June Market Update

Trade War Escalates

In May we saw the markets start to price in an increasing level of uncertainty around a trade agreement between the United States and China. In April it looked as if a trade deal was only weeks away from being reached, but President Trump then fired a warning shot across the Chinese negotiators bow in his usual fashion -via a Tweet.

  • May 5th – President Trump states the tariff of 10% will be increased to 25% on 10th May.
  • May 15th – President Trump signs an executive order restricting the export of US technology to “foreign adversaries”
  • June 1st – China responds raising tariffs on $60 billion worth of US goods

On the back of this increased uncertainty the S&P500 has recorded the worst May performance in over 10-years, and the second worst since the 1960’s. This is ringing more than a few alarm bells around the globe and strangely appears to be driving investors from overpriced shares into overpriced bonds.

What could calm these markets?

  • A US/China Trade Agreement – potentially may occur as soon as June-July, but who can tell with Trump at the helm;
  • A signal from the US Fed that they have recognised the risks in markets and will now start lowering rates again – this occurred on the 5th June with the US Fed stating they were ready to act if the Trade War impacted the economy further.

Bad month in May in markets

Source: FE Analytics, PWA

How will this end? It is unlikely to be any time soon. Even if a trade deal is reached this is simply the opening salvo of what will be an ongoing economic battle between the two super powers as China grows and its influence continues to expand globally.

Global economies continue to slow

As the trade war continues, and global debt levels increase the Purchasing Managers Index (PMI) continues to slow and has now moved below 50 suggesting the world in moving closer to a global recessionary environment.

This is a major change from how the global economies looked in early 2018 and has occurred on the back of the end of the US Quantitative Easing (QE), and an expectation that the European Central Bank (ECB) would also cease their QE in 2019.

JP Morgan Global Manufacturing PMI

Source: Daily Shot, WSJ

Quantitative Tightening (QT) was expected to accelerate into 2019 but is now more likely to cease and revert to QE for both the US and ECB. This has seen a small relief rally in the US markets since the start of June. We continue to remain cautious given the growth engine for the world continues to slow.

Australia – the lucky country?

Australia has been going through its own slowdown in growth since the middle of 2018 with house prices in most major cities leading the way lower. The Reserve Bank of Australia has been monitoring this and post the recent election they have commenced an easing cycle that may see the RBA Official Cash Rate (OCR) move to as low as 0.50% by the end of 2019 (three more rate cuts).

More interestingly we are now hearing more commentators start to talk about possible QE in Australia if the lower rates do not provide enough stimulus. If this did indeed eventuate we would expect this to be very stimulatory for both the Australian share and bond markets.

Australia GDP slowing

Source: Charles Schwab, Fact Set, WSJ Daily Shot

RBA Official Cash Rate falling

Source: Danske Bank

What goes up must come down?

The US Fed has been increasing their cash rate since 2016, this is now on hold. The market is now pricing in a 90% chance that the US Fed will reduce their cash rate in the next two-months. As the chart below shows there remains a high level of uncertainty around the direction of interest rates.

90% chance US Fed will reduce rates in 2019

Source: Daily Shot, WSJ

Off the back of the increased concern about share market valuations we have seen investors move from global shares into global bonds. Given Quantitative Easing, which has hoovered up a large amount of global government bonds the prices on the remaining tradable bonds continue to defy logic, with US$11 trillion worth of global bonds now being purchased at a gross yield that is below 0%. In other words, the purchasers of these bonds are locking in a loss to maturity and the only way that they can make money from buying these bonds is if interest rates move further into negative territory.

As shown in the volatility chart below the “MOVE index” (white line) is spiking well above the “VIX index” (green line). The Move index is a measure of the implied volatility on one-month treasury options and is used to measure volatility in the bond market. The VIX index is a measure of US S&P500 share volatility. The volatility chart is telling us that people are investing into negative or low yielding bonds that have a high level of volatility at present, hence it would appear bond holders are not getting paid enough return to justify the risk they are taking on.        

Volatility in bonds rising fast

Source: Bloomberg Finance LP

US$12 Trillion negative yielding bonds in the world

The Daily Shot WSJ

Australian Property update

Property prices in Australia have been declining with Darwin house prices falling a staggering 30% since they peaked in 2015, with the more talked about Sydney & Melbourne falling 15% and 11% respectively from their 2017 peak prices.

How far can they fall? The price correction we have seen was needed with house prices moving well beyond the reach of the average Australian’s ability to service their mortgages. The slow down has come on the back of bank funding getting tighter and the reduction of foreign investment into their property market.

It is hard to see their property prices fall much further given there is potentially 1% coming off mortgage rates this year on the back of the RBA rate cuts. Current auction data is supporting this view with a larger number of properties being sold under the hammer versus being passed in unsold.

Australian Property Market – decline from peak prices

Source: CoreLogic, ANZ Research

Will we see a similar decline in New Zealand property? Barring an unexpected bout of inflation that drives interest rates higher, or a reduction in local banks ability to lend we see the NZ property market as likely to have a more sedate flat to slight decline over the coming 5-years.

Regional House Price Inflation – April 2019

Source: ANZ Research, REINZ

NZ vs. Australian Lending Standards

Source: ANZ Research, APRA, RBNZ

One area where New Zealand may be more protected than the Australian housing market slow-down is the difference in lending behaviours between the two countries. New Zealand banks have just under 10% of total lending over an 80% Loan to Value Ratio (LVR) versus Australia’s 22%. Also New Zealand banks have less investment borrowings (c.19%) than Australia’s 30%.

We continue to monitor the New Zealand property market closely with a high level of concern around borrower’s ability to repay debt if interest rates do move higher. However, in a world where interest rates are testing new record lows we can expect to see some possible support for the property market via increased lending.

This information is generic in nature and is not intended as financial advice.