Market Update 28 June 2019

Investment markets and key developments over the past week

Global shares were generally soft over the last week ahead of the Trump/Xi meeting at the G20 and with fears that the US Federal Reserve (the Fed) may not be dovish enough in the face of soft data. US shares fell 0.3%, Chinese shares fell 0.2% and Australian shares lost 0.5% but Eurozone and Japanese shares rose 0.1%. Bond yields were flat to down reflecting global uncertainties, expectations for monetary easing and safe haven demand. Oil prices rose on US/Iran tensions and gold and metal prices rose helped by a falling US$ but the iron ore price was little changed. The A$ rose to US$0.70 as RBA Governor Lowe referred again to the limitations of monetary easing and the US$ fell.

Presidents Trump and Xi have agreed to another trade war truce – the third so far – with trade talks to resume, the US suspending threatened tariffs on the remaining US$300 billion of imports from China and China reportedly agreeing to buy more US agricultural products. The end result if the negotiations are successful is likely to be something like the US removing all tariffs if China passes into law agreed changes to protect intellectual property, prevent forced technology transfer, etc. It’s in both sides interests to reach a deal soon, given the economic damage the trade war is causing as seen in falling US business conditions readings and a rising risk of recession. Ultimately, we think they will cut a deal, but the risk is that China decides to wait for a more conventional and respectful US president.

Tensions between the US and Iran continue to increase, with the US announcing more sanctions and Iran saying diplomatic channels are closed in response. The threat to the passage of oil through the Strait of Hormuz – through which nearly 20% of world crude oil moves – is continuing to increase. Trump’s maximum pressure approach may have an Art of the Deal logic to it but it is not clear it will work with Iran. And support from many traditional US allies like Europe is weak because they didn’t support Trump’s decision to break off from the 2015 nuclear deal with Iran. Middle East tensions and wars regularly flare up only to fade or end with no more than a short-term impact on oil prices, the global economy and share markets and the same could be expected this time. But any significant further flare up from here could cause a bout of weakness in global markets at a time when they are already vulnerable.

Fed heading to rate cuts but not as dovish as the market would like. Fed Chair Powell reiterated the Fed’s openness to cutting rates, but Fed dove James Bullard’s comment that a 0.25% cut would help but 0.5% may be overdone got the market concerned that the Fed is not dovish enough. Ultimately, the market is over-reacting and the Fed will do whatever is necessary, but – assuming there is a resolution to the US/China trade war – it’s unlikely to be the 100 basis points of easing factored into money markets. More likely around 50-75 basis points.

Overall, we remain optimistic on shares on a 6-12 month view, partly on the back of central bank easing. But after a strong rebound in June – which saw Australian shares gain around 3.5% leaving them up 17% year-to-date – they are vulnerable to a short term pull back in the months ahead on weak data, trade uncertainties and Middle East tensions.

Bitcoin bounces back with a 340% gain from its December low. But that’s after losing 84% from its December 2017 high. And after surging in the last week it had a 25% plunge before rebounding again. Bitcoin is good to talk about and for some to speculate on! And there is a bright future for blockchain technology. But it can’t be taken seriously as a currency (or money). Amongst other things, money should be a reliable store of value, and Bitcoin is hardly that. The value of the A$50 note in my wallet is far more reliable! And it faces competition from numerous other crypto currencies. And as an investment it produces no income so has no yield and is impossible to value.

Major global economic events and implications

US economic data was mixed. Pending home sales rose but new home sales fell sharply. While underlying durable goods orders rose, the slump in Boeing orders weighed on headline orders. Regional business surveys continued to weaken, highlighting the negative impact from the trade war. Personal spending rose solidly in May, but consumer confidence fell to 2017 levels with consumers less optimistic on the jobs market. This is likely concerning President Trump – sounding tough on trade may appeal to his base but if it starts to affect consumer confidence and the jobs market it won’t be good for his re-election prospects. Meanwhile, core personal consumption deflator inflation remained soft at 1.6% year-on-year.

Eurozone economic sentiment fell in June and core inflation was just 1.1% year-on-year, leaving the ECB on track for more easing. Europe needs fiscal stimulus. Italy wants to do it but can’t, Germany can do it but doesn’t want to.

Japan’s jobs market remained strong in May, but this was helped by a falling labour force. Industrial production bounced in May, but the trend remains soft.

Australian economic events and implications

Credit data for May showed a further slowing in credit growth to its weakest since 2013 with growth in lending to property investors remaining stalled and at its weakest on record, as is growth in total housing credit. Personal credit growth is at its weakest since the GFC. Clearly the combination of tight lending conditions and reduced demand for debt continue to impact, consistent with slowing economic growth overall.

In other data, new interest-only loans provided in the March quarter fell to a new low of just 14.9% of new home loans, which is well down from their 2015 high of 46%. Similarly the total stock of outstanding interest-only loans as share of all outstanding housing loans has fallen to 23%, which is down from a record high of nearly 40% in 2015. Clearly interest-only loans remain out of favour, despite the relaxation of the 30% limit on loans going to interest-only borrowers in December. With interest returning to the Sydney and Melbourne property markets, it’s likely interest-only loans may soon bottom out, but given tougher lending standards its doubtful they will return to anything like the 40% share of total loans seen a few years ago.

RBA Governor Lowe’s often-repeated request for more fiscal stimulus and structural reform looks to being heeded to some degree. Infrastructure spending is continuing apace and the Federal Government has noted it was looking at trying to bring some of it forward and in the last week PM Morrison flagged a new focus on reducing business regulation and to taking a fresh look at improving the industrial relations system. And confirmation with May data that the budget could be in surplus for 2018-19 – a year ahead of schedule – helps provide more room for additional fiscal stimulus.

What to watch over the next week?

Reaction to the latest trade war truce between Presidents Trump and Xi at the G20 and continuing tensions between Iran and the US will likely dominate in the week ahead.

In the US, the focus will be on whether payroll employment growth for June (due Friday) bounced back after a soft May. Expect to see payrolls up a solid 160,000, unemployment remaining low at 3.6% and wages growth remaining subdued at 3.2% year-on-year. In other data, expect a further fall in the ISM manufacturing conditions index (Monday) to around 51 based on soft PMIs and regional surveys and the non-manufacturing conditions PMI (Wednesday) to remain solid at around 56.

Eurozone unemployment for May (Monday) is expected to remain unchanged at around 7.6%.

The Japanese June quarter Tankan business survey (Monday) is expected to show some softening.

Chinese business conditions PMIs for June will be released Sunday June 30 and Monday and are expected to remain softish but relatively stable.

In Australia, the RBA is expected to cut the cash rate by another 0.25% on Tuesday, taking it to a new record low of 1%. June’s cut is unlikely on its own to achieve the RBA’s objective of lower unemployment and higher inflation; economic data since the last easing has been mixed with notably softish GDP and jobs reports, RBA Governor Lowe has signalled that “it’s not unrealistic to expect a further reduction in the cash rate” and while the Government looks to be listening to the RBA’s request for help with fiscal stimulus and structural reform it’s not clear how strong the response will be and it will take a while to be put in place and longer to impact. Of course, it’s a close call as to whether the RBA cuts on Tuesday or waits till August. But rate moves usually come in at least two’s and the risks to the economic outlook have increased so it’s probably best to get another cut out of the way and then the RBA can sit back a bit and see whether it’s working. Ultimately, we remain of the view that the RBA will then cut again to 0.75% around November and then to 0.5% around February next year.

On the data front in Australia, expect CoreLogic data to show a 0.1% fall in house prices for June (Monday) with roughly flat prices in Sydney and Melbourne helped by the election result and the rate cut, June building approvals to show a 2% bounce and the trade surplus (both Wednesday) to remain at record levels and retail sales (Thursday) to rise 0.2%. Job vacancies data will also be released Thursday.

Outlook for investment markets

Share markets remain vulnerable to short term volatility and weakness on the back of uncertainty about trade, Middle East tensions and mixed economic data. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve into the second half if the trade issue is resolved and monetary and fiscal policy is likely to become more supportive, all of which should support decent gains for share markets over the next 6-12 months.

Low yields are likely to see low returns from bonds, but government bonds remain excellent portfolio diversifiers.

Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.

National average capital city house prices remain under pressure from tight credit, record supply and reduced foreign demand. However, the combination of rate cuts, support for first home buyers via the First Home Loan Deposit Scheme, the relaxation of the 7% mortgage rate test and the removal of the threat to negative gearing and the capital gains tax discount point to house prices bottoming out by year-end. We see a 12% top to bottom fall in national capital city average prices. Next year is likely to see broadly flat prices as rising unemployment acts as a constraint.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.

The A$ is likely to fall further to around US$0.65 this year as the RBA moves to cut rates by more than the Fed does. Excessive A$ short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an A$ crash.