China/US trade war – He said, Xi said
Coming into the US mid-term elections (where the Republicans lost control of House of Representatives to the Democrats) President Trump’s rhetoric was strongly anti-China. Post the mid-terms his tone has become more accommodative to China.
The G20 has produced 90-days of breathing room in the all-important trade war between China and the US. President Trump met with President Xi Jinping, where they apparently discussed 142 different structural items, including the removal of forced joint ventures and loss of intellectual property for US companies expanding into China.
Unsurprisingly, President Trump has stated “It’s an incredible deal, and if it happens it will go down as one of the largest deals ever made”. Not to steal from the President’s comment, but as we progress past this meeting it will be interesting to see if anything actually changes.
President Trump left the meeting with an understanding that China will be reducing and removing the 40% tariff they had placed on American made cars. Interestingly, as at 4 December, President Xi has yet to confirm this, so it is unclear whether this was agreed or is to be part of the discussions over the next 90-days.
There are contrary reports coming from both sides as to what was agreed, including the 90-day timeframe that President Trump has suggested. No Chinese media outlet has confirmed that there is a 90-day term. China has also communicated that the US and China will now work towards eliminating all tariffs, which again is not something mentioned in the US statement. This all points to a very challenging road ahead for the negotiators and given President Trump is in the middle of it all we can also expect more fireworks over the next three months.
Share markets achieved a modest rally immediately following this news, but at this stage it remains modest as investors await confirmation from both sides of a mutual understanding. Energy, agricultural and emerging share markets rallied on the back of this news, with the volatility index (VIX) dropping.
Part of the reason this will be a very interesting negotiation is the fact that China is currently a leading funder of the US economy’s ever-increasing deficit, with China now holding c.US$1.175 trillion worth of US bonds. On top of this the US is currently requiring a large level of foreign support to fund the tax cuts that President Trump implemented earlier in 2018.
Words are powerful things
At the end of November Jerome Powell, the current head of the US Federal Open Market Committee (FOMC), provided updated guidance on the US economy and the plans for the US Federal Reserve’s cash rate increase. Below we have included the “important words” from the October FOMC statement versus the November statement.
October 2018 statement: “Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral,” he added. “We may go past neutral, but we’re a long way from neutral at this point, probably.”
November 2018 statement “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy – that is, neither speeding up nor slowing down growth”.
The October statement was hawkish, and markets priced in interest rates continuing to be pushed higher into 2019. The November statement was more dovish and saw share markets around the world jump higher on the back of this statement, as well as a decline in the US dollar.
So what does all this mean, and how does this impact you? We see this as an indication of a fickle market that is driven by small changes in wording. This means that markets are struggling to find “fair value” and are being driven higher and lower by varying and changeable perceptions.
We expect the US Federal Reserve to continue to raise interest rates, with one more in December 2018 and maybe a further 1-2 rate rises in 2019. As they continue to increase interest rates, the cost of borrowing will continue to climb leading to further slowing in profit growth in the US and globally. We expect this to lead to further market volatility in 2019.
New Zealand property market continues to slow
New Zealand’s property market had the benefit of a significant tail wind from the unprecedented level of quantitative easing that was used to push global and local interest rates to record low levels over the past eight years. The time of cheap and easy money has come to an end for most of the world. However, as the US continues to increase their interest rates, New Zealand’s mortgage rates continue to hold at record low levels … for now.
New Zealand’s property market has once again overtaken Canada to reclaim the number one spot as the most overvalued property market in the world, according to data compiled by Deutsche Bank. This has occurred even as our property market continues to slow, driven by tighter lending practices from the banks and the removal/reduction in foreign buyers.
Property prices in New Zealand have risen 3.9% year-on-year according to data from ANZ. Auckland and Canterbury residential property prices continue to track sideways over the past year. Auckland house prices are now down 2% on average over the past eight months as the support of property investors is removed by stricter lending requirements and fewer foreign buyers due to new rules from the Overseas Investment Office.
There are several different financial measures that we can look at that will confirm that New Zealand’s house prices remain overvalued but maybe the most disconcerting piece of data we have seen is the measure of household debt as a percentage of disposable income. At present across all households this measure sits at 166% (a record level). ANZ broke this down further and looked at households with a mortgage and found that the true number for New Zealand is 325% of the borrowers’ net disposable income.
What this means is that any increase in interest rates will have a meaningful impact on borrowers’ ability to service debt levels. To date we have not seen the impact of this as NZ mortgage rates have declined slightly through 2018, but with the rest of the world’s borrowing costs increasing it is likely only a matter of time before we follow them higher.
Australian Property market
While house prices in Auckland and Christchurch have been flat so far this year, the Australian property market has fared much worse, with Sydney leading the way lower. On the back of the Royal Commission into the Australian banks’ questionable lending practices we have seen banks tighten their lending rules – making it harder for investors and marginal borrowers to secure funding. We have also seen a marked drop in the level of “interest-only loans” which were 45% of new loans in 2015, and now make up only c18%.
Several analysts are expecting more credit tightening in 2019 which is likely to further exacerbate this downward trend. This slowdown has turned potential buyers off committing to a property in a falling market with a marked drop in loans to owner-occupiers over the past two months, which has further accelerated the sell-off.
Since its peak in late 2017 Sydney house prices are now down almost 10%, including a 1.4% decline in November alone according to Corelogic data. At this level property values have fallen back to 2016 levels; meaning most home buyers are still above water with positive equity in their homes.
The forecast from Corelogic is for Sydney and Melbourne property prices to continue to decline into 2020.
The Australian economy is growing well, and the number of forced sellers is low so there is still potential for this to be a short-term correction, however the clouds for a potential storm in the property market are building – 2019 is going to be a very interesting year for the Australasian property sector.
What are we expecting in 2019
As we come into the end of 2018, which has been a rollercoaster year for share markets around the world, it is now time to reflect on what has changed this year and how this might translate into 2019.
What has changed? Investors have finally stopped believing in the “lower for longer” view about the US Federal Reserve’s management of short-term interest rates. While they may only move 0.50% to 0.75% higher in the US in 2019, this could be enough to stimulate more volatility. The record high earnings growth from US corporations is expected to be lower in 2019.
We are also potentially going to see the end of quantitative easing from the European Central Bank (ECB). The ECB has been a major purchaser of some of the more debt heavy members of the European Union, such as Italy and Greece. If this support is removed, we can expect interest rates in Europe to rise in 2019. Again, this will likely produce periods of higher volatility as the markets price in rising debt costs and declining profits.
Given we expect inflation pressures to persist in 2019, and interest rates to continue to rise around the globe, international bonds may continue to be a hard sector to produce positive performance from as bond values continue to decline, as they have through 2018.
The views expressed above are all based on fundamental market analysis. This does not allow for any “black swan” events, which as the name implies we will be unlikely to see coming. We could also see more known risks intensify in 2019, such as the US/China trade war, or maybe even the impeachment of President Trump!