Robert Gottliebsen
Behind the Trump-fuelled market jump
Whether you like him or not, you need to understand Donald Trump and the market’s reaction to him.
Wall Street is basking in the joy of having a President that understands how the business community works and, having been elected on a series of promises, who moves to implement them immediately. It has been a long time since Australia had a Prime Minister of that sort.
So today, let’s look at what President Trump is doing that makes the market so excited but then look at the hazards ahead.
If ever we get a decisive business-oriented Prime Minister, then expect the Australian share market to go through the roof. As it is, our miners look set to benefit from, at least indirectly, the increased momentum in the US. No one particularly likes many of the personal traits of Donald Trump, but middle-American voters put those aside and now that he is President we must do the same thing.
Playing the Trump game
First and foremost, Trump is actually talking to big companies and trying to discover how to press the right buttons so they will invest in America. In all those discussions there is the carrot and the stick, and the stick comes in the form of threats of higher tariffs and other measures aimed at those that don’t want to play the Trump game.
He is a tough and hard operator. The Mexican President discovered this when he refused to discuss paying for the border wall, only to find Trump responded by announcing plans to put a 20 per cent tax on all Mexican exports to the US.
At the core of Trump's plan is a massive reduction in company and individual taxes that will send the American deficit much higher and no doubt cause American interest rates to rise.
But it will also boost consumer spending and create a momentum that, when it is combined with lower taxes and a threat of higher tariffs plus other measures, looks set to increase American investment.
At the same time, as part of additional corporate investment, there needs to be a substantial increase in investment in American infrastructure. Trump also wants to be free from dependence on Middle Eastern oil so that, apart from attempting to blow ISIS to smithereens, Trump will not need to spend nearly as much money in Middle Eastern wars as the two previous Presidents. I suspect the Middle East will become a Russian sphere of influence.
The plan will only work if American companies respond. But the signs are that this is exactly what will happen. But first and foremost, he has to announce and have passed in Congress the tax cuts which are at the core of his strategy. Already the currency markets are getting jittery with the US dollar – they want the tax details and action. If that nervousness spreads, it will threaten the momentum he has created.
Whatever form they take, tax cuts mean a much higher US deficit, which he hopes to cover longer term by massive reductions in public service waste (American public service waste is similar to Australian waste and there are massive amounts to be saved). Also reducing the longer-term US deficit is the fact that if enterprises invest and inflation starts to rise, then those reduced taxes will be partly offset.
All of us can see how this could go pear-shaped, but when the Dow hit 20,000 on Wednesday it was clear that Wall Street was in love with the dream and is prepared to risk higher interest rates and possible global back lashes if Trump increases tariffs.
Trump has a reasonable chance of pulling this off because he is talking to companies, and so if he is sufficiently skilled he will devise an environment that will create the investment but will not create a global back lash. It will be tricky, but it’s a lot better strategy than the Australian system of making announcements and talking later.
Tackling China a looming threat
As far as Australia is concerned, the negotiation with China will see everything on the table including backing Taiwan and sending American war ships into the South China Sea. The risk of conflict to our north has been increased substantially. The view in the Trump camp is that the conflict in the South China Sea should have been tackled by former President Obama as soon as China started to move.
Now the Chinese have naval bases in the area it is more dangerous, but if it is again put in the too-hard basket then China will control the region’s shipping.
Usually when booms like the current Wall Street rally erupt in reaction to a change in administration, the market gets far too excited because the developments take much longer to take place than the market expects. In particular, nobody is going to invest on a massive scale in the US until those tax cuts have moved through Congress. So don’t be surprised if the current weakness in the US dollar spreads to shares and metals. But longer term, if this week’s sentiment on Wall Street is right, then we are going to see a big rise in the demand for steel.
A potential windfall for BHP
President Trump asked BHP chairman Jac Nasser and CEO Andrew Mackenzie in to see him prior to the inauguration, and no doubt they talked about BHP investing large sums in US oil and gas. I would be surprised if, towards the end of the conversation, Jac or Andrew didn’t mention the fact that the US is going to need a lot of steel (and copper). Currently the vast bulk of US steel is either imported or produced from scrap, because American iron ore mines are high cost. If the US needs more ‘blast furnace’ steel in its system, then BHP has iron ore available in Australia and perhaps in Brazil via Samarco.
BHP currently produces its Australian iron ore at around $US15 a tonne, but by the time royalties and transport costs are included then the landed costs in China are around $US30. To get the ore to the US we could add on $US5, which is still way under the iron ore market price. Australian ore will transform the economics of making non-scrap steel in the US.
But a warning sign for retail property
While I was looking through the US steel data I noticed an amazing event in Pittsburgh – once the steel-making capital of the world.
The equity in a retail mall in Pittsburgh was valued some years ago at $US190 million. That equity was recently sold for sold for just $US100: yes, $US100. Now, of course, there is a debt on the property of around $US140 million but that is still a huge fall. It came about because Pittsburgh is a depressed city and is one of the places that has been decimated by globalisation.
But the retail mall business is also increasingly becoming vulnerable to competition from online traders. In the US, as I have discussed previously, Amazon is really starting to eat into the American retail market. That penetration is going to increase because Amazon has now taken steps to slash the costs of its imported goods by taking control of the supply chain rather than outsource it to others. This year Amazon plans to launch in Australia, and all shopping malls and retailers will need to be very alert or they will go the way of Pittsburgh.
It was fascinating during the week to see that Macquarie Bank is starting to have second thoughts about some of the retail shopping malls including Westfield. Macquarie says that as well as the online challenge, higher interest rates will increase borrowing costs and reduce the value of assets like retail malls as well other property and infrastructure assets.
In the US, the retail industry will get the stimulus from the tax cuts to offset any effect of higher interest rates. But, in Australia, we will get no such tax-driven stimulus but our overseas borrowing costs will affect retail malls and other infrastructure assets. However, don’t forget that if interest rates rise, it will actually stimulate spending by self-funded retirees.
Readings & Viewings
Well, one week into the new US administration and the President was certainly true to his word that he would be getting things done.
Or undone, in the case of the Trans-Pacific Partnership. But writing in the Harvard Business Review, Clyde Prestowitz says don't cry for the TPP.
On the business front, Trump put his foot down with US auto makers.
And The Donald is putting sparkle back into the diamond market, apparently.
But De Beers and Alrosa are concerned of a slowdown in rough diamonds.
Meanwhile, the Financial Times had a great read on Rex Tillerson and Exxon (free-article limit): “The defining moment in cementing Exxon’s exacting culture was the 1989 grounding of the tanker Exxon Valdez … Mr Tillerson is steeped in that culture. After BP’s Deepwater Horizon disaster in 2010, he made no attempt to conceal his contempt.”
Over at the New York Times, Trump advisor Steve Bannon turned heads this week when he revealed the media – not the Democratic Party – is the administration's main opposition.
Elsewhere in the world, China's birthrate increased 11.5 per cent in 2015 after the one-child policy was partially abandoned in 2013, and before a further easing of the policy last year.
Canadian fintech company Goldmoney Inc has launched a Sharia-compliant offering.
Still in Canada, the Quebec taxi industry aims to set a precedent in its Uber class action.
Meanwhile, the Brexit is on, and Citigroup and Credit Suisse aren’t wasting any time.
Still in Britain, small UK businesses are turning up on heat on PM Theresa May, asking for assurances their trade with the EU won’t suffer after Brexit.
Who would have thought that Rolls-Royce could be described as junk? Well, that’s exactly what credit ratings agency Standard & Poor’s thinks of the premium carmaker – almost.
And some lighter news: Next time you prepare your tax return, take a look at these bizarre expense claims including pet food and designer jeans.
A mushrooming empire gets even bigger in Ireland.
Finally, this fantastic video clip was released for Australia Day – it's an Aussie anthem, cleverly adapted from the tune of Outkast's 2003 hit Hey Ya!
Last Week
Shane Oliver, AMP Capital
Investment markets and key developments over the past week
The past week saw share markets break higher helped by solid global economic data, good US earnings results and optimism that Donald Trump’s policies will help boost the US economy. In particular the US share market broke upwards out of a range it’s been in since mid-December, pushing the Dow Jones index above 20,000. Reflecting growth optimism bond yields rose as did oil and metal prices. The Australian dollar fell slightly as slightly lower than expected December quarter inflation kept open the prospect of another RBA rate cut.
Not too much should be read into the Dow crossing 20,000. Yes it creates a bit of short term excitement (like crossing from Victoria into NSW) and generates some headlines but it's really just an arbitrary number for an index which only has 30 companies that are combined using a ridiculous price weighting system (so that Goldman Sachs gets a bigger weight than GE). And there is no evidence of higher than average returns after each 1000 point level has been crossed on the Dow anyway.
President Trump and his team’s announcements and comments have continued to create uncertainty but the negatives (e.g. the US’s withdrawal from the TPP, arguments about 'alternative facts' and the floating of a 20 per cent border tax to pay for the wall with Mexico) have been drowned out by the positives (Trump’s reiterating of his commitment to deregulation and tax cuts, moves toward approving the Keystone XL and Dakota Access oil pipelines and the construction boost from building the wall with Mexico). So investors have been left to mainly focus on the positives. And it’s not just Trump – fundamental news has been good too with good US earnings results and continuing strong business conditions readings in the US, Japan and Europe in January. So the pause in share markets as investors digested the rally that occurred since the US election may have run its course.
Two issues regarding President Trump’s policies are worth a mention. First, the US withdrawal from the TPP is no surprise (it would not have passed Congress anyway) and its loss is hardly a disaster for Australia, particularly with other regional trade deals likely to fill the gap. The real issue will be if Trump embarks on a trade war with China … but it’s looking more like Trump will go down the path of negotiation as opposed to unilateral measures at least initially. Secondly, talk of a 'border tax' is heating up in the US. Quite what this means is debatable with the US Congress proposing shifting corporate tax to taxing only the value added of goods consumed in the US such that imports are taxed but exports receive a rebate (much as occurs under value added taxes or GSTs). This is commonly referred to as a 'border adjustment tax'. Trump initially called this approach too complicated and his 'border tax' concepts have thought to have been more direct but his recent comments suggest he could be warming to the idea (or just waving a stick at Mexico). There is a long way to go but if it does get up it would be a huge boost for US exporters (e.g. Boeing) and a huge negative for importers (e.g. Walmart) and would put significant upwards pressure on the value of the US dollar.
Italy’s Constitutional Court’s ruling on the electoral law for its lower house has refocused attention on political risk in Italy explaining why its share market fell and its bond yields rose more than most over the last week. By ruling against a two round electoral system the risk that the populist Five Star Movement attains power is somewhat reduced but the pressure for an early election remains. On current polling another grand coalition would be the likely outcome of an early election, but the risk of a 5SM led Government will rise for a later election if the economy continues to perform poorly. But note that even if 5SM ultimately win’s it would first require a constitutional change to call a referendum on Italy’s membership of the Euro and in any case a majority of Italian’s support remaining in it. Of course that won’t stop markets from having bouts of 'Itexit' fears
Major global economic events and implication
US economic data was mostly strong. Home sales fell in December but manufacturing and services conditions PMIs rose further in January, the leading index rose and home prices continue to rise.
The US December quarter earnings reporting season is also looking impressive. Roughly one third of US S&P 500 companies have now reported with 75 per cent beating earnings expectations and 54 per cent beating on revenue. Earnings are now expected to be up 5 per cent from a year ago taking them to a new high, which is up from an expectation of 3.6 per cent yoy highlighting that the earnings recession that began in 2014 is long over.
Eurozone business conditions PMIs remained strong in January pointing to a slight acceleration in economic growth.
Japan’s manufacturing conditions PMI continued its recovery in January pointing to stronger growth. Inflation remained stuck around zero but at least it was fractionally higher than expected and does seem to have bottomed.
Australian economic events and implications
Low December quarter consumer price inflation in Australia is consistent with another RBA rate cut as inflation remains well below target, but it’s hard to see a move in February. Annual inflation at 1.5 per cent year on year in December was in line with the RBA’s own forecasts and its likely to want to monitor the uptick in lending to property investors and see how the economy performs after its September quarter slump before cutting rates again. However, our assessment remains that with record low wages growth and ongoing spare capacity in the economy along with the increasing likelihood that low inflation is feeding on itself via falling inflation expectations it will take longer to get inflation back to target than the RBA is allowing. As a result we continue to expect another RBA rate cut around May.
Meanwhile a big rise in export prices saw the third successive rise in Australia’s terms of trade in the December quarter. This will boost national income which in turn will help real economic growth but in the absence of another leg up in commodity prices we have probably seen the best for now.
Shane Oliver is chief economist at AMP Capital.
Next Week
Craig James, CommSec
A big week for economic data
A flood of new economic indicators is expected over the coming week. In Australia the latest data on home prices is the highlight.
The week kicks off in Australia on Tuesday, when the Reserve Bank releases the latest private sector credit figures (essentially data on outstanding loans). For 14 straight months, credit has grown by between 0.4-0.6 per cent per month and it is reasonable to expect a similar result in December, keeping annual growth at 5.4 per cent.
Also on Tuesday, the NAB business survey and weekly consumer sentiment data are expected. Consumers remain generally positive, especially on spending intentions. The interesting thing to watch is the indicator on inflation expectations which is at 4½-year highs.
On Wednesday, the Australian Bureau of Statistics (ABS) releases estimates of living costs (inflation) for different groups in the community such as wage earners and pensioners.
Also on Wednesday, CoreLogic will release the January estimates on home prices – the most comprehensive monthly report on the topic. In December, capital city home prices recorded a solid 1.4 per cent gain. But on the data available so far in January, capital city home prices have only lifted by 0.4 per cent. Melbourne prices have lifted 1.1 per cent in January so far but Perth and Brisbane prices have fallen by around 0.5 per cent. Sydney prices are up 0.3 per cent in the month.
And the latest gauge on manufacturing activity – the Performance of Manufacturing index – is also released on Wednesday. The December reading was encouraging at 55.4 (any reading over 50 indicates expansion). Investors would hope for similar strength in January.
On Thursday there are two indicators of note to be released by the ABS – international trade and building approvals. In November Australia’s trade balance improved by $2362 million to a surplus of $1243m. It was the first monthly trade surplus in 33 months and largely reflected higher coal and iron ore prices. But higher coal and iron ore volumes and prices as well as higher liquefied natural gas (LNG) revenues should support trade accounts in coming months. A surplus of $3 billion is tipped for December.
Dwelling approvals have been volatile in recent months – up 7 per cent in November after an 11.8 per cent fall in October. Approvals have peaked, although they are only easing slowly in trend terms from peak levels.
On Friday the Federal Chamber of Automotive Industries will release the January new car sales figures – one of the timeliest economic indicators. Car sales were at record levels for a calendar year in 2016.
Overseas: US interest rates and jobs are in focus
There are two standout events in the coming week: the interest rate decision from the US Federal Reserve and the release of monthly jobs data in the US.
The week kicks off on Monday with the release of US personal income and spending figures together with the pending home sales index. Economists tip healthy gains of 0.4 per cent for both incomes and spending.
On Tuesday, the US Federal Reserve starts a two-day meeting (decision announced Thursday morning Sydney time). The Fed is poised to lift rates – but not yet, given that inflation is contained. Most economists expect around three rate hikes this year, but the Fed may hold off a little longer.
Also on Tuesday the Case-Shiller measure of home prices is released alongside consumer confidence and the weekly data on chain store sales. Confidence is at 15-year highs while home prices are up a healthy 5.1 per cent on a year ago.
On Wednesday, the ISM manufacturing activity gauge is released with the ADP National employment index and January auto sales data. Latest data shows solid manufacturing activity (index of 54.5). The ADP survey is also expected to see a lift in job growth from 153,000 in December to 168,000 in January.
On Thursday, the Challenger survey of job layoffs is released with the weekly data on claims for unemployment insurance.
And on Friday the all-important non-farm payrolls (employment) data is released with factory orders and the ISM survey of activity in the services sector. As per the last report it is not just jobs in focus. Average earnings (wages) rose by 0.4 per cent in December. If we see a similar sort of increase in January, policymakers may start worrying about potential inflationary pressures. And as a result the Fed may be more likely to lift interest rates.
In China the National Bureau of Statistics releases its purchasing manager reports for manufacturing and services sectors on Wednesday. And the Caixin manufacturing survey is issued on Friday.
Sharemarkets, interest rates, exchange rates and commodities
The US earnings season is in full swing. And it is a case of so far, so good. According to Thomson Reuters, December quarter earnings may have lifted 7 per cent over the year, the biggest increase in two years. “Of the 146 companies that have reported earnings through Thursday morning, 69.2 per cent have topped expectations, compared with the 63.6 per cent average since 1994.”
The Australian earnings season gets underway next week with Navitas and CYBG Plc to report on Tuesday. There will be much focus on whether companies are now experiencing better fortunes than was the case around mid-2016.
Craig James is chief economist at CommSec.
