

Recession Odds Are Rising

Mortgage Brokers

Population

The Global Picture

Messing About In Boats

Research and Diversions

Facebook Live

Next Week

Last Week

Recession Odds Are Rising

The chances of a recession in Australia are rising. A technical recession is two consecutive quarters of GDP contraction, and if it’s not that, then it’s something that feels like one.

I’m not saying the odds have got into “more likely than not” territory, but they’re getting there, and that’s even if the housing market decline remains fairly orderly and stops soon. If it gets messy, all bets are off.

What do I mean by messy? Two possibilities: first, the price declines in Melbourne and Sydney go past the 20% that the pundits now predict and hit 30%, and/or second, a large number of the off-the-plan apartments still being built fail to settle, so that developers and lenders start going bust.

Is it all about the housing market? Well yes, which is good news and bad news.

The bad news is that the health of the economy in 2019-20, and therefore your investment portfolio, is all about the housing market, which means that they’re feeling crook; the good news is that the housing bust didn’t happen spontaneously but was caused by regulators.

That suggests those same regulators, backed by RBA rate cuts, might be able to stop the fall – but they would need to act soon to loosen credit. They have already started, but it may be too little, too late.

The first of the above possibilities – that the market keeps falling beyond current predictions – is about the so-called “wealth effect”, so it’s worth investigating in more detail what that means.

Essentially the wealth effect means the saving rate, or to be precise, the propensity of consumers to save less and spend more as their wealth increases. There’s both a practical and psychological element to this: people feel wealthier so they are inclined to treat themselves and not skimp as much, but also if the house is worth more maybe they don’t need to save as much for retirement since the sale of the family home will yield more. Also, the rising equity in the home allows them to borrow more along the way for holidays and such like.

Gerard Minack had a couple of excellent graphs on this subject a while ago. The first one compares Australia’s recent household saving experience with the average of the countries that had significant house price declines during the GFC – that is, US, UK, Spain, Ireland, Netherlands and Denmark.

On average, the household saving rate for those countries increased by 3.5 percentage points over an eight quarter period, starting one year after the peak in house prices. Australia’s has not yet started rising.

The second graph below shows the impact on spending. It divides consumer spending since 1990 into income funded and savings funded, with a forecast of what would happen if the saving rate were to rise by 3.5 percentage points.

Gerard has assumed that real household disposable incomes continue to rise by 1.5%, but adds: “Of course, that would be too optimistic: income growth would weaken if consumer spending – which accounts for over 55% of GDP – started to weaken as this scenario implies.”

The point of that chart is to show that the wealth effect alone is capable of causing a recession – it just depends on how far house prices fall.

The house price falls from the peak to January 31, 2019, in Sydney and Melbourne, are now 12.5% and 9% respectively.

Darwin’s housing market has dropped 27%, from peak to January 2019, and the Northern Territory is well into a deep recession – its GDP contracted 5.6% in the past year according to CommSec’s State of the States report.

The markets that were contained in the red line on Gerard’s first chart all suffered housing price declines of 25-33% during the GFC. Sydney is now half-way there.

The question now is: where will they bottom? Tim Lawless at CoreLogic says 20% last time I spoke to him, which looks a fairly safe bet from here.

Bear in mind that the US, UK, Ireland etc all saw their banking sectors completely seize up during the GFC. Banks and other lenders were going bust at the same time as the housing markets were collapsing, and it’s hard to distinguish the chicken from the egg.

Did the housing markets in those countries end up falling 25-33% because the banks stopped lending after October 2007, and then Bear Stearns, Northern Rock, and finally Lehman Brothers went broke? Or did the credit squeeze and wave of bankruptcies result from the fact that house prices started declining in early 2007?

It’s impossible to know, and in the end it doesn’t really matter. Banking and housing are inextricably connected, especially in Australia these days. In the 1980s banks were more exposed to the corporate sector than they are now, and in particular the riskier side of it, although it’s worth noting that the 1987 sharemarket crash didn’t cause a credit squeeze and recession – that had to wait for housing lenders like Pyramid Building Society to go under.

Which brings me to the other thing that could cause a recession this time: settlement failures and lender defaults.

Craig James of CommSec published these rather eye-popping charts on Thursday:

Apartment construction has been a big part of the reason the mining investment downturn has not caused a recession: dwelling construction replaced the construction of minerals and energy projects.

Note that those charts show apartments currently being built, that is, in almost all cases they have been sold off the plan and a deposit has been paid. The developer has employed the architect and builder and they’re off and running, and he has typically funded the construction through a mezzanine financier at interest rates up of up to 15% p.a., which is OK since the loan is short-term and the funding costs are loaded into the margin on the apartments.

The banks have not been touching developer business, but they were lending to the buyers of the apartments on very high loan-to-value ratios.

That finance – investor loans at high LVRs – is now very hard to get, if not impossible. The developers of 135,000 apartments currently under construction in Melbourne and Sydney – worth around $50 billion – are sitting there with that amount of high-interest debt, hoping their buyers can get the finance to settle.

Maybe many of the buyers have already got their finance arranged, we don’t know.

In its quarterly review published this week, CoreLogic commented: “There is already evidence suggesting that in certain areas and markets settlements are taking longer and valuations are coming in below or at the purchase price.”

In other words, not only are the buyers finding it hard to get finance, the price they have agreed to buy the apartment at is now obviously well above the market value – they are ripping up $50,000 as soon as they settle, so the motivation to do so, and beg the bank for the money, has probably slipped somewhat, particular if the capital loss is greater than the deposit.

As CoreLogic’s quarterly review says: “with a relatively high proportion of off-the-plan unit valuations coming in below the original contract price in certain cities, if the decline is less than or similar to the deposit amount it is unlikely buyers would walk away.

“If the differential between contract and value at the time of completion grows we may see an increasing number of buyers unable or unwilling to settle their contract.”

Don’t forget the developers’ lenders are almost exclusively non-bank mezzanine financiers – otherwise known as “shadow banks” – mostly using money provided by high net worth individuals and super funds as well as wholesale funding lines provided by the big four banks.

In many ways the situation is similar to what happened in the United States before during and after 2008.

In the US the loans were provided by “shadow banks” outside the banking system and packaged up by brokers and investment banks into multi-layered securities and Collateralised Debt Obligations and sold to investors.

When house prices fell, the phenomenon called “jingle mail” kicked in, where home owners apparently just sent the keys to their house in the mail to the mortgage broker, and went off and rented somewhere else, possibly in a trailer park.

The other expression being used in the US at the time was “NINJA loans” – no income, no job or assets – and it was those borrowers who mostly walked away. They had been lent money by brokers chasing trailing commissions, and who didn’t look very hard, or at all, at the financial circumstances of the borrowers

The situation is different here because in the US home mortgages are non-recourse – that is, the lender has no access to the other assets of the borrower, whereas in Australia they do. “Jingle mail” is not really possible here because the bank would take everything, not just the house, and send the borrower bankrupt.

But the looming problem in Australia is not so much that owner-occupiers will walk away from their houses and post the keys to the bank or broker, but that apartment buyers who have paid a deposit but not yet signed the mortgage paperwork to borrow the rest, decide not to do so.

In last Saturday’s briefing I wondered how many NINJA loans were sitting on Australian banks’ books, since Hayne had highlighted the fact the banks had been using the “Household Expenditure Measure” (HEM) to judge the capacity of borrowers to repay the loans, and had recommended they stop it.

For owner-occupiers who possibly shouldn’t have got a loan using the HEM system, the problem really only arises if consumer spending falls and unemployment rises so they can’t keep servicing the loans.

For Australia in 2019 the more likely problem is the apartments that are now under construction – a total of 225,000 across the country, for a total value of … what? $100 billion, assuming an average price of $500,000?

How many of those will actually settle? And how many of the buyers who thought they could get a loan now either can’t or don’t want to? Nobody has any idea.

I’ve gone into this in some detail because I believe it’s the key risk facing Australian investors right now. If there is a wave of settlement failures and developer bankruptcies, there will be fire sales of the apartments by receivers, which would definitely push the decline in house prices into the 20%+ territory and bring the wealth effect and recession into play.

I am not saying it is the most likely scenario but it’s a risk, and I also think the authorities are aware of it – especially the RBA, which is why Governor Philip Lowe shifted from tightening bias to neutral last week.

Whether one rate cut, or even two totalling 0.5% will make much difference is another matter. It’s about volume of credit, not price, and the willingness to lend and borrow.

Mortgage Brokers

It’s worth briefly covering the situation with mortgage brokers in the context of the housing market, since a vigorous debate has now sprung up about them following the Hayne final report.

That’s because Hayne recommended the end of trailing commissions, and more importantly, that borrowers should pay them, not lenders, which would be the end of the industry, since it’s generally agreed that borrowers wouldn’t pay them anywhere near enough to keep them going.

I wrote a piece for The Australian on Monday headed: “Why we’d be better off without mortgage brokers”, which was based on my view that “marketed credit”, as I put it, was a key problem for the economy, leading to household debt at 125% of GDP.

Brokers are part of the credit marketing business because paying a commission for the sale of something, anything, is designed to increase the amount of it that is sold (obviously).

Bob Gottliebsen wrote, also in The Australian, that getting rid of mortgage brokers would increase the severity of the credit squeeze, as well as the market share of the big four banks, since the brokers facilitate a lot of lending by small banks and other lenders.

He’s right. I spoke to a few brokers during the week, including the CEO of Mortgage Choice, Sue Mitchell (read the interview here) and it’s clear that more than half of the loans being written by brokers are outside the big four banks, and they do facilitate lending, so without them there would be more of a credit squeeze.

For that reason I doubt very much that this Hayne recommendation will be picked up by either political party, at least until the housing market recovers.

I’d say both sides will say they will implement that recommendation, but like St Augustine, they will say “God help me to be chaste, but not yet” – that is, they will say they’ll do something about mortgage brokers’ conflicts of interest, but not yet – it will be delayed and/or phased in later.

Population

The main saviour of the Australian economy, now and in the past, is population growth, currently running at about 400,000 extra people per year (250,000 immigrants, 150,000 births). That’s basically a new city the size of Hobart every six months.

Population growth has been Australia’s only home-grown economic policy for about ten years – the rest has been China. That is, per capita GDP has grown at about the rate of net exports; the difference between the impact of China and actual GDP is population growth.

Most of it, needless to say, is immigration, and most of that came after John Howard doubled the intake in 2006, from 150,000 a year to 300,000.

Immigration has since settled at an average of 200,000 a year, and last year it was 250,000.

73.1% of those new people decide to live in NSW or Victoria. If you add the 12.5% who go to Queensland, that means 85.6% of them went to the eastern states.

It’s complicated a bit by the fact a lot of people are shifting from NSW to Queensland. Over the 12 months to June 2018, 21,672 NSW residents left the state mostly for Queensland, its greatest annual loss since 2008. Victoria is still gaining people from other states, but less than before.

The bottom line is – and this is very much an estimate – a bit less than half of the apartments currently being built in NSW and Victoria can be soaked up by next year’s population growth.

Assuming total immigration stays at 250,000 next year, and 70% of them go to Melbourne and Sydney, and assuming three people per dwelling, that means 58,000 apartments needed in those cities. There are 135,000 currently being built, so 2.3 times what’s needed.

Mind you, as long as immigration stays at 200-250,000 that means 50-60,000 dwellings per year needed, so it shouldn’t take too long for the empty ones to be occupied.

The Global Picture

The problems with Australian housing are happening against a deteriorating global picture, and we know this because central banks everywhere have been shifting their stances this year to loosening, not tightening.

Australia’s RBA is among them, of course, but also The Reserve Bank of India actually cut rates a week ago, the Bank of England shelved plans for multiple rate hikes, and the Federal Reserve did a U-turn and put rates on hold as well.

The IMF now says global growth will slow from 2.3% in 2018 to 2% in 2019 and 1.7% in 2020, and global manufacturing activity is now at a two-and-half-year year low. A year ago, the world was in a solid synchronised upswing; now it’s a synchronised downturn.

What’s gone wrong? Two words: Trump and debt.

As Stephen King, an economic adviser to HSBC, told the Financial Times recently, of 37 countries he recently examined, only eight have reduced their aggregate debt ratios compared with the beginning of the financial crisis. “If you thought the crisis was associated with debt, in some senses we are in a more vulnerable state now.”

Last week I highlighted the issue of zombie firms, kept alive by low interest rates, with a link to this study of the subject by the Bank for International Settlements.

In general, it’s very difficult for any economy to grow rapidly if it’s weighed down by a lot of debt. Consumers don’t spend, companies can’t invest, governments can’t run deficits and central banks can’t increase interest rates so that capital is properly allocated.

As for Trump, it’s mostly to do with the US versus China, which runs deeper than the current President, although he leading the charge on trade. On that subject, Trump wants to rebalance their commercial relationship which, for a few decades, has involved America getting cheap goods and China getting US dollars and jobs.

It seems China is happy to concede on trade and buy more stuff from the US, in particular farm products and airplanes, and it looks like Trump will be able to trumpet a win on trade next month, which will spark a pretty solid relief rally on stockmarkets, so get ready for that.

But be careful: this morning, trade talks ended in Beijing with no progress, so they are obviously running up to the wire, and anything could happen.

The other, separate, front of the new US-China contest is technology, and that’s not going to be so easily resolved. At the moment it’s being fought out through Huawei, and hapless CFO Meng Wanzhou, languishing in prison somewhere.

China has responded to the American actions in two important ways: it has thrown money at semiconductor production, which is bad news for US technology firms. Who wants a competitor with almost unlimited funding whose investment decisions are driven not by perceived returns on invested capital, but instead by perceived national security needs?

Second, China has ramped up the rhetoric on Taiwan and the “One China” policy.

Taiwan is a big producer of semiconductors and other technology. The not-so-subtle message seems to be: “if you won’t let us have access to semiconductors, then maybe we will take over Taiwan and then you won’t have access either!”

If China does take over Taiwan as part of the cold war with America over technology, then all hell could break loose … or not. What would Trump do? No one knows, but this is where the rivalry between China and America has the most uncertainty and the greatest potential for accidents. On the other hand, it’s possible that Taiwan could win on its own. This piece argues that it could.

Messing About In Boats

“Believe me, my young friend, there is nothing – absolutely nothing – half so much worth doing as simply messing about in boats.” – Water Rat to the Mole in Wind in the Willows

I was in Canberra this week for the InvestSMART seminar (more to come in each capital city over the next few weeks) and spent Wednesday afternoon in the ABC office in Parliament House.

Everyone was still fanning themselves after the excitement of Tuesday, when the Government was defeated on the so-called “Medivac” bill that Kerryn Phelps had proposed and the ALP had supported. It was the first such defeat since 1941 or something and by all accounts journalists were running around like headless chooks.

In the end, of course, it was sound and fury signifying not much because the Government didn’t fall and the election isn’t being brought forward. If anything, it was a win for Scott Morrison because it gave him something to talk about that the ALP doesn’t like: boats.

And there’s nothing Scott Morrison and the Coalition like doing more than messing about in boats – this subject has been marvellous winner for them since the Tampa Affair of 2001, when John Howard used boats to turn around the election and defeat Kim Beasley.

Will the latest episode of messing about in boats turn this election? I doubt it, but with that and Labor’s franking credits problem, the Coalition has its first sniff for a while.

Should make for a more interesting few months.

Research and Diversions

Research

Franking credits: time to consider your options. Not sure this piece does the title justice, but it’s not a bad summary of the situation.

Negative interest rates in 2008-09 could have helped the recovery and allowed inflation to rise more quickly.

Why has Bitcoin failed? It has failed because the community has failed. What was meant to be a new, decentralised form of money that lacked “systemically important institutions” and “too big to fail” has become something even worse: a system completely controlled by just a handful of people.

Mining Bitcoin now costs more than it’s worth.

There’s no good reason to trust blockchain technology.

An interview with an anonymous algorithmic trade. He says high speed trading is an arms race in which the fastest computer wins. The second use for high speed computers is for sifting through large data sets to discover patterns and correlations that can be turned into trading strategies, which holds obvious dangers. “All quantitative models use historical data to train themselves. As these techniques become more widespread, the assumption that the world will behave in the future the way it has in the past is being hard-wired into the entire financial system.”

John Abernethy’s letter to investors, always worth reading “Why no world recession? The massive fiscal deficits in two of the world’s largest economies – US and China – are expansionary for world growth. Both administrations need economic growth to be maintained at reasonable levels. Whilst some structural and emerging cyclical factors suggest their growth will be below historic norms, both economies will grow in 2019.”

The detail of tax is a lot like superannuation. It’s complicated and most people find it boring. The thing is, understanding how franking credits can work as a tax loophole is boring on purpose.

Slow going, but no recession 2019.

Vimal Gor, Head of Bond, Income and Defensive Strategies at Pendal Group: the world can’t handle higher rates.

“Brexit – silly, sappy, snappy word – is not a fact, not an event. It’s a condition. It’s the new weather. Brexitosis is what it is. One would rather just groan, or scream, or swear, or feel seasick about the whole thing. All we know is there’s nothing we can do about it. You can’t fix it in the past, and you can’t fix it in the future. It’s like coming round after an operation when they took out the wrong organ.”

The strange saga of MoviePass. It seemed like a great idea at the time, presumably: Buy movie tickets at full price, sell them at a deep discount to attract millions of subscribers, and figure out how to monetise the subscribers later. Actually, it was a stupid idea. Most subscription models rely on users who keep paying the subscription but give up on the service. Nobody was dumb enough to sign up for MoviePass and not use it to the full.

Did you see this? In the midst of getting sacked, Andrew Thorburn found that his PA had stolen $500,000 and had $7.5 million in assets frozen. I thought this story deserved a bigger run than it got.

Targeted advertising: The current state of the art seems to be that when you buy something online you are bombarded for days afterwards with adverts for the thing you just bought; when you read something online, you are told to read something next about what Donald Trump did or did not do in the past six hours. Where’s the magic in that?

Surveillance capitalism: “Tech companies, under the pompous cover of disrupting everything for everyone’s benefit, have developed a panoply of rhetorical and political tricks that insulate them from any pressure from below. It helps, of course, that the only pressure coming from below is usually the one directed at the buttons and screens of their data-sucking devices.”

Correction or bear market? Six charts that analyse market declines.

The NBN is, technically speaking, “a mess”. Too many technologies running over budget and behind schedule. This article discusses the politics and economics influencing the change of the NBN’s technology from Labor’s fibre-to the premises (FTTP) network to the Liberal-National Party Government’s “multi-technology-mix” (MTM) network.

Chinese facial recognition will take over the world in 2019. “The best facial recognition startups are in China, by a long-shot. As their software is less biased, global adoption is occurring via their software.”

“Maybe you want your partner to stop smoking. This startup will generate a special link, you send it to your partner, and when they click it, they get a cookie secretly loaded into their browser. This cookie enables the company to track your partner across the web. You write up an anti-smoking ad, and the company will ensure that your partner sees that ad everywhere. Now your partner’s entire internet experience is permeated with pressures to stop smoking.”

Apple’s vehicle AI lost its nerve and handed control back to a human almost once every mile in 2018. Waymo’s only did it once every 11,000 miles.

Young men are staying at home to play video games instead of going out to find jobs. There seem to be two related reasons for this: Video games are amazingly good; and there is no such pleasure to be had from anything else you might buy on a minimum wage, so why bother earning one?

Explainer: what is a quantum computer? “They won’t wipe out conventional computers, though. Using a classical machine will still be the easiest and most economical solution for tackling most problems.

Diversions

This is a bit late, but still worth catching up with, if you missed it: Hugh Mackay’s Australia Day address: “the Australia I love today – this sleep deprived, overweight, over-medicated, anxious, smartphone-addicted society – is a very different place from the Australia I used to love.”

The future of food goes way beyond lab-grown meat. “We’ll probably see more insect foods being consumed. There is already cricket flour, and it’s being used in cookies and stuff like that. It’s relatively low impact and relatively nutritious.”

A private company has set off a revolution in space by launching hundreds of small satellites, enough to photograph the entire landmass of the Earth every day.

Why is medicine so expensive? “More than two hundred brand-name drugs are currently without generic alternatives. The main reason, it seems, is that the market for the drugs is too small to attract or sustain generic producers. This enables single suppliers to gouge their customers.”

Simone de Beauvoir: “INTERVIEWER: None of your female characters are immune from love. You like the romantic element. DE BEAUVOIR: Love is a great privilege. Real love, which is very rare, enriches the lives of the men and women who experience it.”

Not surprising department: the Bezos text and selfie thing has triggered alarm among billionaires around the world. How did National Enquirer get that stuff? Am I next?

Memo to the honchos at the National Enquirer: if you are going to threaten one of the richest men in the world by saying that you have sexually explicit selfies of him and his girlfriend, don’t have your lawyer and top editor put the threats in writing. The rich guy might decide he can ride out a stolen dick pic or two, especially if he’s already announced that he’s getting divorced.

Evolution is not the cause of selfish capitalism. Cooperation is imprinted in our genes just as unmistakably as competition.

This is so interesting: the invention of vowels revolutionised language. The earliest writing was a form of shorthand, an aid to memory. Letters or symbols were merely hints; you had to recover the meaning before you could speak it. The arrival of vowels allowed written words to correspond directly and precisely with spoken words.

Kevin Rudd’s essay, entitled “The Complacent Country” (published on his own website). “More than five years after the election of the Abbott-Turnbull-Morrison government, and the systematic political carnage that has accompanied it, what now of Australia’s long-term future?” etc etc.

A visit to the marshlands of southern Iraq, where civilisation flourished for five thousand years until Saddam Hussein diverted the rivers and drained the land. Now the waters of the Tigris and Euphrates are flowing back; the foxes and falcons have returned, as have the flamingos and the marsh Arabs themselves. Families build tall houses out of dried reeds on islands in the mud, as they have since biblical times.

The most expensive home ever sold in the United States has gone for US$238 million. It’s an apartment, sort of.

Analysis is easy, information is hard. Nathan Leamon, head of research for the England cricket team, talks about the rising influence of sabermetrics in cricket, enabled by a flood of data in the past decade from 3D camera systems installed at major grounds to settle disputed umpires’ calls.

The invigorating strangeness of Friedrich Nietzsche: A new biography reveals Nietzsche to be a perfect gentleman—shy, attentive, and a little whimsical

Bighorn sheep have much to teach us about the importance of tradition. Ignore science and you ignore many of the most important issues in the world today. Climate change, genetic engineering, artificial intelligence – the relevance of all of those should be obvious. Less so the travails of the bighorn sheep –what, at first sight, looks like a bog-standard conservation story, is really quite extraordinary.

This typewriter repairman was told computers were king and he would soon be out of business. Twenty years later, he’s still going.

Devices that will invade your life in 2019 (with voice commands), and what’s over-hyped.

Your Curiosity Rover report (from Mars). Today – how it takes a selfie.

“The transformation of Facebook into a tool for demagogues and foreign attackers was facilitated at every step by Facebook itself. And the more we find out about how the company—and other platforms—handled this threat, the more we discover where their priorities really lie.”

It’s the 45th anniversary of Blazing Saddles. I must have watched it 20 times in a row when it came out and I was 22, and I laughed as hard the last time as the first. Still laugh at it. Here are 11 facts about Blazing Saddles.

Happy Birthday Arcangelo Corelli, the fabulous violinist and composer, born February 17, 1653. If he had been born 292 years later, he would have been Eric Clapton. Here’s his Concerto in D Major, on the original instruments. Beautiful.

Speaking of The Eric, here he is doing Old Love in Hyde Park in 1997. It’s still my favourite Clapton song.

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 askalan@investsmart.com.au (new email!) then keep an eye out for the Facebook Live video in next week’s Overview.

Next Week

By Ryan Felsman, Senior Economist, CommSec.

Australia: Job market and wages growth in the spotlight

The December quarter Wage Price Index release dominates the local agenda in the coming week. The semi-annual update on average weekly earnings will also be keenly observed together with the January jobs report and Friday’s testimony from the Reserve Bank Governor.

The week kicks off on Tuesday when the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan. And the minutes will be released from the Reserve Bank Board meeting held on February 5. We expect interest rates to remain on hold for the foreseeable future, provided there is continued labour market strength to cushion households from the property downturn.

when the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan. And the minutes will be released from the Reserve Bank Board meeting held on February 5. We expect interest rates to remain on hold for the foreseeable future, provided there is continued labour market strength to cushion households from the property downturn. Also on Tuesday, the Australian Bureau of Statistics (ABS) releases tourism and migration data in the Overseas Arrivals and Departures publication for December. Tourists from China hit record highs over the year to November, but annual growth of Chinese inflows is the slowest in 8½ years.

the Australian Bureau of Statistics (ABS) releases tourism and migration data in the Overseas Arrivals and Departures publication for December. Tourists from China hit record highs over the year to November, but annual growth of Chinese inflows is the slowest in 8½ years. On Wednesday, the Commonwealth Bank’s Business Sales Indicator is released together with the Wage Price Index (WPI). According to the ABS, the WPI rose by 0.6 per cent in the September quarter pushing annual growth to 3½-year highs of 2.3 per cent. Including bonuses wages rose by 2.7 per cent over the year. According to the Department of Jobs and Small Business Enterprise Bargaining Report, average annualised wages increased by 3.2 per cent over the year to September.

the Commonwealth Bank’s Business Sales Indicator is released together with the Wage Price Index (WPI). According to the ABS, the WPI rose by 0.6 per cent in the September quarter pushing annual growth to 3½-year highs of 2.3 per cent. Including bonuses wages rose by 2.7 per cent over the year. According to the Department of Jobs and Small Business Enterprise Bargaining Report, average annualised wages increased by 3.2 per cent over the year to September. Also on Wednesday , the Department of Jobs and Small Business will release the Skilled Vacancies data for January – a key leading index on the labour market.

, the Department of Jobs and Small Business will release the Skilled Vacancies data for January – a key leading index on the labour market. On Thursday, the all-important January employment report is released. Employment growth was strong in 2018, but was driven largely by part-time jobs in November and December. Unemployment rates are at record lows of near 4 per cent in NSW and Victoria. CBA economists’ forecast 10,000 jobs to be added with the unemployment rate steady at 5 per cent.

the all-important January employment report is released. Employment growth was strong in 2018, but was driven largely by part-time jobs in November and December. Unemployment rates are at record lows of near 4 per cent in NSW and Victoria. CBA economists’ forecast 10,000 jobs to be added with the unemployment rate steady at 5 per cent. Also on Thursday, the CBA and Markit issues ‘flash’ February factory and services activity indexes and the ABS releases more wages data. The average weekly earnings figures are released every six months and are important as they provide dollar estimates of wages in the economy across states and industries.

the CBA and Markit issues ‘flash’ February factory and services activity indexes and the ABS releases more wages data. The average weekly earnings figures are released every six months and are important as they provide dollar estimates of wages in the economy across states and industries. On Friday, Reserve Bank Governor Philip Lowe will provide his semi-annual testimony before the House of Representatives Standing Committee on Economics.

Overseas: The Federal Reserve back in focus

The recent US government shutdown is continuing to impact release dates for key economic data. US financial markets are closed on Monday as George Washington’s Birthday/President’s Day public holiday is observed.

as George Washington’s Birthday/President’s Day public holiday is observed. The week begins on Tuesday in the USwhen the National Association of Home Builders (NAHB) releases its monthly index. Builder sentiment rebounded off two-year lows in January after mortgage rates fell.

in the USwhen the National Association of Home Builders (NAHB) releases its monthly index. Builder sentiment rebounded off two-year lows in January after mortgage rates fell. On Wednesday in the US, minutes of the last Federal Reserve meeting are scheduled.

in the US, minutes of the last Federal Reserve meeting are scheduled. On Thursday in the USweekly jobless claims data (claims for unemployment insurance) is issued alongside durable goods orders, existing home sales, the Conference Board Leading Index and the Philadelphia Federal Reserve manufacturing survey.

in the USweekly jobless claims data (claims for unemployment insurance) is issued alongside durable goods orders, existing home sales, the Conference Board Leading Index and the Philadelphia Federal Reserve manufacturing survey. Also on Thursday, Markit issues ‘flash’ purchasing manager indexes for both the services and manufacturing sectors for the month of February.Leading business surveys weakened in December and January, especially in China and the Eurozone, contributing to a swathe of economic growth forecast downgrades and a more ‘dovish’ tone in global central bank commentary.

Markit issues ‘flash’ purchasing manager indexes for both the services and manufacturing sectors for the month of February.Leading business surveys weakened in December and January, especially in China and the Eurozone, contributing to a swathe of economic growth forecast downgrades and a more ‘dovish’ tone in global central bank commentary. And on Friday in China the latest house price data is due. House prices are seen expanding at a 9.4 per cent annual growth rate in January, down from 9.7 per cent in December.

Financial markets

The Australian corporate reporting season reaches its peak with a host of major companies expected to release earnings results, including:

On Monday: Altium, Ansell, Baby Bunting, Brambles, GWA, Netwealth, nib and Prime Media.

Altium, Ansell, Baby Bunting, Brambles, GWA, Netwealth, nib and Prime Media. On Tuesday : Arena REIT, Beacon Lighting, BHP, Blackmores, Charter Hall REIT, Coles, Emeco, IOOF, Monadelphous, OceanaGold, Oil Search, Senex Energy and Seven West Media.

: Arena REIT, Beacon Lighting, BHP, Blackmores, Charter Hall REIT, Coles, Emeco, IOOF, Monadelphous, OceanaGold, Oil Search, Senex Energy and Seven West Media. On Wednesday: APA, Asaleo Care, Corporate Travel Management, Crown Resorts, Domino’s Pizza, Euroz, Fortescue Metals, Greencross, Lovisa, Moelis, Regis Resources, Saracen Minerals, St Barbara, Vocus, Western Areas, WiseTech Global, Woolworths and WorleyParsons.

APA, Asaleo Care, Corporate Travel Management, Crown Resorts, Domino’s Pizza, Euroz, Fortescue Metals, Greencross, Lovisa, Moelis, Regis Resources, Saracen Minerals, St Barbara, Vocus, Western Areas, WiseTech Global, Woolworths and WorleyParsons. On Thursday: APN Property, Coca-Cola Amatil, Flight Centre, IRESS, MYOB, Nine Entertainment, Origin Energy, Perpetual, Qantas, Reject Shop, Santos, Simonds, Southern Cross Media, Star Entertainment, Sydney Airport, Viva Energy, Webjet, Wesfarmers and Yowie.

APN Property, Coca-Cola Amatil, Flight Centre, IRESS, MYOB, Nine Entertainment, Origin Energy, Perpetual, Qantas, Reject Shop, Santos, Simonds, Southern Cross Media, Star Entertainment, Sydney Airport, Viva Energy, Webjet, Wesfarmers and Yowie. On Friday: AfterPay Touch, Alumina, Ardent Leisure, Automotive Holdings, Charter Hall, Clean TeQ, Kogan.com, Michael Hill, Mortgage Choice, Reece, Regis Healthcare, Resolute Mining and Village Roadshow.

Last Week

By Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital.

Investment markets and key developments over the past week

Global share markets rose over the last week helped by optimism on US/China trade talks, progress towards averting a renewed partial government shutdown in the US along with okay earnings results . Australian shares were little changed having outperformed sharply in the previous. Bond yields were little changed. The oil price rose but metal and iron ore prices fell. The $A was little changed as the $US rose.

. Australian shares were little changed having outperformed sharply in the previous. Bond yields were little changed. The oil price rose but metal and iron ore prices fell. The $A was little changed as the $US rose. Progress in US/China trade talks and the (likely) avoidance of a return to the partial government shutdown in the US are both positive to the extent that they help dial down the political risk that weighed on investors last year . If the March 1 tariff deadline is delayed it’s likely that the US auto tariff threat will also be delayed as Trump has been inclined to avoid multiple battles at once. Avoiding a return to the shutdown – even if Trump goes down the contentious path of declaring a National Emergency to get Wall funding – is good news as it removes a threat to the economy and adds a bit to confidence that a debilitating battle over the need to raise the debt ceiling from March will be avoided.

. If the March 1 tariff deadline is delayed it’s likely that the US auto tariff threat will also be delayed as Trump has been inclined to avoid multiple battles at once. Avoiding a return to the shutdown – even if Trump goes down the contentious path of declaring a National Emergency to get Wall funding – is good news as it removes a threat to the economy and adds a bit to confidence that a debilitating battle over the need to raise the debt ceiling from March will be avoided. Some lessening in political threats (for now) along with a swing to more dovish/stimulatory economic policy globally are consistent with our view that this year will be a decent year for share markets. However, with share markets having run hard from their December lows and technically overbought and economic data still weak the risk of a short term pull back is high. The Australian share market particularly looks to have run ahead of itself. Earnings results have been better than feared but economic growth looks to be slowing, the earnings outlook is constrained, and RBA rate cuts are still a way off.

Major global economic events and implications

US data was messy over the last week . Retail sales fell sharply in December possibly reflecting the impact of the shutdown and share market falls at the time, small business confidence continued to fall and jobless claims rose continuing a rising trend. Against this, job openings and hiring were all strong. Meanwhile, headline inflation was weak thanks to falling energy prices, but core inflation was flat at 2.2% year on year and with momentum accelerating again. The weakness in retail sales is consistent with the Fed pausing, but the acceleration in core CPI inflation in recent month means that it’s premature to conclude that the Fed has finished tightening for this cycle. We expect the Fed to be on hold for the next six months with maybe one hike later this year.

. Retail sales fell sharply in December possibly reflecting the impact of the shutdown and share market falls at the time, small business confidence continued to fall and jobless claims rose continuing a rising trend. Against this, job openings and hiring were all strong. Meanwhile, headline inflation was weak thanks to falling energy prices, but core inflation was flat at 2.2% year on year and with momentum accelerating again. The weakness in retail sales is consistent with the Fed pausing, but the acceleration in core CPI inflation in recent month means that it’s premature to conclude that the Fed has finished tightening for this cycle. We expect the Fed to be on hold for the next six months with maybe one hike later this year. The US December quarter earnings reporting season continued to surprise on the upside over the past week, but its still showing a slowdown from previous quarters as the tax boost and underlying earnings growth has slowed. 80% of S&P 500 companies have now reported with 72% beating on earnings with an average beat of 3.3% and 60% beating on sales. Earnings growth is running at 18.5% year on year for the quarter. As can be seen in the next chart the level of surprises and earnings growth is slowing down. US earnings growth is likely to be around 5% this year.

Source: Bloomberg, AMP Capital

Eurozone December quarter GDP growth was confirmed at 0.2% quarter on quarter or 1.2% year on year . Germany just missed out on falling into a technical recession with growth of just 0.02% qoq. Pressure on the ECB and the German government for more stimulus is intensifying.

. Germany just missed out on falling into a technical recession with growth of just 0.02% qoq. Pressure on the ECB and the German government for more stimulus is intensifying. Japan’s economy grew again in the December quarter after a natural disaster affected September quarter. But GDP is flat on a year ago. That said inventory, trade and public investment were the drags on growth and consumption & investment were solid. The BoJ will still have to keep the pedal to the metal.

after a natural disaster affected September quarter. But GDP is flat on a year ago. That said inventory, trade and public investment were the drags on growth and consumption & investment were solid. The BoJ will still have to keep the pedal to the metal. Chinese exports and imports bounced back in January suggesting that things aren’t as bad as feared. That said it would be wrong to get too excited either way as the Lunar New Year holiday is known to distort Chinese data around this time of year. Meanwhile inflation continued to fall in January.

Australian economic events and implications

After weeks of poor data, Australian data was mixed over the last week . On the positive side the NAB survey measure of business conditions and consumer confidence bounced back in January and February respectively although both remain at uninspiring levels. Pressure remains on the housing market though with housing finance sliding sharply in January, reports that China has moved to make it even tougher for its citizens to move money out of China destined for property markets in Australia and elsewhere and ASIC moving to toughen up its regulatory guidance to lenders to the effect that Household Expenditure Measure benchmarks are too low an estimate of borrowers’ living expenses and that actual verification of income is required. In terms of the latter while many lenders have already moved in this direction its likely that there is still further to go in terms of tightening up lending standards.

. On the positive side the NAB survey measure of business conditions and consumer confidence bounced back in January and February respectively although both remain at uninspiring levels. Pressure remains on the housing market though with housing finance sliding sharply in January, reports that China has moved to make it even tougher for its citizens to move money out of China destined for property markets in Australia and elsewhere and ASIC moving to toughen up its regulatory guidance to lenders to the effect that Household Expenditure Measure benchmarks are too low an estimate of borrowers’ living expenses and that actual verification of income is required. In terms of the latter while many lenders have already moved in this direction its likely that there is still further to go in terms of tightening up lending standards. The Australian December half earnings reporting season has been better than feared but shows a slowdown in growth and caution regarding the outlook. So far about a third of results have been released. 60% of companies have seen their share price outperform on the day of reporting (which is above a longer term norm of 54%) and 45% have surprised analyst expectations on the upside which is around the long term average, but a more than normal 33% have surprised on the downside, the proportion of companies seeing profits up from a year ago has fallen and only 55% have raised their dividends which is a sign of reduced confidence in the outlook – six months ago it was running at 77%. Concern remains most intense around the housing downturn and consumer spending.

Source: AMP Capital

Source: AMP Capital

Source: AMP Capital

What to watch over the next week?

In the US, expect the minutes from the Fed’s last meeting (Thursday) to confirm that the Fed remains upbeat but that it is waiting patiently to decide what to do next in terms of interest rates and that it might end its quantitative tightening process earlier than previously expected . On the data front expect a slight rise in the National Association of Homebuilders’ conditions index (Tuesday), a modest rebound in underlying durable goods orders, business conditions PMIs for February to remain around 54-55 and existing home sales (all due Thursday) to rise slightly.

. On the data front expect a slight rise in the National Association of Homebuilders’ conditions index (Tuesday), a modest rebound in underlying durable goods orders, business conditions PMIs for February to remain around 54-55 and existing home sales (all due Thursday) to rise slightly. In the Eurozone the focus will be on whether the business conditions PMIs (Thursday) show signs of trying to stabilise after falling through most of last year or continue to fall.

Japanese inflation data for January is expected to show core inflation rising slightly but only to 0.4% year on year.

In Australia the minutes from the last RBA board meeting (Tuesday) will confirm the shift to a neutral bias in terms of the immediate outlook for interest rates and Governor Lowe’s parliamentary testimony on Friday will be watched for further clues in terms of how the RBA is seeing the outlook for the economy . On the data front expect December quarter wages growth (Wednesday) to hold around 0.6% quarter on quarter or 2.3% year on year as the lift in the minimum wage increase to 3.5% continues to feed through. January jobs data is expected to show a 5000 gain in employment and a rise in unemployment to 5.1%. Data for skilled vacancies and the February CBA business conditions PMIs will also be released.

. On the data front expect December quarter wages growth (Wednesday) to hold around 0.6% quarter on quarter or 2.3% year on year as the lift in the minimum wage increase to 3.5% continues to feed through. January jobs data is expected to show a 5000 gain in employment and a rise in unemployment to 5.1%. Data for skilled vacancies and the February CBA business conditions PMIs will also be released. The Australian December half earnings results season will see its busiest week with 70 major companies reporting including Ansell, Brambles and Coles (Monday), BHP, Bluescope and Cochlear (Tuesday), Fortescue, Stockland, Seven Group and Woolworths (Wednesday), and Coca-Cola Amatil, Nine and Wesfarmers (Thursday). 2018-19 consensus earnings growth expectations are around 4% for the market as a whole. Resources, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained.

Outlook for investment markets

Shares are likely to see volatility remain high with the high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.

Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.

Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.

National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.

The $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.