AMP Capital – 22 July 2016
It’s now four weeks since the Brexit panic on June 24 and since then US shares are up 7%, Eurozone shares are up 6%, UK shares are up 10%, Australian shares are up 7% and Japanese shares are up 11%. Fears around Brexit’s global impact look to have been wildly exaggerated. The only really lasting impact (so far) has been on the British pound which is down another 4% leaving it down 11% from June 23rd, which reflects the negative impact of Brexit on the UK economy.
Over the past week the rally in shares generally continued with US shares up 0.6%, Eurozone and Japanese shares up 0.8% and Australian shares up 1.3% but Chinese shares down 1.6%. A combination of good economic data, good US profit results, the absence of a major negative impact outside the UK from Brexit and talk of more policy stimulus in parts of the world are continuing to help. Bond yields were generally flat to down, commodity prices fell and the $A fell partly in sympathy with NZ moves towards another monetary easing.
The talk around Japan’s planned fiscal stimulus is continuing to get ramped up with the size of the package supposedly rising from ¥10trillion, to ¥20trillion to maybe even ¥30trillion which is around 6% of GDP, albeit it depends how many years it is spread over. If as we expect it’s focussed on encouraging consumers to spend more then it should have a reasonable chance of success.
In maybe a sign of things to come in Australia – NZ looks to be heading for another rate cut. After a low inflation outcome, a further tightening in restrictions on residential mortgage lending and the Reserve Bank of New Zealand stating that “a decline in the [$NZ] is needed”, the RBNZ has set the scene for a rate cut next month. In fact, it said that “it seems likely that further policy easing will be required”.
The IMF downgraded its global growth forecasts to 3.1% for 2016 (from 3.2%) and to 3.4% for 2017 (from 3.5%) on Brexit risks – but hardly a surprise. It must often strike the ordinary investor as weird that much fanfare is given to the IMF downgrading its growth forecasts but share markets seem to largely ignore it. There are several reasons for this but in essence it’s because the market (and most economists) have already moved ahead of the IMF and the IMF global growth forecasts have been starting out too optimistic for years now. Since early this decade they have been starting out forecasting 4% global growth for the year ahead only to end around 3%. This is not great – but it’s not bad either! Just more of the same.
One positive from the last week – we learned that Trumps can say thoughtful things. Not to worry that they were Michelle Obama’s. In the week ahead it’s on to the Democrat convention which may be a lot calmer!
Major global economic events and implications
US data on a roll. Housing data was strong (with solid readings for home builder conditions, starts, sales and home prices), jobless claims remain very low, leading indicators rose more than expected and the Markit manufacturing PMI rose solidly in July. So much for all the waffle about a US recession! The US housing recovery likely has a long way to go as housing starts at 1.2 million continue to run below underlying demand of 1.5 million with the overbuilding of the last decade having been more than worked off. Buying a house in Detroit still looks like a good proposition!
Evidence is continuing to build that US profits bottomed in the March quarter. 125 S&P 500 companies have now reported June quarter earnings to date and so far so good with 82% beating on earnings and 60% beating on sales. While the market expects profits to fall 3% from a year ago, this will translate into a rise in profits of 8% from the March quarter.
As expected the ECB remained in wait and see mode at its July meeting. However, President Draghi referred to greater uncertainties in reference to Brexit and reiterated the ECB’s “readiness, willingness and ability to act” if necessary. We remain of the view that its QE program will be extended beyond its current expiry of March 2017. Eurozone business conditions PMIs and consumer confidence fell slightly in July suggesting little impact on confidence and conditions from Brexit. They remain at levels consistent with moderate growth. Interestingly the ECB’s bank lending survey showed an increase in demand for loans and a further easing in lending standards which is also a good sign as the survey was conducted before and after the Brexit vote.
It’s not so good for the UK where its PMI fell sharply in July as Brexit hit adding to evidence it may be heading into recession. Just remember though that the UK is only 2.5% of world GDP.
Japan’s manufacturing conditions PMI showed a welcome improvement in July albeit it’s still weak.
The Chinese property market recovery remains a positive for growth – with residential property prices up another 0.8% in June or 7.8% year on year. Meanwhile, the MNI Chinese business sentiment index rose in July and significant flooding in parts of China could have a short term positive impact on GDP from rebuilding and may temporarily boost food prices.
Australian economic events and implications
In Australia, the minutes from the RBA’s last Board meeting confirmed that the door is wide open for another rate cut at its August 2 meeting. While not as direct as the Reserve Bank of New Zealand, the RBA indicated that it was waiting on further information on inflation, the labour market and the housing market and the next update of the RBA’s economic forecasts. Since it has described the labour market and the housing market as “mixed” and recent data on both suggest no reason to change that assessment, the implication from the RBA is that should we see another low inflation reading when the June quarter CPI numbers are released on Wednesday then it’s likely that the RBA will cut the cash rate from 1.75% to 1.5% on August 2. A CPI outcome of 0.4% quarter on quarter for headline and underlying – which is what we expect – would likely be enough to see the RBA cut again.
What to watch over the next week?
The focus in the week ahead will be on monetary policy – with June quarter inflation data in Australia providing a guide to whether the RBA will cut rates again next month and both the Fed and Bank of Japan meeting – and European banks with another round of stress tests.
In the US, we expect the Fed (Wednesday) to leave rates on hold as it seeks to gain more confidence that US growth is back on track and that the impact from Brexit will be minimal but to indicate that it still expects to raise rates in a gradual and cautious fashion. The US money market is only implying a 10% chance of a hike in the week ahead but the Fed may try and push up the market’s implied probability of a hike going forward which is currently at just 24% for September and 45% for December. With US growth averaging around 2%, the labour market continuing to tighten with wages growth edging higher and inflation heading up towards target we see more like a 65% chance of a hike in December. The main brake on the Fed will be if the $US rises too strongly as it amounts to a de facto monetary tightening. On the data front in the US expect to see continuing gains in US home prices, a rise in new home sales but a fall in consumer confidence (all Tuesday), softish durable goods orders and a rise in pending home sales (Wednesday), a slight edging up wages growth according to the June quarter employment cost index and a bounce back in annualised GDP growth to 2.6% in the June quarter (both Friday) after just 1.1% growth in the March quarter. Earnings will also remain a focus with over 180 S&P 500 companies to report June quarter earnings.
In the Eurozone, the focus will be on the latest ECB bank stress tests (Friday) which will indicate whether banks are sufficiently capitalised or not. Italian banks of course will be the main focus, and the stress tests should help clear the way for some of them to be recapitalised. On the data front expect June quarter GDP (Friday) to show moderate economic growth of around 1.5% year on year and confidence readings (Thursday) will provide a further guide to the impact of Brexit on business confidence. Data will also be released for bank lending (Wednesday) and core inflation (Friday) is likely to have remained around 0.9% year on year on July.
The Bank of Japan (Friday) is likely to announce further monetary easing as the Japanese government prepares to unveil its much talked about fiscal stimulus package. While it’s doubtful this will involve “helicopter money” (i.e. direct BoJ financing of government spending), it is getting close. Rather it’s likely to involve further monetary easing through some combination of increased ETF and corporate debt purchases and another cut in the negative deposit rate. While Bank of Japan Governor Kuroda rejected the idea of helicopter money in June he also rejected negative interest rates shortly before announcing them. Japanese data due Friday is expected to show continued labour market strength and a bounce in industrial production but soft household spending and inflation.
In Australia, expect another low inflation reading on Wednesday for the June quarter to clear the way for an August RBA rate cut. While headline inflation is expected to rise 0.4% quarter on quarter thanks to higher petrol prices and a seasonal rise in health costs this is likely to see annual inflation drop to 1.1% year on year and low wages growth and competitive pressures are likely to have seen underlying inflation rise just 0.4%qoq or 1.4%yoy which is down from 1.6%yoy in the March quarter. June credit data (Friday) is likely to show that credit growth remains moderate with the stock of lending to property investors continuing to show slower growth.
Outlook for markets
Brexit related risks, Italian bank risks, renewed $US strength as the Fed heads back towards tightening and seasonal September quarter weakness could still see more volatility in shares in the short term. However, beyond near term uncertainties, we anticipate shares trending 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 (with one third of the global bond index in negative yield territory) 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. Renewed expectations of a Fed hike may be the driver.
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 tougher lending standards and as apartment prices get hit by oversupply in some areas. Prices are likely to continue to fall in Perth and Darwin.
Cash and bank deposits offer poor returns.
The Australian dollar is still higher than it should be and the longer term downtrend looks likely to continue 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. The $A is still likely to fall to around $US0.60 in the years ahead.