Weekly market & economic update – week ending 6 September

Key events of the past week and implications

• While share markets mostly rose over the past week helped by a delay to action regarding Syria and on the back of more evidence that the global economy is improving, gains were limited as bond yields rose sharply as stronger US data fuelled expectations that the Fed will start to taper its monetary stimulus this month.
• In Australia, the focus in the week ahead will likely be on the aftermath of the Federal election which if the polls and betting agencies are correct will see a new Liberal/National government. Based on stated policies, key policy changes under a Coalition Government are likely to be the abolition of the mining and carbon taxes, reduced company tax but offset by a levy on large companies to pay for paid parental leave, a refocusing in government spending towards infrastructure, a delayed increase in the superannuation contribution, smaller government, a greater focus on returning the budget to surplus and a range of inquiries (including into the labour market and productivity) which will likely pave the way for less regulation and more economic reform. The likely change in Government towards what would appear to be a more business friendly approach will probably provide a boost to confidence and past experience points to a post-election bounce in shares. This has averaged 5.4% over three months for elections since 1983. However, much will depend on whether conservative forces gain control of the Senate – the prospect of a double dissolution election next year would not go down well – and how hard the new Government goes in cutting spending with an announcement on this front likely in November.
• While an attack on Syria has been delayed it still looks likely with a key US Senate committee approving it, on the grounds its limited and tailored and doesn’t involve troops on the ground. It now goes to a Congressional vote on September 9. As with all US led military interventions in the Middle East, the concern is that it will lead to a wider confrontation threatening oil supplies. Given this it wouldn’t be surprising to see further share market weakness and oil price strength in the run up to any strike, even though Syria only produces 300,000 barrels of oil a day. This is consistent with past experience which saw share market weakness/oil price strength in the run up to interventions followed by a recovery in share markets from around the time it commences. The 1991 Iraq invasion, the December 1998 bombing of Iraq, the March 2003 Iraq invasion and the March 2011 Libyan bombing saw US shares fall 5.6%, 3.5%, 14% and 6.3% respectively in the run up only to see the losses recovered within two months. A similar pattern could be expected this time around, particularly as it becomes clearer that any intervention will be limited and that surrounding countries are unlikely to become involved.

Major global economic events and implications

• US economic data was mostly positive, adding fuel to expectations that the Fed will soon start to slow its monetary stimulus. The ISM manufacturing conditions index improved further in August, the non-manufacturing ISM rose to its highest since 2005, labour market indicators improved, construction spending rose solidly and auto sales rose to their highest since 2007. However, higher mortgage rates and higher oil/gasoline prices are clearly a bit of a headwind for US growth and so if the Fed slows its monetary stimulus following its September 17-18 meeting, as appears likely, it may only cut it back by $10bn a day.  
• Final Eurozone business conditions PMIs confirmed the recovery already evident in the flash readings. As expected the ECB and the Bank of England left monetary policy unchanged but with the ECB retaining a dovish bias. Italy remains a risk point though with the threat remaining that members of Berlusconi’s party will withdraw support for the Government if Berlusconi is forced out of his Senate seat.
• In Japan, the Bank of Japan left monetary policy unchanged but Governor Kuroda made clear it can respond if a planned hike in the GST impacts growth. The Yen fell through 100 to the $US as a result.
• Chinese business conditions PMIs mostly improved in August or stayed around solid levels, adding to confidence that 7.5% growth remains on track for this year. House prices continued to rise in August but the new Chinese leadership seems to be less concerned about it, perhaps concluding that demand curbs are ineffective and the only solution is via increases to supply.

Australian economic events and implications

• In Australia, June quarter GDP data showed that growth remains sub-par at 0.6% quarter on quarter or 2.6% year on year, the same pace it has averaged since the June quarter 2012, reflecting soft consumer spending and investment. The bad news is that growth is below the pace necessary to stop unemployment rising, but the good news is that growth has not collapsed. Other indicators presented a soft picture as well with retail sales very weak, business conditions PMIs still soft and the trade balance back in deficit.
• However, there are some positive signs: house prices continue to rise, building approvals rebounded in July consistent with an ongoing recovery in dwelling construction, household savings remain high at 10.8% indicating a significant buffer in household budgeting, productivity growth is solid at 2.2% and inflationary pressures are weak with falling real unit labour costs and a benign reading on inflation from the latest TD Inflation Gauge.
• The RBA surprised no one in leaving interest rates on hold. What was surprising though was that its post meeting statement was virtually identical to that from last month leaving out yet again any explicit easing bias. As a result it has yet again missed an opportunity for a free kick in pushing the $A down. The risks still point down though for rates particularly if the $A holds up from here, economic data remains soft and the post-election Government embarks on more spending cuts.

Major market moves

• Share markets mostly rose on the back of good economic data and the delay to any attack on Syria, but with gains limited as Fed tapering looks likely this month. Australian and Japanese shares fell slightly.
• While the $A rose earlier in the week as the RBA left out any explicit easing bias from its post meeting statement and GDP growth was fractionally stronger than expected, its gains were limited as the $US strengthened.
• Bond yields rose sharply in most major countries, including Australia, as stronger US data fuelled expectations for Fed tapering. US and Australian ten year bond yields rose to their highest since 2011.

What to watch over the next week?

• Globally, Syria will probably be the big one to watch with the US Congressional vote on approving a US strike. Don’t expect much from the G20 leaders’ summit though, other than the usual hot air from such events – it’s unlikely to have any impact on what the Fed does or on what the US does regarding Syria.
• On the data front the focus is likely to be on China though with key activity data due Tuesday likely to show that the improvement in growth evident in July continued into August. In particular, growth in industrial production is likely to have continued to edge higher rising 9.9% year on year, up from a low of 8.9% in June. Meanwhile, inflation (Monday) is likely to show a slight moderation on the back of a fall in food prices.
• In the US, it’s a pretty quiet week till Friday when August retail sales are expected to show a 0.3% gain and producer price inflation data is expected to remain benign. Consumer confidence data will also be released.
• In Australia, the aftermath of the election will likely dominate. On the data front though it will be interesting to see whether the NAB business confidence survey (Tuesday) and the consumer sentiment survey (Wednesday) show an improvement on prospects for a change of Government. Odds are they probably will. Expect an ongoing rising trend to be evident in housing finance data (Monday) but another round of soft jobs data (Thursday) with employment likely to be flat and unemployment rising to 5.8% from 5.7%.

Outlook for markets

• Shares are vulnerable over the next month or so with various events and risks that could trigger investor nervousness including the Fed’s September meeting where it will likely start to taper its monetary stimulus, US Government funding and debt ceiling negotiations, the nomination of the next Federal Reserve chairperson, various imbalances in the emerging world, a likely military intervention in Syria, political instability in peripheral Eurozone countries and post-election fiscal tightening in Australia.
• However, a pullback should be seen as a buying opportunity as the broad trend in shares is likely to remain up: valuations are not 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.
• Despite the bond sell off so far this year, sovereign bond yields still remain low and point to low medium term returns from bonds as yields gradually adjust higher in response to the improving global growth outlook. An unwinding of years of massive inflows into bond funds though runs the risk of causing a more aggressive rise in bond yields and hence losses on sovereign bonds.
• 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 and costs, expect the $A to fall to $US0.80.

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