A look at the week gone by
Correction or ‘Gummy Bear Market’? Future still unclear
Share markets remained under pressure over the last week, with many falling back to or below their late October lows due to worries about trade, tech stocks and global growth. Despite the risk, off tone bond yields were little changed, but the oil price remained under pressure and the iron ore price fell a bit too. The US dollar rose slightly and this weighed on the Australian dollar.
Meanwhile, share markets fell back to around their October lows over the last week. A retest of the lows is quite normal after the sort of fall we saw in October, and whether markets form a double bottom and head back up or break decisively lower to new lows is unclear.
In favour of the former, less stocks have made new lows into the latest fall, and Asian and emerging markets are looking a lot healthier (having led this share slump and having had much deeper falls).
However, against this, many of the triggers for the fall in markets remain in place.
The bottom line is that I don’t know whether it will remain just a correction or maybe slide deeper into what I like to call a “gummy bear market” (where markets have a 20 per cent top to bottom fall but are up a year after the initial 20 per cent decline).
I remain of the view that it’s unlikely we are sliding into a deep or grizzly bear market, as the conditions are not in place for recession in the US, globally or Australia.
Italy rocky but unlikely to experience major crisis
In Europe, Italy looks to be heading into what is called an “Excessive Deficit Procedure” – a process administered by the European Commission but approved by Eurozone finance ministers designed to get its expansionary budget deficit back on track with debt limits.
However, a major crisis still looks unlikely. More likely is some sort of fudge, combining various delays in enforcing any deficit reduction and some compromises.
The rest of Europe won’t want to put too much pressure on Italy, for fear of fuelling anti-Euro sentiment and, in any case, by the time Italy has to respond to any requests under the EDP, it won’t be till later next year, by which time the 2019 budget will be largely history.
Events on the home front
Australia was a bit quiet on the data over the last week, with a rise in the CBA’s business conditions PMI for November, albeit it remains well down on last year’s high.
However, skilled vacancies fell again in October and the trend is now down for seven months in a row, pointing to a slowing in employment growth.
RBA Governor Lowe voiced his concerns that “the pendulum might be swinging a bit too fair the other way” when it came to credit tightening. He also acknowledged the risks around wages remaining weak even if unemployment falls further.
He is clearly aware that estimates putting the so-called NAIRU at 5 per cent are rubbery. Perhaps he is starting to question the RBA’s own mantra that the next move in rates is more likely up than down.
Prime Minister Scott Morrison changed all that in the last week, flagging a cut to the annual immigration cap of 190,000 by 30,000. This sounds like just affirming the actual level of immigration, which has already slowed by about 30,000.
However, having brought the debate into the centre of politics risks seeing immigration getting cut further.
This is particularly relevant to the property market, as it was the surge in population growth from around mid-last decade without a housing supply pick-up (until around 2015) that has played a big role in the surge in house prices relative to incomes.
If immigration starts to fall back at a time of rising supply, it will be one more factor sending property prices south in Sydney and Melbourne, which take something like 60 per cent of immigrants.
Our view remains that these two cities will see 20 per cent top to bottom price declines out to 2020, but there are clearly some risks on the downside to this.
What’s happening in the week ahead?
The big event in the week ahead will be the meeting between Presidents Trump and Xi on the sidelines of the G20 meeting in Buenos Aires to discuss trade.
The APEC debacle between the US and China and a report by the US Trade Representative repeating criticism of China are driving low market confidence of a deal being reached between the US and China on Friday/Saturday.
However, against this, Trump appears to want a deal knowing that further tariff hikes (which are really tax hikes) will start to offset his fiscal stimulus next year and may be starting to impact business confidence and hence capital spending. All of which may start to negatively impact Trump’s 2020 re-election prospects.
Reports that White House trade adviser and protectionist Peter Navarro will not be attending the meeting is also a positive.
In the US, the focus is likely to be on the Fed, with more signs of a possible pause on interest rates. A speech by Fed Chair Powell (Wednesday) is likely to repeat that he is aware of the various headwinds to the US economy, leaving the impression that the Fed is open to a pause on interest rates next year.
Of particular interest will be if he has to say anything about continuing share market volatility and recent softness in housing and business investment indicators
On the US data front, expect home price data (Tuesday) to show continuing modest gains, consumer confidence for November (also Tuesday) to show a slight fall from 18-year highs, new home sales (Wednesday) to show a bounce, September quarter GDP growth (also Wednesday) to be revised up 0.1 per cent and personal spending growth (Thursday) to have remained solid, but with core private consumption deflator inflation falling back to 1.9 per cent year on year.
Eurozone economic confidence for November (Wednesday) should be watched for any stabilisation, after several months of softness.
Unemployment for October (Friday) is likely to be unchanged at 8.1 per cent and core inflation for November (also due Friday) is likely to be unchanged at 1.1 per cent year on year.
Japanese data, to be released Friday, is likely to show continuing labour market strength helped by a falling population but industrial production is likely to show a bounce.
This is against a backdrop of Japanese headline inflation rising by 1.4 per cent year on year in October.
However, this will fall back with the oil price in November, while core inflation is stuck at 0.4 per cent year on year, so the BoJ is no closer to being able to tighten monetary policy.
Chinese business conditions PMIs for November will be released Friday, with the focus likely to be on the manufacturing PMI, which has been slowing lately.
Speeches by RBA Governor Lowe and Assistant Governor Kent on Monday will be watched for any clues on rates.
On the data front, expect to see a 1 per cent gain in construction data for the September quarter (Wednesday), a 1.5 per cent gain in September quarter business investment (Thursday) and continuing moderate credit growth (Friday), with ongoing weakness in lending to investors.
A key focus will be whether investment intentions data points to further improvement.
Into the future
Low yields are likely to drive low returns from bonds. However, Australian bonds will continue to outperform global bonds as the RBA holds and the Fed continues to hike (albeit they may slow down a bit).
Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
National capital city residential property prices are expected to slow further, with Sydney and Melbourne property prices likely to fall another 15 per cent or so, but Perth and Darwin property prices at (or close to) bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
Alongside this, cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2 per cent.
Having fallen close to our target of US$0.70, the Australian dollar is at risk of a further short-term bounce, as excessive short positions are unwound.
However, beyond a near-term bounce, it likely still has more downside into the US$0.60s, as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Being short the $A remains a good hedge against things going wrong globally.