Key events of the past week and implications
- Global share markets pushed higher over the last week helped by mostly good economic news, notably this time from China, and the possibility of a diplomatic solution with respect to Syria.
- In Australia, the boost to confidence from the change in Government was evident in higher readings for consumer and business confidence, a rally in the share market and a slight gain in the $A. While other factors also played a role in the share market gain, eg global share markets also rose, confidence has been a missing ingredient in the Australian economy in recent times so if the new Government can maintain higher confidence levels by implementing a program of lower taxes, smaller government and less regulation resulting in a more business friendly environment then it will help drive Australia’s path back to stronger growth. The likelihood that a mix of independents and minor parties to the right of the Coalition will control the balance of power in the Senate increases the chance that the new Government will get its legislative program through Parliament.
- The further surge in the Australian share market pushed the ASX 200 to its highest since June 2008 and the accumulation index (which takes account of capital growth plus dividends) rose above its November 2007 all-time record. While shares are vulnerable to a short term correction, the combination of reasonable valuations, low interest rates and easy money and the anticipation of an upswing in economic growth and profits next year is likely to push the share market up to around 5350-5400 by year end with further gains likely next year.
- In the US, the focus is now turning to Congressional negotiations regarding a new Budget (required by October 1) and an increase in the debt ceiling (required by mid-October). Expect the usual cantankerous argy bargy between both sides of politics to cause bouts of financial market nervousness ahead of the usual last minute deal. With the US budget deficit having fallen to 4% of GDP (from a 2010 peak of above 10%) it will be harder for the Republicans to push too hard without risking alienating the public, which they probably don’t want to do ahead of mid-term elections next year.
Major global economic events and implications
- Chinese data for August was unambiguously positive with stronger exports, industrial production, power generation, retail sales and fixed asset investment, solid growth in money supply and lending and all at the same time that inflation is low. Momentum in China appears to have bottomed and is on track for 7.5% growth this year. This is good for global growth but also provides support for commodity producers like Australia.
- A pickup in exports is also starting to appear in other emerging countries including Korea and India and is consistent with an improvement in broad global growth momentum.
- Meanwhile the problems in parts of the emerging world are a long way from over with Indonesia hiking interest rates yet again to defend the Rupiah and fight inflation, but which will only make the growth outlook worse,
- It was a quiet week on the data front in the US. Weekly jobless claims fell but this was distorted by two states failing to file. Consumer credit was weaker than expected, small business optimism fell very slightly, and weekly mortgage applications fell highlighting the ongoing impact of the rebound mortgage rates that has resulted from the back up in bond yields. US mortgage rates are now running around 4.6% compared to a low in May of 3.4%.
- While Eurozone industrial production fell in July, the rising trend in manufacturing PMIs suggests this is an aberration with the recovery likely to resume.
- Japanese economic data was somewhat messy with June quarter GDP growth revised up to 3.8% annualised and bankruptcies down but mixed readings on business conditions and sentiment.
Australian economic events and implications
- Apart from the poor jobs report, Australian data releases over the last week were positive. The deterioration in the labour market in response to the sub-par growth of the last year was clearly evident in August with jobs falling for the second month in a row and unemployment rising to 5.8% which is just below its post GFC peak. Labour force underutilisation is now at its highest since 2002. Unfortunately, falling job ads and business hiring plans point to a further deterioration ahead. The soft labour market with higher unemployment still to come highlights that the risks for interest rates remain on the downside. However, the labour market is always a lagging indicator and leading indicators released over the past week were more upbeat with a continuing rising trend in housing finance and solid gains in both business and consumer confidence. While the bounce in confidence owes much to the change in Government they are nevertheless welcome news given the important role confidence plays in driving the economy.
- More broadly, four factors have played a role in holding the economy back over the last few years: relatively high interest rates, the high $A, China worries and the political mess. We have now seen relief on all these fronts.
Major market moves
- Share markets had a good week helped by good economic data from China and signs that a diplomatic solution will be found for Syria.
- Commodity prices mostly fell on nervousness ahead of the Fed’s taper decision despite stronger Chinese data.
- The Australian dollar rose helped by a combination of strong data from China and a post-election boost to confidence. The gains were partly reversed though as poor jobs data kept alive the prospect of another rate cut.
What to watch over the next week?
- In the US, we expect the Fed to announce that it will be scaling back its monthly asset purchases from $US85bn to $US75bn. Such a move will hardly come as a surprise as the Fed has been warning of its since May and a September taper has become the market consensus expectation. The softer than expected August jobs report means that such a move is not a done deal, but on balance the run of data released recently suggest that the US economy has picked up pace enough to withstand a lessening in the pace of stimulus. However, because growth is still far from robust the Fed is likely to indicate the pace of quantitative easing will not be reduced in a straight line and that interest rates are unlikely to be hiked until some time in 2015 at the earliest. Its dovish forward guidance is likely to be focussed on pushing back against the recent back up in bond yields. To avoid pressure on mortgage rates it’s also more likely to cut back purchases of bonds as opposed to mortgage backed securities. Finally, it’s worth stressing that tapering its QE program is not the same as a monetary tightening – it will just be equivalent to cutting interest rates at a slower rate.
- On the data front in the US, expect a modest rise in industrial production (Monday), benign inflation (Tuesday), a slight fall back in the NAHB homebuilder conditions index (Tuesday), a further rise in housing starts (Wednesday) but a slight fall in existing home sales (Thursday). Manufacturing surveys for the NY and Philadelphia regions are expected to show continuing strength.
- In Europe, the German Federal election (Sunday 22 September) is most likely to see the return of Angela Merkel as Chancellor with the main uncertainty relating to whether she will lead a coalition with the Free Democrats (as at present) or the Social Democrats (as over 2005-09). Either outcome is unlikely to pose a threat to Germany’s relationship with the rest of the Eurozone and so is unlikely to have significant investment market implications, beyond any initial kneejerk response.
- In Australia, the minutes from the RBA’s last Board meeting (Tuesday) will be watched closely to see whether the explicit easing bias that was removed from the post meeting statement in August, but returned with the August minutes only to be left off from the post meeting statement two weeks ago will be returned again. It would make sense for the RBA to make it clear that it retains an easing bias because it helps maintain downwards pressure on the $A without necessarily having to do anything. A speech by Assistant Governor Malcolm Edey will also be watched for clues regarding interest rates.
Outlook for markets
- After a strong run up, shares are at risk of a short term correction as we go through the seasonally weak period of September/October and given various worries including the Fed’s taper decision, the German election, coming budget and debt ceiling negotiations in the US, the nomination of the next Federal Reserve chairperson and various imbalances in the emerging world and remaining risks involving Syria.
- However, any pullback is likely to be modest and just another bull market correction which should be seen as a buying opportunity as the broad trend in shares is likely to remain up. Valuations remain reasonable, monetary conditions are set to remain easy well into next year, and profits are likely to improve next year as global and Australian growth picks up. So by year end we see further upside in global and Australian shares with gains continuing next year.
- Government bond yields have increased too far too fast and could stabilise or even decline a bit, particularly if the Fed presents dovish forward guidance when it decides to start tapering. However, still low yields and an unwinding of years of massive inflows into bond funds point to poor returns ahead.
- The $A looks to be undergoing a short covering rally which could take it to around $US0.95/96. But once this has run its course and extreme short positions have been unwound the downtrend is likely to resume.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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