Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Investment markets and key developments over the past week
Major global share markets fell over the last week on worries about global growth, with US shares down 2.2%, Eurozone shares down 1.3%, Japanese shares losing 2.7% and Chinese shares down 2.5%. Australian shares pushed 0.2% higher though on increasing expectations for rate cuts offsetting, for now, the negative impact of slowing growth. Bond yields fell as the ECB announced more monetary easing and on growth worries. Commodity prices were mixed, with metals and iron ore down but oil and gold up. The $A fell on increasing expectations for RBA rate cuts as the $US rose.
There were three positives on the global policy/geopolitics front over the last week. First, reports indicate that the US and China are close to a trade deal and that President Trump is keen to announce a win on this ahead of his 2020 election campaign. Second, China’s National People’s Congress saw more policy stimulus announced (including a cut to the Value Added Tax rate equal to around 0.6% of GDP) with the growth target set at 6-6.5% for this year which is in line with market expectations. Finally, as widely expected the European Central Bank announced another round of cheap bank funding (which is a form of quantitative easing) and further pushed out its commitment to keep interest rates down. A settling of trade issues and a shift to policy stimulus (or at least more dovishness in the case of the Fed) is consistent with our view that global growth will improve into the second half this year and the combination of stronger growth supporting profits and still easy monetary policy will likely make this a good year for shares. The trouble in the short term though is that share markets – both globally and in Australia – have run hard and fast from their December lows and, with global economic data still weak right now, they are vulnerable to a short-term pullback.
Doom and gloom on the Australian economy has gone into overdrive. Talk of recession is rife. Economists are falling over themselves in predicting rate cuts. My dog is as excited (if that’s the right word) about an impending recession as she was about Bitcoin 18 months ago! Maybe it’s the curse of The Economist magazine’s cover from last October. But there are five things you need to know about the Aussie economy:
- First, economic growth has definitely slowed further and is likely to remain weak going forward as the housing downturn continues, dragging on construction activity and consumer spending.
- Second, while we have gone into a “per capita recession” with two quarters of growth running below population growth, these have occurred occasionally before, with the last one in 2006 in the midst of the mining boom! In fact, as Peter Switzer reminded me, prior to last week I had never heard of the term so there is a danger in reading too much into it, just as many did a few years back with the obsession about an “income recession”.
- Third, a conventional recession remains unlikely given that the mining investment slump is near its bottom, non-mining investment is looking healthier, infrastructure investment is strong, global and specifically Chinese growth is likely to pick up later this year, the April budget is likely to see tax cuts/fiscal stimulus and the RBA can cut interest rates.
- Fourth, while a conventional recession is unlikely, growth is likely to be well below what the RBA is expecting, and this will drive higher unemployment and lower for longer wages growth and inflation, the anticipation of which will drive the RBA to cut interest rates at least twice this year. We had thought that this would not occur until August, and after the budget and election were out of the way so the central bank could get a chance to assess any fiscal stimulus, however the run of weak data is increasing the risk that the first cut will be sooner. Maybe even on budget day next month to get it out of the way before the election campaign! Waiting for unemployment to rise runs the risk of being too late!
- Finally, it’s worth noting that the east coast drought is continuing, with the Southern Oscillation Index indicating a minor El Nino. Over the last year the drag on growth has only been around 0.15 percentage points, but it could increase the longer the drought continues.
A rising risk facing the RBA is that the 2-3% inflation target will lose credibility. For several years now the RBA has been forecasting inflation to move back towards the mid-point of the target range. But as can be seen in the next chart these expectations have proven way too optimistic (and this has been the case for many forecasters, not just the RBA!). The danger is that the longer inflation remains below target, the more it will be expected to remain down and the harder it will be to get it up as the experience in Japan and Europe demonstrates. All of which is an argument for the RBA to cut rates sooner rather than later.
It’s now 10 years since the US share market bottomed at the end of the GFC on the 9th of March 2009 at an intraday low of 666.79 for the S&P 500. Of course, many perma-bears saw that as the mark of the devil and so missed the subsequent rebound! Since then it’s rallied 333% to its September high last year. For a while now the debate has been around when the rally will end but it’s worth bearing in mind that the US share market has already had quite a few sharp falls along the way (down 19% in 2011 and down 20% last year), which have helped relieve overvaluation and excessive optimism and the US economy still does not exhibit the sort of excesses (like overinvestment, high inflation and tight monetary policy) that in the past have preceded recessions and major share market plunges like the tech wreck and the GFC. “Bull markets don’t die of old age but of exhaustion.”
The latest Financy Women’s Index for the March quarter showed that women are making financial and economic progress across areas like education, work, wages, leadership and superannuation, but there is a long way to go to achieve financial equality with men. It’s worth a look.
Major global economic events and implications
US data was mixed, but okay. The non-manufacturing conditions ISM rose very strongly, new home sales rose for the second month in a row and housing starts rebounded in January. Against this, the trade deficit widened in December, construction spending fell and payroll employment rose a much less than expected 20,000 in February. However, it would be wrong to read too much into the soft February outcome as it’s probably payback for the unbelievably strong 311,000 payroll gain in January, the 3-month average in jobs growth is a solid 186,000, it may have been partly weather-related, with construction jobs down and both unemployment and underemployment actually fell. Meanwhile, wages growth edged up further to 3.4% year-on-year but still remains relatively benign in terms of driving inflationary pressure. Overall, the jobs report is not as weak as the headline payroll number suggests, but it’s consistent with the Fed remaining in pause mode.
The European Central Bank has finally accepted reality and revised down its growth and inflation forecasts and announced another round of cheap bank funding conditional on lending to the private sector (what they call TLTRO) and pushed out its commitment to not raise rates out to the end of the year in response. Quite clearly, it ended quantitative easing too early and is now seeking to correct the mistake. This is a move in the right direction and adds to confidence that Eurozone growth will stabilise and improve this year. That said, the ECB may still have to do more as it not clear that its new round of TLTROs is aggressive enough.
Japanese data showed a stronger than first reported recovery in December quarter GDP and better consumer spending.
Chinese trade data was very weak in February but looks to have been exaggerated by Lunar New Year holiday distortions. Averaging across January and February still saw exports fall nearly 6% year-on-year, reflecting an unwinding of the front-running of exports last year ahead of US tariffs and slower global growth and imports fell 3% year-on-year, reflecting slow domestic demand.
Australian economic events and implications
Australian data released over the last week was decidedly soft. December quarter GDP growth was just 0.2% quarter-on-quarter, with broad based weakness (apart from government demand) and ongoing signs that the housing downturn is impacting consumer spending and this followed similarly weak growth in the September quarter. What’s more, building approvals and retail sales remained weak in January, service sector conditions PMIs remained very weak in February and ANZ job ads fell further in February, suggesting that weak growth will soon show up in slowing jobs growth and rising unemployment. On top of this, the Melbourne Institute’s Inflation Gauge showed continuing below-target inflation in February. It wasn’t all bad though, with another spike in the trade surplus in January – although mainly due to gold exports, it nevertheless highlights the strength in export prices and holds out the possibility that net exports will contribute to growth this quarter. Overall though it adds to the argument for the RBA to cut rates sooner rather than later.
What to watch over the next week?
In the US, expect a modest bounce back in January retail sales (Monday) after their December slump, February core inflation (Tuesday) to fall slightly to 2.1% year-on-year, durable goods orders (Wednesday) to show a modest gain and industrial production (Friday) to bounce back for February.
In the UK, it will be back to another round of parliamentary votes on Brexit on Tuesday on: May’s Brexit deal; a No Deal Brexit; a delay to 29 March Brexit date; and also on whether to have a second referendum. At this stage, parliament probably won’t support the Brexit deal (although it’s close), it will reject a No Deal Brexit and vote for a delay, but a new referendum likely won’t get up (just yet). We remain of the view that the final outcome will be either some sort of soft Brexit (as there is no majority in parliament for a No Deal or hard Brexit) or another referendum which turns into Bremain.
The Bank of Japan is not expected to make any change to its ultra easy monetary policy on Friday with indicators regarding growth and inflation remaining soft.
Chinese economic activity data for January and February (Thursday) are likely to show some further slowing in industrial production (to 5.7% year-on-year) and retail sales (to 8.5%) but a slight acceleration in fixed asset investment (to 6%). Chinese growth may slow a bit further in the current quarter, but with stimulus measures it’s likely to pick up into the second half.
In Australia, expect to see a bounce in housing finance (Tuesday), but weaker readings for business confidence (also Tuesday) and consumer confidence (Wednesday).
Outlook for investment markets
Shares are likely to see volatility remain high, with a 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, Europe and Australia 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% into 2020, 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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