China got the past week off to a bad start with growth coming in at 7.7% in the March quarter against expectations for 8% growth and industrial production and fixed asset investment also coming in a bit weaker than expected.
- What’s more continued gains in home prices with virtually all cities seeing price gains in March and average property price growth rising to 3.6% year on year have raised the prospect of more property tightening measures although it may be the case that the measures already announced have yet to impact.
- The weakness in March quarter GDP growth in China appears to at least partly to reflect a failure to allow for the leap year a year ago and also the public sector frugality campaign weighing on consumption. And the difference between 7.7% growth and 8% growth is not really that much. However, many appear to have been expecting a deep V recovery in China and those misplaced expectations are now being dashed which may partly explain recent sharp falls in commodity prices.
- More generally it’s becoming increasingly clear that the generalised commodity price boom that dominated last decade is over as growth in China, India and Brazil looks like running at levels below the averages seen last decade at a time when growth in advanced countries remains constrained and the supply of commodities is picking up. This means that some of last decade’s relative investment winners, such as commodities, emerging markets in South America, resources stocks and the $A may not fare as well this decade. Rather global shares led by a resurgent US and Japan and financial shares look like they will be better placed, at least relatively. Lower commodity prices take pressure off inflation allowing easier than otherwise monetary policies. Asia, being a commodity importer, and Asian shares will also benefit if commodity prices are weaker.
- Why the sharp fall in the gold price? There are several reasons for the slump in the gold price, with further falls over the last week leaving it down by around 26% from its all time high of $US1900 an ounce reached in September 2011. Firstly, just over a week ago it broke through technical support at around the $US1550 an ounce, which triggered technical selling. Second, and more fundamentally there is no sign of the hyperinflation or $US collapse that “gold bugs” had expected to follow quantitative easing in the US. Thirdly, the financial crisis in Europe appears to have settled down a bit further reducing safe haven demand. And finally, gold is also part of the commodity complex that has been under pressure since 2011.
- While there was renewed talk about currency wars following Japan’s reinvigorated reflation efforts and in the run up to the G20 finance ministers meeting the latter has simply reiterated its commitment to refrain from competitive devaluations and has actually supported Japan’s reflation efforts. It’s hard to expect anything else as after all Japan is simply trying to get its economy moving again which is something the world has been imploring it to do for years and Japan has refrained from making comments about the Yen.
- The IMF’s downwards revision to its forecast for world growth this year to 3.3% from 3.5% didn’t really say anything new and just brings it into line with our own view.
Major global economic events and implications
- Economic data released in the US was messy. While there was a further slight fall in the NAHB home builders conditions survey, housing starts were stronger than expected and weekly mortgage applications continue to rise. While industrial production rose more than expected in March, manufacturing conditions deteriorated slightly in the New York and Philadelphia regions and leading indicators fell. Jobless claims rose 4000, but this followed a 40,000 fall the previous week. Meanwhile, the Fed’s Beige book characterised the economy as expanding at a moderate pace, which seems about right. Finally, there is still no sign of the much feared inflation surge on the back of quantitative easing: in fact headline inflation fell to 1.5% in March and core inflation was just 1.9%.
- The US earnings reporting season is good at a headline level with 72% of the 103 S&P 500 companies to have reported so far exceeding expectations, but only 49% have exceeded revenue expectations and guidance has been soft.
- Eurozone data remains weak with falls in construction activity and imports and core inflation of just 1.5%.
- Indian inflation surprise on the downside, providing more scope for rate cuts from the Reserve Bank of India.
- Brazil’s 0.25% interest rate hike, which took its official interest rate to 7.5%, doesn’t signal the start of a global tightening cycle. Brazil’s inflation rate is 6.4% and trending up whereas global inflation is running around 2% and falling at a time of sub par global growth and falling commodity prices.
Australian economic events and implications
- In Australia, housing finance picked up in February leaving in place a modest rising trend. The Westpac leading index also rose 0.6% mom in February, but car sales surprisingly fell. Despite its easing bias the minutes from the RBA’s last board meeting indicated it retained a wait and see approach. However, a softer run of global and Australian data over the last few weeks could motivate it to act on its easing in the next few months.
Major market moves
- Most major share markets fell on the back of softer growth in China and mixed economic and earnings news in the US. Resources shares led the falls in Australia but with high yield and defensive stocks holding up reasonably well. US shares fell 2.1%, European shares fell 2.2%, Japanese shares fell 1.3% and Australian shares fell 1.6%. Surprisingly, despite setting off the latest bout of weakness, Chinese shares rose 1.7% over the past week.
- Commodity prices fell sharply on the back of softer than expected Chinese economic growth. The continuing slump in the gold price led the declines, with a fall of 5.5% over the last week.
- The fall in commodity prices saw the $A coming under pressure, although it’s still stuck in the $US1.02 to $US1.06 range it has been in since last July.
- Bonds rallied on safe haven demand, but even Spanish and Italian bond yields fell making the latest bout of risk aversion seem very different to the Eurozone driven fear outbreaks of the last three years.
What to watch over the next week?
- In the US, expect gains in existing home sales (Monday), new home sales (Tuesday) and house prices (Tuesday), a slight bounce in core durable goods orders (Wednesday) after a fall in February and March quarter GDP data (Friday) to show growth around 3% annualised. The flash Markit PMI (Tuesday) is likely to have fallen slightly. March quarter earnings results will continue to flow with around 160 major companies reporting.
- In Europe, the focus will be on preliminary business conditions PMIs for April (Tuesday) to see if there is any improvement after falls in the previous few months. UK March quarter GDP data will also be released.
- In China, the flash HSBC manufacturing conditions PMI index (Tuesday) will be watched closely to see if it maintains the improvement seen in March, particularly after the softer than expected March quarter growth.
- Japanese inflation data (Friday) is expected to show continued consumer price deflation. The Bank of Japan also meets Friday but is unlikely to undertake more easing just yet having done so much at its last meeting.
- In Australia, the focus will be on March quarter inflation data due to be released Wednesday. We expect that the combination of constrained demand and downwards pressure on import prices from the strong $A will have offset seasonal rises in health and education costs to ensure that inflation has remained benign. As a result we expect the CPI to have increased by 0.6% quarter on quarter or 2.7% year on year and underlying inflation to have risen 0.5% in the quarter or 2.4% year on year.
- Continued benign inflation will leave the door wide open for further RBA rate cuts. In fact an outcome of 0.4% or below for underlying inflation could bring forward a rate cut to the May meeting given the soft run of global and Australian data we have seen lately.
Outlook for markets
- Shares remain at risk of a further correction as we come into the seasonally weak period around mid year. China, Europe, a further soft patch in US economic growth, North Korea, bird flu and continued softness in the non-mining parts of the Australian economy are all risk factors. However, any set backs in shares are likely to remain mild and the broad trend is likely to remain up. Shares are still far from expensive, the strengthening growth outlook led by the US 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 ensuring solid “buy on the dips” demand. A pick up in mergers and activity from cashed up lowly geared companies is also likely to be a big positive for shares this year. So notwithstanding the usual bumps along the way, this all adds up to a positive backdrop for share markets.
- Sovereign bonds will be helped by Japanese monetary reflation and any further correction in shares. However, they remain fundamentally vulnerable as the improving global, and Australian, growth outlook will likely see bond yields move higher over the year ahead resulting in capital losses for investors in them.
- The renewed softness in commodity prices is acting as a strong offset to the impact of monetary printing in the US and Japan on the $A. As a result the $A looks like remaining range bound, but with a bit of a downwards bias into mid year if shares and commodities continue to correct.