The Housing Bust is (Almost) Over, Bond Yields, RBA and the Treasurer, Mueller, Scotland

Last Night's Markets
TCI migration to InvestSMART
Now Mexico Too
The Housing Bust is (Almost) Over
Bond Yields Are Falling On My Head
The RBA and the Treasurer
Australia and the US
Mueller and Trump
Packer’s Slipped Crown
I’m On My Way (To Scotland)
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

TCI migration to InvestSMART

We'll soon be finalising the migration of The Constant Investor to InvestSMART, which will include closing down The Constant Investor website, so best to note down the below:

1. All TCI members will now be charged by InvestSMART; you will be able to log in to InvestSMART and go to My account > My Invoices to download invoices. All invoices will be in the name of InvestSMART Financial Services Pty Ltd, and you'll be able to access them by clicking here.
    
2. All TCI members can access all TCI content plus more on the InvestSMART website. We will continue to update the TCI website with normal TCI content until July and then we will be closing down the TCI website in July.  
    
3. All TCI members will still be able to access content on the TCI App, but you should download the InvestSMART App because we will be shutting down the TCI App in July as well. There is more content available on the InvestSMART App plus the portfolio manager.

If you've got any issues accessing the InvestSMART website or using the InvestSMART app, best to send an email to the great customer service team via support@investsmart.com.au or via get in touch with them via phone on 1300 880 160.

Now Mexico Too

Markets came under fresh pressure last night after President Trump announced (on Twitter of course) that a 5% tariff would be imposed on goods from Mexico unless they stopped the flow of illegal immigrants.

“Tariff will gradually increase until the Illegal Immigration problem is remedied,” he added. “....at which time the Tariffs will be removed. Details from the White House to follow.”

There were a few more tweets a bit later, including this: “In order not to pay Tariffs, if they start rising, companies will leave Mexico, which has taken 30% of our Auto Industry, and come back home to the USA. Mexico must take back their country from the drug lords and cartels. The Tariff is about stopping drugs as well as illegals!”

Once again the American President is using trade as a weapon for something else. With China, it’s the way they are trying to gain technology supremacy (by stealing it) and with Mexico it’s the flow of illegal immigrants. They’re both real issues and something should be done, but taxing imports to do it? It’s definitely novel.

Markets were hit hard by the latest news, just as they are trying to evaluate the re-escalation of the US-China trade war. New York indices are all down well over 1% this morning, European markets are also well down, gold is up, oil is down almost 6%.

It’s all about uncertainty as well as than the direct impact. A lot of companies were apparently thinking about shifting production from China to Mexico and they will have to rethink that.

As for imports from Mexico, there were US$347 billion worth in 2018, of which US$114.3 was cars, trucks and auto parts, and there’s a very wide range of other products. Prices would go up across and the US economy would suffer a “wrenching blow”, as one commentator put it.

But it’s largely about the car industry, and it’s unlikely to be good for the US auto companies, since they have shifted production to Mexico, and where they still manufacture in the US, the parts come from Mexico. General Motors shares fell 4.3% and Ford, 2.3% this morning.

There was also news last night that China’s manufacturing PMI fell back into contraction (49.4 from 50.1), which added to the gloom.

There’s no doubt that America’s use of trade barriers in this way is causing a lot of business and consumer uncertainty which is having its own impact on the economy, and rubbing off on markets. That’s only going to worsen now that Mexico has been added, because it’s apparent that trade and economic activity has become Trump’s diplomatic weapon of choice.

And this comes as the US economy is beginning to show the effects of nine rate hikes plus the Fed’s quantitative tightening. The Fed has now paused and the market is predicting rate cuts, but that hasn’t happened yet.

The Housing Bust Is (Almost) Over

With the RBA about to start cutting interest rates again, it’s time for investors to start looking ahead to what that will mean for them in 2020. In short, it means the housing decline has either ended already, or will end soon.

The reason to be confident of that is that the Government, APRA and the Reserve Bank are all determined to make it happen, and since the housing downturn didn’t just start on its own this time, but was engineered by an APRA-imposed credit squeeze, there’s no reason to think they can’t make it stop if they put their minds to it.

• APRA has loosened credit restrictions
• The RBA is about start cutting interest rates
• The Government is helping first home buyers

Sometimes things aren’t all that complicated. I’m not saying that a new house price boom will start immediately (although that’s always possible in Australia) but that the bottom is probably in. By the end of 2020, it’s likely that house prices will be higher than they are now.

The only thing holding the housing market back will be the banks’ own reluctance to lend, which is very high at the moment. They were traumatised by the royal commission, and all anecdotal evidence suggests that inside the banks the effects are lingering.

But I suspect the desire to make money won’t take too long to prevail.

For investors, it means housing-related stocks will do relatively well. They are all well down, both in absolute and relative terms, since the housing downturn began in 2017.

From here the winners are likely to be banks (all of them) and mortgage brokers (AFG and MOC), home listing websites (REA, DHG and NEC, which owns 60% of DHG), and building materials (JHX, BLD, ABC, BKW, CSR, WGN and RWC).

Australian equities tend to be highly correlated to the housing cycle:

The only reason equity returns on average have held up over the past two years is that resources stocks have significantly outperformed, especially lately.

This chart shows the Australian resources index (XKR), in blue, versus the global MSCI index (red), since July 2017:

With a new rate cut cycle about to begin, fiscal stimulus also likely to be around the corner, and APRA loosening the purse strings as well, this could be time to refocus on domestic equities instead of international.

Bond Yields Are Falling On My Head

Bond yields are falling everywhere:

This week the Australian 10-year bond yield fell below the cash rate - 1.5% - for a while, and is still barely above that. The 5-year yield is 1.2% and the 180 bill rate is 1.4%.

The yield curve is inverted - here, there and pretty much everywhere.

In the 4th quarter of 2018 bond yields fell (that is, bond prices rose) and equities fell with them. In the first two months of 2019, bond yields stabilised while equities rallied, hard. In April, bond yields rose and so did equities, and in May bond yields and equities have fallen – both markets are freaking out.

The disruption began at the start of October last year with two events: Fed chairman Jerome Powell said interest rates were “a long way from neutral”, apparently signalling rate hikes, and Vice President Mike Pence made a very belligerent speech about China.

Since then markets have been tossed around by the latest news on either of those things, and it’s fair to say the Fed is a lot less volatile than the Trump Administration.

Gradually, and then suddenly, the Fed shifted from hawkish last October to dovish in January; the sharemarket corrected then rallied. Bond yields fell on the expectation of rate hikes, did nothing when the Fed did an about-face in January/February and then fell again when Trump got going properly with the trade war with his May 5 tweet that flagged tariff increases on $200 billion worth of goods from 10 to 25%. Equities corrected then too.

So the stock market is back in agreement with the bond market: things look bad, not because of a hawkish Fed, but because of a hawkish Trump (on China).

Talk of a recession caused by the trade war is overblown, in my view. It is, and will be, disruptive and cause a lot of uncertainty. That certainly won’t help business investment and consumer sentiment, but on the other hand, the tariffs will probably boost domestic employment in the US to some extent, as well as inflation. In any case, the Fed is clearly standing by ready to cut interest rates again if needed.

The least likely scenario is a trade deal in the short term, especially since the US put Huawei on the entity list.

Politics on both sides no longer favour a deal. For the US, preventing Huawei from being able to build 5G networks around the world is a matter of national security. And for Xi Jinping, signing a trade deal while accepting the assassination of Huawei is impossible.

It’s very unlikely that the US hardliners would accept a situation where the US agreed to go easy on Huawei in order to extract a few more concessions in the trade deal, and Chinese hardliners won’t accept a trade deal unless Huawei is also off the hook.

In a recent conference call, GaveKal’s China analyst, Arthur Kroeber, said he thought China and the US wouldn’t necessarily be the worst affected countries from all this.

“I think (there’ll be) a general loss of confidence in the business community around the world on the grounds that we're moving into a more protectionist, higher cost environment and this will tend, I think, to slow global trade volumes and slow the rate of global business investment.

“And therefore, the countries that will fare worst are the ones that in Europe are heavily dependent on exports to China, and that also have very little policy space to revitalize the domestic economies when things slow down. Some emerging markets I think are in a similar situation.”

And Australia. He didn’t mention Australia because it was a European audience, but Australia is “heavily dependent on exports to China” as well.

And to finish this segment, here’s a chart from Gerard Minack:

The RBA and the Treasurer

As foreshadowed last Saturday, this week I interviewed the Treasurer Josh Frydenberg on Monday and then sat on an off-the-record panel with the Governor of the Reserve Bank, Philip Lowe, at a private function in Melbourne.

You can read a transcript of my conversation with Frydenberg here, but there’s not much point: he didn’t say much. Nice man, and he’ll be a hard-working, safe Treasurer, but like all experienced politicians he knows how to get through an interview without giving anything away.

As for the Governor - pity it was Chatham House Rule, under which he can’t be quoted, but let me give you a narrative that is, shall we say, well informed.

The backdrop to the event was the 100% certainty that rates will be cut on Tuesday, beginning a new and remarkable easing cycle.

In my 49 years as a financial journalist I have never seen anything like it: an easing cycle that begins without any preceding tightening at all, and with the cash rate already at a record low. The only “tightening”, if you can call it that, was a shift in the RBA’s bias towards a rate cut last year without actually doing it, and which has been comprehensively reversed in the past couple of months. The whole thing is extraordinary.

Why is it happening? Because a year ago the Australian economy was OK, now it’s barely OK. GDP growth is weak, so is consumption growth because incomes are not rising. In the past three years, disposable income growth has been 3% per annum; it has traditionally been 6%.

When the Governor and I were lads (he in Wagga Wagga, me in Oakleigh) the problem was stagflation, the coexistence of high inflation and high unemployment. The central banks of the world decided to brutally crush the inflation rather than the unemployment, and brought about two devastating recessions in 1982 and 1991 to do it. Could they have dealt with unemployment instead, and not caused such misery? We’ll never know.

Now we have the coexistence of low inflation and low unemployment. Why? No one is sure, or at least no one in central banking.

Perhaps it’s the credibility of central banks these days (patting themselves lightly on the back) - that is, inflation expectations are low because if it rises everyone believes the RBA will stamp on it. There’s also globalisation, technology and competition removing pricing power (which is what I think it’s about).

In any case, the RBA’s objective, as laid out in its statutory mandate, is “price stability, full employment and the wellbeing of Australians”, or words to that effect.

Price stability, they have decided, is 2.5% inflation. Why? Well, no one has properly explained that, beyond the proposition that some inflation is necessary because deflation would be even worse and if price stability was taken to mean no inflation at all, then by definition it would occasionally go below zero, on average.

I don’t really buy that argument. I reckon the current inflation rate of 1.5% is OK and certainly worth panicking over. Zero price rises would be just fine too.

But getting unemployment down below 5%, and underemployment below 8% is definitely a worthy aim, but I don’t believe a rate cut or two is going to achieve it.

The economists at JP Morgan Australia have worked out that a 50bp (0.5%) cut in interest rates will reduce unemployment by 0.15% over two years. Less than one-sixth of one per cent cut in unemployment for every half per cent cut in interest rates? I call that pushing poo uphill with a stick.

The only thing that will get unemployment down beyond patience and the normal operation of the business cycle, is a big loosening of fiscal policy – that is, putting off the return to surplus by bringing forward the far-off tax cuts, and then some, and a lot of infrastructure spending.

Dr Lowe spelt this out in his recent speech, and although Frydenberg played a straight bat on this subject in our interview, I think he will bring down a mini-budget before long to put the fiscal shoulder to the easing wheel along with the monetary one.

The other reason for that is that GDP growth could be close to zero on Wednesday, if not actually zero (quarter on quarter), and 1.5% for the year. That’s pretty low – probably deserves more than a rate cut.

Why is economic growth so low, and falling? Because of weak consumption growth, and consumption represents 60% of the economy. The reason for that, in turn, is that incomes are not rising: for the past three years, growth in disposable income has been 3%. Before that, it averaged 6%.

I don’t think a rate cut or two is going to change that, but it’s worth a try and it’s the only thing the RBA can do. The Fair Work Commission raised the minimum wage by 3% this week, which was pretty tentative, it must be said, but it can’t hurt.

Overall (and this is all me now) we may be in an extended period of low numbers – low growth, low inflation, relatively low unemployment and low interest rates.

Stagflation went for a decade until it was crushed by Paul Volcker in 1981. The opposite of that could last much longer because it can’t be crushed – the Fed printed $4 trillion and kept interest rates at zero for seven years and that didn’t work.

If I’m right, it’s better than more boom-bust cycles, but low growth and low interest rates present challenges for investors of their own, but as discussed in the first item today, at least the housing cycle is about to turn, which brings some important opportunities for investors.

Australia and the US

I read yesterday that the Australian stock market has decoupled from Wall Street, because it outperformed in May. “Historically when the US sneezes Australia catches a cold, but that is no longer the case,” the note said.

So to check, I went back over the past 12 months to compare monthly performances. Here’s the result (Aussie outperformance in blue):

Err, that’s four out of 12. And by the way, the outperformance in May was entirely due to the banks rallying after the election because negative gearing and capital gains tax won’t be changed, helped to some extent by the iron ore price boom.

So I doubt there has been some big shift so that we no longer catch a cold when Wall Street sneezes. If anything, and as discussed above, Australian equities are likely to do worse than the US if the trade war drags on.

Mueller and Trump

It’s hard to escape the feeling that United States politics is approaching some kind of denouement. Maybe impeachment proceedings, maybe capitulation by the anti-Trumps. Or then again, who knows? Maybe the whole show will just grind on like this until the election in November 2020 and there’ll be no denouement till then.

This week Special Investigator Robert Mueller made a surprise appearance in front of a lectern and basically said that Trump broke the law but that he couldn’t prosecute him because “under longstanding department policy, a president cannot be charged with a federal crime while he is in office. That is unconstitutional.”

So he made no determination about Trump’s criminality because there was no point, although he added: “if we had had confidence that the president clearly did not commit a crime, we would have said so.”

So – it was pretty clear, and damning.

But here’s what happened next: Trump completely misrepresented what Mueller said in a tweet: “The Greatest Presidential Harassment in history. After spending $40,000,000 over two dark years, with unlimited access, people, resources and cooperation, highly conflicted Robert Mueller would have brought charges, if he had ANYTHING, but there were no charges to bring!”

There were a few more tweets along similar lines, basically saying that Mueller found No Obstruction and everyone should now move on.

What interests me most about this is that Trump has 60 million Twitter followers. Fox News, the highest rating news channel, has 2.4 million viewers. The New York Times has a bit over 2 million readers, print plus digital. The total circulation, print and digital, of the top 100 American newspapers is 15 million – a quarter of Trump’s Twitter crowd.

Trump is the largest media outlet in America. That is, he has the largest audience – in fact it could be larger than all the rest of the media put together.

Of course, not all of his followers are fans, and many (including me) are not American, but even allowing for that there is absolutely no doubt that more people read Trump’s version of what Mueller said than heard Mueller say it, or read it, or read any other report of it.

In other words, Trump is framing the news about himself in a way that no political leader has ever done before. He‘s not just doing it with Twitter but also his rallies and rambling press conferences, which also get plenty coverage because of the desire by most media to give equal time to both sides, Republican and Democrat.

What’s happening in the US is unprecedented, and it’s impossible to predict how it ends.

Packer’s Slipped Crown

I don’t have much to add about James Packer’s sale of 20% of Crown resorts to Laurence Ho, other than it probably makes Crown a buy (at Ho’s price).

The key to global gambling revenues is the Chinese market, and to have someone involved in the company who is not only fully engaged, unlike Packer, but an expert on Chinese gamblers is a big plus, it seems to me.

Ho obviously thinks Australia – Barangaroo in particular – is going to be an important destination for Chinese punters, especially if China continues its policy of periodically cracking down on Macau.

The price was obviously disappointing - $13 versus the $14.75 that Wynn offered and then withdrew last month when it leaked – but James Packer was clearly a very motivated seller, as they say in real estate.

I’m not sure why you wouldn’t buy Crown at the same price as Laurence Ho is paying – that is, of course, if you’re into investing in casinos.

I’m On My Way (To Scotland)

This is my last Weekend Briefing for a month – Deb and I off to Scotland for a WEB (well-earned break).

Any tips on what to see and do there would be welcome (a.kohler@investsmart.com.au). At this stage we’re in Edinburgh for a week or so, then to Skye and the Outer Hebrides, and then the Highlands, fueled, I’m thinking, by single malt tastings.

Research and Diversions

Research

Will the new cold war break the internet? (Podcast).

“China has no philosophy, only thought.” “Intellectual reflection in traditional China centred on the moral ideal of the sage. The way in which this was considered was fairly subtle and speculative, but the validity of arguments was not a primary concern”. Classical Chinese philosophy was born of “the need for good governors”; its Western counterpart was born of “awe at natural phenomena”

Beyond blue chips: A road map for income investors.

The Bitcoin bulls are back – what’s driving the price action? (it’s up 146% from the December 2018 low). It seems to be China.

Amazon is chomping in to the food delivery market with an investment in Deliveroo. In fact, “Within the past year alone, Amazon has announced more than half a dozen major investments representing billions of dollars - essentially Amazon has been gradually racking up investments to position itself for the future as its core business slows.” 

Tesla Vs Waymo. “When comparing Tesla and Waymo, there’s an understandable impulse is to draw a parallel to the age-old vertically integrated Mac vs. the “open” PC clone debate. Given Tesla’s integration of software and hardware, it’s easy to pose the company in the role of its Cupertino neighbour. But is Waymo a fitting analogue for Microsoft?

“Nuclear energy is a permanent feature of human civilization, like fire, agriculture, and gunpowder. As such, the decision by scientists to recognize nuclear as a revolutionary technology could help humankind to finally accept the technology along with its potential to lift all humans out of poverty, protect the natural environment, and end war as we know it.”

It’s never been easier to be a CEO, and the pay keeps rising.

Why VPNs are everywhere, and how to pick the best one. And anyway, is a “private connection” really worth it?

“Conservatism is the dominant politics of the modern world. Even when rightwing parties are not in power, conservative ideas and policies set the shape of society and the economy.” The bloke wrote this piece in The Guardian went on to add that the right is clinging to power but its “ideas are dead in the water”. That may be true of the UK, but I don’t think it’s true elsewhere. Conservatism, it seems to me, is far from dead in Australia or the US, or elsewhere in Europe for that matter.

Further on that subject: “Anyone who wants to explain what’s happening in the West needs to answer two simple questions. First, why are right-wing populists doing better than left-wing ones? Second, why did the migration crisis boost populist-right numbers sharply while the economic crisis had no overall effect? If we stick to data, the answer is crystal clear. Demography and culture, not economic and political developments, hold the key to understanding the populist moment. Immigration is central.

I do agree with this: “Trump is a phenomenon. Only a genuinely formidable personality could withstand such intense, unremitting investigative pressure and hostility. Trump lacks the facility to govern effectively, but he knows how to command the attention of the highly educated. His marketing prowess, applied to the political world, is outrageously good”

“I’m against tariffs and for trade war” – China should be forced to level the playing field.

Yikes! Artificial intelligence can now copy your voice.

Three (global) companies with significant tailwinds.

John Abernethy interviews himself (it’s not quite as crazy as it sounds). For example: “Q. John – the equity markets have been a rollercoaster for the last 18 months and the recent trade dislocation created a downward shift. Where to from now? I don’t know where markets are going in the short term, but I do know that quality companies who fund their own growth will do well over a period. I also suspect that bond markets (whilst currently elevated) will bounce around inside yield bands. Government bonds currently offer very poor returns forcing yield investors to look elsewhere for decent returns.

“Brexit is not about Left versus Right”. Interesting (hour-long) video explanation of what’s going on in Britain, and global politics generally for that matter, by Sir John Curtice, Professor of Politics at the University of Strathclyde and Senior Research Fellow at NatCen Social Research.

Re Germany: After Merkel, the darkness. “There are many reasons for Merkel to look around the globe with concern. But the most important reason of all is Donald Trump. There's much to suggest that his election was her primary motivation for seeking a fourth term in office.”

Diversions

Great inaugural speech by the newly elected president of Ukraine, Volodymyr Zelenskyy, fresh from his previous career as a television actor in which he had portrayed, most recently, a newly elected president of Ukraine. “Please, I really don’t want you to hang my portraits on your office walls. Because a president is not an icon and not an idol. A president is not a portrait. Hang pictures of your children. And before you make any decision, look into their eyes”

The company that built an enormous replica of Noah’s Ark at a theme park in the United States is suing its insurance company because of – wait for it – rain damage.

Good grief: “The U.S. military plans to analyse 350 billion social-media posts from around the world to help it track how popular movements evolve.” Apparently it’s necessary to “help defend against adversaries seeking to undermine democracy and create divisions within western societies”.

Do you get restless leg syndrome (I do sometimes). This might help (thanks to Percy Allan for the link).

At last: Scientists at the U.S. Department of Energy’s Lawrence Berkeley National Laboratory in northern California have created a next-generation plastic that can be recycled again and again, into new materials of any color, shape, or form.

In the Middle Ages, fish was so valuable that chefs sometimes tried to disguise beef as fish. As archaeologists learn more about medieval consumption, they're understanding how dramatically Europeans reshaped fish populations,

From Queen Victoria’ diary: “I was awoke at six o’clock by Mama, who told me that the archbishop of Canterbury and Lord Conyngham were here and wished to see me. I got out of bed and went into my sitting room (only in my dressing gown), and alone, and saw them. Lord Conyngham then acquainted me that my poor uncle the king was no more, and had expired at twelve minutes past two this morning, and consequently that I am queen.” 

Furthermore: “American voters (and Australian ones too for that matter) don’t care about the economy.”

The Abortion Debate Is No Longer About Policy. "Abortion politics in 2019 is a morality play about what happens when one side has all the political power, yet feels culturally embattled. In this atmosphere, victories are not satisfying if they leave the other side with a foothold, a vestige of respectability. (It’s) no longer about policy wins, but about establishing dominance." 

A young paleontologist may have discovered a record of the most significant event in the history of life on Earth (the day the dinosaurs died).

Should we feel sorry for the youth of the West, embarking on life as the stability and prosperity of the post-war order collapses around them? Or should we envy them their chance to re-make the world? “…the exciting times are back again. It is especially exciting for the young people because the richness of ideological choices they have before them is immense: liberalism, new socialism, nationalism, political Islam, Chinese political capitalism, probably more.” 

What’s the most powerful and persuasive construct of the human imagination? It’s the idea of hell.

The enduring brilliance of Leonardo da Vinci. “Not one of his predecessors or contemporaries produced anything comparable in range, speculative brilliance, and visual intensity. And we know of nothing really comparable over succeeding centuries.”

A true life detective story involving a stolen Volvo containing a beloved dog, a city-wide search and a pet detective named Sherlock Bones.

11 people have now died on Mt Everest this season. The picture with this story is astonishing: it’s a dense queue of people leading to the summit. Pure madness.

Yuval Noah Harari: Why Fiction Trumps Truth: “We humans know more truths than any species on earth. Yet we also believe the most falsehoods.”

Happy Birthday Marilyn Monroe, born June 1, 1926, died 1962. Here she is singing “I Wanna Be Loved By You” from Some Like It Hot. Boop boop be doo.

And here’s Elton John’s song about her – Candle In The Wind.

And here are a few videos to get me in the mood for next week’s trip to Scotland.

First, massed pipes and drums doing Scotland the Brave on their way to the Highland Games on 2018.

Second, a bit of Billy Connolly stand-up.

And third, of course, The Proclaimers – I’m On My Way (From Misery to Happiness).

From a subscriber:

#AskAlan Live

The weekly Facebook #AskAlan livestream is above, and has migrated to a new platform on the InvestSMART website which can be found here.

While Alan is enjoying the Scottish sights, there will be no #AskAlan sessions - back in July!

Next Week

By Craig James, Chief Economist, CommSec

Australia: Interest rates & economic growth

• A strange quirk of the statistical calendar is that each new season is ushered in by a barrage of new economic data. So, the ‘Winter Whirlwind’ is upon us – around a dozen surveys or data releases are scheduled over the coming week.
• The week kicks off on Monday when the Bureau of Statistics (ABS) issues the Business Indicators publication that includes data on profits, sales, wages and stocks.
• Also on Monday are surveys of manufacturing from AiGroup and CBA. CoreLogic issues the May data on home prices. ANZ job ads and the Melbourne Institute inflation gauge are issued.
• In May, home prices may have fallen by around 0.5 per cent. But the data pre-dates the Federal Election result, APRA announcement of mortgage serviceability and the Reserve Bank Governor’s guidance on rate cuts.
• On Tuesday the Reserve Bank meets and economists are in agreement that a quarter of a per cent rate cut will be delivered – the first move in almost three years. The Reserve Bank Governor speaks at the RBA Board dinner held with the business community.
• In terms of data, the quarterly balance of payments figures are issued with government finance, retail trade and the weekly reading of consumer sentiment.
• Retail spending has risen for the last three months, averaging 0.4 per cent gains a month. But some of this growth in spending can be attributed to higher grocery prices.
• On Wednesday the focus will be on the March quarter economic growth (GDP) estimates. The data is now almost ancient history. Not only are readings on the economy available for April and May, the federal election is also in the rear window. Activity has seemingly lifted markedly post-election.
• Overall we expect that the economy grew by around 0.5 per cent in the quarter with annual growth near 2.3 per cent.
• Also on Wednesday, both AiGroup and the CBA release the May surveys on services activity. And the Federal Chamber of Automotive Industries issues the May data on new vehicle sales.
• On Thursday the April figures on exports and imports (international trade) are released. There have been 15 consecutive monthly trade surpluses and the annual surplus to March was at a record high of $34.1 billion.
• And on Friday, the comprehensive April data is released on new lending by financial intermediaries to the household and business sectors with the Performance of Construction index. Encouragingly, Bankers Association data suggests that the number of housing loans lifted 1.7 per cent in the month with the value of commitments up 6.5 per cent.

Overseas: US jobs data & the Beige Book awaited

• A busy week is in prospect. In the US the Beige Book is issued on Wednesday and non-farm payrolls (jobs) on Friday.
• The week begins on Monday with readings on the manufacturing sector in the US and China. In the US there are rival surveys from Markit and the Institute of Supply Management. In China, there is the survey from the private sector Caixin group. Manufacturing activity has softened across the globe.
• Also on Monday in the US is data on new vehicle sales and construction spending.
• On Tuesday in the US, data on factory orders and the ISM New York index are released with weekly chain store sales. The Federal Reserve chair, Jerome Powell, gives opening remarks at a conference.
• On Wednesday, the focus shifts to surveys on the services sector. Again, in the US there are the Markit and ISM services surveys. In China, the services survey is conducted by Caixin.
• Also on Wednesday in the US is the ADP survey of private sector payrolls as well as the Beige Book survey of economic conditions across Federal Reserve districts. Traders are now closely looking for any signs of slippage in the economy that could provoke the Federal Reserve to cut rates.
• On Thursday in the US is the April international trade data (exports and imports). The deficit is seemingly stuck near US$50 billion.
• Also on Thursday are final estimates of unit labour costs and productivity for the March quarter, the Challenger survey of job cuts and the weekly data on initial claims for unemployment insurance.
• On Friday in the US, the all-important non-farm payrolls (jobs) data is released. The job market is strong. Unemployment stands at a 49-year low of 3.6 per cent. Jobs lifted by 263,000 in April. And hourly earnings are up 3.2 per cent over the year.
• Economists tip a 195,000 lift in payrolls with little change tipped for hourly earnings and the jobless rate.

Last Week

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

Investment markets and key developments over the past week

• Global share markets fell again over the last week on the back of worries about global growth in the face of the escalating US/China trade war, made worse by Trump’s decision to put a 5% tariff on imports from Mexico rising to 25% by October unless it stops illegal immigration. Australian shares were dragged lower too as post-election euphoria wore off with utilities, property, consumer staples and energy shares hard hit. Chinese shares managed to rise though helped by the prospect of more policy stimulus. Bond yields fell further on the back of safe haven demand, growth fears, weak inflation and increasing expectations of monetary easing. While the iron ore price rose slightly copper and oil remained under pressure. The $A slipped towards $US0.69 as the $US rose.
• Trade threat escalating badly. Trade war fears continued to ramp up over the past week with Trump saying he was “not yet ready” to make a deal with China and hints from China that it may stop exports of rare earth minerals to the US highlighting that the dispute is moving beyond tariffs and Trump opening a new tariff front with Mexico. China supplies around 80% of US rare earth imports and they are essential in sectors like defence and electronics. The US could retaliate by banning the sale of semiconductor chips to China. While the tariffs on Mexico are immigration-related, imports from Mexico are around 14% of total US imports and will reap havoc with US companies supply chains – particularly in the auto sector. Business will wonder who in their supply chain will be disrupted next. Clearly this ongoing escalation will not be good for business confidence, growth and profits. Share markets are likely to have to fall a lot further to make Trump realise just how great the threat to the US economy and by implication his 2020 re-election prospects are (US President’s don’t get re-elected when unemployment is rising). So shares likely face more short term downside as the trade conflict(s) will likely get worse before it gets better. The “great negotiator” (Trump) surely realises that he won’t look so great if all he has to show for his trade war is rising unemployment.
• Back to business as usual after the EU parliamentary elections failed to see a populist/Eurosceptic surge. While the centrist parties lost seats this was not so much to the populist/Eurosceptics who have secured a similar number of seats as in the old parliament but to smaller pro-EU parties like the Greens so pro-EU parties maintain a roughly two thirds majority. So it’s business as usual. One risk with the EU parliamentary elections out of the way and haggling now shifting to Europe’s top bureaucratic jobs is that Germany’s Jen’s Weidmann could succeed Draghi as ECB President. Weidmann is a well-known hawk who opposed much of Draghi’s stimulatory measures so if he were to take over it would likely be taken badly by investment markets – or at least until he shows he will be more pragmatic.
• The UK EU parliamentary vote saw the Conservatives and Labour suffer a protest vote for not solving Brexit but it’s interesting to note that outside of them pro EU parties got 40% of the vote, which was more than Brexit parties did at 35% suggesting more support for Bremain than Brexit! Notwithstanding that, the likely rise of a hard core Brexiteer as Tory leader (Boris Johnson) increases the risk of a no-deal Brexit for the UK.
• In Australia, the Victorian budget highlighted the silly dependence Australian states have on the property market with the property downturn causing a slump in stamp duty revenue which in turn prompted Victoria to hike other taxes at a time when growth in state public capital spending is set to slow. This is bonkers and risks accentuating the negative impact of the property downturn on economic growth. It highlights the need to ditch ridiculous state stamp duties and replace them with more stable revenue streams such as an increased GST or a land tax.

Major global economic events and implications

• US consumer confidence rebounded in April and remains solid highlighting that while the trade war is impacting business confidence its not yet having much impact on consumers. In particular, consumer perceptions of the jobs market remain very strong which is consistent with jobless claims remaining ultra-low. Meanwhile, housing data remains mixed with pending home sales down in April and flat on a year ago and house price growth slowing but lower mortgage rates should help.
• Meanwhile, US core private consumption deflator inflation has been revised even lower and Fed Vice Chair Clarida has noted that while the US economy is in a “good place” an increase in downside risks to growth and inflation could drive rate cuts. Unless the trade war is resolved soon Fed rate cuts are looking increasingly likely.
• Eurozone economic sentiment rose in May with gains in business and consumer confidence and credit growth accelerated in April.
• Japanese data for April showed a continuing strong labour market (as the labour force shrinks) and a small bounce in industrial production, albeit it's still down 1.5%yoy. Core inflation in Tokyo slipped back to just 0.8%yoy.
• China’s composite business conditions PMI was little changed in May at a reasonable 53.3 thanks to resilient non-manufacturing conditions but a fall back in the manufacturing PMI, probably not helped by the renewed trade threat, will maintain pressure for more policy stimulus in China

Australian economic events and implications

• Australian data was generally soft over the last week with a further fall in building approvals, broad-based declines in business investment and continuing soft credit growth. There was some good news though with rising business investment plans for 2019-20 as the mining investment bust bottoms out and turns up and as non-mining investment continues to head up. Weak demand growth in the economy will probably mean that it won’t be anywhere near as strong as the next chart implies though.

Source: ABS, AMP Capital

• The minimum wage to rise 3% from July - but that’s less than last year’s 3.5% rise. So with around 20% of workforce (those on awards) getting the minimum wage rise it actually implies a 0.1% pa fall in overall wages growth over the year ahead (ie from 2.3% year on year down to around 2.2%yoy) all else equal. Expect wages growth to remain soft!
• The combination of slower growth in the minimum wage, falling building approvals, soft credit growth, falling March quarter investment and likely only modestly rising capex in 2019-20 leave the RBA on track to cut rates on Tuesday by 0.25% with further cuts to follow.

What to watch over the next week?

• In the US, the Markit business conditions PMIs point to softer readings for the May manufacturing and non-manufacturing ISM indexes due Monday and Wednesday respectively, but payroll employment for May (Friday) is expected to show another solid gain of around 190,000 jobs keeping unemployment at 3.6% although with wages growth remaining benign at around 3.2% year on year.
• The ECB at its meeting on Thursday is expected to leave monetary policy on hold but remain dovish and biased to providing more stimulus. It may announce that its negative interest rate on bank reserves only applies beyond required reserve levels. On the data front unemployment (Tuesday) is expected to be unchanged in April at 7.7% and core inflation for May (also Tuesday) is expected to remain soft at 1.3%.
• China’s Caixin manufacturing and services conditions PMIs for May will be released on Monday and Wednesday respectively.
• In Australia, the RBA is expected to cut the cash rate to an historic low of 1.25% at its board meeting on Tuesday. This will be the 13^th rate cut in the easing cycle that started way back in November 2011. The RBA has revised down its growth and inflation forecasts sharply and now accepts that it needs lower unemployment to get inflation back to target. The problem is that recent signs point to rising unemployment. And Governor Lowe strongly hinted at an imminent rate cut saying that “the case for lower interest rates” would be considered at Tuesday’s meeting. So the RBA has now fully prepared the market for a cut and of course the election is out of the way. With the recent reduction in bank funding costs and nearly 90% of bank deposits on interest rates above 0.5% (and hence able to be cut if the RBA cuts) we expect all of the RBA’s cut to be passed on to customers. While rate cuts may not have the same bang for the buck as they did a few years ago now that debt is much higher and lending standards much tighter (so don’t expect a quick return to the house price boom) they will help households that already have a mortgage (to pay down their debt faster and maintain their spending) and keep the $A lower which in turn should help Australian businesses. They should also be seen as part of a package with fiscal stimulus on the way as indicated in the April Budget (with scope for more given the tax revenue boost from higher iron ore prices).
• Beyond Tuesday’s likely cut we expect the RBA to cut by another 0.25% in August and we now expect the RBA to take the cash rate down to 0.5% by mid next year. The basic problem for the RBA is that it needs to get unemployment down but the slowing economy and jobs market points to a further rise in unemployment which we expect to reach 5.5% by year end. As a result, we now expect that the RBA will have to take the cash rate below 1%, which will see an increasing debate about whether it should use quantitative easing. QE is not our base – as we don’t think things are that bad and if they were fiscal policy should really take over – but as has been the case at other major central banks the RBA is likely to prefer exhausting cash rate cuts before considering QE and this is unlikely until it gets the cash rate down to 0.5%, which we expect to be reached by mid next year.
• On the data front in Australia the focus is likely to be March quarter GDP data due to be released Wednesday which is expected to show continuing weak growth of 0.5% quarter on quarter or 1.8% year on year thanks to weak consumer spending and investment and falling housing construction. In other data, expect to see a further moderation in monthly house prices falls to -0.3% month on month in CoreLogic data for May (Monday) helped by a post-election bounce as property tax uncertainty was removed, a constrained 0.2% rise in April retail sales and a 0.1 percentage points contribution to March quarter GDP growth from net exports (both due Tuesday), a continuing strong trade surplus of around $5.1bn in April (Thursday) and flat housing finance for April (Friday).

Outlook for investment markets

• Share markets are likely to see a further pull back in the short term on the back of uncertainty about trade and mixed economic data. But valuations are okay, global growth is expected to improve into the second half if the trade issue is resolved and monetary and fiscal policy has become more supportive of markets 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 government bonds remain excellent portfolio diversifiers.
• Unlisted commercial property and infrastructure are likely to see a further slowing in returns. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.
• National average capital city house prices are likely to remain under pressure from tight credit, record supply and reduced foreign demand. However, the combination of imminent rate cuts, support for first home buyers via the First Home Loan Deposit Scheme, the relaxation of the 7% mortgage rate serviceability test and the removal of the threat to negative gearing and the capital gains tax discount point to house prices bottoming out by year end and higher than we had been expecting. We now look for a 12% top to bottom fall in national capital city average prices, up from 15%. Next year is likely to see broadly flat prices as rising unemployment acts as a bit of a constraint.
• 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 further to around $US0.65 this year 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. Excessive $A short positions and high commodity prices may help drive a short-term bounce though before the downtrend resumes and will likely prevent an $A crash.