World stock markets are being torn between the competing forces of fear and fundamentals. Since September fear has been a clear winner. For the first couple of days of 2019 it appeared the market had taken a dose of anti-anxiety medication. But it took only one big shock – a downgrade in Apple’s revenue forecast – to smash the veneer of calm. The response to Apple’s particular predicament was based on real fundamentals. The broader market reaction – a 2.8 per cent fall in the US Dow index on Thursday night – was mostly fear related. Apple itself tumbled 10 per cent.
Apple boss Tim Cook mentioned some of the revenue malaise was related to the US China trade war and this country’s slowing economy. This counts as a broader based issue. The ripple effect of this event is worldwide and Australian investors felt it on Friday as our market tumbled regardless of whether this was Apple specific or something more structurally sinister.
Of course Australia is particularly sensitive to anything that happens in China and the weaker growth outlook has a real and fundamental effect on our economy and the mining companies that supply materials to China’s manufacturing sector. It’s the China factor that has been knocking around the Australian dollar. But the Australian stock market fall is really all about skittish US investors who are concerned that the US China trade war will escalate and hit the US economy or that the US central bank, the Federal Reserve, will raise interest rates too quickly and that this will dampen US economic growth.
Both are legitimate but in the case of the Federal Reserve there is plenty of room for it to scale back plans to raise rates if it perceives the economy has a negative response. This week’s weaker-than-expected US ISM Manufacturing Index is just the sort of trigger for the Fed to take a renewed look at schedule of rate rises. As Capital Economics noted this week, “the chances of the Fed raising interest rates two more times in the meantime, as we had previously anticipated, now appear to be fading rapidly”. Donald Trump, the instigator of the trade war, is of course the wild card.
On the one hand he is applying pressure to the US central bank to ease off on rate increases. But he is offering little certainty about whether he will undertake a cease fire on the trade war.
We have until March to see whether early noises about an agreement between China and the US can reach a cold war status. Commonwealth Bank economists echoed the view of many experts in its predictions for the markets this year saying that “any forecasts for 2019 are contingent on the assumptions made for resolution of the (trade) dispute. We take the view that it is very much in the interests for both countries to have the dispute resolved. And while it may take a little longer than the March 1 data set for resolution, we believe enough progress will be made to provide optimism for investors”.
Even Trump must realise that the trade war that was supposed to garner support among Americans is now a key risk to the country’s economic growth and with it his political future. To achieve some clarity around these risks that are responsible for the markets visceral fear would leave the investors to concentrate on the fundamentals that should drive equity markets.
The IMF expects the US economy to slow from a three-year high of 2.9 per cent in 2018 to 2.5 per cent in 2019. The US unemployment rate remains at a 49-year low of 3.7 per cent. But inflation remains low, near 2 per cent, while wages were up by just 3.1 per cent over the year – the highest in 9 years. The European Central Bank is expecting growth in that region to come in at a more sluggish 1.7 per cent in 2019.
The Chinese economy grew at a 6.5 per cent annual rate in the September quarter, down from 6.7 per cent in the June quarter. It was the slowest annual growth rate in 9½ years and it is expected to ease further in 2019. Things could change but there but based on economic fundamentals there is no case for the equities markets to free-fall further. Indeed they should stabilise or improve. Having said that, another Apple event won’t help because it could be a while before there is a clear winner in the battle between fear and fundamentals.