Weekly Market Update
Investment markets and key developments over the past week
Share markets were mixed over the last week with the US share market reaching record highs helped by good earnings news and gains Chinese and Australian shares, but European shares fell on a further rise in the Euro and Japanese shares were flat. Bond yields were little changed but the big development was a further plunge in the US dollar partly as investors interpreted comments by US Treasury Secretary Mnuchin highlighting that a weaker US dollar is good for the US as indicating a weakening in the US Government’s traditional “strong dollar” policy. The falling US dollar contributed to gains in commodity prices with oil also boosted by falling US oil stockpiles and a rise in the Australian dollar back above $US0.80.
Collapsing US dollar creating consternation but should be self-limiting. The plunge in the US dollar (down 13% since the start of 2017) is basically a monetary easing for the US and will further boost US growth, profits and the US share market. It’s also good news for emerging countries with US dollar debts. The flipside though is that its working against Fed tightening and so may see the Fed tighten faster and US tariff hikes risk driving a stronger, not weaker, US dollar. For Europe, Japan and Australia the falling US dollar is a defacto monetary tightening which could delay eventual rate hikes. Taken together this should help limit downside in the $US. At least a falling US dollar is nowhere near the concern that a surging US dollar posed going into 2016.
Global growth forecasts still being revised up. In its latest global economic review, the IMF revised up its growth forecasts yet again, with broad based increases. The pattern of IMF revisions is basically the same as for private sector forecasters and as the next chart highlights years of growth downgrades have given way to upgrades as the post GFC hangover has given finally given way to more self-sustaining growth. Just as the growth downgrades were associated with falling inflation, ongoing monetary easing and falling bond yields the upgrades are likely to eventually give way to rising inflation, gradual monetary tightening and further increases in bond yields.
US shutdown ended after three days, with Congress extending funding out to February 8th. Agreeing a solution for “Dreamers” (children of illegal immigrants) remains a big political issue and so another brief shutdown is possible after February 8th. However, the economic impact is likely to remain trivial - the Democrats are wary of the political risk of being seen to blame for a shutdown and so any further shutdown is likely to be brief. From the perspective of economists as long as the flow of US economic stats is not disrupted its definitely trivial! The US Government’s debt ceiling will also start to become an issue next month (with the ceiling likely to be reached in March or early April) – but expect another last minute solution as neither side of politics wants to risk default.
Meanwhile, President Trump’s decision to impose tariffs on imported solar panels and washing machines (that will mostly affect China and South Korea) confirms that he is turning to trade to boost his popularity in an election year. Expect more moves this year as Trump tries to push his America First agenda which could cause moments of angst investment markets. An all-out trade war with China is a risk worth watching, but is unlikely though – as Trump won’t want to risk big increases in consumer prices hitting his base and China will likely react calmly. In fact, comments by Liu He, a senior adviser to President Xi, foreshadowing policies to further open its economy, boost imports and cut tariffs suggest China is actually going in the opposite direction. And news that the Trans Pacific Partnership is now going ahead without the US is good news in highlighting that the US is isolated in adopting protectionism.
Major global economic events and implications
US economic data over the last week was mixed with a fall in existing home sales, although this may be due to weak supply, but a solid reading for business conditions PMIs in January and continued gains in home prices. The December quarter US earnings reporting season is off to a strong start. Of the 100 S&P 500 companies to have reported so far 82% have beaten earnings expectations and 83% have beaten on sales.
Eurozone business conditions PMIs and consumer confidence rose even further in January to very strong levels and are consistent with a further acceleration in economic growth. The ECB’s December bank lending survey also showed stable or easing lending standards and rising credit demand. Germany also moved a step closer to stable government with the Social Democrats voting to support formal coalition talks with Angela Merkel’s coalition.
The Bank of Japan made no changes to its monetary policy or its growth and inflation forecasts. While it sounded a bit more upbeat on inflation noting that inflation expectations are no longer falling it continues to see downside risks to inflation, and the one dissent was dovish. With core inflation running way below target no imminent exit from monetary stimulus is likely.
New Zealand inflation surprised on the downside for the December quarter highlighting that the move to higher inflation globally is still taking a while to get underway.
Australian economic events and implications
It was a light week for data releases in Australia, with skilled vacancies showing continuing growth albeit with some slowing.
What to watch over the next week?
In the US, the Fed (Wednesday) is not expected to make any changes to monetary policy but its commentary is likely to be upbeat and consistent with further monetary tightening this year, including ongoing quantitative tightening and another rate hike in March after Jerome Powell takes over. We remain of the view that stronger US growth and rising inflation will drive four Fed rate hikes this year, whereas the US futures market is only pricing in two and a bit. It will also be a busy weak on the data front in the US with payrolls (Friday) likely to show strong January jobs growth of 180,000, unemployment remaining low at 4.1% and wages growth rising slightly to 2.6% year on year. Also expect strong December personal spending data and a slight rise in core personal consumption inflation (Monday) to 1.6% year on year, continued strength in home prices and consumer confidence (Tuesday) and the January manufacturing conditions ISM (Thursday) to remain strong at around 59. December quarter earnings results will also continue to flow.
Eurozone December quarter GDP growth (Tuesday) is expected to confirm a further pick up in economic growth to around 0.8% quarter on quarter or 2.8% year on year. December unemployment is likely to fall to 8.6% (from 8.7%) but core inflation for January is likely to remain unchanged at 0.9% year on year (both are also due Tuesday).
Japanese data for jobs, household spending and industrial production (all due Monday) are expected to be strong.
Chinese business conditions PMIs (due Wednesday and Thursday) are expected to remain consistent with solid growth.
In Australia, December quarter inflation data is likely to be consistent with the RBA remaining on hold for now. Higher prices for petrol and tobacco are expected to push headline CPI inflation up to 0.7% quarter on quarter or 2% year on year, but underlying inflation is expected to remain subdued and below target at around 0.5% qoq or 1.9% yoy. In other data expect the NAB business survey (Tuesday) to show continued solid business conditions, credit growth (Wednesday) to remain moderate, business conditions PMIs (Thursday) to remain solid, CoreLogic data for January (also Thursday) to show a further cooling in the Sydney and Melbourne property markets and building approvals for December (also Thursday) to show a 10% decline after a strong rise in November.
The Australian December half 2017 earnings reporting season will start to get underway but with only a trickle of companies including Navitas, GUD and James Hardie. Expect to see a fall back to single digit earnings growth (after the resource driven surge seen in 2016-17) with overall earnings growth around 5%, with resources slowing to around 1%, banks around 3% and industrials up 8% with strong results for healthcare, gaming, building materials and consumer staples.
Outlook for markets
For 2018, continuing strong economic and earnings growth and still easy monetary policy should keep overall investment returns favourable but stirring US inflation, the drip feed of Fed rate hikes and a possible increase in political risk are likely to constrain returns and increase volatility after the relative calm of 2017
Apart from the likelihood of a correction early in 2018 and more volatility through the year, global shares are likely to trend higher through 2018 and we favour Europe (which remains very cheap) and Japan over the US.
Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth. Expect the ASX 200 to reach 6300 by end 2018.
Commodity prices are likely to push higher in response to strong global growth.
Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds.
Unlisted commercial property and infrastructure are still likely to benefit from the search for yield by investors, but it is waning and listed variants are vulnerable to rising bond yields.
National capital city residential property price gains are expected to slow to around zero as the air comes out of the Sydney and Melbourne property boom and prices fall by around 5%, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
After a short term bounce higher to maybe $US0.81-82, the $A is likely to fall against the $US, as the gap between the Fed Funds rate and the RBA’s cash rate goes negative. Solid commodity prices will provide a floor for the $A though.