Weekly economic and market update

Signs global growth has bottomed continue to build.

• Chinese economic growth rose to 2.2% in the September quarter and indicators for retail sales, industrial production, investment, money supply and exports accelerated in September
• US housing and retail sales suggest US growth may be picking up; Brazil seems to be accelerating again
• business conditions PMIs in most major countries/regions are showing signs of bottoming
• exports improved in Korea, Taiwan and Singapore.

As we saw on Friday in the US and Europe though, global shares are still being weighed down by soft earnings. But its worth noting profits often lag a turn in growth.

• The EU leaders’ summit didn’t make a lot of progress but wasn’t expected to either. However, it did reconfirm the establishment of a common bank supervisor starting from January 1 and praise for Greece adds to confidence its on track to receive its delayed aid payment next month. Debate continues on moving towards a fiscal union. Meanwhile, Spain looks to be getting close to applying for a precautionary credit line, to be used if needed, in return for agreeing to fiscal discipline which would then bring into play ECB buying of its bonds.
• October 19th marked the 25th anniversary of Black Monday when US shares fell 20% in the October 1987 share market crash and October 20th marks the 25th anniversary of Black Tuesday when Australian shares fell 25% in one day as part of a total 50% slump spread over two months. Such an event is most unlikely now as the 1987 crash followed several years of very strong gains whereas shares today are still recovering from the GFC collapse with the Australian share market still 33% below its all time high reached in November 2007.
• What is worth noting though is that it wasn’t till late 1996, ie 9 years after the 1987 high that Australian shares sustainably broke to new highs. Similarly it was almost 10 years until shares in the 1970s broke sustainably above their January 1970 high, with of course a 59% slump in 1973-74 along the way. The message seems to be that after 50% or so slumps it can take a long while to regain previous highs. Given these experiences, and bearing in mind that Australian shares fell 55% in the GFC, it’s not unusual that 4 years after the pre GFC high we still have a long way to go to regain it. That’s the bad news. The good news though is that once the 50% or so slump is out of the way shares trended higher providing good returns from the bear market lows until the highs are regained, viz a 12% pa return after the 1987 crash and 28% pa return after the 1974 slump.

Major global economic releases and implications

• Chinese economic data for September adds to confidence that Chinese economic growth is bottoming. While year on year GDP growth slowed to 7.4% in the September quarter from 7.6% in the June quarter, quarterly growth rose to 2.2% from 1.8% in the June quarter. What’s more momentum for retail sales, fixed asset investment, industrial production and rail freight all picked up in September which is consistent with earlier reported gains in exports, money supply growth and manufacturing PMIs. In particular it looks like infrastructure investment is picking up after a soft patch earlier this year. Growth in China looks to be consistent with the Government’s and our own forecast for 7.5% growth this year. At the same time inflation remains benign having fallen back to 1.9% in September. Overall a good set of numbers for China. Growth is well down from previous double digit levels but appears to be at least stabilising at a strong level without the crash the China doomsters continue to wheel out. Given this, policy stimulus is likely to remain mild and gradual, but with inflation at just 1.9% in September there is plenty of scope to ease more aggressively if need be.
• US economic data suggests growth is picking up pace. While unemployment claims backed up in the past
  week, retail sales rose 1.1% in September following strong gains in previous months, industrial production rose more than expected, manufacturing conditions indexes in the New York and Philadelphia regions improved, leading indicators rose and the housing recovery is going from strength to strength with a 15% gain in housing starts and rises in permits to build homes, improved home builder confidence and rising weekly mortgage applications point to more strength to come. The US housing recovery is hugely significant. The housing slump was the trigger for the GFC and its upturn now could directly contribute 0.5% plus US growth over the year ahead as well as indirectly boosting growth via wealth effects. That housing indicators are continuing to recover at a time of “worries” over the fiscal cliff is a good sign. Maybe the fiscal cliff is the latest incarnation of the Y2K scare.
• US earnings reports were a little stronger over the past week, with 60% of results now better than expected, up from 57% a week ago. But there were key disappointments from large stocks such as Microsoft, GE and McDonalds. September quarter profit growth may come in flat versus expectations for a 2% fall three weeks ago.
• Global monetary easing continued with both Thailand and Turkey cutting interest rates.

Australian economic releases and implications

• The minutes from the last RBA Board meeting reinforced the Bank’s easing bias with concerns that Australian economic growth will be weaker than forecast as the mining boom peaks earlier than expected. The minutes are consistent with our view that interest rates will be cut another 0.25% on Melbourne Cup day, and that the cash rate will fall to 2.5% early next year. While housing finance edged up in August, the uptrend and level of finance remains very weak and consistent with the need for more interest rate cuts.

Major market moves

• Global share markets rose over the week, up 0.3% in the US and up 2.4% in Europe, helped by better data in the US and China and optimism Spain will seek support. However, disappointing earnings results saw the gains reduced on Friday. In a broader sense global shares are still in the correction that has been underway since mid September. Australian shares rose to a 15 month high helped by the continuing impact of RBA rate cuts.
• Bond yields generally rose, except in Spain and Italy, on reduced safe haven buying.
• The “risk on” tone in markets also saw the $A rise 0.9% helped by slightly higher commodity prices.

What to watch over the week ahead?

• In the US the Federal Reserve’s monetary policy meeting (Wednesday) is not likely to announce any changes to monetary policy with open ended quantitative easing just getting underway. The market focus is more likely to be on how the Fed sees recent economic indicators, including the fall in unemployment and the housing recovery, and what this means in terms of the duration of QE3. On the data front expect new home sales and house prices (both Wednesday) and pending home sales (Thursday) to show modest growth, durable goods orders (Thursday) to bounce back after a sharp fall in August and September quarter GDP growth (Friday) to rise at a still subdued annualised pace of 1.7%. The US earnings reporting season will also continue.
• In Europe, business conditions PMIs (Wednesday) are likely to show ongoing evidence of stabilisation around levels consistent with a mild recession. In Japan. CPI data (Friday) is likely to show continued deflation.
• In China, HSBC’s flash manufacturing PMI (Wednesday) will be watched for further signs of stabilisation.
• In Australia, the main focus will be on September quarter inflation data (Wednesday) which we expect to show a 1.1% rise taking the annual inflation rate to 1.7%, up from 1.2% year on year in the March quarter. The main drivers of the rise in inflation are expected to be higher prices for fruit and vegetables and electricity costs partly due to carbon pricing. The carbon price is expected to have added around 0.3% to inflation and the RBA’s underlying measures of inflation are expected to have remained benign at around 0.6% in the quarter or 2.2% year on year, reflecting the continuing tough pricing environment. The likely benign underlying inflation outcome is expected to leave plenty of room for more interest rate cuts ahead. The Federal Government’s Mid Year Economic and Fiscal Outlook might also be released and will likely show the impact of slowing growth and weaker commodity prices on the budget. Any further fiscal tightening to keep the budget on surplus this year will only add to the pressure on the RBA to cut interest rates further.

Outlook for markets

• Global shares have been in correction/consolidation mode since mid September after strong gains since early June. Given uncertainties regarding the global outlook this may have a bit further to run. However, the broad rising trend in shares is likely to remain intact. A pick up in global growth on the back of easing by the Fed, the ECB’s bond buying program and stimulus measures in China should boost profit growth in 2013.
• Australian shares are being given an added impetus by the resumption of RBA interest rate cuts which should boost profit growth in 2013. With shares remaining cheap we see further gains into year end. If there is a setback in the weeks ahead it should be seen as a good buying opportunity.
• While sovereign bonds in safe countries are a good diversifier, bond yields in major countries are very low and point to low medium term bond returns. Corporate debt is a better proposition for those after income.
• The short term outlook for the $A is messy. US QE3, foreign central bank buying and prospects for improved global growth and higher commodity prices into next year are positive. But against this, uncertainties regarding China and ongoing RBA rate cuts are negatives. The likely outcome is for a volatile range of between $US0.95 to $US1.10, with the risk on the downside. We have probably seen the best for the $A.