Share markets rebounded over the past week as worries about Brexit leading to global financial and economic chaos faded somewhat. Despite noise of ongoing political turmoil in the UK, the British share market surged to its highest for the year helped by the plunging British pound and talk of Bank of England monetary easing. Bond yields continued to decline on lower for longer interest rate expectations but currency markets were a bit more stable (apart from the pound), credit spreads narrowed and commodity prices rose.
There have been several positive developments over the last week with respect to Brexit. Well maybe not for the UK, but in terms of the issue that really matters and that is the threat it poses to the rest of Europe and the global economy. First, the Spanish election actually saw support for the governing People’s Party increase with no gain for anti-establishment Podemos suggesting that the Brexit mayhem may have seen voters opt for stability. Of course PM Rajoy’s People’s Party still has to form a coalition government but the prospects are much higher than after the December election.
Second, two clear messages emerged from the European Union leader’s summit in the last week: it is looking to learn the lessons from the UK’s exit to better serve its citizens and strengthen the EU; and it is taking a firm stance with the UK – there can be no access to the benefits of free trade with the EU without meeting the obligations (the free movement of people, adoption of EU rules and regulations and contributing to its budget). In other words the UK will not be let off lightly which will send a strong signal to other potential exiteers.
Third, policy makers around the world have continued to swing into action with the Bank of England foreshadowing monetary easing, talk that the ECB is considering expanding its bond purchases, fresh stimulus in Korea, another rate cut in Taiwan and more moves towards stimulus in Japan.
Fourth, bond yields in Spain and Italy have fallen sharply to new record lows indicating that so far investors are not demanding a higher premium to invest in such countries. The threat of ECB “whatever it takes” intervention to preserve the Euro is helping.
Finally, assets vulnerable to a rising $US have not crashed. In fact oil has hung around $US50, copper is up, emerging market shares are ok. Credit spreads have not blown out. We don’t seem to be seeing a re-run the January-February panic.
Of course uncertainty remains high and the ride will remain rough for UK assets but the British pound appears to be wearing the worst of that and so far at least the threat to the Eurozone and the rest of the world looks to be constrained.
In Australia, after a long eight week campaign the Federal election is now upon us. Each side of politics is offering very different visions for the size of government making this arguably the starkest choice since the 1970s:
- Labor is focussed on spending more on health and education and in the process allowing the size of the public sector to increase, funded by tax increases on higher income earners (retention of the budget deficit levy and cutbacks in access to negative gearing and the capital gains tax discount and superannuation savings similar to those of the Coalition although the details haven’t been spelt out) but a higher budget deficit in the next few years. The ALP would also undertake a royal commission into banking and intervention in the economy is likely to be higher.
- By contrast the Coalition is focussed more on containing spending and encouraging economic growth via company tax cuts and mild reforms. Despite the Coalition’s tilt to “fairness” with its super reforms it’s committed to keeping taxes down. It does plan to reinstate the Australian Building & Construction Commission but it’s unclear whether it will get enough votes to do this.
While the polls still suggest similar levels of primary support for Labor and the Coalition, it’s a big ask to see the ALP become the first opposition in 85 years to regain government after just one term as it will need to win 19 seats. However, the big issue may be what happens in the Senate with there being a good chance that the Greens and minority “parties” control the balance of power again acting as a huge constraint on the government, which would mean another de facto minority government, ie more of the same. Which in turn means poor prospects for getting government spending under control over the next three years and for implementing serious productivity enhancing economic reforms.
Over the 8 weeks since the election was called Australian shares are little changed. The next table shows that shares rose an average 4.8% over the 3 months after the last 12 Federal elections with 8 out of 12 seeing gains. Will we see a post-election rally over the next 3 months this time around? Relief at getting the election out of the way may help but the likely failure of the new government to have control of the Senate, September quarter seasonal weakness in shares and Brexit uncertainty are likely to weigh in the short term even though I see shares being higher by year end.
Australian shares before and after elections
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Major global economic events and implications
US economic data was good with solid growth in consumer spending for the second month in a row in May, a rise in consumer confidence, continued gains in home prices and the June services PMI flat at 51.3 and continuing low jobless claims. While pending home sales and trade data were weaker than expected, March quarter GDP growth was revised up to 1.1% annualised and June quarter growth looks to have rebounded to around 3% annualised.
Eurozone economic sentiment fell only slightly in June and remains consistent with moderate growth and a pick-up in bank lending growth is a positive sign. Inflation rose slightly in June but remains low at 0.1% yoy for headline and 0.9% yoy for core.
Japanese jobs data for May remained strong, housing starts rose and the June quarter Tankan business conditions survey was little changed, but May data for household spending and industrial production were soft and core inflation slipped further to just 0.6% year on year adding to pressure for more stimulus.
Chinese business conditions PMIs for June were little changed consistent with growth running around 6.5% to 7%.
Australian economic events and implications
In Australia, early indications of the impact of the Brexit outcome on confidence suggest little impact with the ANZ/Roy Morgan weekly consumer sentiment reading falling just 1.7% to a level still above its long term average and auction clearance rates remaining solid. Meanwhile, job vacancies fell over the 3 months to May but on an annual basis still point to solid jobs growth, private credit growth slowed in May with credit to property investors continuing to lose momentum and business lending slowing, home price growth slowed in June with four capital cities seeing price declines but Sydney and Melbourne remaining strong, new home sales fell in May and the AIG’s manufacturing PMI improved to an okay 51.8.
What to watch over the next week?
The week ahead will no doubt see bouts of Brexit related nervousness but it may continue to settle down in the absence of any new developments in Europe. In Australia we will see reaction to the election result, but if its more of the same then the impact will be minor.
In the US, June payroll employment (Friday) is likely to bounce back by 180,000 jobs after the disappointing May gain of 38,000 with unemployment remaining at 4.7% and wages growth running around 2.6% year on year. But given the threat to confidence and growth from Brexit it won’t be enough to signal an imminent Fed rate hike in July. It will help ease fears regarding US growth though. Meanwhile, expect the non-manufacturing conditions ISM for July to remain around an ok 52.9 but the May trade deficit to deteriorate a bit given preliminary goods trade data (both Wednesday). The minutes from the last Fed meeting (also Wednesday) are likely to be very dovish but are dated given the Brexit outcome.
Chinese CPI inflation (Sunday July 10) for June is likely to have remained around 2% year on year but producer price deflation is likely to show a continued abatement.
In Australia, expect the RBA (Tuesday) to leave interest rates on hold for the second month in a row. Following its last meeting the RBA expressed a degree of comfort with current interest rate settings and while Brexit related risks have added to the case for another rate cut at this stage the RBA is likely in wait and see mode. That said we still expect further easing this year with the August meeting providing a better opportunity to move as by then the risks flowing from Brexit with be clearer and we will have seen the June quarter inflation data.
In the meantime expect a sharp fall in May building approvals (Monday) after several months of strength and continued moderate growth in retail sales (Tuesday). ANZ job ads, the May trade deficit and the services PMI will also be released.
Outlook for markets
Brexit uncertainty and seasonal September quarter weakness could see more volatility in shares in the short term. However, beyond near term uncertainties, we still see shares trending higher this year helped by relatively attractive valuations, very easy global monetary conditions and continuing moderate global economic growth.
Lower and lower bond yields point to a soft medium term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, low inflation and ongoing shocks like Brexit. That said, the recent bond rally has taken bond yields to ridiculously low levels leaving them at risk of a sharp snapback at some point.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.
Capital city dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to toughening lending standards and pockets of oversupply. Prices are likely to continue to fall in Perth and Darwin, but price growth may be picking up in Brisbane.
Cash and bank deposits offer poor returns.
The Australian dollar is still higher than it should be and the longer term downtrend looks likely to continue as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value. The $A is still likely to fall to around $US0.60 in the years ahead.
