The past week saw risk assets return to favour on the back confidence that the US fiscal cliff will be resolved.
- This results from a meeting between President Obama and Congressional leaders at the end of the previous week, better than expected economic data and a ceasefire between Israel and Hamas. US shares rose 3.3%, European shares rose 3.9% and Australian shares rose 1.2%.
- This was despite a ratings downgrade for France and the failure of European finance ministers and the IMF to reach agreement on how to bridge the gap between the extension of the Greek rescue programme and meeting the target set by the IMF that Greek public debt fall to 120% of GDP by 2020.
- The fact French and Greek share markets both managed to rise in response to “bad” news regarding both tells us that the bad news may already be factored in or the news wasn’t really that bad. On this front, France had already been downgraded by Standard and Poors early this year, so the move by Moodys was just a catch up and an agreement regarding Greece looks to be very close and is likely to be reached in the week ahead. There is a very strong incentive for Europe to get Greece right – the cost of making it solvent by further reducing its debt burden and keeping it in the Euro is small compared to the cost of letting it default in terms of direct losses and the contagion it would likely reignite across Europe.
- The initial readings on manufacturing conditions PMIs for November, which are a key driver as to how we assess the global growth cycle, were good. Yes they are still at sub-par levels but it’s the direction that matters and this was up in the US, China and even Europe. This augurs well for the global growth cycle and a mild pick up in global growth next year. It’s certainly not pointing to the renewed global recession that some of the perma bears are praying for.
- It’s likely that the share market correction that began in mid September globally and in October in Australia is over.
Major global economic releases and implications
- US economic data over the past week was pleasingly good. Homebuilders’ conditions, existing home sales, housing starts and weekly mortgage applications all rose – despite disruption from Hurricane Sandy – indicating that the housing recovery is continuing to gain momentum. This is positive for growth next year. What’s more initial jobless claims have started to fall after the Hurricane inspired boost, the Markit flash manufacturing conditions PMI surprisingly rose in November and the Conference Board’s leading index rose again in October. So despite Sandy and fiscal cliff uncertainty US data is pointing towards continued US growth.
- While a speech by Fed Chairman Bernanke caused some concern mid week when he reiterated the risks associated with the fiscal cliff and that America’s potential growth rate may have slowed as a result of the GFC and subsequent recession he has said all of this before. More interestingly he pointed out that next year could be a very good year for the US if politicians can agree to avert the fiscal cliff, which we think they will.
- Euro zone PMI’s were on balance better than expected: up for manufacturing driven by France and Germany, down slightly for services but up slightly overall. German and French business confidence readings also rose. The overall message is that the recession continues, but it remains mild compared to the GFC experience and doesn’t appear to be getting any worse.
- While the difficulties European leaders are having in reaching agreement regarding their next seven year budget has attracted attention, this budget only amounts to 1% of European GDP and is off little consequence for the Euro-zone debt crisis. They will ultimately reach agreement, but it’s really just a sideshow for investors.
- Japanese data remained poor with falls in machine tool orders and exports, but the Bank of Japan leaving monetary policy unchanged. The BoJ will hopefully be forced into a far more aggressive growth and inflation generating stance post the December election if the LDP regains power and its leader follows through with his comments about making the BoJ less hawkish.
- In China, the HSBC manufacturing conditions PMI and the MNI business conditions survey both rose further in November, providing further evidence that growth has bottomed. House prices continued to hold up in October, in fact rising modestly for the fifth month in a row according to one survey. This is bad and good news. Bad in the sense that the resilience in the housing market makes it much harder for the authorities to ease up on housing constraints – but with growth stabilising more broadly this may be becoming less of an issue. Its good though in the sense that the resilience of the housing market shows that underlying demand remains strong. There is no sign of any bubble bursting here.
Australian economic releases and implications
- Australian data releases were light on over the past week with the Westpac leading index recording reasonable growth but skilled job vacancies continuing to slide, pointing to a weak labour market ahead.
- The clear message from the Minutes from the RBA’s last rate setting meeting and from a speech by Governor Stevens was that the RBA retains a bias to ease again, with the minutes stating that “further easing may be appropriate in the period ahead”. Our assessment remains that the RBA has not done enough to ensure that non-mining demand will fill the gap left by slowing growth in mining investment next year. As such we remain of the view that more rate cuts lie ahead, probably starting again next month.
Major market moves
- Global shares bounced back over the past week as investor confidence received a boost from “constructive talks in the US regarding the fiscal cliff, better than expected economic data and a ceasefire between Israel and Hamas.
- The improvement in investor confidence saw commodity prices and the $A rise.
- Bond yields also backed up in countries like the US, UK, Germany and Australia but fell in Spain and Italy helped by a successful bond auction in Spain and parliamentary approval of Italian PM Monti’s budget.
What to watch over the week ahead?
- In the US, negotiations regarding resolving the fiscal cliff will hot up and it will be busy week on the data front. Expect a 1% fall in durable goods orders (Tuesday) following a 9.9% gain in September, further gains in house prices (Tuesday), a slight fall back in new home sales (Wednesday) but a gain in pending home sales (Thursday), a small rise in consumer confidence (Tuesday) and an upwards revision to September quarter GDP growth from 2% annualised to around 3%. The Fed’s Beige Book of anecdotal evidence will also be released Tuesday along with data for personal income and spending (Friday).
- In the Euro zone, the initial focus will likely be on Sunday’s regional election in Catalonia which may not be good news for confidence in Spain if secessionists do well. In terms of Europe generally, various business and consumer confidence readings (Thursday) are likely to confirm the ongoing recession and unemployment (Friday) is likely to edge up even higher than the 11.6% rate reported for October. European finance ministers will meet again on Tuesday and are likely to reach an accord regarding financing the debt reduction package for Greece.
- In China, the official business conditions PMI (Friday) is expected to provide further confirmation that growth has bottomed.
- In Australia, expect private capital spending data (Thursday) to show continued strength in business investment in the September quarter driven by the mining sector, but with investment intentions showing a further evidence of a loss of momentum for 2013. New home sales (Wednesday) are likely to show a modest bounce after several poor months and growth in private sector credit (Friday) is likely to remain modest.
Outlook for markets
- While it’s impossible to be definitive, it’s likely that the correction in share markets we saw into mid November has run its course. Although fiscal cliff uncertainties will no doubt be with us into next month and cause further occasional gyrations in share markets our assessment is that the correction has provided a good springboard for shares to see their normal seasonal strength into year end. Shares remain cheap, monetary conditions are ultra easy and a slight pick-up in global growth on the back of easing by the Fed, a likely solution to the US fiscal cliff, the ECB’s bond-buying program and improving momentum in China should support profit growth in 2013. Australian shares are being given an added impetus by lower RBA interest rates which should help 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 most of the time, 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 Australian dollar remains messy. Uncertainties regarding global growth and ongoing RBA rate cuts are negatives. But quantitative easing in the US (QE3), central bank buying and prospects for improved global growth are positives. The likely outcome is for a US$0.95 to US$1.10 range, with the risk on the downside.