This has set a difficult environment for the ongoing corporate reporting season in the US. At a headline level, the balance of results continues to be strong from an earnings perspective, although it is the outlook that markets are now less optimistic about, with concerns that earnings are now at peak levels in the cycle. When taken in the context of rising bond yields, this has led to scrutiny over valuations placing pressure on equity markets. From their 2018 peaks, US markets have declined by around 8 to 12%, Europe by around 12 to 17%, and Asia from around 11% to well in excess of 20% on the downside.
While it should be highlighted that the scale of these declines has occurred in the context of some much stronger increases over the past couple of years, the more pressing factor for markets is understanding where the circuit breaker to the volatility may come from. Most of the discussion here has been around if or when the US Federal Reserve may respond to the potential risks posed to the real economy from tighter financial conditions following interest rate rises, reduced liquidity with stimulus measures being tightened and from the volatility in markets.
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In Australia, most of the focus this week was around the housing market with the local data calendar light on events. In particular, the price declines recorded in Sydney and Melbourne over the past year or so continue to be highlighted, while slowing auction clearance rates, which according to CoreLogic data have fallen below 50% on a national basis to their lowest in around 6 years, have also gained increased attention.
However, the key point for us is understanding what impact the slowing housing market could have on the outlook for household consumption spending — the largest component of the domestic economy. This week's chart of the week, which comes courtesy of Dr Alex Joiner, Chief Economist at IFM Investors, is instructive to this point (you can follow Dr Joiner on social media here).
The chart highlights that with softening property prices and, more recently, the declines on global equity markets, household wealth is likely to be easing further through the second half of 2018. Meanwhile, following slow growth in income over recent years, household saving has been declining and now sits at a decade-low level at 1%. That combination of factors — declining wealth and low saving — together with a likely persistence in slow wages growth could be the catalyst that sees households adjust by restricting consumption spending over the quarters ahead.
Chart of the week
Turning to the US, the main event was Friday's first estimate of economic growth for the September quarter. The US economy expanded at an annualised pace of 3.5% in Q3, which while slower than Q2's outcome of 4.2% was ahead of the market forecast for growth of 3.3%. The composition of growth was led by personal consumption spending on goods and services and public demand, although subtractions to growth from business investment and residential construction are likely to raise concerns that the tailwind from tax cuts may be fading, as higher interest rates continue to work through to the real economy and ongoing uncertainty over trade with other countries remains.
In Europe, there were two main factors this week. Firstly, the European Central Bank (ECB) held their policy stance unchanged, as expected, at their latest meeting. The ECB maintained the guidance it provided from June this year, with its quantitative easing purchases now tapered to €15 billion per month from the previous level of €30 billion per month.
While ECB President, Mario Draghi, noted that the momentum in recent economic data had weakened, the risks to the growth outlook were "broadly balanced". To that end, the ECB had not discussed at this meeting extending its asset purchases beyond the scheduled conclusion at the end of 2018. Meanwhile, signs of stronger wages growth were noted, with the ECB confident in inflation lifting towards its target, predicated on an "ample degree of monetary accommodation" remaining in place.
Secondly, earlier in the week the European Commission rejected the Italian government's draft budget for 2019, which proposed to increase deficit spending by 0.8ppt to 2.4% of GDP. EU rules require Italy to now outline a budgetary proposal to reduce its deficit by 0.6ppt to 1% of GDP, with 3 weeks to respond. Also, rating agency Moody's reduced Italy's bond rating to Baa3 — its lowest investment-grade rating — however, it maintained the country's outlook at 'stable', which allayed fears of a downgrade to 'negative'.
