The US share market finally saw a daily decline greater than 1% for the first time since last October and this dragged other share markets down to greater or lesser degrees over the last week, although Eurozone and Chinese shares managed gains. Worries about whether President Trump will be able to pass his pro-business agenda of tax cuts, deregulation and infrastructure spending were the main driver but high levels of short term investor optimism has left the market vulnerable. The risk off tone in markets saw government bond yields decline, credit spreads widen and commodities excepting gold weaken. The $US also fell, but this didn’t stop a decline in the $A.

Will Trump’s pro-business agenda pass Congress? Can the Republicans get their act together? A common concern seems to be that if Trump and the Republicans can’t pass their Affordable Care Act (or Obamacare) replacement, what hope have they got for the bigger measures around tax cuts, etc? This reasoning is too simplistic. Obamacare had three key elements: Federal spending on healthcare subsidies; tax hikes to pay for them; and regulations imposed on health insurers. The Republican House leadership have reasoned that if they reverse the spending increase and tax hikes then their Obamacare reform could pass through the Senate as part of the budget reconciliation process which just requires 51 votes (out of 100 Senators) which they have rather than the normal 60 votes (which they don’t have) if they push for removal of regulations as well. The sticking point is that the Freedom Caucus (a group of conservative tea party sympathetic republicans in the House) want to remove the regulations too. So there is now a risk that any reform bill that passes the House may not have the votes needed to pass the Senate. But a failure of the Obamacare reform to pass does not mean that Trump’s pro-business reforms will be stalled. The Freedom Caucus, the broader Republican Party and Trump all want lower taxes and less regulation and would prioritise this as they want to “starve the beast” of government as they see it. The GOP also realise that given the risks around Trump’s presidency (investigations around links to Russia, risk of eventual impeachment) and the risk they lose the Senate in next year’s mid-terms mean that they only have a small window to get through the reforms they want. So they are not going to let repealing Obamacare get in the way of their small government agenda. So the bottom line is that Trump’s pro-business agenda remains on track.

The tragic events in London perpetrated by another deranged nutcase provide another reminder of the ongoing terrorist threat. But as has been the case with recent terrorist attacks the impact on investment markets was minor as investors have become accustomed to them (much as occurred a generation or so ago with the IRA and other terror attacks in Europe) and their economic impact remains insignificant.

In Australia, signs continue to point to an imminent fresh round of macro prudential controls to slow lending to property investors and further tighten home lending standards. The minutes from the RBA’s last Board meeting clearly indicate that it has become more concerned about a “build-up of risks associated with the housing market” and there is reportedly a special regulatory working group – composed of the RBA, APRA and ASIC – looking at the issue. Likely measures include a cut in the cap on annual growth in the stock of investor lending to 5-7% from 10% now (it’s been running at 8.5% lately) and tougher interest rate tests for borrowers. The last round of macro prudential measures combined with significant negative media publicity at the time worked very well in late 2015/early 2016 in slowing the Sydney and Melbourne property markets and would have kept working if they were tightened again around six months ago when it became clear that the initial impact was wearing off. Sure macro pru is second best to rate hikes to slow property prices, but in the absence of more fundamental solutions it’s the best option at a time when its way too early to hike rates given the state of the overall economy and property markets outside of Sydney and Melbourne.

Major global economic events and implications

US data was mixed with weak existing home sales and home prices but a large gain in new home sales. Jobless claims rose but remain historically very low.

Eurozone consumer confidence rose and is about as high as it ever gets.

Australian economic events and implications

In Australia, official ABS home price data confirmed that the housing market has hotted up again after a soft patch in late 2015-16. Private data points to a further acceleration in the first few months of this year. Sydney and Melbourne remain the main culprits though with prices still trending down in Perth and Darwin and only seeing moderate growth in other cities. Meanwhile, September quarter data showed an uptick in population growth to a solid 1.5% year on year or 349,000 people highlighting a key source of underlying property demand.

What to watch over the next week?

In the US, expect consumer confidence to have remained high and continued growth in home prices (both Tuesday), a bounce back in pending home sales (Wednesday), modest growth in personal spending and core consumption deflator inflation remaining around 1.7% for the 12 months to February (Friday).

Eurozone economic confidence indicators (Thursday) are expected to remain solid and core inflation is likely to have remained unchanged at 0.9% year on year in March.

Japanese data for February to be released Friday is likely to show continued strength in the labour market, strong industrial production but weak household spending and core inflation remaining only just above zero.

China’s manufacturing conditions index for March (Friday) is expected to slip back to 51.5 but retain most of its recent gains.

In Australia, expect credit growth (Friday) to remain moderate but the focus will likely be on a further acceleration in lending to property investors. Data on new home sales and job vacancies will also be released.

Outlook for markets

Shares remain vulnerable to a short term pull back of around 5% as investor sentiment towards them is very bullish and a lot of good news has been factored in as the uncertainty around Trump’s pro-business agenda showed over the last week. However, we see this as an opportunity to “buy the dips” as valuations are okay, global monetary conditions remain easy and global profits are accelerating on the back of stronger global growth. So shares are likely to continue to trend higher on a 6-12 month horizon.

Still 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 to around 3-4% this year, as the heat comes out of Sydney and Melbourne. Threats to the Sydney and Melbourne property markets are steadily building: state and Federal governments are shifting into gear to improve affordability; another round of macro-prudential measures looks on the way; the banks are starting to raise rates for owner occupiers out of cycle; all at a time when the supply of units is surging; and prices are ridiculous

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 $US0.72 and $US0.78 and this may continue for some time yet. 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 3 or 4 times and the RBA remains on hold).

By Shane Oliver, AMP Capital

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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