China Congress To Be A Focus In The Week Ahead

Originally published by AMP Capital

Investment markets and key developments over the past week

• While US and Eurozone shares rose only slightly over the last week, Japanese and Chinese shares saw strong gains and Australian shares had a good rebound from the bottom of the range they have been in for the last few months. Bond yields fell in the US, Europe and Australia. Prices for oil and metals rose but iron ore fell. The Australian dollar rose as the US dollar slipped again.

• Reflecting the ongoing improvement in the global growth outlook the IMF yet again revised up its global growth forecasts for 2017 and 2018, highlighting yet again how the global growth story has switched from disappointment over the 2012 to 2016 period to upside surprises more recently. This is supporting profits and hence growth assets.

Chart

• The risks around Catalonia receded a little bit over the last week – with Catalonia’s president suspending a supposed declaration of independence in favour of talks with the Spanish Government – but the issue has a long way to go and the Spanish Government is likely to play hardball and may yet take over Catalonia’s government (which it can do under Article 155 of the Spanish Constitution). We remain of the view that it’s not a major European (let alone global) issue: a Catalan declaration of independence won’t mean much; Catalans are unlikely to rise up and use force to back it; the damage to the Catalan economy (which accounts for 20% of Spanish output) could be immense; and the issue is not about the survivability of the Euro with Catalonia wishing to remain in it.

• Rising female participation in the economy is good for growth as it will boost the workforce and a more gender diverse workforce is good for productivity. The latest Financy Women’s Index (which can be found here https://www.financy.com.au/financy-womens-index-shows-female-progress/) shows that women are continuing to make economic progress both in absolute terms and relative to men, particularly in terms of workforce participation and wages. This is great news but there is much further to go. Boosting female workforce participation to that of males could add up to 8% to the size of the economy or $147bn to annual GDP and help offset the impact of the aging population. There would likely be an additional boost to the extent that greater female participation will result in increased workplace diversity which in turn will contribute to a more productive workforce – as Australian company boards are starting to recognise.

• It was great to see Richard Thaler’s work around behavioural economics recognised in this year’s Nobel prize for economics. Thaler along with others including 2002 Nobel economics prize winner Daniel Kahneman has been a major contributor to economics and finance via his work showing that people are not always rational when making decisions. This goes a long way to explaining why asset prices can deviate far away from fundamentally justified levels and has had a huge impact on my career as an economist and investor which started with my PhD thesis which partly related to such insights. As Thaler pointed out after winning the prize “in order to do good economics, you have to keep in mind that people are human.” Some economists still seem to forget that!

Major global economic events and implications

• US data remains solid. Small business optimism remained high in September despite a dip, August readings for job openings, hiring and quits were all strong, initial jobless claims are continuing to unwind their hurricane related boost and producer price inflation is continuing to trend up. While the minutes from the Fed’s last meeting referred to continuing concerns around low inflation it highlighted an ongoing inclination to raise rates again in December.

• Eurozone industrial production rose by more than expected in August. But with ECB President Draghi saying “we’re still not there yet” in terms of wages and sticking to the commitment to only raise interest rates “well past” the conclusion of its quantitative easing program - which we think will be extended at the rate of €30bn a month from January for another 6-9 months – means that as things currently stand the ECB is unlikely to raise interest rates until well into 2019.

• Japan saw strong reading for machine orders and economic sentiment. Reflecting strong economic conditions Tokyo’s office vacancy rate has fallen to just 3.17%.

• Chinese foreign exchange reserves rose again in September highlighting that capital outflows remain back under control and export and import growth both accelerated in September telling us that global and domestic demand remains strong.

Australian economic events and implications

• Australian data was a bit more upbeat over the last week with continuing strength in business conditions, a slight rise in business confidence and an improvement in consumer confidence albeit only back to long term average levels. September quarter home price data from Domain added to evidence that the Sydney property market has rolled over with significant price declines. It would be wrong to read too much into just one quarter’s data but price softness is consistent with a sharp fall in auction clearances and anecdotal evidence. Housing finance data showing a surge in lending to first home buyers indicates that recent NSW and Victorian government moves to increase stamp duty concessions for first home buyers have worked which along with still strong population growth and various other factors highlights why a property crash is unlikely.

• The RBA’s Financial Stability Review saw the Australian financial system as being strong with low non-performing loans but continues to see the main risks as relating to household debt and the housing market. However, the bank does note slower growth in riskier types of lending and signs of easing in the Sydney and Melbourne property markets. The RBA also announced that it will be conducting bank stress tests which is surprising given that’s normally the role of APRA. Early conclusions suggest that the banks are resilient except in extreme shocks. Its possible such tests could be used to justify a further tightening of macro prudential standards at some point.

What to watch over the next week?

• China will likely be the main focus globally in the week ahead with the commencement of the Communist Party Congress on Wednesday and September inflation and economic activity data due for release. The Congressis almost certain to see President Xi Jinping continue as General Secretary and Li Keqiang remain as Premier, but the leadership team will be renewed around them with President Xi seeing his authority enhanced. Post the Congress we may see a refocus on reform but it’s doubtful that there will be an abrupt policy change and as we have seen over the first five years of President Xi’s leadership there will be a careful balancing of reform and maintaining growth.

• On the data front in China, September inflation data (Monday) is likely to show a fall back in CPI inflation to 1.6% year on year and producer price inflation is expected to fall slightly to 6.2% yoy. More importantly, economic activity data (Thursday) is expected to show a modest slowing in GDP growth in the September quarter to 6.8% yoy, September industrial production growth is expected to pick up to 6.5% yoy, retail sales growth is likely to remain at 10.1% yoy and investment is likely to slow to 7.6% yoy. None of which will cause much excitement in financial markets or at the PBOC.

• In the US September industrial production (Tuesday) is likely to see a return to growth and October home builder conditions (also Tuesday) are likely to bounce back up a bit but September housing starts (Wednesday) and existing home sales (Friday) are likely remain subdued thanks to the hurricanes. Regional manufacturing conditions indicators for October are likely to remain strong. The Fed will also release its Beige Book of anecdotal indicators (Wednesday) and Fed Chair Yellen in a speech on Friday may reiterate the case for another rate hike in December. The September quarter profit reporting season will also start to ramp up and will likely show another increase in profits from a year ago, although the hurricanes may have temporarily dampened things later in the quarter.

• Japan’s election (Sunday October 22) is likely to see PM Abe’s LDP led coalition comfortably returned with poll support for the new Party of Hope declining. Abenomics will continue! (although I suspect it would have anyway but under a difference name if the Party of Hope were to win.)

• In Australia, the minutes from the RBA's last board meeting (Tuesday) are unlikely to add anything new and will continue to imply that the RBA retains a neutral short term bias with respect to interest rates. September jobs data (Thursday) is likely to show a 10,000 fall in jobs but with unemployment unchanged at 5.6%.

Outlook for markets

• This is still a seasonally volatile time of the year for shares, North Korean risks remain high, Trump related risks remain and Wall Street is overdue for a decent 5% or so correction which would affect other share markets. However, beyond short term uncertainties we remain in a sweet spot in the investment cycle – with okay valuations particularly outside of the US, solid global growth and improving profits but still benign monetary conditions – so we remain of the view that the broad trend in share markets will remain up. This should eventually drag Australian shares up from their range bound malaise.

• Low starting point bond yields and a likely rising trend in yields will likely drive poor returns from bonds.

• Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this will wane eventually as bond yields trend higher.

• Residential property price growth in Sydney and Melbourne is likely to have peaked with a slowdown likely over the next year or two, but Perth and Darwin are likely close to the bottom, Hobart is likely to remain strong and moderate price gains are expected to continue in Adelaide and Brisbane.

• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.25%.

• While further short term upside in the Australian dollar is possible, our view remains that the downtrend from 2011 will ultimately resume as the Fed continues to tighten and the RBA remains on hold into next year.

All the best for a delirious weekend.