB business survey (Tuesday) to show continued solid business conditions and confidence, consumer confidence to remain subdued according to the Westpac consumer confidence survey (Wednesday) and housing finance data (also Wednesday) to show 1% gain for June.

The August profit reporting season will start to ramp up in the week ahead, with around 20 major companies reporting including Cochlear, CBA, AMP, Newscorp and AGL. 2016-17 profits for the market as a whole are likely to have increased by around 18%, driven by a huge 135% gain in resources profits on the back of the rebound in commodity prices. Profit growth for the rest of the market is likely to be around 5.5% led by retailers, utilities, healthcare stocks and financials. As always, in a low interest rate world, dividends will be a key focus, but the key to watch will be on outlook statements as the current financial year won’t have a repeat of the huge boost in commodity prices to resources profits.

Outlook for markets

The risk of a short-term share market correction has increased: the gains in the US share market are increasingly concentrated in a few stocks; political risks in the US have escalated a bit with the Mueller inquiry intensifying and the need to avoid a government shutdown and raise the debt ceiling next month which will likely see the usual brinkmanship ahead of a solution; the risks around US-China trade seem to be increasing; North Korean risks remain; and we are in the weakest months of the year seasonally for shares. While Australian shares have already had a 5% correction from their May high it would nevertheless be vulnerable to any US/global share market pull back. However, with valuations remaining okay – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we would see a pullback as just a correction with the broad rising trend in share markets likely to resume through the December quarter and into 2018.  

Low yields point to ongoing low returns from bonds.  

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

National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne. 

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

The $A has pushed higher on the back of $US weakness, higher commodity prices and technical pressure. While further short term upside is possible, our view remains that the downtrend in the $A from 2011 will ultimately resume as the interest rate differential in favour of Australia is likely to continue to narrow as the Fed hikes rates and the RBA holds. The solid July US jobs report helps take a bit of pressure off the $A and hence the RBA.

Eurozone shares gained 1.1% on Friday as solid US payrolls for July helped depress the Euro, and the solid jobs report also helped push the US S&P 500 up by 0.2%. Following the positive global lead along with a further rise in the iron ore price to $US74.1/tonne ASX 200 futures rose 24 points on Friday night or 0.4% pointing to a positive start to trade for the Australian share market on Monday.

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