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9 lessons from the GFC

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By Shane Oliver

Given the 10-year anniversary of the start of the GFC in terms of its share market impact, which saw 50% plus plunges in share markets its worth recalling the lessons it provided for us as investors. Here is a list of the main ones:

  1. At a time when many were talking of the “great moderation” and the death of the business cycle it reminded us that the economic and investment cycle lives on;
  2. The collapse of higher returning investments – including high yielding “yield funds” - provided a reminder that higher returns come with higher risk.
  3. It showed yet again that investor sentiment can push markets to extremes – eg, by early 2009 when shares had become substantially undervalued and underloved.
  4. It provided a reminder to be sceptical of investments that are hard to understand – remember CDOs?
  5. It provided a reminder of the dangers of too much gearing and debt of the wrong sort (like margin loans).
  6. It provided a reminder of the importance of having assets that provide true diversification to shares like government bonds as opposed to assets that may be lowly correlated to shares in good times (commodities and high yield debt) but highly correlated in bad times.
  7. The post GFC recovery showed that fiscal and monetary policy do work but that it can take longer to return to normal after major financial crises.
  8. It highlighted the importance of asset allocation as opposed to agonising about stock picking and manager selection.
  9. And finally, stuff happens! History tells us another financial crisis is inevitable at some point as each new generation forgets the lessons of the past and has to (re)learn them.

Investment markets and key developments over the past week

While Chinese shares fell 0.7% over the last week, US shares gained 0.3%, Eurozone shares rose 1.1%, Japanese shares gained 2.4% and Australian shares rose 1% helped by a combination of good global economic growth and earnings news.

The Australian All Ords index even managed to push above the 6000 level for the first time since early 2008. Bond yields fell helped by President Trump’s nomination of Jerome Powell to succeed Janet Yellen as Fed Chair and a fall back in Eurozone inflation. Oil and copper prices rose but the iron ore price fell slightly. The $US was flat against a basket of currencies but the $A was hit by very weak retail sales data.

Global share markets have been boosted by a number of positives over the last few weeks: strong economic growth and profits news; ongoing low inflation; progress on US tax cuts; the nomination of Jerome Powell as Fed Chair; confirmation that the ECB will continue quantitative easing next year and remains dovish; the continuation of Abenomics post Abe’s election victory; and the removal of uncertainty around China’s Communist Party Congress. This avalanche of positive news and removal of uncertainties has pushed global shares higher and dragged the Australian All Ords index above the 6000 level.

As expected, the Fed left monetary policy on hold and remains on track for a December rate hike. The Fed upgraded its characterisation of growth from “moderate” to now “solid” and it continues to regard recent inflation softness as temporary and likely to give way to a move back towards its 2% target as a result of falling spare capacity and faster wages. The October jobs report in the US likely keeps the Fed on track for a December hike – wages growth fell back to 2.4% year on year but this looks distorted by the hurricanes and meanwhile employment rebounded by 261,000, previous months’ payrolls were revised up by 90,000 and unemployment fell further to just 4.1%, indicating a labour market that is getting quite tight.

Continuity for monetary policy at the Fed under Jerome Powell. President Trump’s nomination of current Fed Governor Jerome Powell to replace Janet Yellen as Chair when her term expires in February next year signals more of the same at the Fed. Naturally, there may be a bit of market nervousness around the time of the handover and particularly around his first meeting in March next year (assuming he is approved by the Senate). But since becoming a Governor in 2012 Powell has been supportive of the Fed’s approach to monetary policy and is pragmatic and non-ideological and is likely to be a consensus builder as Chair. Barring any significant shocks Powell is most unlikely to alter the Fed’s current path of letting its balance sheet run down in line with the process announced in September and raising rates three times next year. So given Trump liked Yellen why did he even make the change? First, he wanted to leave his mark. Second, Powell appears supportive of taking a more relaxed approach to financial regulation than Yellen was.

The first indictments in the Mueller investigation into the links between the Trump campaign and Russia are unlikely to impact tax reform. First, two of the indictments don’t appear to be linked to Trump or the campaign and second, tax reform is a wider Republican objective that goes well beyond Trump. The investigation poses an ongoing risk and source of uncertainty regarding Trump and of course those indicted may seek to reveal something more damning regarding Trump, but unless there is ultimately a finding of clear criminal wrong doing by Trump the Republican controlled House of Representatives is very unlikely move to impeach him. Of course a Democrat House post the 2018 mid-terms may try – but by then tax reform/tax cuts should be passed. Meanwhile momentum continues on the tax reform front with the House releasing its tax reform bill. There were no great surprises with a 20% corporate tax rate, 12% deemed repatriation tax rate on corporate overseas cash and reduced personal tax rates. There is still a long way to go to iron out the details but we continue to expect it to be passed (with a 70% probability) by the March quarter next year.

The Australian All Ordinaries Index finally broke back above 6000 again in the last week – but its still well below its November 1 2007 peak of 6854 whereas the US share market surpassed its 2007 high back in 2013. Why the big lag? First the Australian share market rose very strongly into the 2007 peak on the back of the mining boom, whereas the US share market just spun its wheels last decade after first getting smashed by the tech wreck. So the 2007 high was a much higher high for our market and hence a higher hurdle to get back to. Second, Australian resource shares have been hit by the collapse in commodity prices since 2011. Third, Australian shares have also been hit by a bit of foreign investor scepticism regarding the outlook for China and perennial fears about a crash in property prices. Fourth, US and many global markets benefitted from zero interest rates and money printing whereas Australia has had neither. Finally, it should be noted that Australian companies pay higher dividends than US and foreign companies and once dividends are allowed for the Australian share market has surpassed its 2007 peak, albeit it’s still underperformed global shares in the period since the GFC.

Major global economic events and implications

US data remained strong and points to 4% or so growth this quarter. The manufacturing ISM fell but remains very high at 58.7, the non-manufacturing ISM rose to a very strong 60.1, consumer confidence rose to its highest since 2000, personal spending was very strong in September, payroll employment rebounded by 261,000 in October and previous months’ payrolls were revised up by 90,000, unemployment fell further to 4.1% and home prices continue to rise. While core private consumption deflator inflation remained low at 1.3% year on year in September, the September quarter Employment Cost Index confirmed some acceleration in wages growth. Wages growth in October fell back to 2.4% year on year from 2.8% but this looks distorted by the hurricanes. Meanwhile, September quarter earnings reports have continued to surprise on the upside with 77% beating on earnings and 67% beating on sales. While GE and hurricane affected earnings results have weighed on earnings growth in the quarter, estimates for the quarter have now pushed back up to 5% year on year after originally starting at 4%.

Eurozone data was remarkably strong with economic sentiment at its highest since 2001, GDP growth rising to its fastest since 2011 and unemployment falling to 8.9% - still high but that’s down from 12% just a few years ago! But despite this core inflation slipped back to just 0.9% year on year highlighting the ongoing lack of inflationary pressure and why the ECB will remain very gradual in slowing monetary stimulus.

The Bank of England raised interest rates by 0.25%, but only to 0.5% and its concerns around Brexit suggest it’s not hawkish.

The Bank of Japan left monetary policy on hold as expected with quantitative easing and the zero 10-year bond target to remain in place for a long time yet given ongoing core inflation near zero. Meanwhile, Japan’s economic data was mixed with strong labour market indicators, weak household spending and some slowing in industrial production. A solid PMI reading and rising consumer confidence suggests growth should remain reasonable in Japan.

China business conditions PMIs were mixed for October but are in their recent ranges and consistent with 6.5-7% growth.

Australian economic events and implications

Australian economic activity data was messy. On the one hand business conditions PMIs were mixed but point to okay growth, home building approvals remain solid, non-residential building approvals are pointing up and net exports look set to contribute around 0.3% to September quarter GDP growth. Against this credit growth slowed, home sales are falling, pointing to slower building approvals ahead and, most importantly, retail sales growth stalled in the September quarter with flat volumes and falling prices highlighting the ongoing pressure on households from weak wages growth, high underemployment and surging energy costs. Growth in consumer services and other parts of the economy, including trade volumes, will likely have kept the economy growing in the September quarter but overall Australian growth is likely to remain sub-par in contrast to the strengthening we are seeing globally.

Meanwhile, evidence continues to build that the property price boom in Sydney is over with CoreLogic data showing a further decline in prices in October. Auction clearance rates in Sydney are now falling towards levels around 55% that are normally associated with price declines on an annual basis and we expect Sydney home prices to fall around 5-10% over the next year or so. Across Australia the picture is very mixed: Perth is showing signs of bottoming; Adelaide, Brisbane and Canberra are seeing moderate growth; Melbourne is cooling a bit; and Hobart is rising solidly.



Source: Domain, CoreLogic, AMP Capital

What to watch over the next week?

It will be a quiet week on the data front in the US, although data on job openings and hiring (Tuesday) will likely show continued labour market strength and the preliminary November reading for consumer sentiment (Friday) is likely to show that consumer confidence remains strong. US September quarter earnings results will continue to flow.

Chinese trade data (Wednesday) is likely to show exports up 8% and imports up 18%, inflation data (Thursday) is expected to show CPI inflation rising to 1.7% but PPI inflation dipping to 6.7%. Credit data will also be released.

In Australia, the RBA (Tuesday) is expected to leave interest rates on hold for the 15th month in a row. The RBA’s forecasts for stronger growth along with solid business conditions and employment growth argue against rate cuts, but ongoing low inflation, record low wages growth, uncertainty around consumer spending as highlighted by very weak retail sales, signs that the housing cycle is slowing and the still strong $A argue against a rate hike. We remain of the view that the RBA will leave the cash rate on hold until a probable rate hike late next year at the earliest. The RBA’s quarterly Statement on Monetary Policy (Friday) is likely to see the RBA revise down its inflation forecasts reflecting the lower than expected

September quarter outcome, ongoing signs of weak pricing power and the latest CPI re-weighting. A shift to providing point forecasts is also likely to highlight a slower than expected path for inflation and maybe also growth. This along with likely ongoing RBA wariness regarding the outlook for wages and inflation is expected to reinforce the RBA’s short term neutral bias on interest rates.

On the data front in Australia, ANZ job ads (Monday) may be worth watching given a softening in job vacancies seen recently and September housing finance data (Thursday) is expected to show modest growth.

Outlook for markets

US shares remain overdue a correction, but looking beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. Australian shares are likely to continue to participate in the global share rally, but remain a relative laggard thanks to a more constrained earnings outlook.

Bond yields look to be starting to break higher again, led by US bonds. Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

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

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

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

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or so and the Fed on track to hike in December with another three or so hikes next year under Jerome Powell the interest rate differential will continue to move against Australia which should result in further weakness in the $A.

Published: Monday, November 06, 2017


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