Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
(AMP Capital)
Investment markets and key developments over the past week
Most major global share markets had a strong end to 2019 consistent with the normal Santa rally seen around the Christmas/New Year period but also reflecting optimism about stronger global growth in 2020 on the back of monetary easing and a de-escalation in US/China trade tensions. Australian shares were an exception though seeing a 2.4% slide in December reflecting year end profit taking and the more uncertain economic outlook for the Australian economy. Nevertheless, the Australian share market rose 18.4% through 2019 for a total return of around 23.4% once dividends are allowed.
2020 saw share markets start on a strong note but gains were reversed to some degree by a renewed escalation in tensions with Iran which boosted demand for safe havens. So far this year US shares are up 0.1%, Eurozone shares are up 0.8%, Chinese shares are up 1.2% and Australian shares are up 0.7%. The latest Iranian tensions have seen oil prices spike 3% and safe haven demand has generally pushed bond yields down, metal prices down and the gold price up. The Australian dollar rose briefly above US$0.70 into year-end on the back of a weakening US dollar but has since fallen back on the back of renewed Iranian tensions.
The huge gains in share markets though 2019 – with US shares up 29%, Eurozone shares up 23%, Japanese shares up 18%, Chinese shares up 36% and Australian shares up 18% – reflected a recovery from the falls seen in 2018, the shift to monetary easing globally, the de-escalation of the US/China trade war, economic conditions not turning out as bad as expected and optimism for stronger global growth in 2020. The rebound has left shares a bit overbought and at risk of a short term pull back (with the escalating US-Iran tensions possibly providing a trigger), but beyond the short term the strong 2019 gains are indicative of positive momentum and while returns are likely to slow this year they should still be positive reflecting an absence of severe overvaluation, easy monetary conditions and some improvement in global growth.
While the US and China look on track to sign their Phase 1 trade deal on January 15 with President Trump tweeting that he will later travel to Beijing to begin Phase 2 talks, the latest escalation of US/Iran tensions and North Korea’s Kim Jong Un’s declaration that he is no longer bound by his pledge to President Trump to halt major missile tests provides a reminder that geopolitical risks remain high. The return of North Korean risk may at times worry markets but the reality has not changed: the US will not tolerate North Korea having the ability to hit the US with nuclear weapons, Kim knows this and is not suicidal so it’s all about brinkmanship and negotiation.
The US drone strike killing an Iranian general in Iraq coming after a series of violent episodes including a blockade of the US embassy in Iraq risks further escalating tensions between Iran and the US, threatening higher oil prices if supply is disrupted. Oil prices have spiked about 3% since the drone strike and could simply settle back down again as occurred after the attack on Saudi production back in September and as we have seen after various events in the Middle East. But the risk of further escalation has clearly gone up – given the direct attack on Iran, Iran’s threat of retaliation and Mr Trump’s desire to look tough – posing the threat of higher oil prices. Historically though oil prices need to double to pose a severe threat to global growth and we are long way from that.
The US$2 a barrel rise in oil prices seen so far in response to the drone strike is consistent with only a 2 cents a litre rise in the average petrol price in Australia, but it comes at a time when the regular petrol price cycle was at a low and due for an upswing and so we are likely to see petrol prices spike into the high $1.70s a litre area – which is already evident in some Sydney service stations. This would be new record highs for petrol prices. Higher petrol prices are yet another drag on consumer spending in Australia.
The seemingly never-ending Australian bushfire disaster is another drag on the local economy. This is a natural and humanitarian disaster of increasing proportions and I really feel for those being directly affected. Normally, natural disasters have a brief disruptive impact on the economy, but they are quickly swamped by the positive economic impact of rebuilding, so any negative impact on economic growth is often not that significant and quickly turns into a rebuilding boost. There will be a rebuilding boost in relation to the bushfires too, but the increasing risk is that because they are so widespread and going on for so long they will lead to a noticeable negative disruption to economic activity and will increasingly weigh on the national psyche further depressing consumer spending as Australians feel even less motivated to spend when their fellow Australians are suffering. The bushfires will only add to the pressure for more RBA easing and Federal fiscal stimulus – with the latter initially coming in the form of help for affected communities.
Major global economic events and implications
US economic data has mostly been good with gains in home sales, home prices, solid consumer confidence, rising construction spending, a fall back in jobless claims (although they still remain elevated post the late Thanksgiving distortion), a small rise in underlying durable goods orders and a smaller goods trade deficit. The manufacturing conditions ISM surprisingly continued to weaken in December, but it stands in contrast to the broader and more stable Markit manufacturing PMI which is well up from last year’s lows.
Japanese industrial production fell in November again after the sales tax hike related fall in October, but the labour market remained strong with unemployment falling to just 2.2%.
Chinese PMIs were flat or down slightly in December but remain up from 2019 lows which is a positive sign for growth and industrial profits rebounded in November. The PBOC announced a cut in bank reserve requirements from January 6 continuing the monetary easing seen in recent times.
Australian economic events and implications
In Australia, CoreLogic data showed a continuing strong rebound in house prices in December with average capital city prices up 1.2% month on month and 3% year on year, led by very strong gains in Sydney and Melbourne. The recovery on the back of the election removing the threats to negative gearing and the capital gains tax discount, rate cuts, APRA easing and FOMO against a backdrop of pent up demand from the 2017-19 period of falling prices and strong underlying demand due to population growth clearly continues. Sydney prices have now recovered 57% of the price fall seen since 2017 and Melbourne property prices have recovered 79% of their loss. We expect continued strength in the first half of the year helped by more RBA rate cuts which will take prices to new highs (by February in Melbourne and by May in Sydney). However, slower growth is likely later in the year as a result of the soft economy, tighter lending standards than in the last property boom and a possible renewed intervention by APRA. The boost to wealth associated with the rebound in property prices and strong share market and superannuation returns through 2019 should help support consumer spending but this is offset by slow wages growth, high underemployment and significant consumer uncertainty.
Meanwhile private credit growth in November slowed to just 2.3% year on year, the slowest since 2010 and housing credit growth slowed to 2.9% year on year, which is the slowest on record, as growth in the stock of housing related debt owed by investors went further into negative territory. Don’t forget the credit data reflects the total stock of debt and while rising housing finance commitments indicate growth in the flow of new mortgages this is being offset by the more rapid paydown of existing mortgages by cautious households. So, slowing growth in housing credit is not inconsistent with the rebound in the housing market. But it does tell us that consumer caution is seeing rate and tax cuts dedicated to paying down debt rather than boosting spending. This is often the case initially after such stimulus measures as it takes a while for consumers to get more confident. But they will need to do so soon if we are going to see economic growth pick up in line with Government and RBA forecasts.
What to watch over the next week?
In the US, the main focus is likely to be on jobs data for December to be released Friday, with payrolls expected to be up a solid but more sedate 170,000 after the blowout 266,000 gain seen in November. Unemployment is expected to remain ultra-low at 3.5% and wages growth is expected to remain at 3.1% year on year. In other data expect to see a slight improvement in the November trade deficit and a rise in the December non-manufacturing ISM (both due Tuesday).
Eurozone core inflation for December (Tuesday) is expected to have remained at 1.3% year on year, economic confidence data (Wednesday) is likely to show a slight further improvement and unemployment for November (Thursday) is expected to be flat at 7.5%.
China’s private sector Caixin services conditions PMI will be released Monday & CPI inflation for December (Thursday) is expected to show a further rise to 4.7% year on year due to higher food prices but with core inflation remaining weak.
In Australia, retail sales data for November due Friday will be the big one to watch to see whether Black Friday and Cyber Monday sales inspired Australians to spend a bit of the savings from rate and tax cuts they have seen in the last six months. Our expectation is for a decent 0.6% rise but expect this to have simply drawn spending from December, so the boost is unlikely to be sustained (as occurred in 2018). In other data, expect to see a 4% bounce in building approvals for November after an 8% fall in October and a further fall in ABS job vacancy data for November (with both due Wednesday), and the trade surplus (Thursday) for November is likely to have fallen further to around $4.2bn.
Outlook for investment markets
Improving global growth and still easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares and geopolitical risks are likely to constrain gains and create some volatility:
Global shares are expected to see total returns around 9.5% in 2020 helped by better growth and easy monetary policy.
Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and trade threat recedes as we expect.
Australian shares are likely to do okay this year but with total returns also constrained to around 9% given sub-par economic & profit growth.
Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns.
National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
Cash & bank deposits are likely to provide very poor returns, with the RBA expected to cut the cash rate to 0.25%.
The A$ is likely to fall to around US$0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2020 little changed.
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