Green Shoots Pointing To Better Global Growth

Investment markets and key developments over the past week

• Share markets pushed higher over the last week helped by more “green shoots” pointing to improving global growth this year, including Chinese business conditions PMIs & the US ISM index and a stabilisation in Eurozone composite PMIs, and more indications that the US and China are getting closer to a deal on trade (albeit with issues around enforcement and the removal of last year’s tariff hikes yet to be agreed). This saw US, Eurozone and Australian shares make it to six month or so highs. Reflecting the risk on tone bond yields rose. While the copper price fell, oil rose as did iron ore helped by a new cyclone related supply disruption. The US dollar was little changed and the $A pushed just above $US0.71.

• Brexit got nowhere decisive and time is running out. Either the UK parliament gets its act together pretty quick and seeks an extension (which remains our base case with Parliament voting to reject a no deal Brexit, albeit by a margin of just 1) or it crashes out on April 12. A long extension raises all sorts of issues around the UK being forced to participate in EU elections in May, new UK elections and another referendum. But remember the Brexit comedy is a sideshow for global investors.

• The 2019-20 Australian Federal Budget gets back to surplus but fails to excite. To be sure this budget contained good news with help for low to middle income households, an enhanced plan for reducing taxes next decade (or giving back fiscal drag to be precise), more tax cuts for small business and a further uplift in infrastructure spending all with a return to surplus after 11 years in deficit. After several years of being wide off the mark, budget projections since the 2015-16 Budget have been pretty consistent in terms of their surplus timing and we are now there (well at least we will be in a few months). Against this though, the immediate boost to low to middle income households is relatively modest (at up to $1080 its around half the up to $1000 and $900 payments made by the Rudd Government in the GFC), we remain of the view that the Government’s GDP growth and wages forecasts are on the optimistic side and the Budget is a bit academic as much of it will depend on who wins the May election.

• In terms of the election, Opposition leader Bill Shorten’s Budget reply speech confirmed that a Labor Government will adopt a very different approach to economic policy. The key elements of this include supporting the Government’s immediate “tax cuts” for middle income earners and increasing them for low income earners, butincreasing (not decreasing) tax rates for higher income earners, restricting negative gearing, halving the capital gains tax discount, ending cash refunds for franking credits, a more aggressive climate policy, higher minimum wages with some labour market reregulation and more spending on health and education. As always, much of this will be dependent on Senate passage and that’s not assured in some areas (like negative gearing). But it will likely lead to nervousness in the Australian share market and the changes to negative gearing and capital gains tax will be negative for property prices.If Labor wins, expect a mini-budget in the September quarter.

• But its clear that both sides of politics are aiming for budget surpluses and committed to tax relief for low and middle income households to be received after they complete their 2018-19 tax returns. The latter will provide some boost to spending in the September quarter (although the Rudd payments in the GFC indicate that much will be saved) which along with likely RBA rate cuts, continuing strong infrastructure spending, improving business investment and strong export demand should keep the economy growing despite the drag from the housing downturn – just not as strongly as the Government and RBA are forecasting.

h2 Major global economic events and implications/h2

• US data was a bit messy but mostly encouraging. On the downside underlying capital goods orders and retail sales fell in February. But the level of capital goods orders remains high, retail sales for January were revised up, construction spending and auto sales were strong, jobless claims fell to a new low and business conditions ISMs and PMIs are solid and consistent with reasonable growth.

• The Eurozone’s composite business conditions PMI fell slightly but it is showing tentative signs of stabilising.Meanwhile, unemployment held steady at 7.8% in February but with core inflation falling to 0.8% year on year in March pressure remains on the ECB to boost growth.

• Japan’s March quarter Tankan survey showed a deterioration in business conditions for manufacturers (albeit from relatively high levels) but conditions for non-manufacturers remain strong.

• Chinese business conditions PMIs rose in March adding to signs that Chinese growth may be bottoming. To be sure seasonal volatility associated with the timing of the Lunar New Year holiday may be helping but stimulus is likely helping too.

h2 Australian economic events and implications/h2

• Australia saw some upbeat February data over the last week with a bounce in retail sales and building approvals and the trade surplus rose to a new record high. And the pace of house price falls slowed a bit in March according to CoreLogic. This all provides a bit of confidence that March quarter GDP growth may have improved a bit from the dismal pace of 0.3% and 0.2% seen in the September and December quarters respectively. However, there are reasons for caution. First, economic data often runs hot and cold. Since Christmas we have had a long cold patch so a hot patch isn’t surprising. Second, its hard to see the surge in food sales, department stores, clothing and household goods that drove the bounce in February retail sales being sustained given ongoing soft wages growth and falling home prices. Third, the bounce in building approvals was driven by volatile apartments and the trend remains down. Fourth, the record trade surplus is good news but its mainly being driven by high bulk commodity prices not by volumes. Fifth, business conditions PMIs and business confidence readings were soft in March. Finally, we saw the pace of home price declines slow a year ago only to accelerate again and in any case house price declines are now quite broad based across capital cities and the negatives that are driving house price falls notably in Sydney and Melbourne remain in place including tight lending standards, record unit supply, a collapse in foreign demand, uncertainty around the tax treatment of property investment and price falls feeding on themselves. So we still see further soft economic growth and home price falls ahead.

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• Finally, while the Melbourne Institute’s Inflation Gauge saw a bit of a bounce in March this seems to happen every few months and underlying inflation is still running at just 1.6% year on year.
• Meanwhile, the RBA remained on hold for the 32nd month in a row but there were two marginal dovish tilts in its post meeting statement. First in acknowledging weak December quarter growth particularly in consumer spending and second in noting that it will “continue to monitor developments”.

What to watch over the next week?

• In the US, the minutes from the Fed’s last meeting (due Wednesday) will likely confirm its dovishness and this is likely to be supported by March CPI data (also due Wednesday) showing core CPI inflation remaining around 2.1% year on year. Job openings and hirings for February are likely to have remained strong and small business optimism (both due Tuesday) will be watched for a bounce.
• US March quarter earnings reports will start to flow. These are likely to see a distinct slowing to a slight decline or flat year on year as last year’s tax cut drops out and in response to slower growth but its also likely to be the low point for this year.
• The European Central Bank (Wednesday) is unlikely to undertake further monetary easing having just done so at its last meeting, but its likely to signal a willingness to do more.
• Chinese data for March is expected to show continuing benign underlying inflation (Thursday) and an improvement in export and import growth (Friday). Credit data will also be released.
• In Australia expect a continuing downtrend in housing finance (Tuesday) and a possible bounce in consumer confidence (Wednesday) thanks to the tax cuts. The RBA’s six monthly Financial Stability review will be released on Friday.

Outlook for investment markets

• Share markets – globally & in Australia - have run hard and fast from their December lows and are vulnerable to a short-term pullback. But valuations are okay, global growth is expected to improve into the second half of the year, monetary and fiscal policy has become more supportive of markets and the trade war threat is receding all of which should support decent gains for share markets through 2019 as a whole.
• Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier and bond yields could still fall further in the next few months. Expect Australian bonds to outperform global bonds.
• Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.
• National capital city house prices are expected to fall another 5-10% into 2020 led by Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
• Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.
• The $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.

Written By: Shane Oliver