The Week in Review
Reviewing the key global and local developments from this week.
Investment markets and key developments over the past week
- Share markets were mixed over the last week with US and Eurozone shares down a bit, partly due to US tax reform uncertainty and profit taking after strong gains, Japanese shares also getting hit by profit taking but still managing a modest rise and Chinese and Australian shares up strongly. Bond yields fell were flat to modestly. Oil, gold and iron ore prices rose but copper prices fell. The US dollar fell back a bit and this saw the $A rise slightly.
- Uncertainty around US tax reform ramped up over the last week and will remain for a while yet, but the pressure on Republicans to get it or simple tax cuts done is intensifying. With the Senate releasing its version of tax reform with several differences versus the House version it's clear that there is a long way to go yet before it's agreed with the House (by which time the Senate's proposed one-year delay to the corporate tax rate cut probably won't survive because the House and Trump won't support it). But this was always going to be the case, particularly given the need to constrain the cost to $US1.5 trillion over 10 years. Going by the relative performance of US high tax paying companies, the US share market is now factoring in little prospect of tax reform or tax cuts. However, our view remains that it's on track.
- First, unlike Obamacare reform, lower tax rates are core to Republican belief. It's what they do – think Reagan and Bush.
- Second, political pressure to get it done has intensified. Strong Democrat support in the Virginian elections and President Trump's low popularity indicate the GOP is on track to lose control of the House in the November 2018 mid-term elections. So the pressure on Republican's to get tax reform (or cuts) done to boost their chances in the mid-terms and make sure it's out of the way before they can't do it anyway – is immense.
- Third, if reform of deductions proves too hard politically the GOP can always revert to just delivering tax cuts, albeit the headline rates won't be able to come down as much.
- Finally, some Democrat senators may support it (12 did with GW Bush's first tax cuts and three did with the second round).
- As such, we remain of the view that the chance of US tax reform or simple tax cuts by the March quarter 2018 is 70 per cent. That said, there is a danger in overemphasising their importance to the US economy in the short term. At most it might add 0.1 per cent to US GDP growth a year over 10 years, maybe a bit more in initially. So some might argue it's much ado over nothing much.
- It's too early to expect a negative impact on growth from rising oil prices, but they will likely put some renewed upwards pressure on headline inflation. Recent gains reflect a combination of stronger global growth driving stronger oil demand, constrained supply and worries that tension between Sunni Saudi Arabia and Shia Iran is intensifying again. However, the Saudi Arabia/Iran issue has flared up several times in recent years, only to settle back down again. Our assessment remains that direct confrontation cannot be ruled out, but ongoing proxy wars are more likely. But whatever, it all supports oil prices which could have more short-term upside as global growth continues to improve, before supply starts to ramp up again (including from shale oil) to put a cap on prices. At this stage the rise in oil prices is not enough to threaten global growth – historically it's only when the oil price rises 80 per cent or more over a year that it causes major problems whereas at present it's up only 15 per cent year on year. But it may start to push inflation rates up again. And it's good for energy related shares.
- Australia is a net oil importer but net energy exporter so it will benefit from higher energy prices (as oil prices flow through to gas prices). It's not so good for Australian consumers though. Petrol prices may have another 2-3 cents a litre upside as recent oil price increases flow through and this combined with any further upside in gas prices will be another constraint on consumer spending. (Note in the chart below that for the last three years Australian petrol prices have been running around 10 cents a litre higher than their normal relationship with oil prices would suggest.)
- In Australia, the citizenship issue may become an increasing drag on confidence. While it was hoped that the High Court decision would resolve the issue this has not been the case with questions about new politicians continuing to be raised, with the possibility of more by-elections adding to the risk regarding the Government's majority. The sense of malaise in Canberra that's been the norm since 2010 continues.
- Just as we saw the All Ords push through the 6000 level, the ASX 200 has now followed suit. Correction risks aside our view remains that the share market has more upside ahead thanks to rising profits and benign monetary policy. The headline effect of the share market making it back through the 6000 level may also help boost interest in shares amongst ordinary Australian investors where share market scepticism has been running high. However, while the Australian share market has finally made it back above the 6000 level it has significantly underperformed global shares since 2009, this remains the case this year (with Australian shares up 6 per cent or so but global shares up 14 per cent per cent) and is likely to remain the case for some time as global earnings growth is now running around 15-20 per cent compared to underlying earnings growth in Australia of around 5-6 per cent.
- News that my favourite social media – Twitter - has doubled its character limit to 280 has come as a shock. After six years of learning to be concise and precise on Twitter I can now waffle on in my tweets. Even pad them out with the “it could be this or it could be that” stuff so favoured by some economists. A basic axiom of economics is that “more is preferred to less” but this may be another case where more is not best. Well I guess it means less time having to cut characters when I am just over 140!
Major global economic events and implications
- US data was a bit light on but job openings, hiring and workers quitting for new jobs all remain very strong and unemployment claims remain ultra low consistent with a tight labour market and rising wage pressures. Meanwhile, the September quarter earnings reporting season is now largely complete with 91 per cent of S&P 500 companies having reported. Companies have continued to surprise on the upside with 77 per cent beating on earnings and 67 per cent beating on sales. Earnings growth for the quarter has come in around 7 per cent year on year, which is up from 4 per cent a month ago and would have been closer to 10 per cent were it not for the hurricanes.
- Japanese wages growth picked in September but only to 0.9 per cent year on year and it's just back to where it was 18 months or so ago, so there is a fair way to go to be able to call it a sustained inflation driving pick up. Meanwhile, Tokyo office vacancies fell to an ultra-low 3 per cent in October.
- Chinese export and import growth slowed slightly in October but remains consistent with solid growth and foreign exchange data implies that capital outflow remains under control. Chinese consumer and producer price inflation came in a bit stronger than expected but not alarmingly so – core CPI inflation of 2.3 per cent year on year is still low for an emerging country. It's consistent with no PBOC easing though and points to solid nominal growth in China.
Australian economic events and implications
- RBA on hold and revises down its inflation forecasts yet again. While the RBA's Statement on Monetary Policy remains relatively upbeat and still sees 3 per cent plus growth by the end of next year, it slightly downgraded its growth forecasts and revised down its inflation forecasts by 0.25 per cent to 0.5 per cent seeing inflation remaining below target for longer. The downwards revision to the RBA's inflation forecasts reflects the ABS's new CPI weights that correct for “substitution bias” (which sees increasing spending on things that fall in price like computers and reduced spending on items that go up a lot in price like tobacco), but regardless it all means that inflation is expected to take longer to get back to target, which in turn runs the risk that low inflation expectations will just get further entrenched making it even harder to get inflation back up again and increasing the risk of deflation the next time the economy slows down. All of which means low interest rates for longer. Improving global growth and the RBA's own forecasts for stronger growth along with solid business conditions and employment growth continue to argue against rate cuts. But ongoing low inflation and wages growth, uncertainty around consumer spending, signs that the housing cycle is slowing and the still strong $A argue against a rate hike. We remain of the view that the RBA will leave the cash rate on hold until a probable rate hike late next year. The risk is that rates won't start rising until 2019 though.
- On the data front in Australia, ANZ job ads showed good growth in October suggesting the labour market remains solid, but a further 6 per cent plunge in housing finance commitments to investors in September highlights that APRA tightening measures are continuing to bite. Falling investor housing finance, falling auction clearance rates along with anecdotal evidence are consistent with an ongoing slowing in the Sydney property market and to a lesser extent in Melbourne. Expect more price declines in Sydney and eventually Melbourne ahead. The good news is that there is more room now for first home buyers whose share of housing finance has risen to a five year high.
Dr Shane Oliver is the Chief Economist at AMP Capital.
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