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The Experts

Shane Oliver
Financial markets
+ About Shane Oliver

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

What’s my take on the Aussie economy?

Thursday, February 14, 2019

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

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

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

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

Australian economic events and implications

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


Source: ABS, AMP Capital    

What to watch here this week

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

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

Outlook for investment markets   

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

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

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

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

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

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

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Going up or down?

Wednesday, February 06, 2019

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

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

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

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

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

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

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

Thursday, January 17, 2019

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

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

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

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

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

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

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

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

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

Source: ABS, AMP Capital

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

Source: Bloomberg, AMP Capital

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Jobs, jobs, jobs

Friday, December 21, 2018

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

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

Source: ABS, AMP Capital

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

Source: ABS, Bloomberg, AMP Capital

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

Source: ABS, Bloomberg, AMP Capital

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

Implications for interest rates

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

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

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Surplus and tax cuts here we come

Tuesday, December 18, 2018

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

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

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

Source: Australian Treasury, AMP Capital 

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

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

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

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

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Have we seen the bottom?

Monday, December 17, 2018

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

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

Source: Bloomberg, AMP Capital

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

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

Source: REIA, AMP Capital

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

What to watch...

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

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

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Will interest rates rise or fall in 2019?

Thursday, December 13, 2018

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

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

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

What to watch over the next week?

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

Outlook for markets

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

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

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

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The week ahead

Monday, December 03, 2018

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

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

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

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

Around the globe

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

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

Down under

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

Source: ABS, AMP Capital

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

Source: RBA, AMP Capital

What to watch over the next week?

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

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

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

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

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

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

Outlook for markets

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

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

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

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

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

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

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No grizzly bears in this market

Monday, November 26, 2018

US shares fell 3.8%, Eurozone shares lost 1.6%, Japanese shares fell 0.2%, Chinese shares fell 3.5% and Australian shares declined 0.3%. Reflecting the “risk off” tone bond yields fell, credit spreads widened and commodity prices fell, with the oil price down another 11% over the last week, leaving it down 34% from its high in early October. The $US rose slightly and this weighed on the $A.

Shares retesting October lows – double bottom or resumption of the slump? Share markets fell back to around their October lows over the last week. A retest of the lows is quite normal after the sort of fall we saw in October. Whether markets form a double bottom and head back up or break decisively lower to new lows is unclear.

In favour of the former, less stocks have made new lows into the latest fall and Asian and emerging markets are looking a lot healthier (having led this share slump and having had much deeper falls). But against this, many of the triggers for the fall in markets remain in place. The bottom line is that I don’t know whether it will remain just a correction or maybe slide deeper into what I like to call a gummy bear market (where markets have a 20% top to bottom fall but are up a year after the initial 20% decline). But I remain of the view it’s unlikely we are sliding into a deep or grizzly bear market as the conditions are not in place for recession in the US, globally or Australia.

Potential triggers to watch for a rebound include a meeting at the G20 meeting between Presidents Xi and Trump in the week ahead, more signs of a possible Fed pause on interest rates and a stabilisation/improvement in growth indicators outside the US. In terms of the Trump/Xi G20 meeting, the APEC debacle between the US and China and a report by the US Trade Representative repeating criticism of China are driving low market confidence of a deal being reached between the US and China. However, against this, Trump appears to want a deal, knowing that further tariff hikes (which are really tax hikes) will start to offset his fiscal stimulus next year and may be starting to impact business confidence and hence capital spending. All of which may start to negatively impact Trump’s 2020 re-election prospects. Reports that White House trade adviser and protectionist Peter Navarro won’t be attending the meeting is also a positive.

On the petrol front

While the 34% plunge in the oil price since early October is weighing heavily on energy shares, it’s positive for growth going forward and hence an eventual recovery in share markets. Lower oil prices help take pressure off inflation and put discretionary spending power back into the hands of households. So far it’s a saving of around $11 a week for a typical Australian household but this could increase, as the fall in oil prices flows through with a lag to lower petrol prices.

Along with the high likelihood of more income tax cuts (which could be announced in next month’s mid-year budget review), this means that despite falling house prices, it’s not all doom and gloom for consumer spending in Australia. Further falls in world oil prices may be limited though as OPEC is likely gearing up to cut production at its December 6 meeting.

Source: Bloomberg, AMP Capital

What’s happening in Italy?

Italy looks to be heading into what is called an Excessive Deficit Procedure – a process administered by the European Commission but approved by Eurozone finance ministers, designed to get its expansionary budget deficit back on track with debt limits – but a major crisis still looks unlikely. More likely is some sort of fudge combining various delays in enforcing any deficit reduction and some compromises. The rest of Europe won’t want to put too much pressure on Italy for fear of fuelling anti-Euro sentiment, and in any case, by the time Italy has to respond to any requests under the EDP it won’t be till later next year by which time the 2019 budget will be largely history.

What’s happening in the US?

US economic data was on the soft side. Home building conditions fell sharply in October, albeit catching down to other housing-related indicators, housing starts and existing home sales rose but are trending sideways, underlying capital goods orders were soft, leading indicators were weak in October, with the falling share market acting as a drag and business conditions PMIs fell slightly in November, albeit they remain strong. Naturally, the weakness in housing indicators raises memories of the GFC but note that housing investment is running at a relatively modest 3.9% of GDP and hasn’t kept up with demographic demand, in contrast prior to the GFC when it reached 6.7% of GDP and was way ahead of demographic demand. While you can get hurt falling out of high rise, you are less likely to get hurt falling out of the ground floor.

And Down Under?

RBA Governor Lowe’s comments in the past week were particularly significant for two reasons. Firstly, he looks to be becoming more concerned about credit tightening in saying that “a few years ago credit standards were way too loose, there has been a correction of that, but I am starting to be a bit concerned the pendulum might be swinging a bit too far the other way.”

Second, he also acknowledged the risks around wages remaining weak, even if unemployment falls further: “I suspect nationally we could sit at [an unemployment rate] around 4.5 per cent without seeing wage growth pick up by too much”.

He is clearly aware that estimates putting the so-called NAIRU at 5% are rubbery. Perhaps he is starting to question the RBA’s own mantra that the next move in rates is more likely up than down.

Lower immigration levels on the way? 

There is always a debate going on about the appropriate level of immigration in Australia, but this has been mainly outside the major political parties or on the fringe of them. PM Scott Morrison changed all that in the last week flagging a cut to the annual immigration cap of 190,000 by 30,000. At present, this sounds like just affirming the actual level of immigration, which has already slowed by about 30,000. So, no big deal. But having brought the debate into the centre of politics risks seeing immigration getting cut further, given angst about the issue particularly in Melbourne and Sydney. This is particularly relevant to the property market as it was the surge in population growth from around mid-last decade without a housing supply pick up (until around 2015) that has played a big role in the surge in house prices relative to incomes.

Yeah, yeah, yeah, the surge in credit, speculation, foreign demand, etc, also played roles too. But the point is that if immigration starts to fall back at a time of rising supply, it will be one more factor sending property prices south in Sydney and Melbourne (which take something like 60% of immigrants) – along with tighter credit, rising supply, a significant pool of borrowers having to switch from interest only to principle and interest mortgages, reduced foreign demand, fears around tax changes reducing future investor demand, etc. Our view remains that these two cities will see 20% top to bottom price declines out to 2020 but there are clearly some risks on the downside to this.

Source: ABS, AMP Capital

Keep an eye on these this week

The big event this will be the meeting between Presidents Trump and Xi on the sidelines of the G20 meeting (Friday & Saturday) in Buenos Aires to discuss trade.

In the US, the focus is likely to be on the Fed. While the minutes from the last Fed meeting (Thursday) will likely confirm that it remains upbeat and on track to raise rates again in December, another speech by Fed Chair Powell (Wednesday) is likely to repeat that he is aware of the various headwinds to the US economy, leaving the impression that the Fed is open to a pause on interest rates next year. Of particular interest will be what, if anything, he has to say about continuing share market volatility and recent softness in housing and business investment indicators. On the data front, expect home price data (tomorrow) to show continuing modest gains, consumer confidence for November (also tomorrow) to show a slight fall from 18-year highs, new home sales (Wednesday) to show a bounce, September quarter GDP growth (also Wednesday) to be revised up slightly to 3.6% from 3.5%, personal spending growth (Thursday) to have remained solid but with core private consumption deflator inflation falling back to 1.9% year on year.

In Australia, speeches by RBA Governor Lowe and Assistant Governor Kent today will be watched for any clues on rates. On the data front, expect to see a 1% gain in construction data for the September quarter (Wednesday), a 1.5% gain in September quarter business investment (Thursday) and continuing moderate credit growth (Friday) with ongoing weakness in lending to investors. A key focus will be whether investment intentions data points to further improvement.

Outlook for markets

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

Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike (albeit they may slow down a bit).

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

Eurozone shares rose 0.4% on Friday, but the US S&P 500 fell 0.7% with energy shares down 3.3% as the oil price continued to plunge. The weak US lead saw ASX 200 futures decline 37 points (or 0.6%) pointing to a weak start to trade for the Australian share market on Monday, with energy shares particularly likely to be under more pressure.

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The story of the three bears

Monday, November 19, 2018

It’s still too early to say we have seen the bottom in share markets. Put very simply, there are three types of significant share market falls – corrections with falls around 10%, “gummy” bear markets with falls around 20% but where the market is up a year later (like in 1998, 2011 and 2015-16) and “grizzly” bear markets, where a year after the initial 20% fall the market is down another 20% or so (like in 1973-74, the tech wreck or the GFC). A grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession does not imminent as the excesses that normally proceed recession (overinvestment, inflation surging, tight monetary policy) are not present on a significant enough scale. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls into the October lows) and it could still turn into a gummy bear market, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that has left investors nervous, the rebound from late October was not particularly convincing and many of the drivers of the October fall are yet to be resolved.

However, there were three positive developments over the last week, which help add to our conviction that we are not going into a grizzly bear market:

1. While Fed Chair Powell remains upbeat on the US economy and a December hike looks assured (for now), he is clearly aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of 8 interest rate hikes and stock market volatility and appears open to slowing the pace of interest rate hikes or pausing at some point next year. The stabilisation in core inflation around 2% seen lately may be supportive of this. Overall, he now seems a lot more balanced than in early October when referring to rates going to neutral and beyond. Fed Vice-Chair Clarida delivered a very similar message to Powell in an interview two days later, reinforcing the impression that the Fed is open to softening its stance on rates.

2. There have been more positive signs on trade. Talks between the US and China on trade have reportedly resumed “at all levels”, US Treasury Secretary Mnuchin and Chinese Vice-Premier Liu have spoken by phone, the China Daily has reported that China and the US have agreed to promote a bilateral relationship, China has sent a trade document to the US and President Trump has repeated that he is optimistic of a trade deal with China and that the US might put any further tariff increases on China on hold, if there is progress in trade talks. All this is on top of the Trump/Xi phone call a few weeks ago and suggests that there was much more to it than just a pre-midterm election publicity stunt by Trump. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet at the G20 summit at the end of the month but with Trump wanting to get re-elected, I remain of the view that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. And finally, for now at least, the US has held off on tariffs on automobiles. Of course, the market reaction to such positive developments has been relatively muted because investors are sceptical, given the failure so far this year of various US/China trade talks, but this just indicates there is all the more room for a positive response in markets, if progress is actually made.

3. While the 27% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, ultimately it has the potential to extend the economic cycle as the 2014-16 plunge did (although it’s likely to be on a much smaller scale this time). Oil prices are short term historically oversold and due for a bounce but it’s increasingly looking like slower global demand than expected is a contributor to the price plunge – along with US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil (which highlighted yet again that Trump doesn’t want to let anything damage US growth and weaken his re-election chances in 2020), rising US inventories, the rising $US, and the cutting of long oil positions. This means while oil prices are unlikely to fall for as long or as much as they did in 2014-16, when they fell 75%, they may stay lower for longer. This is bad for energy companies but maybe not as bad for shale producers, as in 2015 as they are now less geared and their break-even oil price has already been pushed down to $50/barrel or less. And it’s less of a threat to the US economy, as energy investment is much smaller than it was in 2014. It will depress headline inflation (monthly US CPI inflation could be zero in November and December) and if it stays down long enough, it could dampen core inflation. All of which may keep rates lower for longer. And it’s good news for motorists. For example, Australian petrol prices have plunged from over $1.60 a litre a few weeks ago to now falling back to around $1.30 in some cities and prices could still fall further as the oil price fall flows through to the bowser with a lag. That’s a saving in the average weekly household petrol bill of around $10.

The outlook…

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

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