The Week in Review: March 30, 2018

Investment markets and key developments over the past week

• Share markets had another messy week with an early bounce as investors realised that trade war fears were overstated but concerns about restrictions on Chinese investment in US tech stocks, a regulatory response to Facebook's privacy breach and a continuing rise in bank funding costs all weighing on shares. This saw US, Eurozone and Japanese shares up a bit but Chinese and Australian shares down. The hit from trade war fears, Facebook and funding cost increases on the back of Fed worries saw the correction that got underway in February continue in March with most major share markets, including the Australian share market down 4 per cent or so in March. Safe haven demand saw bond yields slip a bit further over the last week and commodity prices were mixed with oil, gold and iron ore down but metals up. The US dollar rose and this saw the Australian dollar fall.
• The initial response to President Trump's proposed tariffs on China was an overreaction with US shares losing $US1.4 trillion in market cap in response to maybe less than $50 billion in tariffs on a tiny fraction of global trade in a year when the US will see something like $US800bn in fiscal stimulus this year. Our view remains that China and the US will reach a negotiated solution both in terms of trade and investment restrictions such that the tariffs and restrictions will ultimately be very modest, if at all. But this could take a month or more to resolve and so market nervousness around this issue will linger for a while.
• US bank funding costs are still blowing out, with a flow on to Australia – but it's not a GFC re-run. The gap between US dollar interbank lending rates and the expected Fed Funds rate has continued to widen raising concern about some sort of credit crunch. This has also had some flow on to Australia with the gap between 3-month bank bill rates and the expected cash rate also widening to over 0.5 per cent with the bank bill rate currently around levels consistent with a 2 per cent cash rate. The longer this goes on the greater the hit to bank margins and the greater the risk of a rise in variable mortgage rates (which would be more likely for investors than owner occupiers given the bad publicity this would cause with the Banking Royal Commission underway). However, it is minor compared to what occurred at the time of the GFC and it does not does not reflect banking and credit stresses. Rather the drivers have been increased US Treasury borrowing after the lifting of the debt ceiling and US companies repatriating funds due to tax reform. So it should settle down – but it's worth keeping an eye on until it does. 

Source: Bloomberg, AMP Capital

• Is the FAANG bubble over? Tech stocks remained under pressure over the last week led by Facebook on the back of its privacy violation along with worries about a broader regulatory response for e-commerce stocks and concerns the Trump Administration will limit Chinese investment into tech stocks. Tech stocks have been at the forefront of the US bull market and some worry that a bubble in FAANG stocks has come to an end. Tech shares have certainly had a long run up and have been a key beneficiary of quantitative easing. As such they are vulnerable to a likely tightening in regulation and quantitative tightening and we think there are better opportunities to be had in value stocks that have been relative underperformers. However, while the run- up in FAANG stocks in recent years does look a bit bubbly its nowhere near the scale of the late 1990s tech boom – see the next chart. 

Source: Bloomberg, AMP Capital

• And the forward PE on tech stocks today is well below what it was at the height of the tech bubble and has been more in line with that of the overall market.

Forward PE – US tech stocks v S&P500

• While we expect the tailwind from falling bond yields as a driver of unlisted commercial property and infrastructure returns to start to fade this year, parts of unlisted commercial property are seeing the typical boost that they get in this stage of the cycle from rising rents. This is clearly evident in the Sydney office market with prime effective rents pushing above $1000 m2 for the first time and effective rents in the Melbourne CBD up 13 per cent year-on-year as vacancy rates fall.
• And on Easter Sunday just watch the chocolate eggs… Athlete's Foot pointed out that a 100g chocolate Easter egg has 538 calories, which will take a 60 minute run to burn up!

Major global economic events and implications

• US data was mixed over the last week. Consumer confidence fell slightly in March but remains very high, pending home sales rose in February and home prices continue to rise solidly and December quarter GDP growth was revised up to 2.9% annualised thanks to more consumer spending. Against this the goods trade deficit worsened slightly further and some regional manufacturing conditions indexes slowed.
• Eurozone economic sentiment slipped in March, as business sentiment fell slightly but it remains very high.
• Chinese industrial profits accelerated in January/February to growth of 16% year on year providing more evidence that Chinese growth has held up at the start of the year.

Australian economic events and implications

• In Australia, job vacancies remained very strong in February according to the ABS consistent with various private surveys in continuing to point to ongoing strong jobs growth. Meanwhile, credit growth remains moderate with housing investor credit continuing to slow. A tightening in bank lending standards around borrower income and expenses could lead to a further slowing in credit growth ahead.

Shane Oliver is the Chief Economist at AMP Capital.