AMP Capital – 30 September 2016
Shares had a volatile week, with support from higher oil prices but volatility in banks led by concerns around Deutsche Bank. Eurozone shares lost 0.8%, Japanese shares lost 2.0% and Chinese shares fell 0.7% but Australian shares rose 0.1% and US shares staged a late recovery (on reports that Deutsche Bank may pay a lower US fine than feared) to end up 0.2%. Bond yields fell and commodity prices were little changed, except oil, which rose nearly 8% on the back of OPEC’s reported agreement to reduce output. The US$ was little changed, but the A$ rose slightly.
The main issues around Deutsche Bank appear to relate to the size of a US Department of Justice penalty relating to mortgage backed securities (where the opening position was $US14bn) and whether it will require a capital raising. This appears to be affecting sentiment around banks generally, although many US banks have already settled with the US Department of Justice, and reports that Deutsche may settle for $5.4bn helped sentiment late in the last week. It seems whenever there are issues with banks these days, investors start to fear a re-run of the GFC, but with all the tougher regulations and greater transparency now the risk of this is low.
OPEC’s agreement to cut oil production adds to confidence that we have seen the low in oil prices. The reported agreement will see production cut to around 32.5 to 33 million barrels per day from around 33.25 mbd in August, but the details won’t be agreed until OPEC’s late November meeting. The deal, if stuck to, could signal better cooperation between Saudi Arabia and Iran and a return to discipline by Saudi Arabia. Time will tell, but it adds to confidence that we have seen the low in the oil price. That said, while the oil price has bounced 7% or so on the news, it’s just normal volatility and the oil price remains below its June high of $US53 a barrel. Expect a bit of an upwards drift in the oil price but constrained demand growth, the prospect of shale oil production picking up again as the oil price pushes through break-evens for such producers (of around $US50-$US60) and the ongoing switch to alternatives should limit the upside in the oil price, probably to around $US60.
For the time being it’s hard to see a big flow on to Australian petrol prices, as the bounce in the oil price around the OPEC news has only been around $US3/barrel, which would translate to about 3 cents a litre at the bowser in Australia. In any case, the petrol price is still averaging around 10-20 cents a litre above levels normally implied by current oil prices, suggesting wider than normal margins. More broadly, to the extent that the OPEC deal reflects better supply discipline and is consistent with the bottoming in commodity prices seen generally over the last nine months and energy in particular, it’s positive for Australia and adds to a lessening in downwards pressure on the Reserve Bank of Australia (RBA) to cut interest rates again. The complication is the A$, which briefly rose above $US0.77 and is at risk of re-test of April’s high of $US0.78.
Has global trade peaked? A World Trade Organisation report downgrading its estimate for global trade growth to 1.7% this year (from 2.8%) and five years of low or stagnant trade growth begs the question that global trade may have peaked. This is a risk, but the recent stagnation appears due more to a return to trend after the trade boom of the 2000s, slower demand driven growth due to slower growth in Europe, the end of the commodity boom and a shift in China’s growth from industrial production to services. That said, all the talk of protectionism and the stalling of the Doha trade round is a concern.
The first presidential debate between Hilary Clinton and Donald Trump has kicked off financial markets’ focus on the November 8 election. While the general conclusion was that Clinton won and she reinforced her key strength of being more “presidential”, there was no knockout blow, so the outcome remains close. There are still two presidential debates to go on October 9 and 19 and a debate between the vice presidential candidates on October 4. See our website here for an analysis of the coming US election http://bit.ly/2cYngwI.
The Bank of Japan’s (BoJ) latest moves are more profound than first appeared. There has been much debate as to whether the BoJ actually did anything of substance at its meeting a week or so ago. There was no big increase in quantitative easing or change in interest rates. But by the same token if it actually does what it says it really could be a big thing. Put simply the BoJ has committed to pumping cash into the Japanese economy until inflation rises above its 2% target and stays there. If it actually does this then inflation expectations will rise and investors will naturally want to sell bonds. But the BoJ has committed to keeping the 10 year bond yield at zero and if private investors start selling bonds it will have to buy even more bonds to keep the yield at zero. Which all means that real yields will fall which will encourage spending and push the Yen down, all of which will reinforce the pick-up in inflation. At the same time the commitment to keep the 10 year bond yield at zero is an open invitation to the Government for more fiscal stimulus. This is all kind of heavy, but if the BoJ actually does what it says – even though I suspect it may need a bit of helicopter money along the way – then what it has announced is actually quite profound. Time will tell, but I suspect that the BoJ under Kuroda should be given some benefit of the doubt.
Major global economic events and implication
US economic data was mostly better than expected. Consumer confidence rose to its highest since 2007, the Markit services conditions PMI rose, regional business conditions surveys rose, durable goods orders were stronger than expected, jobless claims remained low, the goods trade deficit narrowed and new home sales were stronger than expected. August consumer spending though was weaker than expected, suggesting some moderation in consumer spending. Various Fed speakers offered nothing new, but an edging up in August core inflation to 1.7% yoy, as measured by the private consumption deflator, is consistent with a December rate hike.
Eurozone economic data was good, with a rise in the German IFO business conditions survey to its highest since May 2014, a rise in overall Eurozone economic confidence to an eight month high and stronger growth in bank lending, all of which points to continuation of moderate economic growth at least. CPI inflation rose in September on base effects, but remains low at 0.4% yoy and core inflation fell to 0.8% yoy.
Japanese labour market indicators remained strong in September and industrial production rose, but household spending slowed sharply and headline inflation remained in deflation with core inflation falling to 0.2%yoy highlighting the BoJ has a lot of work to do to get inflation above its 2% target.
Chinese industrial profits rose 19.5% year on year in August, September business conditions PMIs were either up slightly or stable and consumer confidence rose to its highest since June all of which is consistent with a stabilisation in Chinese economic growth.
Australian economic events and implications
In Australia, job vacancies rose solidly in the three months to August, which is consistent with continued solid jobs growth. Growth in private sector credit decelerated further, with credit to property investors slowing further to 4.6% year on year, which is well below APRA’s 10% threshold. So APRA can claim a victory, although it does look like monthly growth in property investor credit may have bottomed and the Sydney and Melbourne property markets remain uncomfortably hot.
What to watch over the next week?
In the US, September data for the ISM manufacturing conditions index (Monday) and payroll employment (Friday) will be the main focus for the week ahead. Regional manufacturing conditions surveys and the Markit PMI already released suggest a recovery in the ISM to around 50.5 (from 49.4 in August). Payroll employment is likely to be solid at 180,000 new jobs, but unemployment is likely to remain around 4.9% and wages could edge up to 2.6%. All up this should keep the probability of a December Fed rate hike around 60%.
In Japan, the September quarter Tankan survey (Monday) will provide a guide to business conditions and confidence.
In Australia, the RBA (Tuesday) is expected to leave interest rates on hold for the second month in a row at 1.5%. Not enough has changed since the last rate cut in August, with the most recent commentary from the RBA, including from Governor Lowe, expressing a broadly neutral tone regarding rates. The RBA is likely waiting for the release of the September quarter inflation data (in late October) as a guide to whether it will cut in November. Governor Lowe has already stressed the importance of what the next inflation data will look like as a determinant of whether another rate cut occurs, so it will be interesting to see whether the post meeting Statement makes reference to this as it did three months ago ahead of the release of June quarter inflation data. Our view remains that the RBA will cut again at its November meeting, but this assumes another low September quarter inflation result & the A$ remaining uncomfortably high. Given recent solid growth data & a bottoming in commodity prices, we would have to admit that getting another rate cut is a close call.
On the data front in Australia, manufacturing and services sector conditions PMIs (due Monday and Wednesday respectively) are likely to show a bounce after hard-to-explain falls in August, CoreLogic home price data (Monday) is expected to show continued strength in Sydney and Melbourne for September, building approvals (Tuesday) are likely to fall 9% or so after an 11% bounce in July, retail sales (Wednesday) are expected to gain 0.3% month on month and the trade deficit (Thursday) will also be released.
Outlook for markets
While the period for seasonal share market weakness (August to October) so far has passed without a major mishap, we remain cautious on shares in the short term, as event risk remains high for the months ahead, including ongoing debate around the Fed, issues around Italian and Eurozone banks, the Italian Senate referendum & Austrian presidential election re-run (both to be held on December 4), the US election on November 8 and global growth generally. However, after any short term weakness, we anticipate shares to trend higher over the next 12 months helped by okay valuations, continuing 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 on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
Dwelling price gains are expected to slow as the heat comes out of Sydney and Melbourne, thanks to poor affordability, tougher lending standards and the apartment supply ramping up.
Cash and bank deposits offer poor returns.
There is a high risk that the A$ will re-test its April high of $US0.78 as the Fed continues to delay, presenting challenges for the RBA. Beyond the short term though, we see the longer term downtrend in the A$ ultimately resuming as the interest rate differential in favour of Australia narrows (as the RBA continues cutting and the Fed eventually resumes hiking), commodity prices remain low and the A$ sees its usual undershoot of fair value.