Christmas in February, Donald and Xi, Europe, Hydro, Water, and more

Christmas in February
Donald Xi
Negative Europe
Pumped Morrison
Water, water nowhere
Research and Diversions
Facebook Live
Next Week
Last Week

Christmas in February

That’s a song by Lou Reed, of course, but it was also true of February 2019 for investors, especially investors in the banks.

The ASX 200 accumulation returned 6% for the month on top of 3.8% in January, so 10% in the first two months of the year – a phenomenal start to 2019.

The last time something like this happened was 2015, when the ASX200 accumulation started with 11% in January and February (and ended the year with a gain of 2.5% - all dividends – so not so great by year end).

It’s been a big start to the year all round: the MSCI returned 10.7% for the first two months of 2019, the S&P 500 11.4%, the Dow Jones 11.1% and the Nasdaq 13.9%.

Who would have thunk it? Not me, and not anybody I know.

Some details for the month: the bank index returned 9.2% for February (you’d be happy with that for year) and the materials index, 5.9%. All of them outdid the US market in the month both the S&P 500 (3.2%) and the Nasdaq (4%). The best of the banks was ANZ (12.3%!), while Westpac gained 9.3%, CBA 6% and the weakest link, NAB, 5.6%.

Most of the best stocks in February were some of 2018’s worst performers, for example, BWX (55.4% for the month), Automotive Holdings (47%), Breville (46%), Ausdrill (37.5%), IOOF (33.8%), Speedcast (33.3%) and Viva Energy (31.7%).

I wouldn’t normally go into such detail about the end of the month, but February was a real outlier and it tells us a lot about what’s going with markets at the moment.

Investors have had a belter of a month despite a weakening macro picture and an ordinary earnings season.

On the local front, I saw the first 0.0% forecast for fourth quarter GDP yesterday, from Morgan Stanley (although they revised that the next day to 0.1%), and the consensus for next week’s national accounts has dropped from 0.6% to about 0.3%. That was largely because of a shocking 3.1% slump in construction in the quarter revealed this week, and continued weakness in credit growth.

As for earnings season, see the chart:

The global picture is also softer macro conditions and earnings:

Nevertheless, February was a month for recovering oversold positions out of the gloom of the fourth quarter of 2018 and bounding into 2019 with renewed optimism and buying everything is sight.

Why? Simple really. Markets have moved to pricing in rate cuts, both here and the US. Equities always rally when the central bank stops tightening, or in our case stops pausing, even if it’s because a recession is coming.

Mind you, if there IS a recession, it’ll be a brief (6-9 month) period of sunshine before the storm of a bear market sets in, and most of the time that’s what happens – central banks don’t usually engineer a soft landing.

Gerard Minack noted this week that only three of the 12 completed Fed tightening cycles since the mid-fifties have avoided recession - that is, 75% of the time it ended in recession. I’m not sure what it is in Australia, but I doubt that it would be very different.

In any case, investors are inherently optimistic – if you were a pessimist you wouldn’t take any risk with your money at all, ever. So even though history tells you that most tightening cycles end in recession, most investors reckon this time will be one of the 25% that didn’t, otherwise they wouldn’t invest.

Central bankers, on the other hand, are inherently cautious, and more so now since the GFC than ever before. That’s not so much because the burns of 2008 are still hurting but because debt has only increased since then, and economies more vulnerable to monetary policy.

For that reason the Fed has acted early to signal that it’s on pause and the RBA has moved from tightening bias to balanced, although in both cases markets are now pricing in cuts.

Source: Shaw & Partners

Markets have returned to pricing for perfection – in monetary policy, not necessarily macro growth and earnings.

It means the key risk to markets in 2019 is not so much deteriorating economies, which is priced in, but ironically the opposite – anything that would cause the Fed in particular to shift back towards tightening. Specifically, if there was any sign of inflation accelerating in the US that would hit markets hard.

It’s hard to see that at the moment – in fact, if anything the economic risks are skewed the other way – but as always, you never know.

Donald and Xi

So now it looks like there’s going to be a US-China trade deal.

Why do we think that? Because of two tweets by Mr Trump:

“China Trade Deal (and more) in advanced stages. Relationship between our two Countries is very strong. I have therefore agreed to delay U.S. tariff hikes. Let’s see what happens?”

And:

“If a deal is made with China, our great American Farmers will be treated better than they have ever been treated before!”

Not conclusive, perhaps, but it’s looking like I was wrong in my pessimism about US-China trade: Trump’s need for a political win is about to trump the Pence-led Washington consensus that China needs to be contained and its technology dominance ambitions squashed.

With the posse closing in, Trump is seeking refuge in being the international deal-maker, although he seems to have left Hanoi without a deal with Kim Jong-un.

Anyway, the question for investors about the forthcoming trade deal is whether it’s in the price. It’s hard to tell: after the huge post-Christmas rally taking both the US and Australian markets close to their 2018 peaks, you’d say it probably is, but that was mainly about the Fed, as discussed, not trade optimism, so equities might go for another trot when the deal is actually announced.

Given Trump’s desperation to get a win, in light of Michael Cohen’s testimony etc, it’s unlikely China will be required to do much – the balance of negotiating power looks to have tipped decisively towards Xi Jinping.

It looks like the deal will include promises from China to buy more soybeans from America, as well as semiconductors, and maybe also some relaxation of joint venture and technology transfer requirements for US companies operating in China.

As GaveKal China specialist, Arthur Kroeber, wrote the other day: “China can easily deliver most of this without breaking a sweat.”

A key item in the negotiations is the exchange rate: Xi is being asked to promise not to depreciate any more, and perhaps even push it higher, what some are calling “Plaza Accord-Lite”. (In 1985, the Plaza Accord was about getting the yen and the deutsche mark up against the US dollar, which had disastrously appreciated about 50% - the deal resulted in huge central bank intervention and the yen rose 60% and the deutsche mark 45% in 12 months).

But the renminbi has been rising steadily since November anyway, having depreciated almost 10% since April because the market’s view that US tariffs would be terrible for the Chinese economy. The exchange rate has risen 4% in four months because of the growing conviction that there will be a deal.

If there is a deal, as now seems likely, then the renminbi will rise some more on its own, so Beijing will be able to fulfil any deal on that score without doing a thing.

Kroeber says the Chinese sharemarket looks due for a sustained rally, partly because the severe credit tightening that led to last year’s 25% decline has been replaced by renewed credit growth, and also because MSCI is apparently going to quadruple the inclusion factor for inclusion in the MSCI emerging markets index.

If China picks up this year on the back of a trade deal with the US and loosening credit, it should puff some wind into the sails of BHP and Rio Tinto, and therefore the whole Australian market.

Negative Europe

And then there’s Europe. The European Central Bank’s balance sheet has grown to 39% of GDP, twice the relative size of the Fed’s, and the overnight cash rate is minus 0.4% (it first got there in March 2016 and the benchmark rate has remained below zero since June 2014). 

Meanwhile Bank of America informs us that about US$11 trillion of European sovereign debt is priced to yield less than zero, up 21% from October and not far from the US$13 trillion peak of 2016.

This sort of thing has never been seen in 3000 years of governments issuing bonds to finance their wars.

Why has Europe slipped back into the sludge of negative yields? Mainly because of the sinking Germany economy: flat fourth quarter GDP, a surprise contraction in December factory orders on top of eight straight months of declining economic sentiment across the eurozone.

There have been other factors as well: succession at the European Central Bank is unclear as President Draghi’s term ends on October 31, and political risk is on the upswing, shown by growing discord between Italy and other member states as well as popular discontent movements like France’s gilets jaunes. And of course, there’s Brexit as well, and the rising prospect of a Europe-America trade war.

That’s especially the case if there’s no longer a trade war between America and China: Trump will need an enemy, and it’s looking increasingly like it’s Europe’s turn.

The Euro/Aussie exchange has been stable for 12 months because the European currency has fallen as much as the AUD. But that will change if China improves and Europe doesn’t because of all the factors mentioned above.

Best to stick with European holidays rather than European investments.

Pumped Morrison

A note on this week’s announcements from the Prime Minister about Snowy 2.0 and the proposed second Tasmanian interconnect.

Along with the $2 billion “Climate Solutions Package”, these are meant to rescue the Coalition’s standing on climate change, since they’re in danger of losing more seats to independents, on top of Wentworth.

Scott Morrison got quite excited standing in the Snowy announcing Snowy 2.0: “It is absolutely fair dinkum power. It doesn't get more fair dinkum than this. This is fair dinkum! 100 per cent!”

I suspect it will take more than this to wipe 10 years of climate change denial and mockery of science, not to mention the Coalition’s sabotaging of energy policy. Apart from anything else, it’s not hydro power, but storage – of solar and wind power.

In fact both this week’s announcements are actually about pumped hydro energy storage.

Pumped hydro energy schemes are “batteries” that use water flowing down from higher dams, to which it has been pumped, to drive turbines. Storage is critical for renewables, and it’s already proven after storing coal-fired power during low-demand night-periods when it’s cheap, to be used when the price goes up at peak times.

Pumped hydro fills in the periods when there isn’t much sun or wind for days on end. Lithium battery storage is better for time-shifting power from sunny days to still nights through fast-response, but is expensive and not long-lasting enough by itself, for large-scale grid supply.

The preliminary feasibility study prepared by TasNetworks for the Marinus Link, which is what the second Bass Strait interconnector is called, says that “the benefits … are likely to be greater than costs when approximately 7000MW of the National Energy Market’s present coal-fired generation capacity retires.”

That is, it’s only viable, according to TasNetworks, if 7000MW of coal-fired generation is replaced by solar and wind, so that more smoothing from batteries would be needed – only then it would be worthwhile to transport the power so released from Tasmanian hydro storage across Bass Strait.

The Prime Minister says it will be built as early as 2025, which means he is expecting that amount coal generation to be shut by then and replaced by renewables. That would comfortably push renewables beyond 50 per cent of total Australian generation, which is also Labor’s renewable energy target

And then there’s Snowy 2.0, which also requires a big increase in renewables and reduction in coal to be viable, estimated to be around 5000MW. Together the two big pumped hydro projects, plus Labor’s stand-alone target, more or less guarantee a rapid increase in Australia’s solar and wind electricity generation over the next decade.

This has big implications for investors. A lot of renewable projects are going to get up and energy storage businesses like Genex Power will be worth a look (I interviewed the CEO Simon Kidston last July – the share price has sunk from 30c to 25c since then), although Snowy 2.0 and Tassie pumped hydro might swamp the market with capacity.

Broadly, whoever wins the election the energy market in Australia is going to be rapidly transformed. Enormous pressure will come on the big players like AGL and Origin. Others will be big winners.

Water, water nowhere

Stand by for a Federal water Royal Commission if Labor wins the election.

In the last week both the Coalition and the ALP have published scientific reviews into the million-plus fish deaths in Menindee, and there has also been the Productivity Commission’s report and the SA Royal Commission, which has been disputed and ignored by the Government for purely political reasons.

A Shorten Labor Government will quickly call a Royal Commission into the water crisis, in my view. Like all Royal Commissions it won’t be great for investors in the companies affected.

The banking Royal Commission has led to fund outflows and a big step up in regulation of the banks and retail wealth managers (namely AMP and IOOF); the aged care Royal Commission is clearly going to lead to increased staffing levels in nursing homes and therefore higher costs for the operators.

Neither of those things are bad – far from it. In fact they are well overdue.

Even more so with water. Irrigation allocations were too high to begin with, and now with global warming drying the place up even more, they are definitely too high now.

Even if there isn’t a Royal Commission, allocations for irrigators are going to be cut.

To be specific, Costa Group is now facing structural risk with its citrus farms in the Murray-Darling Basin, growers like Graincorp are likely to see lower crop yields, livestock firms like Inghams, Tassal, Huon Aquaculture and Aust AG Co are facing higher feedstock prices and there will be – has to be – a reduction in regional populations, which affect consumer spending in those areas and therefore retailers with a lot of stores in the bush.

The largest user of water and the lowest return per megalitre is cotton, farmers of which are under serious threat from any reduction in allocations to irrigators. There are no listed cotton producers, however Nufarm and Incitec Pivot supply them with fertiliser (a lot of it!). As cotton volumes and profitability declines, so will the demand for fertiliser.

Broadly, the recent drying across southern Australia is the strongest recorded large-scale change in rainfall since records began in 1900.

According to Bureau of Meteorology and CSIRO, it’s associated with a trend towards higher mean sea level pressure which results from climate change, and that very high sea level pressures across southeast Australia are more likely to occur in future because of global warming.

Australia is already a dry continent, becoming dryer.

Invest in water, not companies that need it.

Research and Diversions

Research

Michael Cohen’s testimony to Congress this week, in full. Devastating. A snippet: “I am ashamed that I chose to take part in concealing Mr. Trump’s illicit acts rather than listening to my own conscience. I am ashamed because I know what Mr. Trump is. He is a racist. He is a conman. He is a cheat.”

It’s never been easier to trade. It’s cheaper than ever, you have unlimited access to information, and you can execute a trade from the device sitting at your fingertips right now. It’s easy and it’s tempting to fiddle with your investments. Don’t do it.

Most economists see a recession in the US by 2012. Stocks don’t care (or don’t believe it).

The only charts that matter today. Here’s the first one:

An interview with Robert Shiller: We have to understand human psychology; we have to accept an impulse towards selfishness, which is the reality. We cannot change that. And yet, we do have an engineered environment. Our economy is an invention, a reaction to past crises and depressions, and we can try to coordinate it. 

Two weeks ago, Elon Musk predicted that “safe, full self-driving” cars would be available by the end of this year. “I have too much respect for Elon Musk to think that he really believes that, because there’s not the slightest sign that we are anywhere close to that level of automated driving. Therefore I must very reluctantly conclude that he’s intentionally misleading the public.”

Ten potential surprises for 2019 which probably won’t happen but shouldn’t be written off entirely.

How Xi Jinping became a networked authoritarian thanks to his little red app.

China is seeking a bigger role in the Middle East arms trade, with a major state-owned shipbuilder opening an office there and exporters showing hi-tech weapons – including an advanced killer robot ship – at a regional defence expo last week.

This is the best explanation of how Britain ended up at Brexit that I have read so far. “British politics is where it's at today because of two minor moments: a headbutt and a putdown.”

How Ben Bernanke killed the world economy. “The paper provides theoretical backing to and a possible mechanism for the observation set out in this column on several occasions in the last few years: that ultra-low interest rates in Japan, the Eurozone, Britain and the United States were closely correlated with unprecedented declines in the rate of productivity growth in those countries.

Amazon is crushing small business. what’s to be done? 

“I have little sympathy for the hand wringing over “fake news,” and worst, the plans to regulate content provision on the Internet. There is no evidence that “Russian” campaigns on social media has any impact on election results, and political scientists like Tom Ferguson have debunked the idea. (Also) Cambridge Analytica’s claims about its ability to sway voters were hogwash.” 

The Kalashnikov assault rifle changed the world. Now there's a Kalashnikov drone.

How to negotiate with North Korea. “As a general rule, North Korean negotiators proceed cautiously, sometimes circuitously. The path to “yes” tends not to come in a straight line. They insist on a sense of balance and reciprocity at all times, especially in any documents that emerge from talks. Procedure and agenda are seriously important. An American position that starts with “You are the problem, and you have to solve it,” is a good way to get nowhere fast.”

President Trump’s moves against Venezuela are part of a long history of US intervention in Latin America. "It would be hard to name a country where the United States didn't have an intervention."

Who is MacKenzie Bezos? Well, for a start she’s now really rich, on her own, instead of as part of a couple.

The Department of Home Affairs is a failed experiment. It should be dismantled.

Donald Trump is the world’s most powerful child. “The President is not a sociopath. He is a malignant narcissist.”

Then again, here’s a classicist who sees him as a tragic hero.

The unethical greed of Deliveroo and Uber Eats. “Beneath their wonderfully-designed facades are business practices that appear to be hell-bent on profit, with negligible ethical considerations.” I must say I have given up using them – I always go out and get the takeaway now. It takes too long, the food gets cold, and I do think the drivers are being exploited.

Artificial intelligence, energy storage, robotics, genome sequencing, and blockchain technology are leading the global economy into what could be the most transformative period in history.

Diversions

Funded by Silicon Valley elites, researchers believe they are closer than ever to tweaking the human body so that we can finally live forever (or quite a bit longer). Then again, if you fund researchers, they’ll tell you they can do anything.

Here’s a podcast about how to make the perfect Bolognese sauce. Finally – something really worthwhile in a podcast!

Could we soon be able to detect cancer in 10 minutes? Maybe, in at least five years. But that’s something at least!

The deadly truth about a world built for men – from stab vests to car crashes. Crash-test dummies based on the ‘average’ male are just one example of design that forgets about women – and puts lives at risk.

The most effective exercise isn’t exercise. “Have you recently carried heavy shopping bags up a few flights of stairs? Or run the last 100 meters to the station to catch your train? If you have, you may have unknowingly been doing a style of exercise called high-intensity incidental physical activity.”

“The danger is not so much artificial intelligence conquering the world and turning humans into domestic animals, as of AI gradually infiltrating us — remaking us in its image. Will AI digitalize us?

Subscriber Andrew grant sent his to me this week – it’s David Gilmour in concert in 2011, in aid of “50 years of the Fender Stratocaster”. With Hank Marvin. Definitely worth 15 minutes of your time.

“What if unhappiness contains the secret to happiness? Maybe we should just give up on happiness.” This isn’t piece as miserable as it sounds – it’s quite interesting.

It’s official: having good grammar makes you more attractive (according to Tinder).

“There’s a serious hitch in the GOP plan to make California a symbol of Democratic dysfunction and socialistic stagnation: It’s basically thriving. California is now the world’s fifth-largest economy, up from eighth a decade ago. If it’s a socialist hellhole, it’s a socialist hellhole that somehow nurtured Apple, Google, Facebook, Tesla, Uber, Netflix, Oracle and Intel, not to mention old-economy stalwarts like Chevron, Disney, Wells Fargo and the Hollywood film industry.”

World War One became a giant laboratory that changed basic thinking about medicine. Doctors had tended to approach the human body as a collection of parts, each of which could be treated separately. The war encouraged a new paradigm: The body was a complex whole whose main parts reacted (and failed) together. Pain was recognised as a central fact of medicine, not merely an inconvenience for the surgeon.

How we tamed ourselves. Humans are by nature violent, yet also cooperative. How did we evolve this way? By killing off the most violent among us, argues a new book.

Mark Humphries (who hosts my favourite TV show, Pointless) is also quite good at satire. He does a spot of satire for 7.30. His latest one is about Clive Palmer – it’s funny! And true.

The best I’ve read on the Pell verdict, by David Marr of course.

Scientist, Freeman Dyson, constructs a history of the theory of evolution, linking together the work of six visionaries from Charles Darwin to Svante Pääbo by way of Motoo Kimura, Ursula Goodenough and Richard Dawkins, and… H.G. Wells, the novelist. According to Dyson, Wells was the first person to grasp the significance of “cultural evolution”, which consists of “changes in the life of our planet caused by the spread of ideas rather than by the spread of genes”.

A good piece about the importance of Karl Lagerfeld, if you’re interested. I’m not, very interested that is.

Happy Birthday Lou Reed. He would have turned 77 today, except he died of liver failure on October 27, 2013. Here’s a great live version of Sweet Jane, while some bloody credits are playing for something or other. Just listen.

And you gotta love The Last Great American Whale.

And today is also Chris Martin’s birthday. (He’s the lead singer of Coldplay). He’s 42. What’s your favourite Coldplay number? A Sky Full Of Stars? Yeah it’s pretty good. Good video too.

I really like Fix You too. Incredible sound, and fantastic when the audience sings along at the end.

Facebook Live

If you missed #AskAlan on our Facebook group this week (or if you don’t have access to Facebook) you can catch up here. And there's also the Facebook Livestream page where you can also opt to just listen to the questions and answers.

If you’re not on Facebook and would like to #AskAlan a question, please email it to askalan@investsmart.com.au (new email!) then keep an eye out for the Facebook Live video in next week’s Overview.

Next Week

By Ryan Felsman, Senior Economist, CommSec.

Australia: Autumn avalanche

• A strange quirk of the statistical calendar is that each change of seasons in Australia is ushered in by a bevy of economic events. And so the ‘Autumn avalanche’, with more than a dozen indicators or events scheduled this week.
• The week kicks off on Monday when the Australian Bureau of Statistics (ABS) releases the Business Indicators publication for the December quarter. The data on inventories or stocks is a direct input to Wednesday’s economic growth figures.
• Also on Monday, the ABS also publishes the building approvals data – a key leading indicator for home building. And the ANZ issues its job advertisements index for the month of February.
• On Tuesday, the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan. And the ABS publishes quarterly data on government spending and the Balance of Payments – the broader data on the trade position.
• Also on Tuesday the Federal Chamber of Automotive Industries issues the February new vehicle sales figures. And both AiGroup and CommBank publish their respective purchasing manager survey results for the services sector.
• The Reserve Bank Board meets on Tuesday but no rate change is expected.
• On Wednesday the ABS releases the National Accounts – containing the key reading of economic growth in the September quarter. The current annual growth rate of 2.8 per cent is in-line with the 2.75 per cent long-term average.
• Also on Wednesday Reserve Bank Governor Phillip Lowe delivers a speech on the housing market and the economy.
• On Thursday, the ABS issues the international trade (data on exports and imports) and retail trade data for January. The AiGroup’s construction gauge is also issued. Residential housing construction activity is slowing.
• On Friday the Reserve Bank’s Head of Economic Research, John Simon, delivers a speech in Brisbane.

Overseas: US jobs and China trade data in focus

• The US employment report, together with Chinese trade and inflation data all feature this week. 
• The week begins on Monday in the US when the ISM New York business conditions index and construction spending data are released. Gains in home building have partly offset weakness in non-residential construction.
• On Tuesday, new home sales, weekly Johnson Redbook chain store sales, ISM non-manufacturing and IBD/TIPP economic optimism data are all scheduled. And the latest monthly US budget statement is also due.
• In China on Tuesday, Caixin issues its services purchasing manager index for the month of February. And the National People’s Congress commences when Premier Li presents the government’s draft working plan for 2019.
• On Wednesday in the US, factory orders and international trade data are scheduled with the weekly gauge of mortgage applications. And the Federal Reserve’s Beige Book and ADP’s private payrolls report are issued. 
• On Thursday, the US goods trade balance for January is issued along with the consumer credit report, quarterly unit labour costs/productivity data and the weekly new claims for unemployment insurance (jobless claims).
• On Friday in the US all eyes will be on the February jobs report. The US economy added jobs for a record-breaking 100th consecutive month in January. An additional 170,000 jobs are expected to have been created in February, taking the unemployment rate down from 4 per cent to 3.8 per cent – near 50-year lows. 
• In China on Friday and Saturday the National Bureau of Statistics (NBS) releases international trade and inflation data. After the January trade data exceeded market expectations, a weaker outcome is expected in February due to the seasonal effects of the Lunar New Year holiday.
• US President Trump has said he’ll extend a deadline to raise tariffs on Chinese goods beyond March 1. But we continue to expect soft growth ahead for exports because of slower global growth and the fading effects of US importers’ front‑loading to beat tariff increases. The improvement in imports probably points to the early signs of Chinese fiscal stimulus. Weakening manufacturing activity has also weighed on factory prices with business inflation at 2-year lows.

Financial markets

• The Australian corporate reporting season has ended for the major industrial companies. But a host of earnings results, especially from resources companies, are due in the coming week. The reports include:
• On Monday: Cullen Resources, Dragon Mountain Gold; Hannans, Retail Food Group; Scout Security; Zinc of Ireland.
• On Tuesday: Cap-XX; Carpentaria Resources; Elementos.
• On Wednesday: ALT Resources; Carnavale Resources; Cassius Mining; GoConnect; MMG; Myer; Red Metal; Santana Minerals; Tungsten Mining.
• On Thursday: ActivEx; Argent Minerals; GWR Group; Lithium Consolidated; Primero Group; ThinkSmart.
• On Friday: Alchemy Resources; Bauxite Resources; E3Sixty; Odyssey Energy; Poseidon Nickel; Sovereign Metals.

Last Week

By Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital.

Investment markets and key developments over the past week

• While US shares fell slightly over the last week with geopolitical noise not helping other major share markets including Australian shares continued to rise, arguably playing catch up to the rally in US shares. The Australian share market was led higher by health, IT, banks and industrial shares. Bond yields generally rose as did oil and metals, but iron ore prices continued to retrace some of the Vale accident driven rally. The $A fell slightly despite a lower $US as rate cut talk continued. 
• The past week provided a reminder that geopolitical risks remain with US Trade Rep Lighthizer dampening expectations of a trade deal with China, Trump’s former lawyer Michael Cohen’s Congressional testimony adding fuel to Trump impeachment fears, the second Trump/Kim Jong Un summit ending abruptly with no agreement on de-nuclearisation after Trump walked (again) on differences over removing sanctions and tensions flaring up between Pakistan and India. Each of these are unlikely to cause a major problem:
• Our view remains that a US/China trade deal is likely as it’s in both sides interests and Trump seems increasingly keen on a deal (because not having one would risk a return to last year’s blows to share markets and confidence threatening his re-election prospects) and comments by Treasury Secretary Mnuchin and White House economic adviser were a lot more upbeat.
• Michael Cohen’s testimony provided lots of interesting observations about President Trump that have been lapped up by his opponents but it’s unlikely to be enough to convince 67 senators to remove him from office even if the House moves to impeachment.
• Kim Jong Un is unlikely to push things so far that his regime’s existence starts to come under threat again, he wants to meet up with Trump again and Trump still seems keen on a deal, just that he’d “rather do it right than do it fast”.
• Tensions between Pakistan and India are a worry given their nuclear status – but they have been flaring up and down for decades so I wouldn’t read too much into the latest skirmishes.
• But with shares up dramatically from their December lows (by 19% in the US, 16% globally and 13% in Australia), up against resistance and overbought – at a time when global growth is still softening – one or several of these geopolitical risks could provide a trigger for a short term pull back in share markets. Our view remains though that it would just be a pull back/re-test as opposed to the resumption of last year’s falls as policy stimulus and an improvement in global growth should help ensure that shares have a reasonable year.

Major global economic events and implications

• US data was mixed over the last week, but the good news is that forward looking indicators are moving up. December quarter GDP growth slowed but to a stronger than expected annualised pace of 2.6% thanks to solid growth in consumer spending and business investment. More negatively housing starts fell a sharp 11% in December. However, permits to build new homes held up in December, pending home sales bounced in January after several weak months, consumer confidence rose sharply in February and various regional manufacturing surveys showed improvement too. So while GDP growth is likely to slow further this quarter (partly due to weather related seasonal weakness) we see it picking up again into the second half. Meanwhile Fed Chair Powell provided no surprises in indicating that current conditions are “healthy” and the outlook is “favourable” but there are some “cross currents and conflicting signals” so the Fed is “patient” and “will continue to be data dependent.” We expect the pause on interest rate hikes to continue into the second half.
• Eurozone economic sentiment slipped a bit further in February and lending growth slowed adding pressure on the ECB for further monetary easing.
• Japanese jobs data remained strong in January but this is being helped by the falling population and meantime industrial production fell sharply in January.
• Chinese official business conditions PMIs fell a bit further in February but the services sector continues to hold up well, manufacturing sector new orders rose and the Caixin manufacturing conditions PMI rose suggesting policy stimulus may be starting to impact, particularly for smaller businesses which had been harder hit by the slowdown.

Australian economic events and implications

• Australian data was generally soft. House prices continued their slide in February, credit growth remained soft in January with housing credit growth slowing to its weakest on record and construction activity showed broad based falls in the December quarter. Against this, plant and equipment investment saw a modest rise in the December quarter and business investment plans continue to improve suggesting that business investment should help contribute to keeping the economy growing as the housing cycle turns down.
• CoreLogic data showed that the slide in home prices continued in February with national capital city prices now down 8.6% from their September 2017 high. Tight credit (which will be given another boost along from mid-year by the start-up of Comprehensive Credit Reporting which will see banks crack down on borrowers with multiple undeclared loans), the switch from interest only to principle and interest loans, record unit supply, issues around new building quality after problems with various unit towers, an 80% or so collapse in foreign demand, fears that negative gearing and capital gains tax arrangements will be made less favourable if there is a change of government and falling prices feeding on themselves are driving a perfect storm for the Sydney and Melbourne property markets, with Perth and Darwin still falling sharply and most other cities pretty soft. We see Sydney and Melbourne home prices falling another 15% or so as part of a total top to bottom fall of 25%, which with little change in average prices across other cities will see national average home prices fall another 5 to 10%. While this will be a drag on economic growth it’s unlikely to drive a recession as property price weakness will mainly be concentrated in Sydney and Melbourne, the growth drag from falling mining investment is fading, non-mining investment is trending up and infrastructure spending is rising, the RBA can and we think will cut interest rates again and a likely further fall in the Australian dollar will help support growth.

Source: CoreLogic, AMP Capital

• The Australian December half earnings reporting season is now complete and while better than feared it showed a slowdown for companies exposed to the domestic economy and caution regarding the outlook. 54% of companies have seen their share price outperform on the day of reporting (which is in line with the long term average), but only 38% have surprised analyst expectations on the upside which is below the long run average of 44%, 36% have surprised on the downside which is above the long run average of 25%, the proportion of companies seeing profits up from a year ago has fallen to 59% and only 52% have raised their dividends which is a sign of reduced confidence in the outlook – six months ago it was running at 77%. Concern has been most intense around the housing downturn and consumer spending. While 2018-19 consensus earnings growth expectations have drifted up to 5% (from 4.3% at the start of the reporting season) this was due to an upgrade for resources stocks as higher iron ore prices were factored in. For the rest of the market consensus earnings expectations have slipped to just 2% reflecting the tougher domestic environment. While several cashed-up companies announced special dividends ahead of Labor’s proposed excess franking credit cutback, overall dividend upgrades have fallen.

What to watch over the next week?

• In the US the focus will be on Friday’s February jobs data which is expected to show solid payroll growth of 180,000, a fall in unemployment to 3.8% and wages growth of 0.3% month on month or 3.3% year on year. In other data expect the non-manufacturing conditions ISM to have remained strong at around 57 and new home sales to rise slightly (both due Tuesday), the trade balance (Wednesday) to worsen and January housing starts (Friday) to show a bounce after December’s fall. The Fed’s Beige of anecdotal evidence will also be released.
• The European Central Bank (Thursday) is expected to announce or foreshadow a new round of cheap bank financing (LTRO) to help arrest the slowdown in economic growth seen over the last year.
• Chinese February trade data (Friday) is expected to show a slowdown in export growth to around 1% year on year (after January’s bounce) but an improvement in import growth to around 0.5%yoy.
• The Reserve Bank of Australia is expected to leave interest rates on hold for the 28^th meeting in a row when it meets Tuesday and to reiterate its balanced or neutral outlook for interest rates. Outside of the monthly labour force reports Australian economic data has been mostly soft lately and our view remains that the RBA will cut the cash rate twice this year taking it down to 1% as the housing slowdown cuts into growth and threatens the inflation outlook. But the first cut is unlikely until around August after the RBA gets to see the outcome of the April Budget and the Federal election and revises its growth and inflation forecasts down further. 
• On the data front in Australia, expect December quarter GDP growth (Wednesday) of just 0.2% quarter on quarter or 2.4% year on year reflecting continuing weak consumer spending, weak construction activity and a zero contribution to growth from trade only partly offset by strength in public spending. Monthly data releases are expected to show a bounce in building approvals (Monday) after a few months of sharp falls, a 0.4% rise in December retail sales and a reduced trade surplus of $2.5bn (both due Thursday).

Outlook for investment markets

• Shares are likely to see volatility remain high with a high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China, Europe and Australia and the Fed pausing.
• Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
• Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
• National capital city house prices are expected to fall another 5-10% into 2020 led again by 15% or so price falls in 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 end 2019.
• 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.