The past week saw volatility return in a big way to investment markets.
- Initially share markets fell sharply in response to the poor US non-farm payroll release and intensifying concerns about Spain. They then rebounded mid week in response to an ECB official implying it may start buying Spanish bonds again, a favourable start to the US earnings reporting season, comments from US Fed officials that monetary policy needs to remain ultra easy and stronger than expected Chinese lending data, only to then fall again in Europe and the US on Friday.
- China is showing increasing signs that its economy is in for a soft landing. While GDP growth slowed more than expected to 8.1% over the year to the March quarter (from 8.9%), momentum in retail sales and industrial production picked up slightly, new vehicle sales rose strongly in March and most importantly new bank lending surged in March and money supply growth rose consistent with signs that monetary conditions were eased in March which should also be supportive of growth going forward. While Chinese inflation ticked up in March, this followed a bigger than expected fall in February, and was mainly driven by higher food prices with non-food inflation remaining very low. As such it is not an impediment to further gradual monetary easing. To top it off the Chinese share market increasingly looks like it is trying to build a base and has started to rally again before falling back to January lows (and for technicians looks like it’s forming an inverse head and shoulders). If it is bottoming and confidence starts to build that China is having a soft landing this would be very positive for Asian and emerging market shares. It is also a positive sign for the Australian share market, particularly with the RBA edging towards more interest rate cuts.
Major global economic releases and implications
- US economic news was mixed, but remains consistent with moderate growth of around 2 to 2.5% pa. On the soft side small business optimism fell in March, consumer sentiment fell slightly and jobless claims rose, but probably due to the timing of Easter. Weekly mortgage applications fell over the last week but only slightly and this followed weeks of solid gains. On the positive side though the trade deficit improved more than expected in February setting trade up for a solid contribution to March quarter GDP growth and the Fed’s Beige book described the economy as continuing to expand at a modest to moderate pace. March inflation data was benign.
- The US March quarter earnings reporting season is off to a strong start led by better than expected results from Alcoa, Google, JP Morgan Chase and Wells Fargo. So far 77% of results have exceeded expectations.
- The Bank of Japan left interest rates on hold at 0.1% and failed to announce any more quantitative easing. While the BoJ’s announcement of an inflation objective of 1% two months ago was a step in the right direction and despite oft repeated pledges of strong easing so far it hasn’t done enough to ensure that it will meet its inflation goal with its quantitative easing program badly trailing those in the US and Europe.
- Asian economic data was mixed with stronger than expected March quarter GDP growth in Singapore prompting a slight tightening in monetary conditions, Malaysian exports and industrial production bouncing in February probably on Lunar New Year distortions and Indian industrial production coming in weaker than expected.
Australian economic releases and implications
- Australian economic data was pretty mixed. Consumer confidence and housing finance fell and conditions in the construction sector remained weak, but against this employment was far stronger than expected in March and business conditions and confidence improved slightly according to the NAB business survey, although both remain below longer term average levels. The big surprise was another mortgage rate hike from a major bank – just the last thing Australian households need right now.
- The trend in jobs growth is simply not strong enough to stop unemployment from rising. Over the last year jobs growth has been just 37,600 whereas Australia needs to generate around 148,000 jobs a year to stop unemployment from rising. Our assessment remains that unemployment is likely to rise to around 5.7% over the next six months reflecting increasing layoffs as companies seek to reduce their cost bases in the face of soft demand. The likelihood of increased unemployment ahead along with chronic weakness in key sectors such as retailing, housing, manufacturing and tourism at a time when inflation is benign means that the better than expected March jobs figures do not diminish the case for lower interest rates from the RBA. The latest bank mortgage rate hike adds to the urgency to cut the cash rate and the escalating calls for rate cuts from business and unions highlights danger the economy is now in and the need for lower interest rates. We continue to see a 0.25% cut in the cash rate next month.
Major market moves
- Share markets had a bumpy ride over the last week, initially falling in response to weaker than expected US payrolls and worries about Spain before rebounding on hopes the ECB might buy Spanish bonds, solid US profit news and reduced worries about a Chinese hard landing only to then fall again in Europe and the US. US and European shares ended down, but Asian shares rose and Australian shares were flat. Australian shares proved much more resilient when markets fell suggesting investors are starting to see relative value in the Australian share market with the threat of a Chinese hard landing receding and the RBA getting closer to cutting rates.
- Commodity prices were weak with gold prices up but oil and metal prices down. Despite this the $A rose helped by more confidence regarding China and the stronger than expected jobs report in Australia.
What to watch over the week ahead?
- In the US, expect retail sales growth in April (due Monday) to show a 0.6% gain, a survey of home builders (Monday) to remain consistent with an emerging recovery in the housing sector, manufacturing conditions in the New York and Philadelphia regions to remain consistent with reasonable growth and modest gains in housing starts and permits (Tuesday) and in existing home sales (Thursday).
- The US March quarter profit reporting season will ramp up with 91 companies due to report with the consensus expecting operating earnings to have risen by 5.4% year on year. Negative profit warnings having been running fairly high lately so there is a good chance that the actual outcome will be stronger than this.
- The G20 and IMF meetings on Thursday and Friday will likely consider extra crisis funding following the boost to the Euro-zone debt firewall.
- In Australia, the main focus will be on interest rates with the minutes from the RBA’s last Board meeting likely to affirm that it has become a bit more dovish with growth now seen as running below trend leading the way to a May rate cut providing March quarter inflation data due on April 24th remains benign. On the data front export and import price data will be released on Friday along with data for motor vehicle sales (Wednesday) and the Westpac leading index (Thursday).
Outlook for markets
- While I don’t see a re-run of the last two years where shares peaked around April only to fall 15 to 20%, it does seem that the ride ahead will become a bit rougher after the strong gains seen in the March quarter. That has certainly been the case over the last two weeks. Europe is still a potential source of mishaps given upcoming elections in Greece and France, budget problems in Spain, austerity fatigue and recession; next year’s fiscal drag equal to 3.5% of GDP in the US may worry investors as could a soft patch in economic data after the strong patch of late; and China hard landing fears may take a while to fully recede.
- However, any correction should be mild – say 5 to 10% rather than 15 to 20% – and we still see share markets higher by year end. Shares are cheaper than was the case a year ago – particularly against very low bond yields, the risk of a Euro-zone banking meltdown has faded, momentum in global economic indicators is more positive, global monetary conditions are getting easier and there is lots of cash on the sidelines. Chinese and emerging country share markets should pick up as China starts to more aggressively ease economic policy.
- The Australian share market has been holding up a bit better of late and if the RBA cuts rates next month as expected and confidence regarding a Chinese soft landing builds then the local share market could be in for a period of relative outperformance.
- Low bond yields in major countries suggest low returns unless Europe’s debt crisis intensifies. Don’t expect a bond yield melt up though, as higher inflation and US monetary tightening are still a long way off.
- The correction in the $A may have further to go reflecting soft data in Australia and volatility in global share markets. However, the $A is likely to remain strong overall as the continuing global recovery supports commodity prices and as Australian interest rates remain above US rates.