13 January 2017
The major driver in markets this week was the press conference by incoming US President Trump, but investors were left disappointed. Trump’s comments lacked economic detail about fiscal spending and tax stimulus, which have been key drivers of higher equities, USD & bond yields. Instead, the topics discussed included allegations of Russian hacking, Trump’s business interests, drug pricing and border tax control. At least Trump didn’t back away from his pre-election promises. Following the press conference, the US$ lost some ground and is down by 0.7% over the week. US equities were less affected and are 0.3% higher over the week. Market focus will now turn to the US presidential inauguration Day on 20th January and the Inaugural Address. Any changes to economic policy after this date will take time to be formalised and implemented so the risk is that markets are left disappointed again, particularly after the big upward moves in equities and bond yields over the past two months.
Across other global markets, equities are generally down over the week – Australia (-1.5%), China (-1.8%), Japan (-0.1%). European equities rose by 0.5% over the week.
The fall in the US$ was positive for emerging markets, which were up by 2.0% over the week. A higher US$ is a threat to emerging markets because of the high levels of US$ denominated debt.
A retracement in the US$ was positive for commodity prices this week with the iron ore price back above US$80/tonne. Oil prices rose after Saudi Arabia announced that it would cut output by more than expected with Brent prices up by 0.9% over the week.
The British pound weakened after Prime Minister Theresa May commented that the strategy for Brexit would be discussed over the next few weeks with the formal proceedings to be invoked before the end of March. Markets took her comments as a sign of a “hard” Brexit with the comment that Brexit is about “getting the right relationship, not about keeping bits of membership”. May is scheduled to give a speech on Tuesday that will set out the government’s plan for Brexit which could cause some more downside in the Pound.
The Central Bank of Brazil surprised the market and cut interest rates by 0.75% (markets were expecting a 0.50% cut) because of falling inflation and a slower-than-expected economic recovery. The current environment calls for more interest rate cuts in 2017.
Major global economic events and implication
US December retail sales rose by 0.6%, a touch below market expectations and the University of Michigan consumer sentiment reading was also a little softer than expected. US banks kicked off fourth quarter reporting season, with JPMorgan & Bank of America reporting good outcomes, and bank shares lifted on the back of the results. The US NFIB small business survey showed a surge in optimism in December–reaching its highest level since December 2004. The good outcome was driven by a lift in expectations around a better economic outlook, followed by better sales prospects and businesses noting that it was a good time to expand. US consumer credit rose by more than expected in November – a good sign for consumer spending, but the Bloomberg consumer comfort index declined again this week. Imported US prices are now 1.8% higher than a year ago because of the large lift in energy prices. The uptick in the US$ over the past two months will keep a lid on imported price growth in the near-term.
Chinese producer price inflation was stronger than expected in December, with the PPI (producer price index) lifting by 5.5% over the year to December. Higher producer price inflation has been driven by a rebound in commodity prices, a lift in imported inflation, a reduction in capacity in mining industries and a rebound in property investment. Rising producer prices have historically led industrial profits and stronger investment growth which would be positive for GDP growth in China. Consumer price growth was softer, lifting by 2.1% over the year to December, below expectations, with lower food price inflation dragging growth lower. The December Chinese trade surplus was a little narrower than expected because of softer export growth.
Good European data has continued into 2017 with the European Commission’s index of economic sentiment rising to its best reading since March 2011 and confidence in the industrial sector recording its first positive reading for more than five years. The European Central Bank’s December Council meeting minutes showed that there were numerous policy options discussed with the final decision to extend the asset purchase program by nine months, but a slower pace of €60bn/month. The final decision was seen as a good balance between signalling confidence and also preserving stability in an “uncertain environment” whilst also maintaining flexibility in policy.
Australian economic events and implications
Building approvals rose by 7.0% in November, but this followed a very large fall in the prior month. The volatility in building approvals occurs from the multi-density sector (apartments/semi-detached dwellings) because of the large scale and lumpy nature of this sector. The approval up-cycle in the housing market has already passed its peak. But, the flow-through to actual construction activity is still occurring – which is positive for GDP and employment growth. The mining to non-mining growth transition has relied on a pick-up in dwelling investment to offset falling mining construction from a growth and employment perspective. Dwelling construction will start to slow in the second half of 2017 but it looks like non-residential building activity could pick up the slack with building approvals for this sector looking quite solid over recent months, particularly in commercial building.
Retail sales were up by 0.2% in November, which is a soft monthly outcome but it does follow three months of quite strong growth. Annual retail sales growth eased to 3.3%. The long-term average in annual retail spending is much lower compared to the early 2000’s (see chart below). Structural industry changes (e.g. the rise of online overseas shopping, a shift towards services spending) and lower inflation have been drivers behind slower nominal retail sales growth.
Source: ABS, AMP Capital
The Australian Bureau of Statistics measure of job vacancies rose by 2.2% in the November quarter. Vacancies are around 8.9% higher than a year ago, indicating that employment growth should still hold up well over the next few months. Over the year to November, vacancies rose by the most in service-based industries with other services (repair & maintenance, personal services), finance & insurance and information, media and telecommunications industries recording very strong rises in vacancies. The broad range of employment indicators (job advertisements & vacancies, hiring intentions) are weaker now than compared to a few months ago (consistent with slower employment growth) but are not indicating a collapse in the labour market. Moderate employment growth and a low participation rate should keep the unemployment rate below 6.0% in 2017.
What to watch over the next week?
In the US, there are updates on December consumer prices, industrial production and housing market indicators such as housing starts and building permits. US earningsreporting for the fourth quarter in 2016 continues in the week ahead. While it appears that the earnings recession in the US has finished, there are also some signs that the bar for earnings growth has lifted because of better expectations for growth, so there is the risk for investor disappointment. The presidential inauguration takes place on Friday 20th and after this event takes place, markets will be eagerly anticipating new policy announcements.
In Australia, consumer sentiment, housing finance, dwelling starts and labour force data is released. The employment data is expected to show a small lift in jobs growth in December (around 8K), with the unemployment rate remaining at a low 5.7%. The labour market weakened in 2016, but jobs growth is still running at levels that are enough to keep the unemployment rate unchanged.
The European Central Bank and Bank of Canada meet next week and no change is expected from either central bank.
Chinese data includes the fourth quarter GDP, fixed asset investment, industrial production and retail sales for December. GDP is expected to have risen by 6.7% over the year to December 2016 – the same pace as the prior quarter.
Outlook for markets
Shares have a very solid rally since the election of Trump in November on expectations of a lift in growth and inflation in the US & and the flow through to other economies. Positive global data has also supported equity prices. But, some consolidation in shares and the US$ is likely in the near-term as sentiment has become stretched on the upside. There will no doubt also be nervousness post Trump’s inauguration around what the new US President will actually do, US-China tensions and the negative consequences domestically and globally of a higher US$. However, we see share markets trending higher over the next 12 months helped by okay valuations, continuing easy global monetary conditions, fiscal stimulus in the US, moderate economic growth and the shift from falling to rising profits for both the US and Australia.
Sovereign bonds are now very oversold and due for a short term pullback in yield which has already started happening in early 2017. But on a medium term view, still low bond yields point to a poor return potential from bonds and the abatement of deflationary pressures as commodity prices head up, the gradual using up of spare capacity and a shift in policy focus from monetary to fiscal stimulus indicates that the long term decline in yields since the early 1980s is probably over. So expect the medium-term trend in bond yields to be up.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors, but this demand will wane as bond yields trend higher over the medium term.
Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas into 2018.
Cash and bank deposits offer poor returns.
A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend in the A$ remain down.