Shares were hit mid week by concerns triggered by the minutes from the last Fed meeting that it may exit quantitative easing earlier than had been thought, renewed property tightening in China and soft economic data.
- However, while these were the triggers, shares had become vulnerable to a pause or correction after a huge surge higher (+14% for global shares, +18% for Australian shares) since the last correction in mid November. A correction was overdue. Our inclination is to see it as just that, ie a correction which may or may not have a bit further to go in the short term but will set the base for more gains in the months ahead.
- With shares up strongly any sign the Fed is about to take away the punch bowl was always bound to create unease. However, while the Fed’s minutes reveal a greater focus on the costs of quantitative easing with “several” participants indicating that the Fed should be prepared to vary the pace of QE, its doubtful that the key policy makers at the Fed including Chairman Bernanke are inclined to start undertaking such a change just yet.
- Bernanke’s Congressional testimony in the week ahead will be watched closely to see where he stands in this regard. Our assessment though is that QE will likely continue at an $US85bn a month pace until at least mid year, but then might start to be reduced in pace to say around $US70bn a month. This is unlikely to be negative for the growth and investment outlook as it will only be reduced in pace if growth is judged to be strong enough and it is unlikely to be abruptly stopped as was the case with QE1 in 2010 and QE2 in 2011. And don’t forget that if the pace of QE is slowed it just means easing at a slower rate – it doesn’t mean monetary tightening. So the concerns seen over the past week are probably a bit premature and overdone.
- In terms of China, it is worth noting that the Government has only asked local authorities to enforce current policies designed to limit property speculation, it hasn’t announced new policies. Moreover, although property prices continued to rise in most cities in January, the property market is not as overheated as it was a few years ago so a property crackdown is likely to be less severe and more selective this time.
- The big event in the week ahead will be the Italian election. The worst outcome would be a return of Berlusconi as Prime Minister. Fortunately, such an outcome is unlikely. An inconclusive outcome in which no party can form government would also be taken badly with parallels with Greece’s inconclusive election last May. However, the most likely scenarios involve either the Social Democrats under Bersani winning outright (a good outcome in terms of stability and Bersani’s economic credentials during previous stints as a government minister) or Bersani requiring a coalition with Monti’s party which would probably be regarded as the best outcome as Monti’s participation would be seen as enhancing Italy’s reform prospects.
Major global economic events and implications
- US economic data was mixed, but with nothing particularly concerning. Homebuilder conditions fell fractionally in February and housing starts fell but this followed a 15.7% rise in December and with, the less volatile and more leading, permits to build homes and existing home sales continuing to rise our conclusion is that the US housing recovery remains on track. While the Philadelphia regional manufacturing conditions index fell the nationwide Markit PMI remained solid. The US profit reporting season is now wrapping up with 72% of companies beating on earnings, 65% beating on revenue and with profit growth estimates revised up by 3%.
- European business conditions PMIs disappointingly slipped in February. Fortunately, the trend is still up and the fall could be seen as normal volatility but we will have to wait another month now to find out. Moreover the German IFO business climate index continued to rise strongly highlighting a rebound in German growth.
Australian economic events and implications
- RBA Governor Steven’s Parliamentary testimony contained nothing particularly new, with the RBA retaining an easing bias on the back of a benign inflation outlook and the slowdown in mining investment at a time when non-mining activity remains soft. However, the tone of Steven’s comments was relatively upbeat emphasising past rate cuts, signs they are working and a better global outlook suggesting that he is in no rush to ease. However, we have heard much talk about the glass half full from the RBA before, so my inclination is still to expect one or two more rate cuts to help boost non-mining activity as mining investment slows.
- The December half profit reporting season is now 73% complete and while the results over the past week weren’t quite as good as those seen in the first two weeks, the overall picture remains much better than had been feared and is consistent with a bottoming in the profit cycle. Other themes are an aggressive focus on cost control and productivity in order to manage margins and rising dividends which is a positive sign as it suggests companies are confident that there will be an upturn in the profit cycle.
- 47% of companies have exceeded expectations, which is the best in three years; 55% of companies have increased their dividends from a year ago and only 22% have cut them; 41% have exceeded expectations on dividends with only 25% delivering dividends worse than expected; and positive outlook comments have beaten negative outlook comments by two to one. Reflecting the better than feared results, 55% of companies have seen their share price outperform the market on the day their results were released.
- Overall profits for the December half look like coming in around 10% down on a year ago driven by a 35% slump in resources profits but with banks and REITs up 1.5% and industrials up around 10%. However, this is much better than feared. Reflecting this, analyst earnings estimates have crept a bit higher.
Australian profit results
Major market moves
- Share markets were mixed over the past week with most falling mid week as part of a correction triggered by the Fed’s minutes, Chinese property tightening and soft economic data, before rebounding on good news from Germany and solid US profits. This left European, Japanese and some Asian markets up, US and Australian shares down slightly and Chinese shares down.
- Commodities and the euro weakened, but the $A was helped by Governor Steven’s relatively upbeat tone.
What to watch over the next week?
- In the US, the main focus will be on Fed Chairman Bernanke’s Congressional testimony on Tuesday for any signs that he is leaning towards slowing the pace of quantitative easing. More likely he will probably signal staying the course on QE for now. On the data front expect modest gains in house prices, new home sales (Tuesday) and pending home sales (Wednesday), a fall in January durable goods orders (Wednesday) after a strong rise in December and a slight fall back in the January ISM (Friday). December quarter GDP growth (Thursday) is expected to be revised up to 0.5%. The budget sequester involving spending cuts also looks like it will kick in on Friday resulting in another 0.5% of GDP in terms of US fiscal tightening this year.
- In Europe the focus will likely be on the Italian election. Euro-zone consumer and business confidence indicators (Wednesday) will be watched to see whether they confirm the February setback seen in PMIs.
- In China, HSBC’s flash business conditions PMI will be released Monday and the official PMI Friday.
- In Japan, the Government will likely announce the next Bank of Japan Governor, with the outcome likely to be a Governor more dovish than the one he replaces but less dovish than some of the candidates.
- In Australia, December quarter business investment (Thursday) is expected to be up 2%, but the focus will likely be on investment intentions as a guide to how quickly the mining investment boom is slowing and whether non-mining investment is picking up. With Governor Steven’s actually singling out the Thursday’s capex data release, its likely to be critical in whether the RBA will cut interest rates next month. January data for private credit is likely to show modest growth and new home sales are likely to show a further recovery. Data for construction activity and house prices will also be released. Australian December half profit results will wrap up with over 50 major companies reporting, including QBE, Harvey Norman, Seven, AGL and Woolworths.
Outlook for markets
- Shares appear to have entered a correction or consolidation phase which may still have a bit further to go in the short term given risks around Italy’s election, Spain, the budget sequester in the US and Chinese property tightening measures. However, the set back is likely to be mild and the broad trend in share markets is likely to remain up. Equity valuations remain reasonable, the strengthening growth outlook points to stronger profits ahead and investors are likely to increasingly switch from low yielding cash and bonds into shares as confidence continues to build. A pick up in M&A activity is also likely to be positive for shares. So notwithstanding the usual bumps along the way this all adds up to a positive backdrop for share markets.
- While sovereign bonds have been a great diversifier and a great investment in recent years they are becoming more vulnerable as the improving global growth outlook will likely see bond yields move higher over the year ahead resulting in capital losses for investors in sovereign bonds.
- The outlook for the Australian dollar remains messy. Mixed Australian economic data is a negative but quantitative easing in the US and now Japan is a positive. The likely outcome is for a $US0.95 to $US1.10 range.