While the past week started on a rough note with stepped up property tightening measures in China, it turned around pretty quick with the US Dow Jones index making it to a new record high. Apart from the generally favourable tone to most economic data, there were a number of positive developments.
- Firstly, while China announced tightened measures to cool property speculation, its 7.5% growth target for this year, which is unchanged from 2012, higher growth forecasts for retail sales and investment and a slight increase in the budget deficit, indicate that it is not trying to slow overall growth. And as always, the growth target should be seen as a minimum acceptable level.
- Secondly, Japan continues to move down a positive path with the proposed Bank of Japan Governor indicating that he will do “whatever we can” to end deflation, that further easing is needed and that he could bring forward open ended asset purchases. It’s little wonder that Japanese shares are up 18% year to date.
- Thirdly, while uncertainty remains as to whether Italian politicians will be able to form a government, there is no sign of the Euro-zone pandemonium that followed the failed Greek election last May. The backstop put in place by the ECB as part of its commitment to do “whatever it takes” to preserve the Euro seems to be holding back any contagion. Spanish bond yields are well below where they were prior to the Italian election.
- Fourthly, European finance ministers appear to be backing away from their hardline, ultimately self defeating, stance on budget austerity allowing Italy and France a bit more leeway to reduce their deficits.
- Finally, there was good news on the US budget with the House passing legislation to avert a Government shutdown threatened for later this month and some encouraging signs of political compromise on a deal to reduce the budget deficit over the long term.
- Which bring us to the new record high in the US Dow Jones index. Is it sustainable? The fact that the US Dow Jones index has made it to a record high after five and a half years, with the S&P 500 less than 1% away, has to be seen as a positive. The US is finally shaking off the malaise it has been in for 13 years helped by a recovering housing sector, an energy boom, a manufacturing renaissance and strong productivity growth. At the same time, US shares are far cheaper than they were when at similar levels in 2000 and 2007. At the March 2000 tech boom high US shares traded on 23 times earnings and 10 year bond yields were 6%. At the October 2007 high the PE was 14.6 times and bond yields were 4.5%. Now the PE is 13.4 times and bond yields are just 2%. So valuations are reasonable particularly versus bonds compared to past peaks, and if the economic and profit recovery continues as we expect then further share gains are likely.
- But why is the Australian share market still 25% below its record 2007 high, despite having a stronger economy than the US? The slower recovery in Australian shares compared to the US share market after the GFC is due to a combination of much higher interest rates, the strong $A and worries about China. More fundamentally though the US share market has been spinning its wheels since the tech boom peak in early 2000. Since then the Dow Jones index is up just 22%, the S&P 500 is up just 1% but Australian shares are up 56%. Adding on dividends and adjusting for the impact of the rising $A over the last decade, the Australian share market comes out even further ahead. So over the longer period Australian shares have performed far better.
Major global economic events and implications
- US economic news remains very positive with a stronger than expected gain in employment pushing the unemployment rate down to 7.7%in February, a solid rise in the ISM services conditions index, a rise in household wealth in the December quarter to its highest in five years, strengthening credit growth and a rebound in new mortgage applications. What’s more the Fed’s latest stress tests show that 17 of the 18 largest US banks could weather a deep recession, potentially clearing the way for some banks to return more capital to shareholders. But is the labour market becoming too strong, pointing to the Fed removing monetary stimulus? No, the US jobs market has clearly improved, but it’s probably still not the “substantial” strengthening the Fed is after. February’s job surge only just balanced out January’s soft reading, the fall in unemployment was helped by a fall in labour force participation and the sequester will likely take the edge of jobs growth in the months ahead.
- In the Euro-zone the services conditions PMI for February was revised up slightly and retail sales rose strongly in January. The picture remains one of a continuing but gradually fading recession.
- Chinese data releases for February were distorted by the timing of the New Year holiday this year being in February as opposed to January last year. This had the effect of depressing February trade data, although not much for exports, and boosting inflation. In terms of the trade data, averaging January and February provides a better guide to the trend and shows exports up 23% and imports up 7%, both of which are consistent with an improving trend. Inflation bounced to 3.2% in February from 2% in January but is likely to fall in March as the New Year distortion falls out and as food prices have since fallen. Meanwhile, economic activity indicators were soft with stronger than expected investment but weaker growth for retail sales and industrial production. While retail sales appear to have been hit by a crackdown on lavish spending by officials and state companies, the softer than expected growth numbers suggest little pressure for any monetary tightening.
Australian economic events and implications
- Australian GDP data for the December quarter confirmed the slowdown in the economy to a sub-trend rate that has become evident over the past six months. Growth has been stuck at an annualised pace of around 2.5% since the June quarter thanks to slowing investment and soft consumer spending. Growth is likely to remain around 2.5% or slightly weaker over the next six months as the economy transits from strong mining investment to more balanced growth. However, there were some positive signs over the past week with data showing private house approvals up for the first time in several months, retail sales rising strongly in January possibly on the back of rising consumer confidence and ANZ job ads up for the first time in a year in February.
- Meanwhile, there were no surprises from the RBA which left interest rates on hold whilst maintaining an easing bias. While there may still be another one or two rate cuts left, the increasing signs that rate cuts are getting traction suggests that we are at or close to the bottom of the interest rate easing cycle.
Major market moves
- Share markets mostly rose helped by good economic news with the Dow Jones index reaching a record and Japanese and Australian shares rising to new post GFC highs. Asian shares were somewhat mixed though with Chinese property tightening fears weighing.
- Commodity prices were also mixed but the $A gained on better Australian economic data.
- Bond yields rose sharply in major countries as safe haven demand faded, but yields in Spain and Italy fell.
What to watch over the next week?
- In the US, the main focus will be on retail sales data for February (due Wednesday) which are expected to show that US consumers are still contributing to growth with a 0.4% gain consistent with reasonable jobs growth and higher consumer confidence. Expect small business optimism (Tuesday) and industrial production (Friday) to show modest gains. Inflation data (Friday) is expected to remain benign.
- In Europe, the new Italian parliament will convene on Friday, so it will be interesting to see whether a new Government is able to be formed. Odds are it will, with none of the major groups wanting a new election.
- In Australia, the NAB business conditions survey (Tuesday) and the Westpac consumer sentiment index (Wednesday) will be watched closely for signs of a continuation of the improvement in confidence that has become evident in recent month. We expect further gains in both adding to expectations that we are at or near the end of monetary easing cycle. Housing finance data (Wednesday) is expected to show a 1% gain after a fall in January. Labour market conditions are likely to have been softish in February with only 5000 new jobs after a 10,000 gain in January and the unemployment rising to 5.5%.
Outlook for markets
- After big gains, shares are still vulnerable to a deeper correction than the slight wobble seen during the second half of February. However, assuming North Korea’s stepped up bluster lately comes to nothing (as it usually does) any set backs in shares are 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.
- Sovereign bonds 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 them.
- 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.