Bitcoin - The Market Can Remain Irrational For Longer Than You Can Remain Solvent

Originally published by AMP Capital

Investment markets and key developments over the past week

• Shares had a few wobbles over the past week with a bit of profit taking partly triggered by the US Senate’s tax reform bill delaying the corporate tax rate cut until 2019 and its retention of the alternative minimum tax for corporates which could mean higher than intended tax for some companies. US, Japanese and Chinese shares fell but Australian shares were little changed and Eurozone shares rose. Bond yields were little changed but commodity prices fell. The Australian dollar fell to around $US0.75 in response to softish GDP growth, a sharp fall in the trade surplus and a stronger US dollar.

• Combining the House and Senate tax reform bills is now the main focus in the US, but this should be resolved by year end. Amongst other things this is likely to repeal the alternative minimum corporate tax that the Senate left in as a last minute saving measure and bring forward the corporate tax cut to a 2018 start but with the rate going down to 22% rather than 20% (a move which Trump seems ok with) to limit the blowout in the budget deficit. The pressure on the GOP to get tax reform done is now immense and having ticked off all the boxes so far (passing a 2018 budget, support in the House and the Senate) the tax reform package looks likely to be passed into law by year end.

• Meanwhile, Congress has passed a two-week government funding extension, so no partial Federal Government shutdown from December 9, and a shutdown from December 23 is unlikely too. Because of the large number of outstanding issues on both sides of politics and amongst various factions (eg around defence spending, spending caps, protection for children of illegal immigrants, etc) a longer term solution was unlikely this week. However, a December 23 shutdown is unlikely because Congressional Republicans and Democrats are well aware after the 2013 experience of the blame they will take if a shutdown happens, particularly if it’s over the Christmas/New Year period. It’s also worth noting that there have been 12 shutdowns since 1981 and their economic impact tends to be modest. In fact, US economic growth actually accelerated around the last shutdown in December quarter 2013.

• Meanwhile, (Bitcoin) mania continues with another 55% gain over the past week, making for a whopping 17.7 fold increase year to date. While the announcement by the Australian Stock Exchange that it will use blockchain to replace its CHESS clearing and settlement system highlights the huge benefits of blockchain, bitcoin’s price surge continues to look like another speculative mania with huge price gains and stories of instant riches drawing attention to it, which is in turn encouraging more and more people to pile onto the bandwagon, which in turn pushes prices even higher, encouraging even more investors to pile in. And futures trading in bitcoin is on the way making it easier to trade. As John Maynard Keynes pointed out, “the market can remain irrational for longer than you can remain solvent” so it’s impossible to know how high it will get and for how long, so shorting it would be very high risk. But while its enthusiasts celebrate its freedom from government involvement and regulation, it will be ironic if they clamour for government help if/when it eventually crashes.

Major global economic events and implications

• US data remains consistent with solid growth. While the non-manufacturing conditions ISM index fell in November this may be due to hurricane related distortions and in any case it remains very strong. Meanwhile, jobs related data also remains strong consistent with a very tight labour market.

• German factory orders rose in October and are up 6.9% over the last year and consistent with a pick-up in growth.

• Japanese GDP growth for the September quarter was revised up to 0.6% quarter on quarter from 0.3%, helped by stronger business investment and adding to evidence that the Japanese economy is a lot stronger these days. That’s the same growth rate as Australia but note Japan’s population is falling and Australia’s is still rising strongly.

• The Chinese Caixin services conditions PMI rose in November, but slightly slower growth in exports and imports is consistent with some moderation in growth this quarter.

Australian economic events and implications

• The Australian economy saw okay growth in the September quarter with good news on investment but a very weak consumer. The uncertainty around the Australian consumer has been apparent for some time and was highlighted in the September GDP data showing just 0.1% growth in consumer spending, its weakest since the GFC. With the national accounts showing continuing very weak average wages growth (just 0.6% over the last year), energy price hikes cutting into spending power, slowing house price gains in Sydney and Melbourne reducing positive wealth affects and ongoing concerns about high household debt, consumer spending is likely to remain constrained for a while yet. At the same time the housing construction cycle is slowing. Fortunately, non-mining business investment looks to be picking up at last, the growth drag from slumping mining investment is fading, public infrastructure investment is strong and export volumes are likely to rise solidly helped by a further ramp up in LNG exports all of which should be enough to keep the economy growing and eventually help support a pick up to around 3% growth on a more sustained basis next year. But for now underlying growth is still subdued at around 2.5% and while good October retail sales may help consumer spending a bit in the current quarter a slump in the October trade surplus suggests this may be offset by weak net exports.

• Meanwhile, housing finance slowed again in October adding to evidence that the property market is still cooling.

• While it was no surprise to see the RBA leave interest rates on hold at its December board meeting our view remains that the risks around the consumer, weak wages growth and weak inflation mean that it shouldn’t and won’t start raising interest rates until late 2018 at the earliest and in the meantime another cut still can’t be ruled out.

What to watch over the next week?

• In the US, apart from noise around tax, the focus will be on the Fed (Wednesday) which is expected to raise interest rates again for the third time this year and for the fifth time in this cycle. However, this is largely factored in – with a 98% probability according to the US money market - so will be no surprise. While the Fed and current Chair Yellen is likely to express concern about ongoing sub target inflation it is likely to reiterate that this is expected to be temporary, particularly with growth running strong and likely to receive a further boost next year from tax cuts. In fact, while the Fed is likely to reiterate that interest rate increases will remain gradual the “dot plot” of Fed officials’ expected interest rate increases for next year is likely to move up from three hikes to four.

• On the data front in the US, the key to watch will be inflation data to be released Wednesday, which is expected to show a rise in headline inflation to 2.2% year on year (thanks to higher oil prices) but core inflation to remain at 1.8% yoy, and retail sales data on Thursday which is likely to show a solid gain of 0.3%. Meanwhile, expect continuing strong or solid readings for job openings (Monday), small business confidence (Tuesday), the Markit business conditions PMIs for December (Thursday) and industrial production (Friday).

• The ECB (Thursday) is likely to express continuing confidence in Eurozone growth but with inflation remaining well below target it’s unlikely to make any changes to monetary policy having already extended its QE program out to September and committed to not raising rates until after it ends. Eurozone business conditions PMIs for December to be released Thursday are likely to remain strong.

• In Japan expect the Tankan business survey (Friday) to show a further improvement in business conditions.

• Chinese economic activity indicators to be released Thursday are expected to show retail sales growth remaining around 10.3% year on year, industrial production growth stuck at 6.2% and investment slowing to 7.1%. Money supply and credit data will also be released.

• In Australia, expect ABS data for the September quarter to be released on Tuesday to confirm a sharp slowing in national home price growth to around 0.7% quarter on quarter, the NAB business survey (Tuesday) to show continued strength in business conditions and confidence, consumer confidence (Wednesday) to remain sub-par and labour market data (Thursday) to show a 20,000 gain in jobs and unemployment remaining unchanged at 5.4%.

Outlook for markets

• With the direction setting US share market not having had a negative total return month so far this year (a very unusual feat historically) the risk of a decent short term correction in global shares led by the US is high. Uncertainty around US tax reform and government shutdown risk could provide a trigger but given positive seasonality with “Santa Claus” related strength usually kicking in from mid-December a correction is likely to wait till next year. Looking beyond short term correction risks though, we remain of the view that the broad trend in shares will remain up because we are still in the sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions.

• Australian shares are likely to continue to participate in the global share rally albeit remaining a relative laggard thanks to a more constrained earnings outlook.

• Low starting point government bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

• Unlisted commercial property and infrastructure are likely to continue benefiting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

• The Sydney and Melbourne residential property markets are likely to slow further over the next year or two with prices likely to fall by around 5-10%.But Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.

Expect the Australian dollar to fall to around $US0.70. With the RBA on hold for the next year or more and the Fed on track to hike in December with another four hikes next year the interest rate differential will continue to move against Australia which should result in further weakness in the Australian dollar.