26 May 2017
Share markets rose over the last week, reversing the Trump FBI/Russia Bump from the previous week as investors bought the dip supported by mostly good economic and profit news. US shares rose 1.4%, Eurozone shares rose 0.04%, Japanese shares gained 0.5%, Chinese shares rose 2.3% and Australian shares gained 0.4%. The gains in Australian shares were constrained by ongoing worries about the banks, retail shares and weakness in the iron ore price. Bond yields were flat to down, commodity prices were weak with iron ore down 7.6% but the Australian dollar was little changed.
The past week saw terrorism rear its ugly head again this time in Manchester in the UK and our thoughts are with those affected. Despite some fears to the contrary, the financial market impact proved yet again to be minor with UK shares only falling 0.1% the next day before rebounding and there was no sign of any impact on other share markets. This is consistent with the experience since early last decade that has highlighted that terrorist attacks on targets like crowds, buildings and entertainment venues, etc, don’t really have much economic impact. While the 9/11 attacks had a big short term share market impact with US shares falling 12% they had recovered in just over a month, the Bali and Madrid bombings had little impact, the negative 1.4% impact on the UK share market from the London bombings of July 2005 was reversed the day after, the French share market only fell 0.1% the next trading day after the November 2015 Paris attacks and 0.3% the day after the July 2016 Nice attack. So while terrorism is horrible for those affected, it would need to cause more damage to economic infrastructure to have a significant economic impact and hence a significant impact on investment markets.
Moody’s downgrading of China’s sovereign credit rating from Aa3 to A1 is unlikely to have much impact. China’s debt problems are well known with China’s policy makers seeking to restrain debt, most investment in Chinese bonds is internally sourced and China is not dependent on foreign capital being the world’s largest credit nation.
As widely expected, OPEC agreed to extend its production cuts to March next year but for the oil price it was a classic case of “buy on the rumour, sell on the fact.” OPEC is basically in a bind: if it cuts supply further it will lose more market share to shale oil but if it hiked production oil prices will plunge again. So it chose the middle path.
President Trump’s fuller budget request released in the last week is best ignored. As always Congress will put the budget together – Trump doesn’t even need to sign it off.
The latest Australian bank rating downgrades tell us nothing new but the drip feed of negative news around the property market in Sydney and Melbourne is continuing to mount: surging unit supply, bank rate hikes, tightening lending standards, reduced property investor tax deductions, ever tighter restrictions around foreign buyers, etc. Our view remains that home price growth has peaked in Sydney and Melbourne and that price declines lie ahead, particularly for units. The extent of the unit construction boom in Sydney is highlighted by the residential crane count which has increased from just 62 in September 2014 to 292 in March.
Source: Rider Levett Bucknall Crane Index, AMP Capital
Still prefer global over Australian shares. Much of the relative underperformance of the Australian share market versus global shares since 2009 – which reflected relatively tighter monetary policy in Australia, the commodity slump, the lagged impact of the rise in the Australian dollar above parity and a mean reversion of the 2000 to 2009 outperformance – has been reversed. However, the Australian share market looks likely to continue underperforming going forward reflecting weaker growth prospects in Australia – with the economy looking like it may have stalled again in the March quarter, the housing cycle peaking and turning down, constraints on consumer spending (high debt, higher bank lending rates, slowing wealth affects, rising energy costs, record low wages growth and high underemployment, risks around the banks and uncertainty around the outlook for bulk commodity prices. We still see the ASX 200 higher by year end, but global shares are likely to do better on both a hedged and particularly unhedged basis.
Source: Thomson Reuters, AMP Capital
Major global economic events and implications
US data was mostly good with the highlight being a rise in the overall business conditions Purchasing Managers’ Index for May pointing to reasonable growth. Meanwhile home sales fell, but home prices continued to rise and March quarter gross domestic product growth was revised to 1.2% annualised from 0.7%. The main dampeners were weaker than expected trade, inventory and durable goods data. The minutes from the last Federal Reserve meeting confirmed that it is likely to hike rates again in June and looks to be on track to start running down its balance sheet (i.e. reversing quantitative easing) from later this year by letting a gradual amount of maturing bonds roll off each month. Rate hikes and balance sheet reduction all remain conditional on the economy continuing to behave though.
Eurozone business conditions Purchasing Managers’ Index data remained very strong in April and business confidence rose in Germany and France which is all consistent with strengthening growth in Europe.
Japanese headline inflation rose slightly in April, but with core inflation still zero, the Bank of Japan is set to continue quantitative easing and maintain its zero per cent 10-year bond yield policy for a long time.
Australian economic events and implications
Australian March quarter construction data fell, adding to the downside risks to March quarter gross domestic product growth. However, it’s not all bad as the 4.7% slump in residential construction looks temporary and likely to reverse in the current quarter as the impact of Cyclone Debbie drops out and the huge pipeline of work yet to be completed kicks in, public construction is up strongly reflecting state infrastructure activity and December quarter construction activity was revised up significantly.
Weak March quarter construction activity along with very weak retail sales and a likely growth detraction from net exports highlights that absent an upside surprise in public spending, equipment investment or inventories, March quarter gross domestic product growth looks likely to be near zero with the risk of another contraction. Reflecting this along with ongoing softness in underlying inflationary pressures, there is far more risk of another Reserve Bank of Australia rate cut by year-end than of a rate hike.
What to watch over the next week?
In the US, the focus is likely to be on the May Institute for Supply Management manufacturing conditions index (Thursday) and jobs data (Friday). The Institute for Supply Management data is likely to have remained solid at around 55 and jobs data is likely to have remained strong with a 175,000 rise in payroll employment and unemployment remaining unchanged at 4.4%, but wages growth modest at around 2.7% year-on-year. In other releases, expect solid growth in April consumer spending but a fall back in inflation as measured by the core personal consumption deflator to 1.5% year-on-year and consumer confidence in May to have remained strong (all due Tuesday), pending home sales (Wednesday) to reverse a fall seen in March and the April trade deficit (Friday) to deteriorate.
Eurozone business and consumer confidence readings for May (Tuesday) are expected to remain solid and unemployment (Wednesday) is likely to have fallen to 9.4% from 9.5%, but core inflation is likely to fall back to 1% year-on-year from 1.2% reversing a distortion in April due to Easter.
Japanese jobs data for April is expected to remain solid – helped of course by a falling workforce, but household spending data is likely to remain weak (all due Tuesday) and industrial production data (Wednesday) is likely to show a bounce.
Chinese business conditions Purchasing Managers’ Index data (Tuesday and Wednesday) is expected to soften marginally.
In Australia, expect building approvals (Tuesday) to show a 3% gain after a sharp fall in March, credit growth (Wednesday) to remain moderate, CoreLogic data to show a further moderation in home price growth, retail sales to show a 0.2% bounce after several soft months and March quarter business investment data to show a 0.5% decline as mining investment continues to fall (all due Thursday). Of most interest in the investment data will be investment intentions which are expected to show some improvement in non-mining investment.
Outlook for markets
Shares remain vulnerable to a further short term setback as we are now in a weaker seasonal period for shares with risks around President Trump, North Korea, Chinese growth and the US Federal Reserve’s next rate hike providing potential triggers. However, with valuations remaining reasonable – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as an opportunity to “buy the dips”. Shares are likely to trend higher on a 6-12 month horizon.
Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from sovereign bonds.
Unlisted 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.
National residential property price gains are expected to slow, as the heat comes out of the Sydney and Melbourne markets.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
For the past year the Australian dollar has been range bound between $US0.72 and $US0.78, but our view remains that the downtrend in the Australian dollar from 2011 will resume this year. The rebound in the Australian dollar from the low early last year of near $0.68 has lacked upside momentum, the interest rate differential in favour of Australia is continuing to narrow and will likely reach zero early next year (as the US Federal Reserve hikes rates and the Reserve Bank of Australia holds or cuts) and commodity prices will also act as a drag (particularly the plunge in the iron ore price). Expect a fall below $US0.70 by year end.