Weekly market & economic update: week ending August 16

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Key events of the past week and implications

  • The past week saw more good data out of the US and Europe, but share markets were mixed with worries about Fed tapering weighing and pushing bond yields higher globally.
  • Several Fed officials have left the impression the Fed is on track to start tapering in September, but the initial move is likely to be modest with additional moves contingent on further economic improvement. Our view remains that while tapering is a potential short term threat to markets, its unlikely to derail the cyclical rally in shares as tapering will only occur in response to stronger growth and won’t signal higher interest rates.
  • Although turmoil in Egypt has the potential to be a source of nervousness Egypt is not a major oil producer and only around 2% world oil consumption flows through the Suez Canal.
  • In Australia, the Treasury’s Pre-Election Economic and Fiscal Outlook added nothing new to the economic and budget projections released in the Government’s economic statement two weeks ago. But it did provide another reminder of the latest budget blowout and how Australia’s public finances are in a rather unfortunate shape given the biggest boom in our history.

Major global economic events and implications

  • US economic data was mostly ok.
  • US economic data was mostly ok. To be sure mortgage applications remained weak on the back of rising mortgage rates and bond yields, industrial production was flat in July and manufacturing conditions slipped a bit in August according to a couple of regional business surveys. But this was more than offset by a fall in jobless claims to their lowest since October 2007, another sharp rise in home builders’ confidence, positive news on retail sales, a small rise in small business optimism and signs that inflation may be troughing in reinforcing expectations that the Fed will taper in September.
  • The news out of the Eurozone was particularly good, with GDP rising 0.3% in the June quarter signalling an end to 18 months of recession. A rising trend in PMIs and business confidence points to continued recovery in the current half albeit at a soft pace. The return to growth has been led by France and Germany, but Spain and Italy are also seeing a slowing in the pace of their contractions.
  • Japan’s June quarter GDP disappointed with 0.6% growth thanks largely to a detraction from inventories and weak business investment. Underling final demand was solid though, but it’s likely that further monetary stimulus to maintain downwards pressure on the Yen will be required. On this front the Bank of Japan’s balance sheet has been flat for two months now and needs to start rising again for the Yen to fall and Nikkei to rise.
  • On the profit front, the US June quarter profit reporting season is now largely done with 72% surprising positively on earnings and 55% on revenues and earnings growth coming in at around 3.6% compared to expectations of 1% a month ago. In Europe, profit results are a bit more subdued with 54% better on earnings but 57% better on revenue. In Asia 60% have exceeded on earnings and 52% on revenue. Overall good but not booming.
  • Indian economic data remained poor with weaker industrial production and worse than expected inflation.

Australian economic events and implications

  • Australian economic data was a mixed bag with business confidence and conditions remaining weak but consumer confidence rising in August and continuing to trace out a gradual rising trend which should augur well for consumer spending. Interestingly the rise in confidence appears to reflect more cheery home owners, after the latest rate cut, and coalition voters presumably feeling happier at the prospect of a change in Government. Meanwhile wages growth remained benign in the June quarter suggesting no threat to inflation from labour costs.
  • We are now about 30% through the June half profit reporting season. So far results have not been fantastic but they have not been as bad as feared which explains why the market has held up ok, nothwithstanding offshore influences. 41% of companies have exceeded expectations, which is down from the February reporting season but not bad compared to the last few years; 33% of results have been below expectations though which is well up; 68% of companies have seen their profits rise from a year ago; 65% of companies have increased their dividends from a year ago and only 9% have cut them; and there have been more positive outlook comments than negative. Reflecting the better than feared results, 55% of companies have seen their share price outperform the market on the day their results were released. Key themes remain ongoing cost control and weak revenue growth. The prospective boost to profits from the lower $A and for iron ore companies from a higher iron ore price may be helping investors look through disappointing results.

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Major market moves

  • Shares were mixed over the past week – down in the US on taper fears and in Japan, but up in Australia, China and most of Asia.
  • Commodities rose on the back of good global growth news and oil prices helped a bit by turmoil in Egypt.
  • Despite higher commodity prices the Australian dollar fell slightly.
  • Bond yields were led higher as Fed taper fears intensified and as European economic data impressed.

What to watch over the next week?

  • In the US, the minutes from the last Fed meeting (Wednesday) will likely be the highlight with investors searching for more clues as to when the Fed will start to taper its quantitative easing program. On the data front expect a 1% rise in existing home sales (Wednesday) but a fall in new home sales (Friday) after a surge in June, a continued gain in house prices (Thursday) and the flash Markit PMI for August (Thursday) to improve slightly.
  • Preliminary August manufacturing PMIs will also be watched closely in the Eurozone (Thursday) and are expected to show a continuing trend improvement.
  • The flash HSBC manufacturing conditions PMI for China will be released Thursday and is expected to show a slight improvement after falling sharply in recent months.
  • In Australia, the focus is likely to be on the minutes from the RBA’s last Board meeting (Tuesday), which are expected to confirm that it retains an easing bias but that it has been weakened following the last rate cut.
  • The June half Australian profit reporting season will hit its peak with 90 major companies due to report, including Amcor, Coca-Cola Amatil, BHP, QBE, Boral, Fairfax, IAG and Lend Lease. Consensus estimates for 2012-13 earnings growth have slipped to -0.5% from +12% earlier this year, so a lot of bad news is factored in. Domestically exposed cyclicals are vulnerable to further weakness. On the positive side though, ongoing cost control and the fall in the $A are likely to be supports for the profit outlook going forward, with the fall in the $A to date potentially boosting profits by around 4.5%.

Outlook for markets

  • Shares are vulnerable to a near term correction after having become overbought following the rally from late June. Potential triggers include: the Fed tapering its monetary stimulus, US Government funding and debt ceiling negotiations, China and the profit reporting season in Australia. However, the broad trend in shares is likely to remain up: valuations are no longer dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other developed countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.
  • Sovereign bond yields still remain low and point to low medium term returns as yields gradually adjust higher in response to the improving global growth outlook.
  • With commodity prices in a downtrend and the Australian economy deteriorating versus the US, it’s likely the $A will fall further. Given its overvaluation in terms of relative prices, expect the $A to fall to $US0.80.

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