Last Night's Markets
Winnie the Trump
Accentuate the NEGative
Blue Sky
Sydney Event
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

Winnie the Trump

Markets have been lurching from one macro risk to another. A week ago it was all about a trade war, now it’s war in Syria.

Perhaps we should call it what it really is: Trump Risk. He is, after all, the common thread. Or perhaps it should really be called Trump Non-Risk, because everything seems to fade to nothing in the end. Or will it?

Three days ago he tweeted: “Russia vows to shoot down any and all missiles fired at Syria. Get ready Russia, because they will be coming, nice and new and “smart!” You shouldn’t be partners with a Gas Killing Animal who kills his people and enjoys it!”

Then yesterday: “Never said when an attack on Syria would take place. Could be very soon or not so soon at all! In any event, the United States, under my Administration, has done a great job of ridding the region of ISIS. Where is our “Thank you America?”

This is unlike anything investors have ever had to deal with. Something similar has been going with trade.

I had been having trouble getting my head around the prospect of a war between America and Russia over Syria, or not, at the same time as the US imposes sanctions on Russia for interfering in the 2016 election on the side of Donald Trump, while a special prosecutor investor investigates whether Trump himself colluded in that and members of his team plead guilty over it.

And like Hitler in WW2, Trump is apparently fighting two fronts: battling China over trade and Russia in the Middle East (while also battling Robert Mueller over his possible private relationships with Russia, and porn star Stormy Daniels over alleged illicit campaign funding and other assorted hanky-panky).

The basic problem is that Donald Trump is a Bear of Very Little Brain, and as Winnie the Pooh said in The House at Pooh Corner: “When you are a Bear of Very Little Brain, and you Think of Things, you find sometimes that a Thing which seemed very Thingish inside you is quite different when it gets out into the open and has other people looking at it."

The way Donald Trump gets his Things out into the open is via Twitter, and sometimes they are no doubt quite different there than when they were inside him.

So now, not only is he congratulating and thanking Xi Jinping for his tone on trade, Trump is tweeting about getting back into in the Trans-Pacific Partnership!

Dealing with the morass that is Syria and with China over its mendacious mercantilism have each been problems that have defeated far better equipped Presidents in the past, working on one at a time. Mr Trump is tackling both at once while maintaining a constant tappity-tap on Twitter. It can’t end well, you would think.

What has raised the stakes in Syria is another chemical weapons attack, which markets are possibly underestimating. There is a view that however you kill your own citizens doesn’t matter – shoot, bomb or poison, what’s the difference?

In fact, there is a big difference. Chemical weapons are a big taboo, something markets are not quite tuned into, in my view. You only need to look at the extraordinary international response to the poisoning of the two Russians in Salisbury with a Russian nerve agent.

Chemical weapons create a different threshold for a military response than conventional weapons, and there are now arguments for more general aggressive action against Russia for its backing of the Assad regime.

While imposing the severest sanctions yet against Russia over the 2016 election tampering, Trump has now directly threatened Russian forces in Syria with missile attacks.

Russia has threatened to shoot down any US missiles and fire on launch sites. The latter point would be an ‘act of war’ in the eyes of British Military Officials.

According to a note from Citi’s Tina Fordham this week, a wild card in any potential Russian response is whether Moscow uses cyber-attacks, at which it has proved rather adept.

She wrote: “In our view a cyber-attack on a US or allied target would generate a considerably more significant market and military response than a regional confrontation using conventional military forces, not to mention the risk of opening a whole new chapter in great power relations.”

“Taken together, we think changes in tactics (to unconventional) and methods (chemical) represent a step change in the history of state-to-state conflict and a wider range of geopolitical scenarios and consequences than markets have yet encountered.”

Meanwhile, US political uncertainty ahead of the November Midterm elections could act as a further drag to the market, especially if the Mueller investigation results in high-profile indictments and/or serious charges. To that end, the FBI raid this week on President Trump’s lawyer, Michael Cohen, was a big escalation.

On the eastern front, some of the heat was taken out of the trade war tensions this week by Xi Jinping’s speech, although there was a pretty wide range of responses.

The Financial Times grumpily noted there were no new concessions from Xi, but markets, and Donald Trump, welcomed his conciliatory tone.

Last week they seemed to be heading for a trade war. I wrote that I didn’t think that would happen and a few days later it’s sweetness and light, so a rare bit of instant vindication for your correspondent there. But where it’s heading now nobody knows, including Donald Trump I suspect, although I also suspect that Xi Jinping knows exactly what he’s doing and where he is heading.

Also in the FT, Martin Wolf wrote an ominous column this week that said: “China is a rival of the US on two dimensions: power and ideology. This combination of attributes might remind one of the clash with the Axis powers during the second world war or the cold war against the Soviet Union. China is of course very different. But it is also potentially far more potent.”

To some extent, the potential for the US/China rivalry to affect markets comes down how far Donald Trump is likely to push it.

Obviously a genuine trade war that affected hundreds of billions of dollars and hammered global GDP would be disastrous for share prices, as would any kind of war (cyber or conventional) between the US and Russia.

But nobody can be sure whether Trump means what he says—probably not even the president himself – although it does look like he’s moving from having to be taken “seriously but not literally”, as they used to say, to “literally but not seriously”.

That is, his bark is worse than his bite: his tweets and off the cuff remarks express how he feels at that moment, having watched Fox News, and what he wants to do. I could be wrong, but it looks like his ability actually to carry them out can’t be taken too seriously.

Markets are, understandably, torn between worrying about Trump’s frenzied barking and the generally benign global economy and low interest rates, all of which argue for a continuation of this long, long bull market.

If it wasn’t for all those things to worry about, there’d be nothing to worry about!

Accentuate the NEGative

In Australia, next week, it’s all about the NEG – the National Energy Guarantee, about which the Council of Australian Governments (COAG) is due to meet on Friday.

Don’t expect any agreement or decision, just more grandstanding and politicking. The decision meeting will be in August, and politicians never decide things until they have fully milked them for doorstops and Question Time rants.

But the NEG will get up and energy policy will die as an issue. I know that’s hard to believe after ten years of shouting about it, and it probably won’t become bipartisan since nothing is anymore, but the thing will be settled. It has to be: both sides of politics will lose if it’s not.

Australia’s energy prices have doubled over the past decade while most other prices have fallen, along with energy prices elsewhere in the world, and few people believe that building new coal-fired power stations will change that or it is a good idea because of global warming.

The rise in prices is due to three things: the retirement of coal-fired power stations (10% of the fleet gone since 2008), rising fuel costs and, most of all, infrastructure charges (the building of excessive transmission capacity).

The combination of high prices and the Renewable Energy Target (RET) has seen close to $55 billion dollars worth of new investment in renewable energy – rooftop and large-scale solar and wind – over the past 10 years, leading to average renewable penetration of 18% across Australia, although it’s much higher in some places.

The transition is now happening very rapidly, possibly faster than anywhere in the world because of our high prices. Shopping malls, warehouse owners, and other high energy users are all investigating their own solar power to cut costs.

To some extent, it means the NEG is unnecessary, or at least mainly needed to ensure governments stay out of the way.

The emissions reduction guarantee part of it is almost certainly superfluous, although important as an expression of the Government’s commitment to the Paris Agreement, and the reliability guarantee will be a useful support mechanism for the work of the Australian Energy Market Operator (AEMO).

For investors, the key issues are around price and disruption.

Prices will fall because the transition from fossil fuels to renewables is essentially a shift from fuel-based generation to technology.

With gas and coal-based generation the main cost is the commodity being fed into the furnaces; with solar and wind the fuel is free, as well as intermittent, and the only cost is paying off the cost of building it. That is a technology cost and is collapsing, still.

(PPA stands for Power Purchase Agreement)

Those current prices for wind and solar are lower than for a new coal-fired power station, although they’re not lower than existing coal generators, where the cost is sunk.

Politically, it may be that Malcolm Turnbull can climb the NEG back to a winning position, but I doubt it. The Coalition is too damaged by the fact that it is obviously deeply divided and has been since John Howard departed.

Howard always called the Coalition a broad church and was able, through sheer political skill, to reconcile the moderates and the extreme right-wing – factions that are embodied in, but not confined to, the Liberal and National Parties.

Neither Tony Abbott nor Turnbull has that skill and simply can’t do it. That is sharpened by Abbott’s and Barnaby Joyce’s personal bitterness about being deposed.

And the reason Turnbull’s survived his own 30th Newspoll loss is that both factions of the Coalition know that neither Peter Dutton nor Julie Bishop will be able to unite them.

So the Coalition, in my view, is doomed. It is disastrous for Australian politics and policy, in my view, because Bill Shorten is not much chop either, and his dividend franking policy will be dreadful for investors.

But perhaps some time in Opposition will bring the other mob to their senses and replace the current idiots with a new generation of rational conservative leaders.

Blue Sky

As promised I interviewed Rob Shand of Blue Sky Alternative Investments and tried to interview Soren Aandahl of Glaucus Research, but he turned me down, saying his reports speak for themselves.

So full marks to Shand for doing the interview, which was hard going and I don’t think he came out of it all that well. Might have been better for him if he hadn’t done it.

Some of the reaction to it has been that he was evasive and dodgy, and it’s true that he didn’t answer every question and in particular fudged on some of the stuff about fees, so I don’t think it will turn around the company’s fortunes, if that’s what he had in mind. But I gather he is tirelessly visiting shareholders individually, often going to their homes, so he’s not going down without a fight.

Before going into my own conclusions on the business, I note the comments of Dean Fergie of Cyan Investment Management. He told Chanticleer in the Financial Review that he has dumped his Blue Sky stock, with great relief.

“It's like breaking up with a girlfriend, once it's done you can just get on with life.”

"I am not big enough and I am not stupid enough to stand in front of the market and say 'you've got this wrong,'" Fergie says. "Momentum is a very strong force and you ignore it at your peril."

That’s a terribly important lesson for all investors: it doesn’t matter what your own convictions are or whether Rob Shand or Soren Aandahl is right, sometimes the market is a truck rolling downhill and the best thing to do is just get out of the way.

The implication of Dean’s comment is that he still believes in Blue Sky but he’s getting out of the way.

What do I think? Well, I think that Rob Shand and the team at Blue Sky are not crooks and liars and that founder Mark Sowerby’s original idea of giving small investors access to the sort of alternative investments to which large super funds allocate 10-20% of their funds was, and still is, a good one.

The problem is that Sowerby’s creation is a uniquely complicated beast, which is hard to value. Half of its assets are property and the other half are alternatives like infrastructure, private equity, and venture capital; no other fund manager presents that sort of combination, especially to a retail audience, and each side of the business requires different thinking. It’s something I have always had trouble with.

Glaucus’ core complaint that Blue Sky’s assets under management (AUM) are presented as a gross number, including debt, rather than a net figure like other alternative fund managers is superficially valid, but all Australian property fund managers do likewise, and the other assets carry little or no debt.

I must confess that, in general, I think it’s ridiculous and fairly outrageous that asset managers report gross AUM as fee-earning, and therefore charge fees on debt that also carries interest but it is definitely “industry standard” as Shand says. And it’s OK I suppose as long as the gearing and the fees are not too high.

As for fees, Glaucus rolls up various once-off capital raising fees and presents them as ongoing fees, which is pretty unfair. Again, I don’t think Blue Sky should be making out like an investment bank and charging capital raising fees as well as ongoing management fees, but it’s not immoral or unusual. If not them, someone else would get the investment banking fees. Macquarie does it, for example.

The problem, it seems to me, is that while Blue Sky’s base management fees are not extortionate and its gearing is not that high, as Glaucus claims, they ARE a bit high, especially when compared to other real estate funds (it’s 1% versus around 0.8%, as far as I can tell, and 50% gearing versus around 30-40%). They are higher than real estate funds but lower than most other alternative asset managers and particularly private equity.

And finally, on the asset valuations – the NTA is audited, and venture capital and private equity assets (businesses) are very hard to value. Should Blue Sky charge fees only on the original capital invested rather than on current valuations? Maybe, but that would make it unique among asset managers.

Fees are always charged on current market values, otherwise, there would be no incentive to increase them.

In the end, it comes down to share price, and the question is what is BLA (Blue Sky Alternative Asset Management) is worth as a business?

The current price of $5.37, down from a peak of $14.70, is still three times NTA of $1.83 and the market cap is 10.7% of AUM. At the peak, BLA’s share price was an eye-watering 8 times NTA.

Centuria Capital, the property fund manager whose CIO, James Huljich, I interviewed this week, changes hands for 1.9 times NTA, which is unusually high, and its market cap is 9% of AUM. Stockland sells for 0.9 times NTA, as does GPT.

So on that basis, BLA is still expensive, even after falling more than 50%. As a property manager, it should be no more than twice NTA, probably more like 1.5 times, which would result in a share price of $3.

But it’s valued as a rapidly growing alternative asset manager, not a property manager. On balance, I think it may have further to fall, but it won’t go to zero, or to the $2.69 that Glaucus says it’s worth.

My own exposure to Blue Sky is through the LIC called Blue Sky Alternative Access Fund (BAF), which is a different kettle of fish and trades as an LIC, as it should. Except it used to be quite expensive as well, and now isn’t. (BAF is a way of investing in all of the group’s various funds, with liquidity).

Stated NTA is $1.12. BAF was changing hands at $1.20 for most of the past six months, which was a premium to NTA of 7%. The stock is now fetching 92.5c, having been smashed with BLA, representing a current discount to NTA of 17%.

Is that reasonable? Glaucus would no doubt say it is still expensive because the assets are not worth anything like $1.12 a share. However, auditors have signed off on that number (yes, yes, I know Dick Smith and Slater & Gordon …).

I haven’t independently valued the assets, but nor has Glaucus. I don’t want to sell for less than $1, and probably won’t because I like having some of my money in alternative assets.

But Dean Fergie’s words are ringing in my ears.

Sydney Event

Don’t forget our Sydney event on May 1st. We’re calling it “Investing in Disruption”, although we’d be happy to talk about whatever you like and the panel includes Joanne Masters, senior Australian economist at ANZ to add a bit of economic heft to the occasion.

Also on the panel, apart from me, will be Alex Pollack, CEO of Loftus Peak Asset Management, the tremendously successful investor in global disruption (and also a former journalist, although we won’t hold that against him). The moderator will be my friend and colleague, Emma Alberici, chief economics correspondent of the ABC.

I’d love to see you there! It’s $25 for members and $50 for non-members, to cover costs.

Click here to buy tickets.

Research and Diversions

Research

Arik Star, Portfolio Manager at Ellerston Global Investments, says this year will be “materially different.” What’s changed? For the first time in 10 years, rates are beginning to rise. Inflation is beginning to rear its ugly head. Unemployment is at historic lows, which is causing tightness in US labour markets resulting in growing wages (video).

By declaring himself China’s absolute ruler, President Xi Jinping is “taking a confusing structure inherited from history, and redrafting it in a more straightforward way”. Xi runs the Communist Party; the party runs China. “He is not overthrowing the fundamental principles of Chinese politics, but trying to apply them more systematically.”

The travel industry looks like being next to be shaken up by blockchain, allowing airlines and hotels to bypass the powerful intermediaries, like Expedia.

Facebook CEO Mark Zuckerberg’s opening statement to the US House Committee on Energy and Commerce. Key bit: “It was my mistake, and I’m sorry. I started Facebook, I run it, and I’m responsible for what happens here.” But he also explains at length what happened.

Had-To-Happen Department: A mind-reading headset lets you Google just with your thoughts.

Dani Rodrik is among the (economic) discipline’s contrarians-in-chief, a function he shares with the Nobel Prize-winner Joseph Stiglitz, with whom he agrees on a number of issues. These days, both are increasingly skeptical that solutions to economic problems will be found at the international level.

For countries like New Zealand and Australia, the international environment is getting much tougher. The post-war global order, within which their entire contemporary foreign policy histories existed, is over.

Celebrity lawyer Alan Dershowitz had dinner with Donald Trump. His advice: “don’t fire, don’t pardon, don’t tweet, and don’t testify." Doesn’t look like the President is taking that advice.

The rise of technology is going to force fundamental changes to the approach of central banks in the coming years, argues Barclays’ Christian Keller. They will have to move away from trying to keep inflation around 2%.

A very high earnings bar has been set for 2018 in the US.

Then again…

Two years ago, The Boston Globe published this parody front page — suggesting what the world would look like if Trump won the election. Look at the date and all those headlines.

The future of journalism? This is on a new site called 'Knowhere News'. Here’s how it works. First, the site’s artificial intelligence (AI) chooses a story based on what’s popular on the internet right now. It then looks at more than a thousand news sources to gather details. Left-leaning sites, right-leaning sites – the AI looks at them all. Then, the AI writes its own “impartial” version of the story based on what it finds (in as little as 60 seconds). And then, and only then, a human being reviews the story.

The seeming compatibility of basic equality with gross material and social inequality has led more than one critic (Marx most obviously) to wonder if talk of being ‘created equal’ is a hollow spiritual promise designed to placate those suffering from earthly misery’

Syria is the smartphone war. It has occurred at a time when the first response of many caught up in a crisis is to get out their phones and start filming.

Trump’s notion of somehow getting a “better deal” out of Iran is delusional. There is no better deal. If he blows up the current deal, Iran gets the bomb.

An interview with the Crown Prince of Saudi Arabia, Mohammed bin Salman.

Australia is on the horns of an artificial intelligence dilemma just like the rest of the planet. But while our business leaders have begun to turn their attention to AI and how it might be applied, the broader political conversation about AI’s economic and security impact is low frequency and low volume.

What the banking royal commission means for your bank shares.

5 rules to avoid investing disaster. These are pretty good.

The kindergarten version of the private equity business model description goes like this: PE firms buy a company, fix its flaws, make it more efficient, and then sell it at a profit. That description, though, barely scratches the surface of the incredible ways that the PE industry has found to take money out of formerly independent companies.

We’re asking the wrong questions on energy – renewables can’t the world’s growing demand. A starting point might be to work out what energy sources are available, calculate their sustainability and then shape energy demand around these constraints.

Good grief. At least a million sub-Saharan Africans have moved to Europe since 2010.

Diversions

Stephen Colbert’s interview of Anderson Cooper’s interview of Stormy Daniels. Very funny. (Thanks to member Andrew Grant for the link)

This is an interesting personal article about not a getting a job (historian) for which the person focused their entire life. It’s called “The sublimated grief of the left behind”. In some ways, the comments below are as interesting as the piece itself.

Having a long and happy life comes down to one thing, according to this psychologist who studied an Italian island with lots of old people on it. And no I’m not going to tell you what it is – you have to read the story. Come on! It’s not long, and it’s worth it.

Unflinching review of ‘The Recovery’, Leslie Jamison’s book about alcoholism and writing. “Speaking as an alcoholic writer, who is married to an alcoholic writer, I think everyone who loves an alcoholic writer should read this book.”

America’s poet laureate, Kay Ryan, on poetry: “It’s a clown suitcase: the clown flips open the suitcase and pulls out a ton of stuff. A poem is an empty suitcase that you can never quit emptying.” 

Do you even give less than 5 stars to an Uber driver? I don’t think I have. Nobody wants to put somebody else out of a job. “In the early days, riders left a range of reviews, but it didn’t take long for the default to become five stars, with anything else reserved for extreme cases of hostile conduct or reckless driving.”

While our consciousness is the only thing we know, it is the most mysterious thing in the world.

In essence, the culture wars are a finely honed media product, packaged and exported by the US right, and marketed through conservative franchises around the world—think tanks, right-leaning media, lobby groups, conservative political parties, partisan pollsters, and the professional purveyors of political division who work as party strategists.

Happy Birthday the adorable Julia Zemiro, 51 today. Here she is singing “Love Is In The Air”, partly in French, her native tongue, with Isabella Manfredi singing in Italian.

And today, let us be thankful for the life of George F Handel, who died on this day in 1759, aged 74. He left us with some the greatest music ever written, perhaps THE greatest. The Messiah at the top, along with 24 other oratorios, 42 operas, and countless cantatas, concertos, and other works. An astonishing legacy. And don’t forget the marvellous Water Music, played here by the Academy of St Martin the Fields.

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: Reserve Bank and jobs in focus

• A quiet week is in prospect on the data front in Australia. The Reserve Bank releases the minutes of its April Board meeting. But the main focus will be on whether the Aussie labour market can continue its record-breaking run of monthly job gains.
• On Monday the Bureau of Statistics (ABS) releases lending finance data. The total value of new lending commitments (housing, personal, commercial and lease finance) rose by 0.5 per cent in January to $71.5 billion, up from US$71.1 billion in December. Commitments are up by 6.1 per cent on a year ago.
• On Tuesday the weekly gauge of consumer confidence is issued by ANZ and Roy Morgan.
• Also on Tuesday the Reserve Bank releases minutes of its April Board meeting. Commentary on wages growth, share market volatility, trade protection and household consumption could be of particular interest to market participants. We don’t expect any significant change in the Bank’s view on the inflation and economic growth outlook for Australia. Interest rates are firmly on hold.
• On Wednesday, the ABS releases the “Overseas Arrivals and Departures” publication. The publication includes data on tourist flows as well longer-term migration data. Tourist arrivals rose by 2.4 per cent to a record-high 760,200 during the month of January. Arrivals increased by 5.7 per cent over the year. Departures increased by 2.2 per cent to a monthly record-high 894,100 in January. Departures were up by 2.6 per cent on a year ago.
• Also on Wednesday the Department of Jobs and Small Business releases its internet vacancy index. The index has now risen for 16 consecutive months – the longest period of growth since March 2011. The index has increased by 10.5 per cent over the year to 5½-year highs in February.
• On Thursday the ABS issues the March employment report. Jobs rose for a record-breaking 17th straight month in February. The unemployment rate edged-up to 5.6 per cent due to an increase in the participation rate to a near 7-year high of 65.7 per cent. The strengthening job market has encouraged people back into the workforce, to look for a job or to work more hours. The underemployment rate is 8.4 per cent, implying that there is still some slack in the labour market. Economists tip an increase in total jobs of around 25,000 during the month.
• On Friday the CommBank Business Sales Indicator (BSI), a measure of economy-wide spending, is released for March. The BSI rose by 1.0 per cent in trend terms in February - the strongest pace of growth in four years.

Overseas: Chinese economic health check

• In China, indicators such as economic growth, retail sales, investment, production and house prices are all issued.  Output is expected to remain solid, despite seasonal volatility caused by the Lunar New Year holiday period. 
• The week kicks off on Monday in the US with data on retail sales, the National Association of Home Builders (NAHB) index and the New York State Empire manufacturing survey. 
• Attention will turn to China on Tuesday. The all-important March quarter economic growth (GDP) will capture the most headlines. The Chinese leadership continues to target ‘sustainable’ and ‘quality’ growth outcomes as it tilts output towards the consumer. Economists forecast an annual growth rate of 6.8 per cent with activity supported by the industrial sector. The technology and financial sectors may have contributed less this quarter. Retail sales annual growth of near 10 per cent is tipped.
• On Tuesday US housing data is released. Starts and permits were weaker-than-expected in February, yet the underlying increase in single-family starts and the uptick in the number of units under construction provided optimism.
• Also on Tuesday economists expect that production rose a further 0.4 per cent in March. Capacity utilisation is at the highest level in three years, implying potential increases in input costs. All at a time when higher tariffs are proposed, potentially boosting inflation.
• On Wednesday, the US Federal Reserve re-takes centre stage. The most recent Beige Book – a national survey – cited that “most [US} districts saw employers raise wages and expand benefit packages in response to tight labour market conditions”. Federal Reserve Vice Chair for Supervision, Randal Quarles, testifies before the US Senate Banking Committee.
• Also on Wednesday the National Bureau of Statistics issues China’s 70-city housing price data for March. House price growth decelerated to 5.2 per cent in February, continuing the decline from a peak of 12.6 per cent in November 2016. Policymakers have announced stricter property-buying controls in an effort to cool prices. In tier-1 cities, housing prices fell on an annual basis in January for the first time since May 2015.
• On Thursday the influential Philadelphia Federal Reserve manufacturing gauge is released for March. In February, 64 per cent of firms reported labour shortages, while 70 per cent of firms highlighted skills mismatches between business requirements and available labour.
• Also on Thursday the Conference Board's Leading Economic index is issued for March. The index increased by 0.6 per cent in February. The index is tipped to rise by 0.4 per cent in March.

Last Week

By Shane Oliver, AMP Capital

Investment markets and key developments over the past week

• Share markets rebounded over the last week as while volatility remained high not helped by worries about a missile strike on Syria and the FBI raiding Trump’s lawyer’s office, trade war risks receded. The risk on mood saw bond yields, commodity prices and the Australian dollar rise.
• Good news on the trade front as China continues down the path of opening its economy despite US tariff threats, and Trump responds favourably. But there is still a long way to go. President Xi’s Boao forum address was extremely positive in reiterating that China will lower tariffs on certain products, ease access for foreign investors and strengthen protections for intellectual property. Yes China is playing good cop (President Xi and Premier Li)/bad cop (with various underlings like Commerce Ministry spokesman Goa Feng talking of Chinese retaliation if the US further escalates trade tensions) in this so far “phoney trade war”. It has to do this if its to achieve a fair outcome for China. But overall China is taking the high ground here in acknowledging its surplus with the US is unsustainable, continuing down a path of opening its economy and implicitly acknowledging the need to protect intellectual property. And President Xi’s comment that cold war, zero sum mentalities are “out of place” and that dialogue is the way to resolve disputes clearly indicates its open to negotiation with the US on trade. This issue has a long way to go yet and there may still be lots of sniping in public. But so far Trump has praised President Xi’s speech and said the tariffs may not be levied. However, the ball is now in his court to get the negotiations going formally.
• Of course, the worry list for investors remains long with another military strike on Syria after yet another chemical attack looming large and the Mueller inquiry getting even closer to Trump. In terms of Syria, yes the risk is significant – but stuff in the middle east has been flaring up and down for years without much lasting impact on global financial markets. The Mueller inquiry is more of a slow burn reminiscent of Watergate, but the story hasn’t changed. Unless Trump is shown to have done something really bad he won’t be impeached/removed from office and if he is it will be rough for markets along the way but US economic policy won’t change much under VP Pence. Some might say it would be more peaceful – with no twitter grenades from the President!    
• The last few weeks have seen lots of market gyrations driven by President Trump’s comments. A week ago he said he was considering tariffs on another $US100bn of imports from China, now he says that the tariffs may not be levied and he considering re-joining the TPP. A few days ago he declared that missiles “will be coming” to Syria and then a few days later they are still being considered. All these gyrations are just classic bargaining/Art of the Deal stuff that creates lots of volatility for traders. But for most investors it’s a case of turn down the noise and stick to a well thought out long-term investment strategy.
• While the volatility could go on for a while some things are worth noting regarding the direction setting US share market: the lows reached in February have held after the retest of the last few weeks; the forward PE has fallen to a reasonable 16 times, corporates are accelerating buybacks and M&A and investor sentiment has become very negative and profit growth is very strong, all suggesting scope for a bounce back if the news flow becomes a bit less negative. This would flow through to global shares including the Australian share market.
• In Australia, tightening lending standards around tougher checks of borrower income and expense levels are upon us. At least one of the major banks have announced formal changes in their standards on this front and for the last week I have heard multiple anecdotes of the extra hoops borrowers now have to jump through to get a loan. The economic impact is likely to be a slowing in housing-related credit growth and since the tightening will more likely hit marginal borrowers in Sydney and Melbourne given higher home price to income ratios it reinforces the downside to home prices in these cities and the uncertainty around consumer spending. It’s also a de facto monetary tightening and with the pressure from rising short-term funding costs on mortgage rates will likely mean a lower outlook for the RBA’s cash rate. We are looking for a rate hike around February next year, but the risk is that this will be delayed into 2020.

Major global economic events and implications

• US inflation pressures continuing to rise, with the Fed on track for more hikes than the market is allowing for. Core producer price inflation rose 2.7% year on year in the March quarter and core consumer price inflation rose to 2.1% (from 1.8%) as the “Verizon unlimited data plan effect” from a year ago is dropping out. Over the last six months, core inflation has been running at a 2.6% annual pace. The Fed’s preferred core consumption deflator is running below the core CPI inflation rate, but it will be heading up too as last year’s mini bout of deflation drops out and capacity utilisation continues to tighten in the US. With the US jobs market remaining ultra-tight and small business optimism remaining very strong we remain of the view that the Fed will hike four times this year. Market expectations for three hikes this year remain too dovish.
• Eurozone industrial production fell again in February for the third month in a row, but still strong business conditions PMIs indicate it will bounce back. Meanwhile the minutes from the last ECB meeting came across as somewhat dovish with concerns about the strength of the Euro. There are no signs of an early exit from easy money or a rate hike here.
• But not everyone is seeing inflation rise - Chinese consumer and producer price inflation fell in March providing no impetus for any PBOC tightening. Chinese exports fell in March but this mainly reflects distortions caused by the timing of the Lunar New Year with growth being very strong in the March quarter as a whole and the same for imports.

Australian economic events and implications

• Australian data was rather bland over the last week. The NAB business survey showed business conditions and confidence slipping in March but that was down from unbelievably strong levels and they remain solid. Consumer confidence fell slightly and remains below business confidence, which is likely to remain the case until wages growth picks up. Meanwhile, housing finance going to first home buyers has continued to improve, but is at risk from the current tightening in lending standards around income and expenses as they tend to have to stretch more to get a mortgage.
• While the RBA’s Financial Stability Review continues to highlight risks for global asset prices as interest rates rise, the risks regarding the Chinese financial system and the risks around household debt in Australia, it sees housing-related risks as having diminished thanks to macro-prudential measures. More broadly it sees the resilience of Australian banks as improving and is not too fussed by the rise in short-term funding costs.
• The Rider, Levett, Bucknall count of cranes being used for residential construction has started to fall, mainly driven by Sydney. However, approvals remain high so the crane count is likely to remain high for a while yet. Meanwhile, the reduction in residential cranes has been offset by a rise in cranes being used for office, hotel, retail & education construction.

[caption id="attachment_142387" align="alignnone" width="737"] Source: Rider, Levett, Bucknall Crane Index, AMP Capital[/caption]

 What to watch over the next week?

• In the US, expect a solid 0.3% gain in March retail sales (Monday) after several soft months, the NAHB home builders’ index (also Monday) to remain strong with housing starts (Tuesday) up solidly and a 0.3% gain in industrial production (also Tuesday). Manufacturing conditions surveys for the New York and Philadelphia regions will also be released along with the Fed’s Beige Book of anecdotal evidence. The March quarter earnings reporting season will start to ramp up. Consensus expectations are for a 17% year on year rise in earnings, but this could be too conservative given that tax reform provided a 5-10 percentage point boost which could take profit growth above 20%.
• Japanese inflation data (Friday) is likely to show a fall in CPI inflation to 1.1% year on year from 1.5% and core inflation remaining at 0.5% year on year.
• Chinese March quarter GDP growth is likely to have remained at 6.8% year on year consistent with reasonably solid business conditions PMI readings so far this year and PBOC Governor Yi Gang indicating growth has been a bit better than expected. Consistent with this March retail sales growth is expected to rise slightly to 9.7% yoy with industrial production rising to 6.5% yoy, but fixed investment growth slowing to 7.7%.
• In Australia, March employment growth (Thursday) is likely to be around 10,000 jobs with leading jobs indicators remaining solid but unemployment will likely remain around 5.6%.

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 and trade 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.