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

Shares at risk of short-term correction

Monday, February 27, 2017

By Shane Oliver

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

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

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

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

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

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

Major global economic events and implications

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

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

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

Australian economic events and implications

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

 

Source: ABS, AMP Capital 

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

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

 

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

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

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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

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Eurozone risks to present buying opportunities

Monday, February 20, 2017

By Shane Oliver

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

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

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

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

Major global economic events and implications

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

Australian economic events and implications

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

Source: Bloomberg, AMP Capital

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

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

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

Outlook for markets

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

Monday, February 13, 2017

By Shane Oliver

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

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

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

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

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

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

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

Major global economic events and implications

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

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

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

Australian economic events and implications

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

Source: AMP Capital

Source: AMP Capital

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

What to watch over the next week?

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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

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Trump jitters persist

Monday, February 06, 2017

By Shane Oliver

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

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

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

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

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

Major global economic events and implications

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

Source: Bloomberg, IMF, AMP Capital

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

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

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

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

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

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

Australian economic events and implications

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

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

What to watch over the next week?

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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

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Investors focused on Trump, US earnings and data

Monday, January 30, 2017

By Shane Oliver

Investment markets and key developments over the past week

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

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

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

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

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

Major global economic events and implication

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

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

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

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

Australian economic events and implications

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

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

What to watch over the next week?

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

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

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

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

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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

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The uncertainty of President Trump

Monday, January 23, 2017

By Shane Oliver

Investment markets and key developments over the past week

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

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

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

Uncertainty remains high

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

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

 

Source: AAP

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

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

Theresa May's Brexit talk

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

Source: AAP

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

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

Major global economic events and implications

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

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

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

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

Australian economic events and implications

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

What to watch over the next week?

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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What to watch over the week

Monday, December 19, 2016

By Shane Oliver

The past week saw share markets have a few wobbles in response to a somewhat more hawkish-than-expected Fed. European shares (up 1.7%) and Japanese shares (up 2.1%) continue to benefit from falls in the Euro and Yen along with good economic data too. Against this, US shares fell 0.1% (not helped by reports that a Chinese naval vessel had seized a US underwater drone), Australian shares fell 0.5% and Chinese shares lost 4.2% (not helped by the People’s Bank of China continuing to tighten liquidity and macro prudential controls). Thanks largely to the Fed’s more hawkish message, US bond yields continued to push higher, as did the $US. Commodity prices were mixed and the $A fell in response to the rising $US.

The more hawkish than expected Fed

Fed undertakes a somewhat hawkish hike. No one can claim surprise that the Fed hiked its key Fed Funds rate by 0.25% to a range of 0.5-0.75%. It had been well flagged and was easily justified by economic conditions. What surprised some though was a shift up in the median “dot plot” of Fed meeting participants’ interest rate expectations from two to three rate hikes in 2017 suggesting a more hawkish bias at the Fed and this drove a "risk off" reaction in markets.

There is a danger in making too much of this, as a year ago, the dot plot pointed to four hikes in 2016 and we only got one, so it’s hardly reliable and the post meeting statement and Fed Chair Yellen's comments were benign, but it does seem that the Fed is turning from somewhat dovish to somewhat hawkish. With the Fed at, or close to, meeting its objectives and fiscal stimulus, on the way we are also allowing for three rate hikes in 2017. 

Source: AAP

However, it’s way too early for US monetary tightening to be a cyclical negative for shares and growth assets, as monetary policy is still very easy and we are long way from any cyclical excess that presages an economic slowdown or recession. Meanwhile, the strong $US will continue to act as a brake on the Fed getting too aggressive in raising rates.

Although its early days, reports regarding the seizure of a US underwater drone in the South China Sea coming on the back of Donald Trump appearing to challenge the One China policy and his views on trade potentially signal a further rise in US-China tensions in 2017. While it should ultimately end OK, it could cause a bit of financial market volatility along the way.

What about Italy?

If you’re wondering what happened to Italy after the No vote and the PM resigned … basically a new government was formed, led by the same party (the Democratic Party) backed by the same coalition and with the same policies (except Senate reform). Only the PM and a few ministers have changed. So, an early election has been averted, and they may hang in there till the next elections are due in 2018. The next big event in Europe will be the elections in the Netherlands in March, where the Eurosceptic Party for Freedom may do well, but not nearly enough to form government.

India’s demonetisation coming to Australia?

It has been reported that the Government is considering removing the $100 note to crackdown on the cash economy. Of course, you won’t see your $100 bills become worthless, but to convert them to smaller denominations you may have to deposit them in a bank ... at which point the tax office could raise questions if there is a lot of them. It’s understandable the Government is upset at missing out on tax because of the cashless economy. But, such a move may not go down well with some who legitimately earned and paid tax on their notes but just don’t trust banks. India’s demonetisation experience also highlights that it runs the risk of short term economic disruption – but this should be much smaller in Australia where the cash economy is estimated to be around 1.5% of GDP compared to much more in India.

Major global economic events and implications

US economic data was mostly strong. Industrial production fell, retail sales were weaker-than-expected and housing starts fell 19%. But the weak retail sales followed two very strong months and the fall in housing starts followed a 27% gain in October and reflects volatility in multifamily starts. Meanwhile, gains in regional manufacturing indices and continued strength in the Markit manufacturing conditions PMI point to stronger manufacturing going forward. Small business optimism also rose strongly in November, and home builder’s conditions rose to their highest since 2005. And jobless claims remain low. Inflation readings were mixed, with a stronger rise in producer prices, but falls in import prices as the strong $US hit and core CPI inflation remained in the range it’s been in for the last year.

Eurozone business conditions PMIs remained solid in December, and continue to point to some acceleration in growth. 

Japan’s Tankan business survey and December manufacturing PMI showed improved conditions for manufacturers.

Chinese economic data for November was stronger-than-expected, with a pick-up in retail sales, industrial production and total credit suggesting that December quarter GDP growth may have picked up a bit from the 6.7% year-on-year pace.

Australian economic events and implications

Australian data was a mixed bag, with a fall in business conditions and consumer confidence, but a slight rise in business confidence and stronger jobs growth. A fall in consumer confidence was to be expected in December, following the weak September quarter GDP news, but the November jobs data was surprisingly healthy.

Yes, unemployment rose, but this was all due to higher labour force participation and monthly jobs growth was strong for the second month in a row with two months of strong full jobs growth. Leading jobs indicators such as job ads and vacancies point to reasonable jobs growth ahead.

Finally, Australians continue to see paying down debt and bank deposits as the wisest place for savings and remain sceptical of shares. The latter tells us that the share market is a long way from being over loved, which is a good sign from a contrarian perspective. Interestingly, real estate remains out-of-favour too.

Source: Melbourne Institute, AMP Capital

What to watch over the next week?

In the US, expect to see continued strength in November’s Markit services conditions PMI (Monday), a fall back in existing home sales (Wednesday), modest growth in underlying durable goods orders and personal spending, with inflation in the core private consumption deflator remaining unchanged at 1.7% year-on-year and home prices continuing to rise (all Thursday) and a bounce back in new home sales (Friday).

The Bank of Japan (Tuesday) is unlikely to make any major changes to monetary policy given the open-ended quantitative easing until it exceeds its inflation target that it adopted in September.

In Australia, the main focus will be the Mid-Year Economic and Fiscal Outlook budget update (Monday) where there is a risk of a further downgrade to the outlook for the budget deficit as lower wages growth offsets the beneficial impact of higher commodity prices. Quite how this pans out is dependent on what assumptions the Government adopts regarding key commodity prices relative to wages, but on balance we anticipate little change to the $37bn budget deficit projected in May for this financial year, but $10bn or so added to the deficit in the subsequent three years, but with the Government still projecting a return to a wafer-thin surplus by 2020-21. In terms of economic assumptions for this financial year, expect real GDP growth to be revised down to 2.25% (from 2.5%) and wages growth is likely to be revised down to 2% (from 2.5%). To offset the further deficit blow out, the Government is likely to announce various savings (eg, abolition of the Green army, more tax revenue from the cash economy). Overall, the MYEFO may not be enough to trigger a rating downgrade immediately, but I think whether it’s in the week ahead, or after the May Budget, a downgrade is just a matter of time. This would be a huge psychological blow to Australia, but I doubt that it will have a lasting impact on bond yields or borrowing costs. 

Source: Australian Treasury, AMP Capital

Meanwhile, the Minutes from the last RBA Board meeting (Tuesday) are likely to confirm that the RBA retained a neutral bias on rates. But these Minutes will be very dated, given the subsequent news of a fall in September quarter GDP.

Outlook for markets

Shares remain overbought and are vulnerable to a short-term pullback with potential triggers being uncertainty about what Donald Trump will do, US-China tensions, the sharp back up in bond yields and the strong $US. However, any correction may not come until the New Year given normal seasonal strength (the Santa rally) into year end. And we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australia. 

Sovereign bonds are now very oversold and due for a short term pullback in yield. This is particularly the case in Australi, where 10-year bond yields at 2.9% look out of whack with the likelihood that the RBA will cut rates again next year, or at the very least, won’t be raising them until 2018 at the earliest. But on a medium-term view still, low bond yields point to a poor return potential from bonds and the abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the long-term decline in yields since the early 1980s is probably over. So expect the medium-term trend in bond yields to be up. 

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

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

Cash and bank deposits offer poor returns. 

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

Eurozone shares rose 0.3% on Friday, but the US S&P 500 fell 0.2% following reports that a Chinese naval vessel had seized a US underwater drone in the South China Sea. Following the mixed global lead, ASX 200 futures fell 0.1% on Friday night so I expect the Australian share market to open down around 5 points on Monday morning.

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Bad news is good news for the stock markets

Monday, December 12, 2016

The past week saw most major share markets rise with US shares up 3.1% to a new record high, a 5.6% gain in Eurozone shares resulting in a clear technical breakout led by banks, Australian shares gaining 2.1% taking them to near their August high and Japanese shares up another 3.1%. The main drivers have been continued good global economic data, the prospect of help for Italian banks, a dovish ECB and expectations of lower interest rates in Australia’s case. Bond yields mostly rose and commodity prices were mixed. Despite a stronger $US the $A was little changed.

Bad news is good news. It seems that ever since the Brexit hoopla seemingly bad outcomes for share markets have seen a brief dip in markets – often in our time zone – only to be followed by a surge higher. This has been the story with Brexit, Donald Trump’s election, the Italian “No” vote and even Australia’s recent poor growth news. There are several reasons for this seemingly perverse response.

First, many share markets had 20% plus falls into earlier this year so bad news was sort of factored in.

Second, many of these events have seemed less negative than feared once they transpired – Britain and more importantly Europe did not collapse after the Brexit vote, many of Donald Trump’s policies are positive for growth and hence share markets and even though Italy voted “No” there is a long way to go to get to an Itexit.

Third, the macro economic backdrop globally – with rising business conditions PMIs, still easy monetary policy and the end of the earnings recession in several key markets – are positive in contrast to say a year ago.

Fourthly, each event has held out the prospect of more pro-growth economic stimulus.

Finally, December is one of the strongest months of the year – see next chart. Normally the Santa rally doesn’t come till mid-December but he seems to have arrived early this year!

A lesson in all this is to turn down the noise – the coverage around Brexit, etc, was huge but investors would have been better off doing nothing but sticking to their long turn strategy. Or if you are going to do anything be contrarian & buy the dips.

Source: Bloomberg, AMP Capital

The Italian “No” vote is a case in point. It was no more a sign of increased support for the populist anti-Euro Five Star Movement than a “No” vote to a similar neutering of our Senate in Australia would signal support for One Nation. And in any case a lot will have to occur before Italy leaves the Eurozone, if at all. Meanwhile, Austrians voted against their anti-Euro far right presidential candidate in greater numbers than was the case pre-Brexit. I remain of the view that a break-up of the Eurozone is unlikely and that the various European elections in the year ahead could simply prove to be buying opportunities.

Meanwhile, the ECB provided more support for financial markets. While it cut its quantitative easing program to €60bn a month it extended it to the end of 2017 which was more than expected and President Draghi’s comments were dovish. The extension takes it right through a period of political risk associated with key European elections next year.

Major global economic events and implications

US economic data remained solid with the non-manufacturing ISM business conditions index rising to a strong 57.2, job openings and hiring remaining strong, jobless claims remaining low and rising consumer confidence.

Meanwhile, Donald Trump’s appointments are continuing to be market friendly with his pick for head of the Environmental Protection Agency consistent with a roll back of EPA regulations and his choice of a China friendly ambassador to China could help soothe relations with China. Meanwhile, although Trump’s tweets have created some angst the trick as borrowed from US political commentator Salena Zito is to treat his comments seriously but not literally.

While German industrial production was soft in October, a 4.9% mom surge in factory orders points to a rebound ahead and a broader pick up in German growth.

Japan wages growth remains weak but an economic sentiment rose to levels last seen before the sales tax hike.

In China, export and import growth improved far more than expected and producer price inflation rose further to 3.3% yoy adding to the message of improvement seen in other Chinese economic indicators.

Australian economic events and implications

As feared the Australian economy contracted in the September quarter – with broad based weakness across housing, business investment, public demand, net exports and consumer spending – but here are seven reasons why it’s unlikely to signal the start of a recession.

First, it looks to be a bit of payback for stronger than expected growth over the year to the June quarter.

Second, the fall in housing and non-dwelling construction looks to have been partly bad weather related which should reverse with approvals for both pointing up in the short term.

Third, public capital spending projects point to a rebound in public demand.

Fourth, the boom in resource export volumes has further to go as various mining and gas projects complete.

Fifth, recent retail sales data point to a strengthening in consumer spending.

Sixth, while the drag from unwinding mining investment has further to run its impact is declining as it falls as a share of GDP and it should reach a bottom in the next year or so.

Finally, it doesn’t feel like the start of a recession. The traffic is jammed up, shopping centre’s seem full and there is not the sense of foreboding seen in 1989-1990 that went into the last recession (yeah – I was around back then!). Sure it’s a recession in WA but that’s been the case for a while now and is a direct result of the mining investment slump, but that’s not the whole of Australia.

In other data the trade deficit was worse than expected, housing finance fell but continues to bounce back for investors, ANZ job ads remain solid and the AIG’s services PMI rose which along with the already reported rise in the manufacturing PMI adds to confidence growth has picked up again.

But while a recession is unlikely, underlying growth looks like its running below the RBA’s assumed circa 3% pace which along with chronic low wages growth means inflation is likely to be weaker than it expects too. This is also not a good time for the banks to be raising mortgage rates (as they have started to lately with the high risk standard variable rates will go up too) and the $A remains too high. As such, we remain of the view that the RBA will cut rates again next year. It could come as early as February.

Finally, New Zealand continues to impress. Its latest budget update showed an ongoing surplus despite its latest earthquake whereas our budget updates seem to just go from bad to worse and we seem to go from one silly debate to another – eg whether to levy a back packer tax at 15% or 13% or around in circles over carbon pricing. No wonder New Zealanders are going back!

What to watch over the next week?

In the US, after a full 12 months since its first rate hike the Fed (Wednesday) will finally raise its key interest rate again by another 0.25%. With this fully priced in the main focus will be on whether it’s a hawkish hike or dovish hike so the key will be whether Janet Yellen continues to refer to “gradual” rate hikes and how aggressive the dot plot of meeting participants rate hike expectations for 2017 are. Our expectation is that the Fed will stick to the gradual language and the September dot plot of two hikes for next year but indicate that it’s waiting to see how significant fiscal stimulus will be under Donald Trump. 

On the data front in the US expect continued solid November retail sales growth but a slight fall in industrial production (both Wednesday), a slight rise in core CPI inflation to 2.2% yoy and continued strength in the NAHB home builders’ index and manufacturing condition PMI (all Thursday) and some fall in housing starts after October’s 25% surge (Friday).

In the Eurozone expect the December business conditions PMIs (Thursday) to remain solid.

In Japan the quarterly Tankan business survey (Wednesday is expected to show an improvement.

Chinese activity data for November (Tuesday) is expected to show unchanged growth in industrial production of 6.1% yoy but a pick-up in retail sales growth to 10.4% yoy.

In Australia, ABS house price data (Tuesday) is expected to show a gain of 2.5% for the September quarter consistent with private sector surveys already released, the NAB survey (also Tuesday) is expected to show business conditions and confidence in November remaining above average but consumer confidence data (Wednesday) may show a dip on the back of the weak September quarter GDP news. Jobs data (Thursday) are expected to show a 25,000 gain in employment and unemployment remaining at 5.6% but the focus is likely to remain on the full time versus part time break up.

Outlook for markets

Shares remain overbought and are vulnerable to the Fed meeting in the week ahead. However, we continue to anticipate shares to be higher into year-end as seasonal strength continues to kick in and see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australia.

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

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

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

Cash and bank deposits offer poor returns.

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

Eurozone shares gained 0.4% on Friday and the US S&P 500 index rose 0.6%. The positive global lead helped by a rise in the oil price saw ASX 200 futures rise 0.4%, so I expect the Australian share market to open up by around 20-25 points on Monday morning.

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Will interest rates rise in 2017?

Monday, December 05, 2016

By Shane Oliver

The past week saw Japanese and Chinese shares both gain another 0.2%, but US and European shares fall 1% and Australian shares fall 1.2% as they had a bit of a consolidation along with the $US (which fell 0.8%), after the post US election rally led to overbought positions. However, energy shares and the oil price (up 12%) got a huge boost after OPEC agreed on a production cut. Metal prices and the iron ore price slipped a bit but the $A still rose slightly as the $US fell. Bond yields were mixed – up in the US and Australia, but down in Europe.

After a “yes they will, no they won't” soap opera, OPEC agreed on an oil production cut of 1.2 million barrels a day. While stronger than talked about in September, this was made necessary by a ramp up in production since then. The cut adds to confidence that we have seen the low in oil prices and that deflationary forces are in retreat. So good news for energy producers and central banks. But there is a danger in getting too excited.

Around $50/barrel is where the median shale oil producer is economic, and so shale production will start to ramp up again (the US rig count is already well up from its lows) and it’s questionable whether OPEC discipline will really hold … so I am sceptical that the oil price will go too high. Maybe $55 or $60 tops. Inflation is already picking up as the 2014 to early 2016 oil price plunge drops out, but so far, the flow on to core inflation has proven to be muted. Don’t forget that the oil price is still less than half 2013-14 levels. For Australian petrol prices, the OPEC cut might add 5 cents a litre at the bowser but that will be lost in normal day-to-day price volatility.

Image: OPEC, AAP

China appears to be seeing another one of its periodic policy tightening phases, with increasing measures to cool the hot property market, a crackdown on capital outflows to ease downwards pressure on the Renminbi, tighter monetary conditions, and measures around shadow banking and commodity markets. The Chinese share market may be a beneficiary though to the extent capital outflows are limited and need to find a home domestically and it’s not seen as too hot.

Major global economic events and implications

US data remained strong, with September quarter GDP growth revised up to 3.2%, consumer confidence rising sharply in November, the ISM manufacturing conditions index rising further in November, home prices continuing to rise, construction spending up and employment up solidly in November and unemployment down to 4.6%. The Fed remains on track for a December rate hike, particularly with the fall in unemployment indicating less slack in the economy. However, a fall back in wages growth in November to 2.5% year-on-year will likely keep rate hikes on a gradual path for now, until the Fed gets more clarity around Donald Trump’s stimulus plans. Meanwhile, Trump’s picks for various cabinet positions including Treasury secretary are adding a bit to confidence in his administration, such that the dial is still pointing to Trump the pragmatist as opposed to Trump the populist.

In the Eurozone, economic sentiment moved higher in November and bank lending accelerated a touch, pointing to slightly stronger economic growth. Unemployment even fell to its lowest since 2009. Meanwhile, CPI inflation rose as the impact of the plunge in oil prices continues to fall out, but core inflation remains stuck at a low 0.8% year-on-year.

Japanese data was better-than-expected, with continuing jobs market strength, stronger-tha- expected household spending, a continuing upswing in industrial production and gains in housing starts and construction orders.

Chinese business conditions PMIs were better-than-expected and remain consistent with good growth. 

Indian September quarter GDP growth accelerated to 7.3% year-on-year from 7.1%. Growth may slow in the current quarter because of “demonetisation”, but the November manufacturing conditions PMI suggests only a moderate impact.

Australian economic events and implications

Weak business investment data both for the September quarter and intentions for the current financial year, along with another sharp fall in building approvals, added to a sense of near term economic gloom regarding Australian economic growth. As we noted a week ago, there is a significant risk that September quarter GDP growth will be negative – thanks to weak retail sales volumes, a fall in dwelling investment, a continuing fall in business investment, and weak net exports. While a continuing decline in mining investment is no surprise, the failure to see stronger non-mining investment is disappointing.

However, there is no reason to get too gloomy. Weak and possibly negative September quarter GDP growth looks like payback for stronger than expected GDP growth over the year to the June quarter of 3.3%. And looking forward, the ramp up in resource export volumes has further to go, there is still a huge pipeline of housing activity yet to be completed so home building is likely to rebound in the short term, strengthening approvals for non-dwelling construction are a positive sign, the drag from mining investment is fading as it reduces in importance, and its likely to be close to a bottom in the next 12-18 months (see chart), recent retail sales data have improved (with three months in a row of solid growth up to October suggesting a consumer bounce back in the December quarter), another rebound in the manufacturing conditions PMI for November suggests that the September quarter growth soft patch may be over, and the rebound in commodity prices tells us that the income recession in Australia is over. 

 

Source: ABS, AMP Capital

Rate hike in 2017?

However, recent soft data highlights that it’s way too early to be talking about a 2017 RBA rate hike.

In fact, given the downside risks to near-term growth, and inflation along with the $A remaining too high, we remain of the view that the RBA will cut the cash rate again during the first half of 2017.

Just finally, home price momentum remained solid in November according to CoreLogic – except in Melbourne where unit prices lost 3.2%. The apartment supply surge is starting to impact in that city and it will likely spread to others next year.

What to watch over the next week?

Reaction to the Italian Senate referendum on December 4 will no doubt impact investment markets early in the week. While confirmation of a “No” vote (as the polls are suggesting) will add to uncertainty about the Italian government and its banks and maybe further fuel fears about a “break-up” of the Eurozone, a lot will have to occur before Italy leaves the Eurozone, if at all. An early Italian election is unlikely to occur, and even if there is, the populist Five Star Movement (5SM) is unlikely to win unless it softens its anti-Euro stance. Meanwhile, if the “Yes” vote wins, Italy’s economic woes will remain (and ironically it would increase the risk that 5SM could form government at some point). So the referendum is unlikely to settle anything either way. More broadly, the Eurozone is likely to continue to hang together and bouts of market turmoil driven by break-up fears should be seen as buying opportunities.

After the Italian vote, all eyes in Europe will shift to the ECB meeting on Thursday which is expected to announce a six-month extension of its quantitative easing program beyond its current expiry of March 2017 and some changes to enable it to buy a wider universe of bonds. Continuing moderate growth and sub-par inflation along with issues around Italy and Italian banks are likely to be the main drivers with the back-up in bond yields giving the ECB a bit of leeway. It may also try and inject a bit of flexibility into its QE program to allow it to speed up and slow individual country bond buying as justified. 

In the US, expect the non-manufacturing conditions ISM index (Monday) to remain strong, the trade balance (Tuesday) to deteriorate and labour market indicators for hiring and vacancies (Wednesday) to remain solid.

Chinese October trade data (Thursday) is expected to show continued softness in exports and imports and a further rise in both consumer and producer price inflation (Friday).

RBA meeting

In Australia, the RBA is expected to leave rates on hold on Tuesday. While recent data points to soft September quarter GDP growth to be released on Wednesday, this is unlikely to be enough to move the RBA to cut rates given recent upbeat commentary on the economy from both Governor Lowe and Assistant Governor Kent.

However, as noted above, we remain of the view that the RBA will cut rates again in the first half of next year, reflecting downside risk to both growth and inflation. 

On the data front in Australia, expect September quarter GDP growth (Wednesday) of just 0.2% quarter-on-quarter or 2.5% year-on-year driven by weak business investment, retail sales, housing investment and trade with a high risk of a fall in GDP. September quarter data for production, profits and inventories (Monday) and net exports and public demand (Tuesday) will help fine tune September quarter GDP forecasts. Expect the surge in coal prices to have led to a further collapse in the trade deficit (Thursday) and housing finance (Friday) to fall.

Outlook for markets

Shares remain overbought and are vulnerable to the outcome of the Italian Senate referendum, the upcoming ECB and Fed meetings and to any further near term rise in bond yields. However, we anticipate shares to be higher by year end as seasonal strength kicks in - the “Santa rally” normally gets underway from around mid-December - and see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, a shift towards fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australia. 

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

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

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

Cash and bank deposits offer poor returns. 

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

Eurozone shares fell 0.5% on Friday but the US S&P 500 was flat after the mixed US jobs report (which showed solid payroll growth and lower unemployment but lower labour force participation and slower wages growth). However, ASX 200 futures gained 0.4% possibly on expectations that Fridays 1% decline in the ASX 200 was overdone and as the oil price advanced another 1% on Friday. This is pointing to a 20 point gain in the Australian share market at the open on Monday. However, this could be affected by reaction to the outcome from Sunday’s Italian referendum.

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What to watch over the next week

Monday, November 28, 2016

By Shane Oliver

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

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

Is Europe different?

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

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

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

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

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

Australia's soap opera

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

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

Mortgage rates

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

Major global economic events and implications

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

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

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

Australian economic events and implications

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

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

What to watch over the next week?

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

Outlook for markets

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

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

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

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

Cash and bank deposits offer poor returns. 

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

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

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