Last Night's Markets
The Royal Commission
Incentives
Unfranked Yield
The Meaning of Syria
Oil
Bob Farrell’s Rules
Why Dave’s Wrong
Oz Economy
Stocks and bonds
Blockchain Technology
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

The Royal Commission

I hate to say I told you so, but … I told you so. I first started writing about the corruption in financial advice about 15 years ago, although at the time I was mainly complaining about the payment of sales commissions to advisers.

Eventually commissions were abolished, but it was obvious that the problem had not been solved. The banks and AMP, I wrote a number of times, still described financial planners as their “distribution divisions”, and the advisory practices as “dealer groups”.

There should have been a Royal Commission five years ago, when the Parliamentary Inquiry into financial related crime recommended one, or ten years ago when a previous Parliamentary inquiry investigated the Storm Financial scandals.

But in 2014 the Coalition went into “defend the banks” mode and stayed there ‘til last week, and the Labor Party didn’t pick up the idea until 2015.

In the Royal Commission this week, financial planning practices were still being called “dealer groups”.

I have written many times over the years, including in The Australian today, that percentage fees are the real problem and should be abolished. Advisers should be forced to send invoices for their services.

“The Clip”, as I call it, lies at the heart of the corruption of this industry because it results in fees that are too large and too easy to get: by not having to send an invoice for their services, advisers don’t have to justify, or even account for, the value they provide.

They just clip the ticket every month of the money they hold, and as we heard this week in the Royal Commission, sometimes they even forget to provide the service for which they’re being paid – for years on end.

I opened today’s column in The Australian as follows: “It’s perfectly understandable that AMP’s and CBA’s financial planning arms kept charging fees when no services were being provided - even, in the case of CBA, charging the long deceased - because there is very little difference between providing financial advice and not providing it.”

But look, I don’t want to go on about it again here today. I’ve said it so many times over the years, you’re probably sick of hearing it.

And there have been so many reports and inquiries over the years, including Adele Ferguson’s excellent work for Fairfax over the past couple years exposing frauds and bad advice, and so much finger wagging by ASIC, that surely it is dawning on everyone that reports and regulation, including the forthcoming stern Royal Commission report and recommendations, don’t change anything.

Something fundamental needs to happen to remove the corruption from financial advice. In my view it’s simple: make advisers send invoices. Abolish The Clip. Kenneth Hayne should recommend that, and the Government should do it.

Incentives

It seems to me the problems identified by the Royal Commission run deeper, and broader, than the big banks and AMP. They are the current champions, to be sure, but short-term thinking and cultural problems are more widespread than that.

When I was a young journalist in the 1970s, CEOs generally just got paid a monthly salary, and fairly modest ones at that. Now they get STIs (short term incentives) and LTIs (long term incentives) as well as whopping base salaries.

Did they work any less hard or less ethically in the old days? I doubt it, although ethics may have taken a dive in the 80s.

Incentive structures in the complex executive contracts that now prevail serve two purposes: to align the interests of management and shareholders and to signal to the CEO what the board wants him or her to do.

The second of those is the more important in my view. Executives want to do the right thing. They got where they are doing that, and it’s a habit; CEOs are not, on the whole, rebels.

So if the message from STIs and LTIs is to pursue profit above all, that’s what they will do.

I was chatting to Malcolm Broomhead on this subject this week and he agreed that remuneration structures are wrong. He reckons the whole system of complicated incentive structures should be abolished in favour of simply paying executives partly in shares that vest immediately but are locked for five years.

Sounds like a good idea to me.

Unfranked Yield

In Thursday’s Facebook Livestream Q&A, Bev asked: “Would it be possible to put together a list of good unfranked stocks that pay a reasonable dividend for us all to research in case Labor gets in, in the next election.”

OK Bev, here are 10 to start with (the current yield is alongside):

Cromwell Property – 7.76%

Charter Hall Retail REIT – 7.27%

Vicinity Centres – 7.05%

Janus Henderson – 6.78%

Viva Energy REIT – 6.67%

Spark Infrastructure – 6.63%

Growthpoint Property – 6.58%

Stockland – 6.56%

Charter Hall Long Wale REIT – 6.51%

Spark New Zealand – 6.19%

As you can see, most are real estate investment trusts (REITs, but not all. As far as I can tell, these are all decent businesses backed by solid assets, although in many cases the share price is a premium to NTA because of the yield.

Another place to look for decent unfranked yield is foreign businesses, such as Spark NZ, above, but their yields tend to be lower than those of the REITs.

The Meaning of Syria

All of the predictions of sharemarket volatility this week after last Saturday’s bombing of Syria by the US, UK and France (including by me) came to naught. The market powered ahead this week and risk appetite remained undaunted.

It was, I think, an enormously important signal about the market’s direction … which is up. What follows is a brief post-fact rationalisation of something I didn’t expect…

The initial reports about how extensive and damaging the bombing was have proved to be overblown, and in fact it’s not going too far to say that because the strikes were so limited they sent exactly the opposite message to the one intended, or at least what the American, British and French politician say they intended to send.

As Hassan Hassan, an expert on Syria and co-author of Isis, Inside the army of terror, told the Financial Times this week: “the limited retaliation, in fact, reinforces the message intended by the gas attack and helps Mr Assad reassert control over remaining rebel strongholds.

“When you defeat the rebels and send a message that the world is not going to stand in the way, that amplifies it many times over,” he says. “It tells other pockets of resistance that no one will come to their rescue. So if they want their life back they have to enable a situation where the regime is back in control.”

External involvement in the Syrian war has always been lopsided: Russia intervening clearly and decisively on the side of Bashar el-Assad; America and Europe occasionally and tentatively getting involved, and these days only to punish the use of chemical weapons. Assad has learnt that western outrage even over the gassing of children is fleeting.

The CIA engineered its first coup in Syria in 1949, helping to overthrow a democratically elected president and install a military dictator, and supports the regime in Saudi Arabia, so there’s no squeamishness about dictators as such.

So I’d say that the non-Russian “international community” really just wants Assad to get back in control of Syria as quickly as possible to settle things down, and the US and Europe don’t really want to support any of the rebels, and the strikes in retaliation for gas attacks in Douma were for domestic political reasons.

Everyone saw what happened in Iraq after Saddam Hussein was removed, and nobody wants that to happen again.

This is what the markets understand about Syria, and reacted accordingly this week.

Oil

Last night, our time, Donald Trump woke up with oil on his mind, and tweeted: “Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!"

Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!

— Donald J. Trump (@realDonaldTrump) April 20, 2018

I’m starting to warm to the Trump tweets. I mean how good is it that we have a President prepared to share his early morning brain farts with 50m followers?

Of course OPEC has been at it again. They agreed last January to work on eliminating the global oil glut and 15 months later they have all but done it.

As a result, pre-Trump tweet the price of Brent crude hit US$74, its highest level since 2014, having gone up 10% since the Douma gas attack and 20% since February. The price dropped back to below US$73 post-tweet and has recovered back to US$73.90 now.

But the goings on in Syria and Twitter are far less important than what OPEC is doing.

The essence of what happened last year was that Saudi Arabia persuaded Russia to help eliminate the glut that had been caused by over-production by American shale producers, in order to boost the value of its oil company, Aramco ahead of the float.

It’s been clear for a few months that this was working, and reports this week are now suggesting that the global oil glut evident in 2016-17 has been virtually eliminated.

There have also been reports that the Saudis are targeting US$80 a barrel. That hasn’t been confirmed, but it’s clear that Saudi Arabia and OPEC are comfortable with the price where it is, or higher, and won’t be taking action to get it down – as it’s done in the past.

The ASX energy index has rallied close to 10% this month so far versus 2% for the ASX200 and minus 1% for the banks.

The question for investors is: where to from here? Specifically, will softening demand because of electric vehicles and renewable energy, plus higher output from US shale producers, cap the price again or is US$100 a barrel back on the radar?

There are large and unpredictable forces at work, including now the most unpredictable of all – Donald Trump.

Supply is not just under pressure because of the OPEC manipulation, which has never been able to hold in the past, but also because of collapsing output from Venezuela and sanctions against both Russia and Iran.

It looks to me like the long-term direction of the oil price remains downwards because of fracking and substitution, but it could stay up for 12 months, until Saudi Arabia gets away the Aramco float next year.

Artificial? Of course. But has the oil market ever not been manipulated, including by America installing dictators in oil-producing countries?

I suppose the only question is whether the President of the United States means anything by “no good and won’t be accepted!” and whether he’s to be taken literally but not seriously this time, or seriously but not literally.

Bob Farrell’s Rules

This week’s Grant’s Interest Rate Observer contained some notes from a speech by Dave Rosenberg, the well-known strategist at Canadian brokerage, Gluskin Sheff, at a Grant’s conference.

Rosenberg is a bit of a perma-bear, so much of the speech was about the how the market is about to crash, but it also included a list of 10 excellent rules from a bloke named Bob Farrell, who worked for Merrill Lynch.

Here they are:

1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras – excesses are never permanent.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5. The public buys the most at the top and the least at the bottom.
6. Fear and greed are stronger than long term resolve.
7. Markets are strongest when they are broad and are weakest when they narrow to a handful of blue chip names.
8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend.
9. When all the experts and forecasters agree – something else is going to happen.
10. Bull markets are more fun than bear markets.

Why Dave’s Wrong

Just to be clear: I study the work of Dave Rosenberg, Jim Grant and the other bears, and while I realise there are risks for investors at present (as there always are), I think that, on balance, they are wrong, at least for now. Eventually the Cassandras will be right, but in the meantime the bull market has some juice left in it, in my view.

There are four reasons for this:

1. Monetary is, still, and will remain, loose, especially in Australia but also in the US, where the Fed’s new chairman, Jerome Powell, has made it clear they are happy staying behind the curve;
2. Fiscal policy is expansionary, especially in the US but also in Australia, where tax cuts are likely to be announced in next month’s budget;
3. Global business confidence and investment is recovering powerfully;
4. China is not going to collapse and in fact consumer confidence and demand there is sky high. Chinese consumers and tourists are taking over the reins of the global economy from the Americans.

As a result, the global economy is accelerating: fiscal and monetary expansion, buoyant and rich Chinese consumers and confident businesses. Bear markets simply don’t happen in such circumstances.

Oz Economy

Having said that, the Australian economy appears to be heading in the other direction: is not accelerating, and may be decelerating.

I interviewed Bill Evans of Westpac this week for Talking Finance, and he was pretty gloomy about next year: he thinks the growth will weaken, a notion that was reinforced this week by the March labour market report from the ABS.

It showed that employment growth is softening already, with a huge downward revision to the February figure, from 17,500 jobs to -6,300. Goodness knows what is going on there, but the March figure of 4,900 was also below par.

The good news is that it means interest rates are on hold for a long time. Bill Evans says at least until the end of next year, maybe longer, which would make it an incredible three years or more of no change (the last move was August 2016).

Stocks and bonds

Speaking of risks, one of this week’s “Markets Chart of the Day” from Business Insider was quite interesting and worth passing on.

It was based on some work from a research and investment house called The Leuthold Group which pointed out that stockmarket corrections are usually accompanied by declines in bond yields, but not this year.

Here’s a chart from Iress of the S&P 500 (blue) and the US 10-year bond yield (red) since January 1st:

And here’s the “Chart of the Day” from Leuthold:

It shows in that in last nine market corrections, the bond yield fell by between 50 and 150 basis points.

Why is this important? Because "To some extent, these corrections proved self-medication," Doug Ramsey, Leuthold's chief investment officer, wrote in a client note. "Falling stock prices forced yields to decline, providing another dose of stimulus to the economy while at the same time reducing an already-low hurdle rate for investors." 

"We're not arguing the market can't bottom without the drug of lower yields — and indeed the slack in the economy that allowed yields to drop no longer exists," Ramsey said. "Just beware that the bull's secret medication for longevity is not currently available. And a bull that's 'off its meds' sometimes exhibits not only change in character but a change in species as well."

Alfie

Our first grandchild joined us yesterday – Alfred Freeman Mills Manning, son of Henry and our daughter Alice. Alfie for short, and kind of named after me, because that has been Deb’s nickname for me for 40 years. Such a great honour.

He was due to come on Monday (a planned caesarean) but Alice’s blood pressure was a touch high so Len the obstetrician decided there was no point waiting, so out he came!

And what an amazing joy for one’s daughter to give birth, 33 years after she came into the world herself!

Here they are:

Blockchain Technology – Investable – When and How?

I will be the Keynote speaker at the Sydney BlockchainEconomy.com.au conference on May 1.  

Come along listen to international speakers and learn about blockchain, how fast it is growing and what types of investment opportunities this space has to offer.

With 3 in-depth panel sessions, 15 international investment opportunities presenting and speakers sharing much of what you need to know to be ready for this revolution this is a not to be missed event.

As a member of The Constant Investor you have been offered a sizable 30% discount for both General Admission and VIP tickets. 

I look forward to seeing you there on the day.

Go to https://www.blockchaineconomy.com.au/tickets/ and use this code at checkout: theconstantinvestor

Research and Diversions

Remarkable video warning about fake videos, using AI to “make” Barack Obama look like he’s saying stuff he wouldn’t say, such as “President Trump is a total dipshit” (Then again maybe he would say that, or would he?)

After the Facebook debacle, will people be less willing to share stuff online? Nah.

From those who invented the internet: "We’re sorry. We didn’t mean to destroy privacy. Or democracy. Our bad.”

This is a fascinating, disheartening piece on the James Comey interview last Sunday. It “made the former FBI director look smaller, more uncomfortable, and more shot through with human failings than the Comey we’d all invented in our heads…. This is the ultimate tragedy of Donald Trump’s moral takeover of our politics and the media: To engage with him in any public forum is to be accused of being like him—venal, self-regarding, and corrupt.”

From The Atlantic magazine: James Comey is no hero. The former FBI director has a low opinion of the president who fired him, but his disregard for Justice Department rules helped put Trump in the White House to begin with.

‘What's astonished me about Donald Trump is how effectively he's managed to take his opponent's strengths and turn them against them, says New York Times editorial board writer, Jesse Wagman. There’s no way Trump will be impeached. The American people are going to have to deal with this problem by showing up at the polls and voting him out. (Short video)

Not one American magazine has put Melania Trump – a former model - on its cover.

German foreign minister: Luckily, the trans-Atlantic relationship is made up of much more than 280 characters in Twitter. It remains clear to us: We need the USA. Only together will we be able to meet the large international challenges facing us. Also: Syria is not Auschwitz.

The CIA organized its first coup in Syria in 1949 to overthrow a democratically elected president and install a military dictator. The U.S. has never given up trying to determine who rules Syria.

This is a cracking piece in New Yorker about Michael Cohen and Trump.

Nixon’s downfall was not inevitable (This piece is really about Trump, I think – a warning)

Finland has found the answer to homelessness. It couldn’t be simpler – give them a home.

State of the world economy, according to the TIGER (Tracking Indexes for the Global Economic Recovery), put together by the World Economic Forum and the Financial Times (PDF).

I’ve often wondered about this: what happens when as stock you’ve shorted goes to zero? Answer: it’s not great.

The major banks seem to be operating in parallel universes. On the one hand it is all doom and gloom with investors facing a daily avalanche of negativity. On the other hand, Australian major banks continue to benefit from surprisingly solid fundamentals delivering modest earnings growth. 

An economist comes up with a plan to heal our fractured societies. Don’t laugh! These are good ideas.

Facebook is now a vital part of our democracy.

Facebook now uses artificial intelligence to predict your future actions, according to a confidential document. In other words, advertisers can target people on the basis of decision s they haven’t yet made.

Meanwhile Google researchers have developed an artificial intelligence system designed to identify individual voices in a noisy crowd.

“I’m thinking $250,000 a bitcoin by 2022,” Tim Draper, billionaire, told a crowd gathered outside Draper University in California. “Believe it, it’s going to happen. They’re going to think you’re crazy but believe it, it’s happening, it’s going to be awesome.”

Until there is a way to bet against Bitcoin, its price will be set by the most upbeat buyer.

Blockchain is not only crappy technology but a bad vision for the future. Its failure to achieve adoption to date is because systems built on trust, norms, and institutions inherently function better than the type of no-need-for-trusted-parties systems blockchain envisions.

Curing people is not a sustainable business model, according to analysts at Goldman Sachs.

An attempt to explain to future generations our indifference to climate-change. The science is complicated, the anecdotal evidence is confusing, the politicians who should provide leadership disagree. “I who send this letter to the future hereby plead that we were no more evil or even selfish than anyone else.” 

An excellent primer on Indian politics, and what’s behind the success of Narendra Modi.

Elections are too easy to hack. We can securely bank online, but can’t securely vote online. If we could do away with anonymity – if everyone could check that their vote was counted correctly – then it would be easy to secure the vote. But that would lead to other problems. Before we had the secret ballot, voter coercion and vote-buying were widespread.

Palantir knows everything about you - it appears to be Facebook on steroids, and on purpose.

Technology’s impact will be bigger than China’s on the global economy. It brings challenges across industries, to policy makers and to our macroeconomic fundamentals. (Video)

From the United States Computer Emergency Readiness Team (US-CERT): Russian state-sponsored cyber actors are using compromised routers to conduct man-in-the-middle attacks to support espionage, extract intellectual property, maintain persistent access to victim networks, and potentially lay a foundation for future offensive operations. In other words, the cyber war is happening already.

Diversions

Everything you need to know about the Trump pee tape (but were afraid to ask).

Spike Milligan turned 100 on Monday, or at least he would have. Here he is hilariously interrupting an ABC news bulletin.

The placebo effect: A reporter with a sore knee travels the world in search of a cure, eventually finding success in Mexico, where a healer offers to suck his blood. “She attached her mouth to my knee and began sucking. I half expected her to cut me or bite me until I bled but she never broke the skin. The drawing of blood, it seems, is metaphorical. When it was over I thanked them and walked back to the car. It was only then that I realized I didn’t feel any pain in my knee anymore. I’d been cured.”

A love letter to Australia’s wonderful public swimming pools, especially the ones at Sydney’s beaches.

A “bombshell” article in Nature finds that “individual level selection forces each male to invest into sexual competition as much as possible”; but at the species level, excessive competition between males greatly increases the chance of extinction.

The fate of handwriting. It was imperiled by the printing press, then the typewriter, the computer, and the phone. But is an elegy premature?

A short history of dining in France: how dinner migrated from a meal taken at dawn to one taken at dusk.

Sandy Denny died on this day in 1978, at the far too young age of 31, mainly from alcohol, having fallen down some stairs and hit her head. Here she is doing Bob Dylan’s “Knockin on Heaven’s Door”.

Mind you, I always preferred Steeleye Span, fronted by Maddy Prior, to Fairport Convention and Sandy Denny, as fantastic as Sandy was. Maddy managed to avoid the booze, and now happily runs an arts centre in Cumbria, at the ripe age of 70. Here they are doing Gaudete live, quite recently. Wow, that just sent shivers up my spine again.

And Thursday was four years since the tragic death of Levon Helm, drummer in The Band, from throat cancer of all things. Here he is doing one of my many favourite numbers from The Band – Ophelia. This is my song of choice whenever I’m feeling a bit down. Love it!

“Boards on the window, mail by the door. What would anybody leave so quickly for? Ophelia - Where have you gone?”

Oh, and then there’s The Night They Drove Old Dixie Down.

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 we've just given the Facebook Livestream its own 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 hello@theconstantinvestor.com then keep an eye out for the Facebook Live video in next week’s overview.

Next Week

By Craig James, CommSec

Australia: Inflation in the spotlight

• In Australia in the coming week, readings on inflation dominate. In the US there is a broad range of indicators to be released including economic growth.
• The week kicks off on Tuesday when the Bureau of Statistics (ABS) releases the March quarter Consumer Price Index – the main measure of inflation in Australia. The annual rate of inflation has only been in the Reserve Bank’s 2-3 per cent target band for one quarter in the past three years. And we expect that low inflation prevailed in the March quarter.
• Overall we expect that both headline and “underlying” measures of inflation rose by 0.5 per cent in the March quarter to be up 2 per cent over the year. Seasonal increases in education fees, pharmaceutical products and domestic travel are expected, offset by seasonal falls in international travel. Some product prices may have been affected by post-Christmas sales. And petrol prices may have lifted by less than 1 per cent.
• Inflation results in line with forecasts will reduce the odds of the Reserve Bank lifting interest rates in 2018.
• Also on Tuesday the weekly gauge of consumer confidence is issued by ANZ and Roy Morgan. And the Reserve Bank Assistant Governor Christopher Kent delivers a speech at a Housing Industry Association breakfast.
• After the ANZAC Day observance on Wednesday, investors will focus on export and import prices when they return to work on Thursday.
• Export prices will be constrained by lower coal and iron ore prices, although offset by higher oil prices. Import prices will be boosted by the higher oil prices. The Aussie dollar also fell only 1.7 per cent over the quarter.
• On Friday the ABS releases the Producer Price Indexes – measures that will provide a guide on inflation across the business sector. In the December quarter, the ‘final demand’ measure was up 0.6 per cent to stand 1.7 per cent higher over the year. Investors will closely watch building construction prices in light of anecdotes noting high demand for labour and rising wages. The 7.5 per cent lift in oil prices will serve to boost petroleum refining and petroleum fuel manufacturing costs.

Overseas: US economic growth & housing in focus

• It is relatively quiet in China over the coming week in terms of new economic data. However there will be data on industrial profits on Friday. In the US, housing market indicators and economic growth are of most interest.
• The week kicks off on Monday in the US with data on existing home sales to be released alongside the Chicago Federal Reserve national activity index. After a 3 per cent rise in February, economists are tipping a 0.2 per cent lift in sales in March. A lack of stock on the market is constraining sales but boosting prices.
• Also on Monday, the Markit organisation releases “flash” readings for activity in manufacturing and services sectors in the US, Europe and Japan. In terms of the US readings, an easing in manufacturing activity is expected to be balanced by higher service sector activity.
• On Tuesday, new home sales data is scheduled in the US, together with consumer confidence, home prices and the influential Richmond Federal Reserve survey.
• Economists believe that new home sales may have lifted 1.9 per cent in March after the 0.6 per cent fall in February to 4-month lows. Sales have fallen for the last three months. The stock of homes stands at 9-year highs, representing a supply of 5.9 months at the current sales rate.
• Also on Tuesday economists expect that consumer confidence eased again, down from 127.7 in March to 125 in April. Back in February, confidence was at 18-year highs. And home prices may have risen 0.3 per cent in February, trimming the annual rate from 6.4 per cent to 6.2 per cent.
• Also on Tuesday the regular weekly data on chain store sales in released in the US while on Wednesday, weekly data on new mortgage applications are released.
• On Thursday a key measure on business investment – orders for ‘durable goods’ – is released. Durable goods are generally described as items with lifespans longer than three years – like cars and aircraft. Orders have risen in three of the past four months. And economists believe that orders may have risen by 1.0 per cent in March.
• Also on Thursday the ‘advance’ March data on trade in goods is released. A deficit of US$75.4 billion was posted in February and the big deficits are clearly in the sights of the US President currently.
• And on Friday the ‘advance’ reading on US economic growth in the March quarter is released alongside the March quarter employment cost index (ECI). Economists expect that the US economy grew at a 2.3 per cent annual pace in the quarter after 2.9 per cent annualised growth in the final quarter of 2017. The included data on prices will be watched carefully together with the ECI. The ECI has been averaging growth of around 0.6 per cent a quarter or around 2.5 per cent over the year.

Financial markets

• US earnings season continues. Amongst companies reporting earnings on Monday are Halliburton, Kimberly-Clark, Alphabet (Google) and Barrick Gold.
• On Tuesday, 3M, Caterpillar, Coca-Cola, Corning and Texas Instruments are amongst those reporting.
• On Wednesday, AT&T, Boeing, Comcast, Facebook, Ford, Twitter and Visa report.
• On Thursday, earnings are due from Amazon, ConocoPhillips, Domino’s Pizza, General Motor, Microsoft and ResMed.
• On Friday, Exxon Mobil and Chevron report.

Last Week

By Diana Mousina, AMP Capital

Investment markets and key developments over the past week

• The news flow was less dominated by politics this week and more by positive economic developments which gave share markets a boost. US shares are up by 1.4% (and have recovered around 5% from post-tariff March lows), Eurozone shares are 1.1% higher, Japanese equities are tracking up by 2%, Australian equities are 0.8% higher while Chinese stocks are 1.8% down over the week.

• Commodity prices have been surging recently, particularly for aluminium, nickel and oil. Current US sanctions against Russian producers (and the threat of more sanctions), as well as some supply concerns, have caused a surge in aluminium and nickel prices which is likely to continue in the near-term. Oil prices have been rising steadily because of supply concerns following tensions in the Middle East. Broad commodity prices strength is also a sign of continued synchronised global growth. But, if commodity prices move too high too quickly, this will be negative for equity markets because of inflation breakout fears, with commodities a large input into global production. This inflation fear started becoming evident in the back end of this week with US yields moving higher and 10-year yields above 2.9% Despite the strength in commodity prices, the Australian dollar moved a little lower this week as the US dollar gained some strength.
• US March quarterly earnings season is underway and so far, is signalling more good news for US earnings growth, despite expectations already being high because of tax reform changes. Repatriation flows into the US may still be underestimated which will be good news for equities if companies use these available funds for capex spending and wage increases. Quarterly earnings are expected to be close to 20% higher over the year which is very strong and a positive driver for US share markets in 2018, offsetting the uncertainty around Trump’s polices (especially around trade) and Fed interest rate hikes.
• Stability in the Chinese economy is also positive for commodity price gains in the near-term. While the medium-term outlook is still for lower Chinese economic growth, the economy has been stronger over the first quarter of 2018 and there may be some more upside over the next few months. Property investment and government spending has been showing stronger signs of growth and is something to watch. This week, the People’s Bank of China (PBoC) cut one of the lending rates in China – the reserve requirement ratio (RRR) by 1% for most banks. This is not a change in monetary policy but a liquidity management tool. The RRR puts a limit on the amount of deposits required in the banking system and the cut was done to assist banks (particularly smaller lenders) in helping to meet balances on medium-term loans.

• It was good to see another positive World Economic Outlook report from the International Monetary Fund (IMF). The IMF kept global growth forecasts unchanged at 3.9% in 2018 and 2019, the strongest level since 2011, which are unchanged on the IMF’s last update in January but are above forecasts made in October last year. And after years of revising global growth forecasts down, the IMF has been revising up growth estimates (see chart below) lately.

Source: IMF, AMP Capital

Major global economic events and implications

• US data was generally positive. Retail sales growth was better than expected in March, consumer confidence is positive and leading indicators around the economy are still rising. Manufacturing readings have been mixed across various regions, with a poor reading for New York but stronger for Philadelphia. Industrial production was up in March and housing starts and permits were also stronger in the month. The US Fed’s Beige Book which looks at activity across the 12 Banking Districts indicated that economic activity continued at a “modest to moderate” but there did appear to be some concern from districts about potential tariffs. There were again signs of labour shortages in some industries, another sign that wages growth will continue to rise. Trump made two new Fed nominations - Richard Clarida as vice chairman on of the Fed Board and Michelle Bowman as a governor. There was also numerous “Fed speak” this week with Chicago Fed member Evans saying he was optimistic that inflation would rise towards the Fed’s 2% target, but that he didn’t see a large risk of an “outsized” inflation breakout. San Francisco’s Williams emphasised that the risk of a flattening of the yield curve was nothing to worry about so far and was a normal part of the Fed tightening process.

• Eurozone data continued to disappoint this week. The ZEW investor confidence survey showed a decline in expectations of economic growth in April, with German expectations in negative territory. This probably reflects the strength in the Euro currency which is a big negative for exporting nations like Germany. Eurozone headline inflation for March was revised down to 1.3% over the year, but the overall trend has been a slight lift in inflation. Core inflation is sitting unchanged at 1%.
• Japanese inflation is trending up with core inflation up by 0.5% over the year to March, a big turnaround compared to a year ago when price growth was still negative. Political risk in Japan remains high with support for Prime Minister Abe continuing to decline on the back of recent scandals.
• Chinese data remains solid. Chinese real GDP was up by 6.8% in the first quarter of 2018, above policymakers target of around 6.5% growth. But, slower growth is still expected over 2018/19 as policymakers work to reduce debt and pollution. Fixed asset investment was up 7.5% over the year, industrial production was up by 6% and retail sales lifted by 10.1%.
• The Bank of Canada (BoC) met this week and kept interest rates unchanged at 1.25% which was expected but the central bank appeared more dovish. While inflation has returned to the 2% target, the BoC appears to be willing to let inflation run above its target rate for now given the risks to the economy from trade policies and a potential slowing in housing.

Australian economic events and implications

• The RBA April Board minutes didn’t contain any new major information with the commentary from the central bank still indicating that the next move in the cash rate is likely to be up. But, given the risks in the housing market (slowing dwelling prices at time when lending standards are becoming tighter again) and low inflation, the risk is that interest rates don’t come until the second half of 2019.
• Australian employment growth stepped down again in March, with jobs up by a low 4.9K. There were also some big negative revisions to last month’s job gains. Employment growth over the last three months is now running at 1.2% on an annual pace, which is low and below recent outcomes around 3-3.5%. But, jobs growth has been exceptionally strong over the past year and some slowing was expected. Leading employment indicators suggest that annual jobs growth will continue to slow, we think to around 2.5% or so over the next 6 months. Despite the low growth in employment over the past two months, the unemployment rate is unchanged at 5.5%.

What to watch over the next week?

• In the US, manufacturing PMIs are released and are expected to show a slight decline for April and March. Durable goods orders are expected to rise but at a slower pace compared to last month. The March quarter employment cost index is released as well as the first quarter GDP data which is expected to come in around 2% on an annual basis which is lower than last quarter but still respectable.
• The European Central Bank and Bank of Japan both meet next week but no changes to monetary policy is expected from either. The ECB will consider further tapering its asset purchase program after September this year. But, interest rate hikes in the Eurozone are still a story for the second half of 2019.
• In Australia, the March quarter consumer price data is released and is expected to show headline inflation rising by 0.5% with annual growth sitting just on the Reserve Bank’s target band of 2-3%, at 2.0%. Underlying inflation, a better reading of trends in the economy, is expected to rise by 0.4% with annual growth at 1.8%. Inflation is subdued broadly because the economy has been operating below potential, and the unemployment rate still has further room to move lower. The inflation data is unlikely to be a game-changer for market pricing of RBA rate hikes. RBA Assistant Governor Kent also speaks about “the limits of interest-only lending” next week which will be important given the recent tightening in lending standards. Import and export price data should show that the terms of trade rose in the first quarter of 2018, thanks to strong commodity prices.

Outlook for markets

• Volatility in share markets is likely to remain high as US inflation and interest rates move up and as issues around President Trump, trade, Syria, etc continue to impact ahead of the US mid-term elections in November, but the medium-term trend in share markets is likely to remain up as global recession is unlikely and earnings growth remains strong globally and solid in Australia. We continue to expect the ASX 200 to reach 6300 by end 2018 – it might take a bit longer to get back on the path up to there though.
• Low yields and capital losses from rising bond yields are likely to drive low returns from bonds.
• Unlisted commercial property and infrastructure are still likely to benefit from the search for yield by investors, but it is waning, and listed variants remain vulnerable to rising bond yields.
• National capital city residential property price gains are expected to slow to further as the air continues to come out of the Sydney and Melbourne property boom and prices fall by another 5% this year, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
• The $A is likely to fall towards $US0.70 as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory. Solid commodity prices should provide a floor for the $A though – in contrast to early last decade when the interest rate gap was negative and the $A fell below $US0.50.