US markets were closed early in the week due to Hurricane Sandy. Our thoughts are with all of those affected. From an economic perspective, rough estimates suggest around $US40-50bn in property and infrastructure damage.
- This is bigger than Tropical Storm Irene last year but far less than Katrina in 2005 which cost $US113bn.
- Disruption to transport, shopping, production, etc, suggests that 0.2% or so will be cut from October /
November activity indicators and maybe December quarter GDP growth. However, this will be more than offset by rebuilding and demand catch-up, with March quarter GDP growth likely to be boosted by 0.3% of more. - In Europe, a threat by former PM Berlusconi to bring down the Monti Government caused some consternation but it’s unlikely to be acted on as Berlusconi only has an approval rating of 19% amongst Italians versus 60% for Monti. Meanwhile an Italian bond auction went off well.
- In Australia, there was debate that the RBA had intervened to bring the $A down. However, a speech by Deputy Governor Lowe suggested this was not the case and that $A was some way from the threshold for intervention.
Major global economic releases and implications
- US economic data was better than expected with the highlight being much stronger than expected employment growth and a further improvement in the ISM manufacturing conditions index for October. The 171,000 gain in a payrolls is still less than the 200,000 monthly jobs growth the Fed would probably like to see, but its heading in the right direction. What’s more data for personal spending, house prices, consumer confidence and construction all rose and a Fed survey of banks showed a further easing in lending standards.
- The US earnings reporting season is 75% complete. 63% of companies have exceeded earnings expectations and earnings growth is coming in flat. The bad news remains that less than 40% of companies are beating on revenue and outlook statements remain poor so earnings expectations are being revised down. Earnings normally lag economic growth and so should start to improve as economic growth picks up.
- Euro-zone consumer sentiment rose slightly in October but business sentiment fell consistent with an ongoing recession. An ECB survey of banks also reported a further tightening in bank lending standards and Euro-zone unemployment rose further to 11.6% in September with even German employment falling. All of this highlights the need for easier monetary conditions across Europe generally.
- Japanese economic data remains poor with a sharp fall in industrial production, a fall in a manufacturing PMI for October, continued falls in household spending and weakness in the ratio of job openings to applicants. Reflecting this and ongoing price deflation the Bank of Japan announced a further 11 trillion Yen expansion in its quantitative easing program, but it continues to fall short of what is required.
- I have just spent a few days in China. While its a big country and its dangerous to draw conclusions from just one city, I struggled to find any sign of a hard landing. Beijing remains very busy and those I spoke to were of the view that growth was bottoming. The flow of data continues to suggest that this is the case with acceleration in industrial profits and sales and in the National Bureau of Statistics’ leading and coincident indicators in September and a further improvement in manufacturing PMIs for October. Meanwhile the PBoC is providing ongoing monetary stimulus by pumping record amounts of liquidity into the Chinese money market.
- In Korea, industrial production rose in September and exports rose for the third month in a row in October adding to confidence that growth may be bottoming. India’s manufacturing PMI rose marginally in October and the central bank cut bank cash reserve ratios in order to boost lending.
Australian economic releases and implications
- In Australia building approvals rose solidly for the second month in a row and monthly credit growth accelerated slightly suggesting that interest rate cuts are getting some traction. However, the strength in building approvals was concentrated in apartments which are normally volatile with private house approvals tracing out only a mildly rising trend, credit growth remains very weak and new home sales fell again in August. What’s more the manufacturing PMI remains in the weak range it has been in for some time, home prices fell 1% in October and export prices fell another 6.4% last quarter, highlighting a loss of national income. This all suggests that interest rates have not yet fallen enough to be confident that non-mining demand will offset a loss of momentum in mining activity over the year ahead. In other words interest rates will need to fall further. A benign reading for September quarter producer prices suggests inflation is no barrier to further rate cuts.
Major market moves
- Global shares rose helped by better than expected economic data with strong gains in Europe and China, but US shares up only marginally on pre election nerves and worries about the impact of Hurricane Sandy. Australian shares fell slightly, possibly reflecting profit taking after a 2.9% gain in October when US shares fell.
- Commodity prices eased as did the $A. Bond yields fell slightly in major countries & rose slightly in Spain & Italy.
What to watch over the week ahead?
- In the US, it will be a quiet week on the data front with the non-manufacturing ISM to be released Monday, but the main event will be the US elections on Tuesday. Current polls suggest a close result. A Romney victory with Republicans taking the Senate and retaining the House would likely see share markets rise very strongly given Romney’s market friendly policies and that such an outcome would boost confidence that relatively quick solutions would be found to America’s fiscal cliff, debt ceiling and long term budget deficit problems. However, the more likely scenario is a continuation of the status quo in terms of divided government with the President’s partly not having control of Congress. The fiscal cliff will ultimately be solved as US politicians have never purposely plunged the economy into recession but it may involve a bit of uncertainly along the way.
- In China, the Communist Party Congress that will resolve the leadership transition will get underway on November 8th. This is likely to last about six days so don’t expect any quick announcements. While it probably won’t lead to any significant changes – at least not initially – it will help remove a degree of uncertainty that has been hanging over China. Chinese economic data for October will also be released Friday and is expected to add to evidence that Chinese economic growth has bottomed. Inflation is likely to have remained benign helped by falling food prices.
- In Europe, the ECB (Thursday) is expected to cut interest rates by another 0.25% to provide a further boost to the economy, but given that such a move is largely symbolic it should really be embarking on another round of quantitative easing. The European composite business conditions PMI for October will be released Tuesday and will likely confirm an ongoing mild recession. The Greek parliament is also likely to vote on further austerity and reform measures necessary to unlock its next bailout payments, possibly on Wednesday.
- The Bank of England will be watched to see whether the current round of quantitative easing will be extended.
- In Australia, the Reserve Bank is expected to cut the cash rate by another 0.25% taking it to 3% on Tuesday. So far the response to lower interest rates from readings for confidence, retail sales, credit, etc, has been far less than normal suggesting that, to be confident growth in non-mining activity will be sufficient to plug the gap left by the slowing mining boom over the year ahead, interest rates still need to fall further. However, higher than expected September quarter inflation means it’s a close call as to whether the RBA will cut on Tuesday as we expect or wait till December. Ultimately though we still see the cash rate falling to 2.5% next year. The RBA’s monetary policy statement on Friday will also be watched closely for clues regarding interest rates.
- On the data front in Australia, expect retail sales to remain softish and the trade deficit to remain wide (both Monday), September quarter house prices (Tuesday) to record a 0.5% gain and employment to have gained 5000 in October (Thursday) resulting in a rise in the unemployment rate to 5.5%.
Outlook for markets
- Global shares have been in correction mode since mid September. Given uncertainties regarding the US election and fiscal cliff, earnings downgrades, Spain, Greece and the Chinese leadership transition this may have a bit further to run. However, the rising trend in shares is likely to remain in place. Shares are cheap relative to bonds, monetary conditions are ultra easy and 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 support profit growth in 2013. Australian shares are getting an added impetus from the resumption of RBA interest rate cuts which should boost profit growth in 2013. As a result we see further gains in share markets by year end and through 2013.
- While sovereign bonds in safe countries are a good diversifier, bond yields are very low and point to low medium term bond returns. Corporate debt is a better proposition for those after income.
- The outlook for the $A remains messy. Uncertainties regarding China and RBA rate cuts are negatives. But US QE3, foreign central bank buying and prospects for improved global growth are positives. The likely outcome is for a $US0.95 to $US1.10 range for the $A.