Headline developments of the past week
- Better than expected economic data in the US, Europe and China along with the European Central Bank moving to extend its liquidity boosting measures and to buy more bonds in troubled countries, saw investor appetite for risk return big time resulting in big gains in share markets and commodity prices over the last week. Bond yields in Ireland, Greece, Portugal and Spain fell sharply.
- It seems that the long worry list for investors of a week ago is now starting to shrink. This is good news for shares. The correction in November has left shares well placed for the traditional seasonal strength and “Santa Claus” rally into January.
Major global economic releases and implications
- While November payroll data was the exception, most US economic data came in on the strong side over the past week suggesting the soft patch seen in the US economy around mid year may now be over. The key ISM manufacturing and services conditions indexes remained solid in November at levels consistent with continuing growth, consumer confidence improved, vehicle sales rose, construction spending rose and the Fed’s Beige Book of anecdotal evidence pointed to improving economic activity. What’s more various surveys suggest strong post Thanksgiving retail sales. While house prices fell in September this largely reflects the earlier large slump in housing activity indicators post the ending of the first time home buyer tax credit. More importantly, a surge in pending home sales and a continuing improvement in weekly mortgage applications to buy a house suggest the housing sector may be starting to improve. Against this backdrop the weaker than expected rise in payroll employment in November looks odd. But the predominance of stronger data in the US points to stronger employment data ahead. So overall it seems to me the US recovery remains on track, albeit there is a long way to go before spare capacity, evident in the 9.8% unemployment rate, is used up. Hence the Fed will be continuing with easy money for a long while to come.
- There was also more good news from European economic data with an index of economic sentiment on the part of consumers and business rising to a three year high in November, despite renewed sovereign debt problems in peripheral countries. The strength in Germany was highlighted by its unemployment rate remaining at its lowest level since 1992 and by a solid jump in October retail sales. The European Central Bank also announced that it would continue its liquidity boosting measures, increase bond purchases and warned investors that if they bet against the resolve of European governments to preserve the EMU they do so at their own risk. While the ECB has been reluctant to follow the US down the QE path, ie using printed money to buy government bonds, our view has been that it will be ultimately forced to do so to help growth in peripheral countries in the face of massive fiscal austerity.
- China’s manufacturing sector accelerated slightly further in November according to business conditions surveys. News that the Government will shift monetary policy to “prudent” from “moderately loose” is nothing new and simply confirms existing market expectations for further monetary tightening. While tightening measures recently put in place and those to come will put a lid on economic growth, we remain of the view that it will remain strong at around 9.5% next year. Strength in the emerging would was also highlighted by an 8.9% rise in Indian GDP over the year to the September quarter.
- Japanese economic data was soft with falls in retail sales, vehicle sales, industrial production and employment and a rise in unemployment. Fortunately, there was some good news on capex.
Australian economic releases and implications
- Australian economic data was generally soft – but there is no reason to get alarmed. While building approvals rose strongly in October, data for new home sales, private credit, retail sales and September quarter GDP growth were all soft. September quarter GDP growth slowed down to just 0.2% in the September quarter or 2.7% year on year. Quite clearly the Australian economy has hit a soft patch coming into the second half of the year. However, there is a danger in reading too much into this. Economic data often runs hot and cold and we have had soft patches on numerous occasions since the last recession ended in 1991. More fundamentally, we are currently in a transition from growth driven by public sector stimulus to growth driven by the mining sector boom which is yet to fully ramp up. This transition was never going to be smooth. Nevertheless, a huge pipeline of mining projects points to a big pickup in investment activity in the year ahead which will add around 2 percentage points to GDP growth, corporate profits are strong which should also help business investment, there is a decent pipeline of housing activity yet to be worked through, the stocks to sales ratio is at a record low implying little drag from destocking, the trade balance is off to a strong start in the current quarter suggesting trade might add to rather than contract from GDP growth and the high household savings rate of 10.1% suggests consumers have built up a big buffer of savings to possibly support future consumer spending.
- The general picture is of an economy continuing to get back to trend but at a less frantic pace than previously thought meaning that the economy is a bit further away from bumping into capacity constraints, which in turn should provide plenty of scope for the RBA to take its time in raising interest rates again. What’s more the caution on the part of consumers is actually great news from an overall economic perspective – as consumer caution will make it much easier for the economy to handle the coming surge in mining investment without overheating and it means that households are steadily reducing their debt levels which is a far better outcome than the consumer response to the pre GFC mining boom which saw household savings run down and debt piled on.
Major market moves
- Share markets had a strong week on the back of favourable global economic data and words and action from the European Central Bank in relation to sovereign debt problems.
- Good economic news also pushed up commodity prices, with the oil price rising to a new recovery. Get set for rising oil prices to become a big issue again next year – a move back above $US100/barrel looks likely. The rebound in commodity prices and investor confidence also pushed the Australian dollar sharply higher.
What to watch in the week ahead?
- In Australia, the Reserve Bank is expected to leave interest rates on hold. RBA Governor Glenn Stevens has clearly indicated that the current level of interest rates is appropriate for the “period ahead”, given the additional increases in bank lending rates last month and the strong Australian dollar. The soft patch in the economy indicated by recent economic data also supports the case for interest rates staying right where they are for now. Key to watch will be the post meeting statement from the RBA for any guidance as to how long rates are likely to remain on hold. We don’t anticipate the next tightening to come until April at the earliest.
- Australian data for job advertisements (due Monday), housing finance (Wednesday) and employment (Thursday) will also be released. Housing finance is likely to have remained soft in October consistent with falling auction clearance rates and anecdotes of continuing softness in the real estate market. Employment is likely to have increased again in November, but only by 12,000 jobs as various indicators point to a slowing in employment growth after the surge of the past year. However, unemployment is likely to have fallen back to 5.2% (from 5.4% in October).
- US data for the trade balance and consumer sentiment will be released on Friday. Consumer sentiment is likely to show another modest rise. Chinese economic data for November will also start to flow with trade figures due on Friday, ahead of economic activity and inflation data due on December 13th.
Outlook for markets
- While significant worries remain, some are starting to recede with tensions on the Korean peninsula settling down and the European Central Bank moving more aggressively to support bond markets in troubled euro-zone countries. We continue to expect solid gains in shares into year end and through next year. Shares are cheap, particularly relative to government bonds, the run of better than expected global economic data is continuing suggesting the mid year soft patch in growth is over, the global liquidity backdrop is highly favourable underpinned by QE2 in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends. The period from US Thanksgiving to May is normally strong for shares, particularly December and January.
- Notwithstanding inevitable volatility, the $A is likely to head higher as the $US and the euro remain under downwards pressure, interest rates in Australia continue to trend up, and commodity prices continue to trend higher. It’s likely that the $A will settle around $US1.10 in the year ahead.
- Deflation worries, along with central bank government bond purchases in the US and elsewhere, are likely to keep bond yields low in the short term. However, medium-term returns are likely to be poor, reflecting low yields and excessive public debt levels in many developed countries.