03 February 2017
Despite good economic and profit news, Trump jitters dominated markets over the last week, but his plan to relax bank regulations and benign US jobs data saw US and Eurozone shares bounce back at the end of the week. This saw US shares rise 0.1% for the week, but Eurozone shares fall 0.8%, Japanese shares down 2.8% and Australian shares down 1.6%. Chinese shares lost 0.7% on the back of People’s Bank of China monetary tightening. Bond yields were mixed but the US$ fell and this combined with news of a record trade surplus saw the A$ rise.
Worries about Trump could be with us for a while yet as his belligerent approach, his team’s inexperience and fears about trade wars and US isolationism could dominate the pro-growth positives of his policies at times as it will take a while to push through deregulation, tax cuts and increased infrastructure spending. That said, the pro-business focus is clearly there with Trump stopping the Obama “fiduciary rule” from taking effect and ordering a review of Dodd-Frank financial rules. One thing we have to get used to though is more noise coming out of Washington, but a lot of it is just that, ie noise!
Eurozone political risks will also feature this year. High on the list is France which has presidential elections in April and May. Polling continues to show that populist Eurosceptic Marine Le Pen will make it into the second round polling more than any other candidate at around 27%, but that the independent former economy minister Emmanuel Macron (polling at 23%) or the Republican party’s Francois Fillon (polling at 20%) will defeat her in the second round (at 65% to 35% and 59% to 41% respectively). Both Macron and Fillon are pro-Europe and reform oriented but Fillon has been hit by a scandal involving the employment of his wife and children as parliamentary assistants (which is legal but the issue is whether they actually worked). Whether its Macron or Fillon who makes the second round against Le Pen, it looks unlikely Le Pen will ultimately win. But then again there are still several months to go and of course last year’s Brexit and Trump “upsets” can’t be ignored. As a result investors will worry about it and so French bond yields have been rising against German yields.
The 0.8% fall in Australian shares in January is not so positive in terms of the January barometer, which states that “as goes January so goes the year”. That said, a negative January is less reliable a guide to the year as a whole than a positive January. Just recall last year! Since 1980, a negative January in Australian shares has gone on to a negative year only 31% of the time. Perhaps more importantly, the US share market rose in January by 1.8%, and since 1980 a positive US January has gone on to a positive year 86% of the time.
New US sanctions against Iran may provide a bit of short-term support for oil prices, but with global oil inventories above normal levels it’s hard to see a huge impact short of a major disruption to Iranian oil flows.
Major global economic events and implication
Looking globally, business conditions PMIs continued to improve in January pointing to stronger global growth. Very different to a year ago when PMIs were heading down.
Source: Bloomberg, IMF, AMP Capital
US economic data was strong with solid business conditions, strong home price gains, solid consumer confidence and growth in personal spending, strong jobs data with a 227,000 gain in January payrolls and a rise in pending home sales. That said, a rise in labour force participation supports the view that there is still slack in the US jobs market, wages growth according to the employment cost index and average hourly earnings in January remains modest and core personal consumption inflation remains stuck around the same levels it’s been at for a year.
The Fed upgraded its comments regarding current conditions but there were no changes to the outlook and there was nothing pointing to a rate hike next month. With wages growth still weak and signs of ongoing slack in the US jobs market we continue to see the Fed remaining gradual with three rate hikes this year with the first being in May or June.
55% of US S&P 500 companies have now reported September quarter profits, with 74% beating earnings expectations and 50% beating on revenue. Earnings are now expected to be up 6% from a year ago taking them to a new high, highlighting that the earnings recession that began in 2014 is long over.
Eurozone economic data was also solid with a pick-up in December quarter GDP growth and confidence and manufacturing conditions PMIs at five and a half year highs. While headline inflation rose solidly in December on the back of higher energy prices, core inflation remains stuck at 0.9% year-on-year suggesting that the ECB won’t be rushing just yet to taper its quantitative easing program.
Japanese jobs data was good with stronger than expected readings for household spending and industrial production. Meanwhile, the BoJ left monetary policy on hold as expected.
Chinese manufacturing conditions PMIs fell in January but services conditions rose slightly, which points to continued solid growth for now. The PBOC’s move to raise short term money market rates by 0.1% continues the incremental shift to tightening in China seen in recent months. With growth stabilising, the focus has returned to controlling credit growth, but the authorities are unlikely to tolerate sub-6% GDP growth.
Australian economic events and implications
Australian data was a mixed bag. The NAB business survey showed strong business conditions in December adding to confidence that growth bounced back in the December quarter and the surge in iron ore and coal prices drove the trade balance to a record surplus in December. Against this though building approvals slipped further adding to evidence that they have peaked. While the surge in commodity prices and the associated boost to national income won’t provide the same boost to the economy seen last decade (as tax cuts are less likely due to tougher budgetary conditions, the mining investment boom has already happened and its likely to be less durable) it’s better than falling national income and will provide some offset to the loss of momentum in dwelling construction.
Meanwhile, a continuing surge in credit growth to property investors in December and a strong start to the year in home price growth adds to concerns that the Sydney and Melbourne property markets remain too hot. If the RBA is to have the flexibility to cut interest rates again, another round of macro-prudential tightening by APRA is likely to be needed.
What to watch over the next week?
In the US, apart from what President Trump may do, the main focus in the week ahead will be on December quarter earnings reports with over 100 major companies due to report. On the data front it will be pretty quiet with December trade data (Tuesday) expected to show an unchanged deficit and consumer sentiment and import price data due Friday.
Chinese trade data for January is expected to show a strengthening in import growth to around 5% year-on-year and a return to positive growth for exports at around 2% yoy.
In Australia, the focus will be back on the RBA (Tuesday) but it’s unlikely to make any changes to interest rates. While the low September quarter inflation reading leaves the door wide open for another rate cut, a move on Tuesday is unlikely as the inflation outcome was in line with the RBA’s own forecast and it’s likely to want to monitor the recent uptick in lending to property investors and see how the economy performs after the September quarter slump. As a result all eyes will be on the post meeting Statement and the Statement on Monetary Policy to be released Friday. Of most interest will be any revisions to the RBA’s forecasts, where we expect a downwards revision to the growth and possibly inflation forecasts. Our assessment remains that – with record low wages growth, ongoing spare capacity, an increasing risk that low inflation will feed on itself and the A$ remaining too high – the RBA will cut rates again around May. Also of interest will be what the RBA has to say about the resurgent Sydney and Melbourne property markets – are they embarking on another round of discussions with APRA?
On the data front in Australia, expect a 0.2% rise in December retail sales and a 0.8% rise in retail sales volumes for the December quarter (Monday) and 0.5% rise in December housing finance (Friday) again driven by property investors.
The Australian December half profit reporting season will ramp up with 16 major companies reporting (including Rio, AMP, NewsCorp and Suncorp). Steady earnings upgrades for resources stocks on the back of the rise in commodity prices has seen the consensus expectation for 2016-17 earnings growth rise to 17% from around 7% last September. Resource company profits are expected to more than double, but profit growth across the rest of the market is likely to be around 5% led by retailers, utilities, telecommunications and building materials companies. Key themes are likely to be: a massive turnaround for resources companies; constrained revenue growth for banks and industrials; and an ongoing focus on dividends.
Outlook for markets
A further short term consolidation or correction in shares is likely as sentiment towards them remains very high, Trump related uncertainty will be with us for a while and as we enter the seasonally weaker month of February. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, some acceleration in global growth and rising profits.
Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. Australian bonds are preferred to global bonds reflecting higher yields and as the RBA remains well behind the US in moving into a tightening cycle.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield, but this demand will wane as bond yields trend higher over the medium term.
National capital city residential property price gains are expected to slow to around 3-4% this year, as the heat comes out of the Sydney and Melbourne markets and rising apartment supply hits.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
The A$ has had a short term bounce as the US$ corrected from overbought levels. This could go further and see a retest of US$0.78. However, the downtrend in the A$ from 2011 is likely to resume as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below US$0.70 by year end.