– Warren Hogan, ANZ chief economist
Winter is coming. That’s what the equity markets are telling us, having suffered their worst start to a calendar year. Ever.
In the US the S&P500 is down over 9.1 per cent from its December 31 close. The Japanese and German markets are both down 13 per cent and Australia is off 8 per cent. Thankfully, Australian volumes are down on normal as most people are still at the beach.
Internationally, the market has all but given up on the Federal Reserve tightening in 2016, commodity prices are hitting new lows and corporate credit spreads are under pressure.
There are two lines of thought on the terrible start we have seen to 2016. One is concerning. The other downright scary.
The milder interpretation of this correction is falling commodity prices have resulted in a big drop in the size of the sovereign wealth funds of commodity exporting nations. In essence, the downturn in commodity prices has forced these SWFs to go from net buyers of global assets to net sellers.
The other great capital accumulation of the last half decade has been the foreign exchange reserve portfolios of many emerging market (EM) central banks. With the slowdown in EM economies in 2015, and subsequent downward pressure on these currencies, the reserve portfolios have become sellers of assets, taking money out of the global financial system.
The Chinese are the biggest player here and SAFE’s portfolio has shrunk by almost $US700 billion. This has been replicated across most EM economies.
As global asset markets recalibrate to the slower EM growth and a low commodity price world, there has been disruption. But low commodity prices will put money back into the pockets of consumers.
Weaker EM growth will take pressure off central banks to hike, keeping the advanced economies on track for continued, though unspectacular, growth. As debt and equity markets cheapen up new buyers will emerge out of the advanced economies, filling the breach left by SWFs and EM central banks.
A cold winter’s tale, yes, but spring is just around the corner.
So what about the scary story? China’s equity market is under severe pressure; it is down 16 per cent this year. At one stage last week it was down 20 per cent until the government intervened. Weak economic data and moves by the authorities to allow the currency to depreciate spooked markets a few weeks ago.
The pick-up in the pace of currency depreciation had markets thinking the government was worried about growth. Also of concern is authorities appear to be back tracking on liberalisation policies. It is the view of many investors the Chinese government needs to press on with economic and financial reforms, not reverse them.
For many years investors have questioned whether China can make the ‘Great Transition’ from an overwhelming government directed industrial economy to a market lead consumer service economy. There are few examples in history of any country making this transition without a major economic downturn and financial event.
To complicate matters, China’s debt levels are very high for an emerging economy. What happens if the currency is scuttled as capital flees; reserves are run dry and the government seemingly endless financial reserves dwindle?
China is now 17 per cent of the world economy and the most important driver of global growth. A disruptive financial event could push what is a very fragile world economy close to recession.
Multinational corporations the world over are linked to Chinese growth in one way, shape or form. Either directly or via China’s impact on other countries. Hence the strong reaction of global equity markets to these growing Chinese risks.
So is it a financial recalibration or China cataclysm? That is the focus of the world’s capital markets right now. There is no doubt recession risks are rising but a global financial or economic downturn is no certainty. Markets are more sensitive to the risk of recession than in the past because most developed market governments have few policy options up their sleeve. Being sensitive to an outcome doesn’t mean the outcome will happen.
PROPERTY: THE STRAW THAT BREAKS THE CAMEL’S BACK?
David Cannington, ANZ senior economist
The combination of financial market turmoil, weaker commodity prices, and concerns over China has reignited debate about Australia’s economy. What then does it mean for Australian property, which has benefited from low interest rates, long-term pent-up demand in capital cities and a strong foreign appetite for housing?
How will Australian property fare given the apparent headwinds globally? When factored in with weaker housing market sentiment, soft price growth and tighter regulation of mortgage and housing construction lending, could this plunge in sentiment be the straw that breaks the back of Australian property?
We think not. But there are certainly risks.
Critically, the key fundamental drivers of the outperformance of Australian housing remain largely intact: strong underlying demand for housing in the major cities; reasonably solid household finances; and improving economic/employment conditions. These factors should prevent a sharp downturn in housing market activity and prices.
Nonetheless, the housing market has come off the boil since mid-2015 and we don’t see the housing sector being a key driver of economic growth in 2016 as it has been in recent years.
Housing’s contribution to overall growth is likely to ease through weaker established housing sales, softer construction activity as the year progresses and a reduced ‘wealth effect’ from much slower price growth. Modest price falls cannot be ruled out in some regions – indeed it has already happened in Sydney in recent months.
However, in the absence of a sharp and sustained decline in global and Australian economic conditions, we do expect the housing market to provide reasonable support to the level of economic activity.
Indeed, the number of dwellings ‘breaking ground’ hit a historical high of 215,000 in the year to September, with the increase over the year roughly equivalent to half a per cent of GDP. There is some evidence however exceptionally strong demand for apartments, particularly from overseas buyers has dampened.
Monetary policy remains a key support to the housing outlook. We expect mortgage rates to remain at very low levels, notwithstanding recent small increases. In fact, ANZ Research still expects the Reserve Bank of Australia to lower the cash rate by 50 basis points from around mid-2016 amid a sluggish global growth backdrop and as the support to growth from housing activity and the lower currency wanes.
CHINA: NO PANACEA IN SIGHT
Li-Gang Liu Chief Economist, Greater China ANZ
China’s below forecast (but still impressive) gross domestic product figures are unlikely to still beating hearts in China which will continue to see heightened levels of market anxiety caused by RMB depreciation, capital flight and equity volatility.
China’s latest, more-or-less expected, 2015 GDP growth of 6.9 per cent was slightly below the 7 per cent target. The GDP and other key data such as investment, retail sales and next exports tell us the economy continues to slow while there are also signs of ongoing economic rebalancing. ANZ expects Chinese growth to bottom out at 6 per cent by 2017.
Source: ANZ BlueNotes