The key development over the last week was that manufacturing business conditions indicators, or PMIs, in the US, Europe, Japan, China, India and even Australia all rose in January providing confidence the global economic recovery is continuing.
This is very different to the situation around the September quarter last year when they were all falling. It’s also positive for share markets and other growth related trades. The good economic news was capped off by news of much stronger US jobs growth in January.
- There was nothing new out of the European summit. The fiscal compact looks ready to be signed in March and once it’s in place it may help Germany feel more comfortable in agreeing to an expansion in the size of Europe’s new bailout fund and the ECB in further easing monetary conditions. One threat though could be France where ratification is likely to be delayed until after the presidential elections in April and May. On top of this the Greek debt restructuring negotiations are continuing to drag on and even once this issue is resolved negotiations over Greece’s next bailout package are likely to go well into March when Greece will need extra funding to make a €14.5bn bond payment. All of these issues are likely to cause volatility. However, the good news is that investors seem a lot more relaxed about the rest of Europe with Italian, Spanish and French bond yields falling further over the last week. Even Portuguese bond yields have fallen in the last few days. Chinese Premier Wen Jiabao also sounded more willing to provide assistance to Europe, probably through the IMF. If China gets on board with further funding for the IMF other countries are more likely to follow.
- The continuing rally in share markets has come despite somewhat soft profit results in the US and quite weak results in Europe. In the US 60% of companies to have reported so far have exceeded expectations which is an improvement on the situation two weeks ago, but well down on the 70% or so surprising on the upside over the previous 10 reporting seasons. Much of the weakness has been driven by financials and basic materials, though with tech stocks and industrials doing very well. In Europe only 49% of companies have surprise on the upside, compared to a norm of about 57%. However, it’s worth noting that shares fell last year despite much stronger profit results, so the soft results now being seen have arguably already been discounted.
Major global economic releases and implications
- US economic data remained consistent with continuing growth, albeit at a sub-par pace. On the negative side, personal spending was flat in December, consumer confidence surprisingly fell in January and the Case-Shiller house price index fell in November. Against this though, the ISM manufacturing and non-manufacturing conditions indexes rose further in January, construction spending rose in December, chain store and car sales rose strongly and payroll employment rose by a much stronger than expected 243,000 in January pushing unemployment down to 8.3%. Maybe the strength in US retail sales last month partly owed to my family and all the other Australian’s over there on holiday buying up shoes and other things for half what we pay in Australia!
- European data remained consistent with a mild as opposed to a deep recession. While business conditions indicators remain in negative territory they have been becoming less negative, led of course by Germany but with surprise improvements in Italy and Spain. The unemployment situation in Europe remains very bleak at 10.4%, but Germany saw a fall in its unemployment rate to 6.7%. In Italy it rose to 8.9% and in Spain its now 23.5%.
- Japan saw a very strong rise in industrial production in January and an increased in a business conditions survey but soft household spending data for December.
- Chinese manufacturing conditions improved slightly in January supporting the view that China is having a soft landing. Further evidence of falling house prices add to confidence policy makers will be able to ease further.
- In Asia, exports and industrial production continued to slow in Korea and Taiwanese GDP growth was negative. On the positive side inflation readings continue to slow consistent with prospects for further monetary easing.
Australian economic releases and implications
- Australian economic data was mixed. Manufacturing and services conditions indexes improved in January, NAB business conditions and confidence readings were little changed and the trade surplus remained impressive. But against this house prices fell in the December quarter and new home sales and building approvals fell. The interest rate cuts of late last year have not been enough to boost housing and confidence.
Major market moves
- Share markets in the US and Europe rose helped by improving economic indicators, including US jobs data on Friday, and a further lessening of European concerns. Australian shares were a bit weaker.
- Commodity prices were mixed, after recent strong gains, but the Australian dollar continued to rise on the back of increasing optimism regarding global growth.
- Bond yields were mixed – up in the US and Germany on better US jobs data, but down in Australia and Japan. Yields particularly fell in Italy, France and Spain. Italian bond yields have now fallen nearly 200 basis points from their panic highs last November.
What to watch over the week ahead?
- In China, economic data for January will be released but caution is required as it may have been distorted by the early timing of the Chinese New Year holiday week. Expect inflation data (due Thursday) to show a further moderation to 4% and export and import data (Friday) to be particularly soft.
- The Bank of England is expected to leave interest rates on hold, but possibly announce an extension to its quantitative easing program when it meets on Thursday. The ECB also meets Thursday and should be cutting interest rates again but it might reserve its next bout of stimulus to the next handout of cheap loans to banks under its Long Term Refinancing Operations later this month.
- In Australia, the RBA is expected to cut interest rates again on Tuesday by another 0.25% which will take the cash rate to 4%. The case to cut rates again is strong. The jobs market is weakening, retail sales and housing construction are weak, house prices are falling, consumer and business confidence are sub-par and inflation is benign and is likely to remain so thanks to the strong Australian dollar. Average mortgage rates at around 7.3% are just above their 10 year average of 7.25%, whereas in the current weak environment they should really be well below it. What’s more, funding costs for the banks are increasing and risk driving mortgage rates higher unless the cash rate is cut further. The RBA’s quarterly Statement on Monetary Policy due Friday is expected to see further downwards revisions to the growth outlook and a benign outlook for inflation which is likely to be consistent with a continuing easing bias in terms of monetary policy.
- On the data front in Australia, expect retail sales (due Monday) to have remained sluggish in December and ANZ job ads (Monday) and consumer confidence (Wednesday) to remain soft.
- The December half profit reporting season will kick-off in earnest with results from Cochlear, BHP, Rio and Telstra. Overall results are likely to be weak with soft domestic demand, cost pressures, falling commodity prices and the strong Australian dollar all weighing. Retailing, manufacturing and housing related sectors are all likely to be weak and while resource profits are likely to remain strong, growth will be sluggish thanks to high base effects.
- Although the consensus is for 7.8% earnings growth in 2011-12, profit growth in the December half could be near zero. The downside risks are seen to be high, but perhaps the saving grace might be that this is already widely expected and when everyone expects a bad outcome there is some scope for a positive surprise.
Outlook for markets
- While shares are vulnerable to a short term pullback after strong gains so far this year, the broader trend is likely to remain up. Valuations are attractive particularly against very low bond yields, the risk of a meltdown in Europe has receded, momentum in global economic indicators has turned positive, monetary conditions are easing and there is lots of cash on the sidelines. We continue to see the ASX 200 pushing up to 4800 by year end.
- Global bond yields are very low in core countries suggesting low returns unless Europe’s debt crisis intensifies. Australian government bonds are relatively more appealing with higher yields. Australian corporate debt is an even better investment proposition if one needs income or is worried about shares.
- The $A is likely to see its usual large price swings this year, but generally remain solid helped by more quantitative easing in the US and Europe, solid commodity prices and safe haven flows reflecting Australia’s safe AAA rating status. After a short-term pull back, another run up to $US1.10 in the next few months looks likely.