Caution Seems Warranted

Global equities posted further gains last week on the back of very dovish Fed commentary, capping off what’s been a promising start to the year so far. Indeed, global equities returned 7.3% in local currency terms in January after posting a loss of 7.2% in December. Australian equities returned 3.9% with solid gains across most sectors apart from financials, with the latter still being weighed down by slowing credit growth and fears of what may emanate from today’s release of the Hayne Royal Commission findings.

More broadly global equities are benefiting from several positive developments since the dark days of late last year. For starters, the US Fed has been obviously shell shocked by the market rout last year (partly caused by it’s own clumsy statements) and appears likely to hold rates steady at least for a few more months. My base base is that the next Fed move will not be until June, though two rate rises still seem likely this year given the ongoing solid momentum within the economy (as evident from Friday’s payrolls report). The Fed also seems likely to announce in coming months that its balance sheet reduction program (i.e. not replacing maturing bonds) could be completed by year-end.

Meanwhile, a trade deal of sorts between the US and China still seems likely within the next few months, although exactly how far reaching it will be remains to be seen. I still suspect both sides will be keen to sign something, if only to appease markets, and even if many tricky problems (such as protection of US intellectual property) are kicked down the road somewhat further. The US Government shutdown has also ended, at least for a while.

It’s also reassuring that US price and wage inflation indicators are still not flashing red, despite the tight labour market. Average hourly earnings in the January payrolls report grew 0.1%, with the annual rate easing back to 3.2% from 3.3%. The current US earnings reporting season is also holding up reasonably well.

That said, market caution heading into this year still seems warranted for several reasons. Global growth outside of the United States (especially Europe) is slowing. US earnings growth expectations for 2019 have also been downgraded in recent months. To my mind, the outlook for US (and global) equities this year remains crucially dependent on the earnings outlook – at best only modest growth is now expected, which together with likely renewed upward pressure on bond yields suggests overall equity market gains could be muted.

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In Australia, recent data – most notably last week’s surprisingly soft NAB business survey – suggests the economy is under downward pressure. So far at least, however, lead labour market indicators are still positive.

There’s little in the way of major US data this week suggesting attention will focus on US-China trade talks and the ongoing earnings reporting season.

In Australia, the outcome of the Hayne report will dominate discussion early this week, after which it’s all about the RBA – with a policy meeting, speech by the Governor and the quarterly Monetary Policy Statement all scheduled. My sense is that the RBA will still want to portray an upbeat message and will continue to suggest the next move in rates is likely up – albeit not for quite sometime. Indeed, my base case view remains that the RBA will leave rates unchanged this year, and will only waver on this if the labour market weakens and the unemployment rate begins trending higher.

Have a great week!