21 April 2017
Uncertainty around the outcome of the first round of the French Presidential election and continuing geopolitical tensions (particularly around North Korea) weighed on equity markets over the past week. The US share market was flat over the week, Eurozone shares lost 2%, Japanese shares gained 1.4% as the Yen depreciated, Chinese equities were down 0.4% and Australian shares were 0.4% higher. The US dollar weakened slightly but this didn’t assist the oil price from declining. Higher US oil inventories and production are weighing on oil prices.
The first round of the French Presidential election has delivered a good outcome for investment markets with centrist pro Euro candidate Emmanuel Macron and far right Anti Euro National Front candidate Marine Le Pen advancing to the May 7 run-off vote for President of France. With over 90% of votes counted, Macron gained 23.8% of votes, with Le Pen on 21.6%, centre right Francois Fillon on 20% and far left Jean-Luc Melenchon on 19.5%. This outcome is pretty much in line with the recent polls. The result is positive for investment markets (the Euro has rallied by around 1.4% from Friday’s close) because markets feared that the uplift in popularity for Melenchon would lead to a Le Pen – Melenchon run-off in the second round with the policies for both candidates threatening the future of the Euro (Le Pen more so) and advocating policies that would be negative for the French economy.
With all the talk about a populist/nationalist surge across Europe (on the back of Eurozone public debt, migration crises and the Brexit and Trump wins), the surprise for many may have been that Le Pen did not do better. However, the French election won’t be over until May 7. Fortunately, Macron has been consistently ahead of Le Pen in polling for the second round run-off with the gap on the latest poll average well above 20% (see chart below). But, there is still a risk that things could go wrong and lead to a surprise Le Pen victory. So worries around a “Frexit” and Eurozone break up risks will remain elevated until the second round of the election, even though we ultimately see a Macron victory. And even if there is an ultimate Le Pen victory the legalities of France deciding to leave the Eurozone are very complex and are far from certain.
Source: Bloomberg, AMP Capital
The International Monetary Fund released its World Economic Outlook, upgrading its global growth forecasts to 3.5% in 2017 (up from 3.4% previously) and 3.6% in 2018 (unchanged from prior estimates). While the upgrade in forecasts is not large, the IMF has consistently been downgrading growth forecasts over the past five years (see chart below). IMF commentary warns that while there have been positive developments in global growth and inflation, the risks are still skewed to the downside and there are still plenty of structural problems (low productivity growth and high income inequality) which could put downward pressure on growth. The IMF also warned that inward-looking policies (i.e. protectionism) threaten growth and integration.
UK Prime Minister Theresa May called a snap general election for 8th June this year – three years earlier than scheduled. An early election gives the best chance for May to capitalise on her party’s current 18% lead in the polls to achieve a larger Conservative majority in parliament. A larger majority gives the government the best chance of negotiating a “hard” Brexit outcome. A “hard” Brexit probably means a smaller UK economy in the long-run because of the negative impact on trade, labour mobility and the financial sector, but the UK economy is only around 2.5% of global GDP. It will be important to watch for any negative flow-through to Eurozone economies, but so far so good.
The Australian Federal Government announced its plan to abolish the 457 visa (a foreign migrant skilled visa) and replace it with a better targeted skilled visa towards areas where there is a “genuine skills shortage”. The number of 457 visa holders is only around 0.8% of the labour market and has declined because of the slowing mining investment boom in WA and QLD. So, the change in policy is unlikely to have much of a large impact on wage inflation.
Major global economic events and implication
Chinese March quarter GDP data was better than expected, up by 6.9% over the year. March retail sales, industrial production and fixed asset investment growth also beat consensus estimates. Broad money growth was softer in March which reflects recent tightening measures from Chinese policymakers. The risk is that policymakers overdo tightening measures which could see Chinese activity data start to roll off in the second half of the year.
US data was mixed. Manufacturing surveys were softer in April. Housing market indicators weakened with a decline in the NAHB housing market index, lower-than-expected housing starts but some lift in building permits and existing home sales. But the US Federal Reserve’s Beige Book was generally positive and indicated that the pace of economic expansion was “modest” and “moderate” across the twelve Federal Reserve Districts between mid-February and March. There were signs of tightness in the labour markets with a broadening in modest wage rises and employers in most districts indicating difficulty in filling low-skilled positions. The leading indicator still points to a pick-up in growth over the medium-term. US quarterly earnings are looking good, with around 19% of companies having reported results so far and earnings surprising by around +5%.
The flash European Commission consumer confidence reading was up in April (albeit still negative) to the highest level since early 2015 and business PMI readings improved, more signs of continued positive growth momentum in the Eurozone.
The first quarter New Zealand consumer price index showed stronger-than-expected annual price growth of 2.2% over the year to the March quarter. But core inflation is still too low (at 1.5%pa) and below the Reserve Bank of New Zealand’s liking, so rate hikes are unlikely any time soon.
Australian economic events and implications
The April Reserve Bank of Australia (RBA) Board minutes noted that the “developments in the labour and housing markets warranted careful monitoring over coming months”. The minutes pre-date the very strong March employment figures so the RBA is probably a little more comfortable around the labour market outlook. Nevertheless, while low underlying inflation and sub-trend growth may indicate lower interest rates, the RBA’s concerns around the risks to financial stability from high household debt and booming house prices will keep the central bank on hold for the remainder of 2017 and we don’t see the RBA lifting rates until the end of 2018.
What to watch over the next week?
Australian consumer price inflation data for the March quarter is expected to show quarterly headline inflation rising by 0.5% with annual growth rising to 2.2%. Higher petrol prices will lift transport costs. The tobacco excise will put pressure on alcohol & tobacco prices. Clothing & footwear prices are likely to come under pressure because of seasonal weakness (post-Christmas sales) and overall soft demand. While headline inflation is rising, underlying inflation is still too low and expected to have risen by 0.4% over the March quarter (+1.7% over the year). The RBA wants core inflation back in its 2-3% target band. A higher-than-expected New Zealand inflation outcome means there are some upside risks to Australia’s inflation print this week. But, we still see limited upward inflationary pressures in the Australian economic landscape. Underemployment is still high, keeping a lid on wages growth. And capacity utilisation still has room to rise. So, below-target inflation is likely to persist for some time. Other Australian data this week includes the first-quarter export and import prices which should show another step up in the terms of trade, the March credit data and a speech from RBA Governor Lowe.
In the US, watch for housing indicators (home sales, houses prices), March durable goods orders (expect an improvement in core orders), wage indicators and first-quarter GDP. The risk is that market consensus of a 1.2% annualised lift in first-quarter GDP is disappointed given the weakness in the Atlanta Fed’s GDPNow number (0.5%saar). But, March-quarter GDP growth has a habit of being weak only to see growth rebound again in the following periods. A weak March-quarter GDP print is unlikely to put the Federal Reserve off course from hiking rates another 2-3 times this year.
No change from the Bank of Japan or European Central Bank meetings are expected. Eurozone activity has lifted but core inflation is still too low. There is an update on inflation with the April CPI reading out next week (and should show a small lift in core inflation).
UK GDP for the March quarter is also released and is likely to show annual growth lifting to 2.2%.
Outlook for markets
Shares remain vulnerable to a further short term pull back as a lot of good news has been factored in which has left them vulnerable to any bad news. A “bad” outcome in the second round of the French election is a key risk in the near-term. But putting short term uncertainties aside, with valuations remaining okay, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as an opportunity to “buy the dips”. Shares are likely to trend higher on a 6-12 month horizon.
Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds. At present bond yields are still consolidating after last year’s rise, but a resumption of the bear market is likely at some point in the months ahead seeing a gradual rise in yields.
Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher over the medium term.
National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
For the past year the A$ has been range bound between US$0.72 and US$0.78 and this may continue for some time. At some point this year though, the downtrend in the A$ from 2011 is likely to resume as the interest rate differential in favour of Australia narrows (as the Fed hikes rates and the RBA holds), as the Fed eventually moves to reduce its balance sheet and hence narrow measures of US money supply and as the iron ore price remains down from its recent highs.