Weekly market & economic update – week ending 13 December
16
Dec
2013
From Shane Oliver - AMP chief economist
Key events of the past week and implications
- US taper talk yet again dominated over the past week, as a US budget deal and more strong economic data was seen as boosting the probability of a tapering in the week ahead. This saw US bond yields rise and global share markets remain under pressure. Australian shares have particularly been under pressure thanks to a combination of tapering fears weighing on high yield shares like banks, the ongoing drain from capital raisings, several profit warnings, foreign investors selling or staying away until the $A stabilises and news that Holden will end local production after 2017 not helping sentiment.
- Our assessment is that it’s still 50/50 as to whether the Fed will announce tapering in the week ahead. The case for a December taper is that US labour market looks stronger and fiscal risks have diminished with the budget deal. Against this though inflation remains very low, Bernanke and Yellen may prefer to see a bit more certainty that recent strength will be sustained and the Fed may prefer to start to tapering when financial market liquidity is stronger rather than just before Christmas. I kind of think they should just bite the bullet and start the process to put an end to the “will they taper or not” soap opera!
- However, whether it’s in the week ahead or early next year, I remain of the view that Fed tapering is not a major threat for investors, apart from a bit of short term volatility. First, it will only occur because the Fed is more confident the US recovery is sustainable. In other words it should be reason for celebration. Second, tapering is not tightening as it will just mean a gradual reduction in the amount of asset purchases (maybe from $US85bn a month to $US75bn a month initially). Third, the Fed will likely couple the start of tapering with a move to further push out expectations for the first rate hike. Finally, when it happens it will be well and truly factored into most markets. As such it could turn out to be a case of “sell on the rumour, buy on the fact”.
- The bipartisan US budget deal is very positive. Not only does it signal a small fiscal easing next year, but it means no risk of shutdowns for almost the next two years and improved Congressional cooperation signals reduced political uncertainty, including around the debt ceiling that needs to be increased again early next year.
- In Australia, news that Holden will cease car production after 2017 is terrible for auto industry workers and sad for people like me who like to own and drive Holden cars. From a broader economic perspective there is a real risk that, given the iconic status of Holden, the announcement will dampen confidence. In this sense the timing is not good. However, the impact on the overall economy of Holden’s demise should not be exaggerated. First the impact will be spread over time. Second, direct job losses of 2900 and total losses of maybe 15,000 are tiny compared to total Australian employment of 11.6 million people (just 0.1%). Third, this impact is likely to be reduced by government assistance programs and if other producers take over some of Holden’s plants. Fourthly, while Holden’s demise adds to the manufacturing sector’s woes, it should be noted that manufacturing has been in decline for 50 year or so. Back in 1960 manufacturing employed 26% of the workforce and now it’s just 8%. And yet the economy has performed well despite this. Finally, we need to accept that government assistance of the auto industry was not a good use of taxpayers’ money. It can now be re-directed to well-targeted infrastructure spending which is what the economy really needs.
- The past week marked the 30th anniversary of the $A float. Its swings over the last 30 years have been a great shock absorber for the economy and a catalyst for economic reforms. Right now its direction is down. To help the economy adjust as the commodity boom slows, RBA Governor Steven’s wants to see the $A at $US0.85, I would prefer $US0.80 but it’s all in the same direction, ie down. More broadly Steven’s comments in an interview indicate a degree of comfort with current rate settings as the focus remains on getting the $A down.
Major global economic events and implications
- US data continues to point to improving growth. Retail sales rose strongly in November indicating a good start to holiday sales, job vacancies rose to a five year high and rising wealth will help add to spending.
- Eurozone economic data disappointed with industrial production falling more than expected in October.
- Japanese data provided more evidence that Abenomics is working with improved confidence readings, the Manpower employment outlook survey at a five year high and M2 money supply growth at its fastest since 1999.
- Chinese data for November was benign with industrial production and investment slowing a notch but retail sales accelerating and all remaining solid consistent with 7.5% or so GDP growth. Meanwhile lending growth was a bit stronger than expected but with non-food inflation at just 1.6% there is little pressure on the central bank to tighten aggressively. Uncertainty over policy tightening to slow the shadow banking system may linger though.
- Indian data was poor with falling industrial production and rising inflation. Strong gains for the opposition BJP in state elections provided a bit of support to the Indian share market though on the grounds that it augured well for the BJP in next year’s national elections which in turn could usher in economic reforms.
Australian economic events and implications
- Australian economic data was messy. Consumer sentiment fell but remained in a rising trend. The NAB’s business survey showed a slight improvement in conditions but a marginal fall in confidence – but at least both well up from their lows. The November jobs report was confusing with a stronger than expected jobs gain but rising unemployment and falling hours worked highlighting that the jobs market remains weak. Against this, housing finance continued to surge higher in October both for owner occupiers and investors and also for construction indicating the housing recovery continues. This is a positive sign for broader economic growth.
Major market moves
- It was another messy weak for share markets with tapering fears dominating globally and Australian shares hit again by the combination of global weakness, capital raisings, the falling $A which acts to keep foreign investors away and the announcement that Holden will cease production not helping confidence.
- The $A continued to slide on the combination of taper talk, more jawboning from RBA Governor Stevens and Holden’s production demise providing another reminder it is still too high.
- Bond yields rose in the US and China but were flat to down elsewhere
What to watch over the next week?
- Globally, the week ahead will see all eyes on the US Federal Reserve (Wednesday) to see whether it starts slowing its quantitative easing program. We would not be at all surprised to see the Fed start tapering in the week ahead as it’s now a 50/50 call.
- Apart from the taper decision in the US, expect the flash Market PMI (Monday) along with various regional manufacturing surveys to remain solid, CPI inflation (Tuesday) to have remained benign, the NAHB homebuilders conditions index (Tuesday) to show a slight gain and housing starts (Wednesday) to be strong.
- In the Eurozone, expect flash PMIs (Monday) to remain consistent with a gradual recovery.
- In Japan, the Tankan business survey (Monday) is expected to show further signs of improved growth.
- China’s flash HSBC PMI (Monday) is expected to remain consistent with growth remaining around 7.5%.
- In Australia, the Federal Government will release its mid-year budget review on Tuesday which will likely show a further blowout in the budget deficit for this financial year to around $50bn as a result of the RBA recapitalisation and more revenue slippage. Minutes from the RBA’s last rate setting meeting (also Tuesday) are likely to reiterate that it retains an easing bias but that it is not close to acting on it given recent signs of improvement in economic data. Parliamentary testimony by Governor Stevens will likely reiterate the same message and provide another opportunity for more $A jawboning.
Outlook for markets
- Fed taper talk and still high short term sentiment readings regarding US and global shares suggest that the share market correction could have a bit further to run. Capital raisings and the falling $A are not helping Australian shares right now. However, we remain of the view that this is just a pause ahead of the resumption of the rising trend as share market valuations are reasonable, monetary conditions are set to remain very easy despite Fed tapering, profits will improve next year as global & Australian growth picks up and there is still a lot of money sitting in cash and bond funds. Australian banks are now back to offering grossed up yields around 8% and so are starting to look pretty attractive again given that term deposit rates of around 3.5 to 4% are continuing to slide. Note that the first half of December is often flattish for shares with the Santa rally usually starting around Christmas and we expect the same to occur this time around. Next year the combination of stronger profits and low interest rates are likely to see the Australian ASX 200 push up to around 5800.
- Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to help ensure the rising trend in yields remains gradual.
- Expect the $A to be buffeted in the short term between signs Australian rates have bottomed but talk of Fed tapering and RBA jawboning. It’s ultimately on its way down to around $US0.80.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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