AMP Capital – 1 September 2016
Global shares rose solidly over the last week with Japanese shares up 3.5% helped by talk of more monetary easing and a fall in the yen, eurozone shares gained 1.9%, US shares rose 0.5% helped by a benign jobs report and Chinese shares rose 0.2%. Australian shares lost 2.6% though as the earnings reporting season came to an end. Bond yields fell in the US, were unchanged in Australia but rose in Europe and Japan. While a rising US$ weighed a bit on commodity prices, the Australian dollar rose marginally.
Softer than expected US August jobs report leaves a September Fed rate hike looking unlikely. US payrolls rose by 151,000 in August which after two monthly gains greater than 270,000 tells us the US jobs market is solid. However, it was much weaker than expected and when combined with flat unemployment, weak wage gains (of just 0.1% month on month or 2.4% year on year) and a soft August manufacturing conditions ISM, indicates that the Fed will likely remain on hold in September. A December hike by the Fed remains our base case. US money market probabilities for Fed hikes of 32% for September and 59% for December look reasonable.
Global manufacturing conditions PMIs slipped in August, but remain consistent with ongoing moderate global growth. While there were significant falls in the US and Australia, India and the UK saw good gains and nearly 75% of countries have PMIs in so called expansion territory (i.e. above 50). The global economy continues to muddle along.
Source: Bloomberg, AMP Capital
Source: Bloomberg, AMP Capital
Surprise surprise, Brazilian President Dilma Rousseff was impeached! Seven years ago when on holidays in Rio the day it was announced that Brazil would host the 2016 Olympics I was interviewed by Brazilian TV at the base of the Sugar Loaf cable car and managed to say “parabens Brasil” (maybe they liked my Hawaiian shirt). Since then it seems to have been downhill for Brazil! And the impeachment of Rousseff doesn’t necessarily improve things. There are some signs that its recession is easing and a stabilisation in commodity prices will help. But former Vice-President and now President until 2018, Michel Temer has his own problems which may deepen as austerity designed to control the budget deficit blow out kicks in and Brazil really needs a radical long term reform agenda to get back on track.
The final days of the Australian June-half profit reporting season offered nothing new. Funny the way most companies with good results report early, but Harvey Norman invariably comes in with good news on the last day. The basic picture remains one of a tough 2015-16 with earnings down 8% led by resources and aggregate dividends down about 10% led again by resources (only a fruit cake could have believed that the super high resources dividends were sustainable). However, the median company did okay with earnings up 5% or so, 62% of companies seeing earnings up year on year, 86% of companies raising or maintaining dividends and 54% of companies seeing their share price outperform the market on release day. Overall, the results are consistent with a return to earnings growth of about 8% this financial year.
Major global economic events and implications
US economic data was mostly good with solid consumer spending in July and a surge in consumer confidence in August adding to evidence that the consumer is in good shape, solid (albeit weaker than expected) payroll growth, solid construction activity, a smaller than expected trade deficit, a stronger than expected rise in pending home sales and continued modest growth in home prices. Against this though, wages growth remains weak and manufacturing conditions softened according to the August ISM index which fell to 49.4 from 52.6. While the broader Markit PMI index held up better at 52, the fall in the ISM, weaker than expected August jobs growth and continuing very low wages growth are likely to see the Fed remain on hold at its September meeting and wait till December before moving on rates again. Meanwhile the Fed’s preferred inflation gauge – the core private consumption deflator – was stable at 1.6% year on year where it’s been for months indicating that upwards pressure on inflation remains weak and that the Fed has plenty of scope to remain on hold.
Eurozone economic confidence fell slightly in August but remains at levels consistent with ongoing moderate economic growth. Meanwhile unemployment remained at 10.1% in July (at least it’s down from 12.1% a few years ago) and core CPI inflation in August fell to 0.8% year on year from 0.9% indicating leaving it well below the ECB’s 2% target.
Political uncertainty continues in Spain with acting PM Rajoy losing a parliamentary confidence vote, risking another election in December. However, a left wing government remains unlikely.
Japanese economic data was good (believe it or not). Unemployment fell to just 3%, the jobs to applicants ratio remained at its lowest level since the early 1990s, real household spending and retail sales rose more than expected and housing starts are up nearly 9% year-on-year. Against this backdrop though, industrial production was soft and small business optimism fell.
While Chinese consumer confidence fell in August, business conditions PMIs were indicative of stable growth. The official manufacturing PMI rose to 50.4 (from 49.9), the non-manufacturing PMI fell but to a solid 53.5 (from 53.9) and the Caixin manufacturing PMI fell to 50.0 (from 50.6). There was lots of noise, but basically consistent with GDP growth stabilising around or slightly above 6.5%.
Indian GDP growth slowed to 7.1% year-on-year in the June quarter (from 7.9%) on slower growth in investment and consumer spending. That said, its way above virtually any other country including China, and India’s manufacturing PMI rose to a 13 month high. At least one of the BRICs is actually better than it used to be!
Australian economic events and implications
Australian economic data was all over the place. Retail sales were flat in July adding to the loss of momentum here (which is partly owed to weak price inflation, but weakness in household goods looks odd given strong dwelling completions) and business investment fell again in the June quarter. However, the fall in capex was driven by buildings and structures and was consistent with the mining driven engineering construction slump already reported in June quarter construction data. Against this, plant and equipment investment actually rose in the June quarter and investment plans for the current financial year improved more than expected, suggesting that non-mining investment may be stabilising. Although mining investment looks like falling another 27% this financial year, at 3% of GDP now, its negative impact on overall economic growth is starting to wane given that it has already fallen from around 7% of GDP. The next chart shows that there has been a loss of downwards momentum when comparing expected capex plans for the year ahead.
Source: ABS, AMP Capital
Meanwhile on the housing front, building approvals surged back to near record highs in July led by another spike in apartment projects. House price growth according to CoreLogic remains uncomfortably high in Sydney and Melbourne despite slowing rents and record low rental yields. That said, July new home sales resumed their downtrend according to the HIA in July, housing credit growth continued to lose momentum (led by investor finance) and I suspect that many of the apartment approvals won’t proceed to construction given the emerging oversupply and weakening conditions in the apartment market in several cities. Nevertheless the case for more APRA intervention in the face of still too hot Sydney and Melbourne property markets remains.
What to watch over the next week?
The G20 leaders’ summit in Hangzhou China (Sunday and Monday) is likely to see the usual motherhood commitments to policy co-ordination, structural reforms and avoiding “competitive devaluation” but don’t expect much financial market impact. Such meetings usually only come up with anything significant at times of crisis (like through the GFC). While there is a market belief that some sort of “Shanghai Accord” to stabilise exchange rate movements was agreed at the G20 finance and central bankers meeting in February this year, this may be tested in the months ahead as the Fed moves towards another rate hike. What the G20 should be doing is stepping up efforts to meet the 2% growth boost objective from the 2014 G20 summit (which now looks unachievable) and fighting back against protectionism.
In the US, expect the ISM non-manufacturing index and data for job openings and hirings (Tuesday) to remain solid and the Fed’s Beige Book of anecdotal evidence on the economy (Wednesday) will also be released.
In Europe, expect the ECB (Thursday) to maintain a dovish message, but to make no changes to monetary policy. Eurozone economic data has been reasonable and more resilient than expected following the Brexit vote which will likely allow the ECB to delay any decision on extending its quantitative easing beyond March 2017 until maybe its December meeting.
Chinese August trade data (Thursday) is likely to show an improvement in export and import growth.
In Australia, the Reserve Bank is likely to leave interest rates on hold (Tuesday). While the Australian dollar remains a little too high for comfort, economic activity data since the August rate cut has been reasonable and there has been nothing new on inflation. As a result the RBA is likely to hold the cash rate at 1.5%. We remain of the view that the RBA will cut rates again but this won’t come until November after the release of September quarter inflation data and when it next reviews its economic forecasts. Another rate cut is a close call though given that the outlook remains for reasonable economic growth.
Meanwhile on the data front in Australia, expect June quarter GDP growth (Wednesday) to slow to around 0.4% quarter on quarter after the March quarter’s unexpected 1.1% growth spurt, thanks to weaker export volume growth and a continued drag from the unwinding of the mining investment boom. Annual growth is expected to be around 3.3% year on year though. Data for job ads and business indicators (Monday), the June quarter current account deficit (Tuesday), the trade deficit (Thursday) and housing finance (Friday) will also be released. July housing finance data will be watched closely to see if finance to property investment has continued to reaccelerate as seen in the previous two months. Finally, a speech by RBA Deputy Governor Philip Lowe (Thursday) will be watched closely for any clues on the interest rate outlook.
Outlook for markets
After a period of strong gains into July/early August, shares are likely to see a consolidation or correction given weak seasonals out to October, along with various event risks in the months ahead including around the Fed, Italian banks, the Italian Senate referendum and global growth generally. However, after a short term correction or consolidation, we anticipate shares to trend higher over the next 12 months helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.
Ultra-low bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels leaving them at risk of a snapback.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.
Cash and bank deposits offer poor returns.
Recent more hawkish Fed commentary has dampened the A$, but with a September Fed rate hike looking unlikely after the softer than expected August jobs report in the US there is a high risk that the A$ will resume its push back up to April’s high of US$0.78, presenting challenges for the RBA. Beyond the short term though we see the longer term downtrend in the A$ ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the A$ sees its usual undershoot of fair value