The past week has seen investment markets continue to trade nervously on ongoing concerns about theglobal growth and earnings outlook.
- Investors are clearly concerned that global policy makers are not doing enough to prevent a further deterioration in the global economic and profit outlook. However, US and European shares benefitted from a late rally on the back of better than expected earnings news from US banks.
- While Spain’s bank bailout and extra time to get its deficit down are welcome, its latest round of fiscal austerity, which will amount to 2.3% of GDP a year, will only make things worse pushing Spain further down the same path as Greece. Europe really needs to give up on its obsession with Austrian economics. In the meantime attention is shifting back to Italy again, with Moody’s downgrading its sovereign rating two notches on concerns that its deteriorating economic outlook will make it difficult for it to meet budget targets.
- There was much better news from ECB president Mario Draghi who told the European Parliament that he would do more if economic conditions warrant. The reality is that with the Euro-zone already in recession and inflation threatening to fall well below the ECB’s target they already do, so hopefully he will follow this up with action.
- Global monetary easing continued with central banks in Brazil and Korea cutting interest rates, with both likely to cut further in the months ahead. Brazil’s policy interest rate was cut to 8%, down from a peak of 12.5% last year.
- Chinese economic growth continued to slow in the June quarter with GDP growth slowing to 7.6% from8.1% in the March quarter. Overall the Chinese growth numbers tell us that while the Chinese economy has slowed, it is not collapsing as many fear. In fact sequential quarterly GDP growth actually accelerated in the June quarter. With policy makers having provided stimulus and this now showing up in stronger banklending, it’s likely that we have now seen the low point for GDP growth. Retail sales are holding up particularly well given the fall in inflation and investment spending is actually showing signs of a pick up. Chinese policy makers will likely continue the process of gradual easing we have seen since last November. Falling inflation to just 2.2% year on year provides plenty of scope for further easing and this is likely as China seeks to ensure that its economy achieves a soft landing. We expect two 25bps interest rate cuts along with two 0.5% cuts to bankreserve ratios over the next two months. Past policy easing plus more to come suggests that growth will pick up to around an 8% pace over the current half of the year, which would be good news for Australia.
Major global economic releases and implications
- US economic indicators continue to indicate sup-par growth with falls in small business confidence and consumer sentiment and a worsening in the trade balance in May implying that trade will be a bigger drag on June quarter GDP growth than previously thought. While jobless claims fell this appears to owe more to seasonal adjustment problems. Fortunately, consumer credit growth is coming in stronger than expected consistent with a continuing recovery in bank lending. So while growth may have slowed it appears to be a longway from collapsing. Meanwhile the minutes from the last Fed meeting had a dovish tone with “a few members”suggesting further easing is likely to be necessary and “several others” noting it would be needed if economic indicators lost momentum. Since the last meeting the two most watched indicators in the US have lost momentum, ie the ISM and payrolls, so it may be argued that the conditions that the “several others” were looking for are now in place. QE3 remains likely in the next few months.
- Meanwhile good earnings news from a couple of US banks highlights the strength of US banks, in sharp contrast to European banks. This helps underpin US bank lending and provides added confidence that the US economy is not about to plunge back into recession.
- Industrial production was stronger than expected in the Euro-zone, but with forward indicators pointing down thislooks more like a dead cat bounce.
- Japanese economic data was mixed with a sharp fall in machine orders and economic sentiment but stronger than expected tertiary conditions and a fall in bankruptcies. Overall, Japan is on track for 1% growth. The Bank of Japan at its latest meeting continued to offer little confidence that it will achieve its 1% inflation objective.
- Indian industrial production rose more than expected in May but the underlying trend remains soft and Singapore’s June quarter GDP contracted, and is up just 1.9% year on year and is likely to slow further as global trade slows.Australian economic releases and implications
- Australian economic data was mostly soft. While consumer sentiment rose in July suggesting that rate cuts may be starting to get some traction it remains subdued. Moreover, business conditions and confidence remained sub-par in June according to the NAB’s monthly business survey, housing finance commitments fell in May and remain very weak and employment fell sharply in June pushing unemployment back up to 5.2% with a fall in the ANZ job ads survey pointing to further labour market softness ahead. This is all consistent with the need for more cuts in the cash rate from the RBA.Major market moves.
- Share markets were mixed over the last week. Investors continued to worry about the global growth outlook,but US and European shares had a strong bounce on Friday thanks to better news from US banks which left them up 0.2% and 0.7% respectively over the week as a whole. However, Asian markets missed out on this andwhile better than feared Chinese growth data provided a boost on Friday most Asian markets were down over the past week, including the Australian share market which fell 1.8%.
- Commodity prices generally rose as did the Australian dollar. The euro fell to its lowest since mid 2010.
- Safe haven demand pushed bond yields in perceived “safe” countries back to near the record lows seen in early June. Bond yields fell Spain, but were kept higher in Italy by the latest downgrade to its credit rating.What to watch over the week ahead?
- In the US, the big thing to watch will be June quarter earnings which will start to flow in earnest, with nearly 150 S&P 500 companies due to report. The recession in Europe, the stronger $US and slowing US growth mean that it has likely been a tough quarter with the consensus looking for a 1.8% drop in profits.Hopefully the bad news has already been factored in as negative profit warnings have been running high. The real risk though is that consensus forecasts for 14% profit growth over the year to the December quarter will be revised down.
- US Fed Chairman Ben Bernanke’s Congressional testimonies on Tuesday and Wednesday will bewatched closely for clues as to how close the Fed is to undertaking more quantitative easing. On the data from the US, expect a slight gain in manufacturing conditions surveys for the New York and Philadelphia regions(due Monday and Thursday respectively), a 0.2% rise in retail sales (Monday), benign readings for inflation(Tuesday) and continuing signs of recovery in housing indicators (due on Wednesday and Thursday).
- In the Euro-zone, data for inflation and construction will be released. The Bank of England is also scheduled to release the minutes of its July meeting.
- In Australia, the minutes from the RBA’s last Board meeting (Tuesday) will be watched closely for cluesregarding the outlook for interest rates, but I suspect won’t give much away bar a degree of comfort with current settings. On the data front, expect the NAB June quarter survey (Thursday) to confirm the sub-par readings for conditions and confidence already apparent in the monthly survey and export and import price data(Friday) are likely to show a further fall in the terms of trade.
Outlook for markets
- Shares are vulnerable in the short term. The September quarter is often difficult for share markets and the European debt crisis, US slowdown and lingering worries about China remain ongoing sources of weakness with earnings expectations likely to be downgraded further. Similarly in Australia revenue pressures are likely to seeongoing earnings downgrades. However, relative to profits and relative to alternatives such as bonds, shares are very cheap and as such should benefit by year end as policy makers add further to the plentiful monetary stimulus already in place.
- While sovereign bonds in safe countries are a good diversifier should the global economy continue to worsen, bond yields in major countries around record lows suggest very low medium term bond returns.Corporate debt is probably a better proposition for those after income but not willing to accept the volatility that comes with shares.
- The Australian dollar remains vulnerable in the short term, reflecting worries about the global growth outlook. However, it is likely to receive support by year end as global central banks undertake further monetary easing.
16 July 2012