Euro-zone finance ministers agreed to Greece receiving a second bailout. However, the Greek tragedy is far from over.
- Greece has to implement agreed policy actions, private investor haircuts need to be implemented with uncertainty as to whether this will trigger insurance payouts and various Euro-zone parliaments will have to vote on the latest bailout (with Germany voting on February 27). But even if Greece implements everything it has committed too it will probably still struggle to meet its deficit reduction commitments as the economy continues to implode in the face of fiscal austerity. So we could be back to square one in four or five months time. Hopefully by then though, the firewall around Greece will have been strengthened by the start up of Europe’s new bailout fund, extra IMF funding, solid support for Portugal and ongoing support from the ECB.
- The price of oil has continued to track higher, partly on the back of Iranian threats to stop supplying various countries in the face of an impending boycott on its exports. This has seen the world oil price push above $US107 a barrel and the Asian tapis oil price rise to above $US133 a barrel, its highest since mid 2008. At current levels it implies a rise in average petrol prices in Australia to around $1.53 a litre. This is still below the all time high of $1.65 a litre reached in mid 2008, but the problem is that it will start to act as another drag on consumer spending and economic growth. The same applies globally. As we saw last year the rise in the oil price associated with various civil wars in the Middle East played a significant role in the global growth slowdown seen from mid year. So the surging oil price is a real risk worth keeping an eye.
- Political uncertainty took a turn for the worst in Australia with Federal Labor Party leadership tensions spilling over to a leadership ballot in the week ahead. While the leadership soap opera may be entertaining it is likely taking a toll on business and consumer spending decisions. And while the combination of relatively high interest rates, the strong $A and China worries largely explains the underperformance of Australian shares relative to global shares over the last two years, its likely that political uncertainty from the time of the resources tax debacle has also played a role. So the sooner the whole issue is settled the better. One suspects though that Monday’s ballot may not be the end of the matter.
Major global economic releases and implications
- US data was generally solid. Weekly mortgage applications continued to fall but against this home sales rose, house prices rose, unemployment claims held on to recent sharp falls and weekly retain sales rose.
- Euro-zone economic data was mixed. The German IFO business conditions index rose for the fourth month in a row and Euro-zone manufacturing conditions rose slightly in February. Against this, Euro-zone services conditions fell. The overall picture is not consistent with the deep recession markets feared late last year, but is consistent with Europe remaining in a mild recession. Meanwhile the European Union has finally revised down its 2012 Euro-zone growth forecast to -0.3%. But they are just catching up to reality. Our forecast is -1%.
- The HSBC Chinese manufacturing PMI rose in February and remains consistent with economic growth running around 8 to 9%. Still no sign of a hard landing. Meanwhile, authorities required reserve ratio of banks by another 0.5% freeing up roughly another 420 billion Renminbi in deposits for lending. Further easing is likely.
Australian economic releases and implications
- In Australia, testimony before the Parliamentary economics committee by RBA Governor Glenn Stevens indicated that the RBA is quite happy with current interest rate settings. In fact, his comments imply less of a bias to ease any further than seen in the Statement and Minutes released following the last meeting. Our view remains that the softness in retailing, housing, manufacturing, tourism and the jobs market along with the rise in bank mortgage rates and the strong $A justify a further easing but its clear that the RBA doesn’t agree. So the next rate cut could still be several months away, if it still occurs. We clearly concur with the Governor’s comment that recent out of cycle bank mortgage rate moves do not materially alter the power of monetary policy. If the RBA is not happy with the level of bank lending rates it can just keep adjusting the cash rate till it is.
- The December half profit reporting season is largely complete, with roughly 90% of companies having reported. While there have been some bright spots, overall the results are soft with companies suffering from soft revenue growth, sticky costs and pressure from the strong $A. Only 31% of companies have exceeded expectations, versus 37% in the June half results and a norm of 45%. 68% of companies have reported positive year on year profit growth, but investors have greeted results cautiously with 52% of companies seeing their share prices underperform the market on the day results were released. The absence of much upside surprise has seen 2011-12 consensus earnings growth expectations fall to 4% (from 7% a month ago) with the biggest downgrades in resources, non-bank financials, media and retail stocks. There may be a bit of light at the end of the tunnel though because outlook statements have become a bit more favourable.
Major market moves
- Share markets were mixed over the last week, with a renewed focus on the risks regarding Greece weighing on European shares, but solid data helping US shares, Japanese shares gaining from stepped up BoJ stimulus & a weaker Yen, Chinese shares benefiting from policy easing and Australian shares playing catch up.
- Commodity prices were generally stronger on the back of confidence regarding global growth and the rise in oil prices. The euro looks to have broken higher and the Yen looks to have broken lower.
What to watch over the week ahead?
- In Europe, the focus will be on the ECB’s second tranche of 3 year refinancing funds for banks on Wednesday, which could see banks borrow between €500bn and €1trn. Interpreting the outcome will be difficult though as a high number could be seen as good in the sense that banks may be raising cheap money to lend or bad in the sense that they are dependent on the ECB for funding. Regardless of the outcome the very existence of cheap ECB funds for 3 years has substantially reduced the risks around the European banking system.
- In the US, the ISM index (Thursday) is expected to show a further slight improvement. Expect pending home sales (Monday) to have risen and underlying durable goods orders (Tuesday) to remain solid.
- In China, February manufacturing PMI’s will be released Thursday and are likely to be little changed.
- In Australia, expect January data for retail sales, house prices & credit (Wednesday) to remain softish, building approvals (Thursday) to show a bounce and solid December quarter business investment data (Thursday). The December half reporting season will wrap up with 25 major companies due to report including Woolworths.
Outlook for markets
- Shares are vulnerable to a consolidation or correction in the short-term given high levels of investor sentiment, strong gains year to date and Greek worries. However, any pullback globally is likely to be mild and the broader trend is likely to remain up. Valuations are attractive, particularly against very low bond yields, the risk of a Euro-zone meltdown has faded, momentum in global economic indicators is positive, global monetary conditions are getting easier and easier and there is lots of cash on the sidelines. We continue to see the S&P/ASX200 pushing up to 4800 by year-end, but thanks to tougher monetary conditions in Australia and the strong A$, the Australian share market is likely to remain a relative laggard.
- Low global bond yields in major countries suggest low returns unless Europe’s debt crisis intensifies. Good quality Australian corporate debt is a better bet.
- Beyond the current consolidation/correction, the broad trend in the $A is likely to remain up, helped by more global quantitative easing, solid commodity prices and improving global confidence. A retest of $US1.10 is likely.