Key events of the past week and implications
- An avalanche of mostly good news out of the US has become bad news for share markets as it is seen as increasing the probability of a December taper by the Fed. This saw most share markets decline as bond yields rose. Australian shares are getting hit relatively hard thanks to a combination of 17 capital raisings draining $4.5bn from the market, a few negative profit warnings and the high yield nature of the Australian market that leaves it more vulnerable to rising bond yields on the back of Fed taper talk.
- The flow of mostly good economic data in the US along with increasing signs that renewed budget turmoil will be avoided early next year is clearly adding to the certainty that the Fed will soon start to slow its quantitative easing program. However, it’s still 50/50 as to whether they move at the December 17/18 meeting or wait till early next year as both Bernanke and Yellen may still prefer to see a bit more certainty that recent strength will be sustained. The uncertainty is likely to continue to weigh on investment markets over the next week and a half though.
- However, corrections aside, I remain of the view that Fed tapering won’t stop the rising trend in share markets. First, it will only occur because the Fed is more confident the US recovery is sustainable. In other words mission accomplished, and better growth means better profits. 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 to tapering with a move to further push out expectations for the first rate hike. Finally, by the time tapering 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”.
- US budget talks seem to be progressing well with a good chance that a budget deal will be reached by the December 13 target that was set as part of the budget/debt ceiling deal agreed by Congress back in October. This looks likely to involve reduced “sequester” spending cuts next year in return for long term savings and should enable an agreement to be passed by Congress to head off another Government shutdown by the time current funding arrangements end on January 15. Cooperation around a budget deal would also augur well for raising the debt ceiling again, which will likely be required again around March.
- There were no surprises from the Reserve Bank which left interest rates on hold for the fourth month in a row. While economic growth is subdued at 2.3% year on year this is line with the RBA’s own forecasts for 2.25% GDP growth this year and more importantly forward looking indicators are starting to look a bit healthier at the same time as the $A has fallen back to around $US0.90. As a result the RBA is likely feeling reasonably comfortable. While the risks to rates are on the downside in the short term our view remains that the RBA will most likely leave the cash rate at 2.5% for at least the next 9 to 10 months as signs of improvement head off the need for more cuts, but still sub-par growth and the need to keep the $A down dictate that rates remain low.
- On the Australian political front, it was good to see the abolition of the debt ceiling. Like its US counterpart the debt ceiling was really a silly construct with little value. Its better to have a debate about the sort of debt we are incurring and how best to get it down rather brinkmanship over whether the ceiling will be raised or not.
- Are the woes at Qantas telling us anything alarming about the economy? I don’t think so as they mainly appear to reflect a capacity war and it’s worth noting that airlines like Qantas are one of the few large caps to be adversely affected by a falling $A – primarily because it means higher fuel costs and possibly also because it will mean less Australians travelling overseas.
Major global economic events and implications
- US economic news was mostly positive with strong data for the manufacturing ISM index, construction, auto sales, labour market indicators and new home sales all adding to confidence that growth is picking up. September quarter GDP growth was also revised up to 3.6% annualised from 2.8% initially reported. Of course it wasn’t all rosy with mixed indications regarding Thanksgiving retail sales, the services ISM index falling slightly and mortgage applications sliding highlighting the risk to the housing recovery from rising mortgage rates. And the GDP revision wasn’t as good as it looks with more than all of it coming from higher inventories and growth in final demand remaining soft. That said the overall picture is one of improvement in the US, but its just not clear whether its strong enough to move the Fed to taper this month or wait till early next year.
- Final Eurozone composite business conditions PMIs showed a small fall relative to October, but less so than initially reported and with the level of the PMI still pointing to continued but gradual growth in Europe. The ECB and the Bank of England both left monetary policy on hold as expected. However, while the ECB revised up its 2014 GDP growth forecast to 1.1% (from 1%) it did revise down its inflation forecast to 1.1% (from 1.5%) and the clear message from President Draghi is that the ECB stands ready to provide more stimulus if needed.
Australian economic events and implications
- Australian economic growth remained subdued in the September quarter at the just below 2.5% annualised pace that has been in place for 18 months now. As is well known this reflects the combination of the mining slowdown occurring at a time when the rest of the economy was weak thanks to the lagged effect of excessively high interest rates. More timely and forward looking indicators released over the last week are looking more positive with strong building approvals, retail sales rising more than expected in October adding to confidence that consumer spending is starting to improve, house prices continuing to trend higher and the various PMIs produced by the AIG trending higher (albeit not in a straight line). As a result we remain of the view that growth will gradually accelerate to around a 3% pace through the course of next year.
- At the same time the TD Securities Inflation Gauge remains benign (up 2.3% year on year at an underlying level in November), highlighting that the RBA does not face an inflation problem despite the slide in the $A.
Major market moves
- > It was a poor week for share markets as good US economic news became bad news as it added to expectations the Fed will soon start to taper its quantitative easing program. Australian shares are getting hit a bit harder given their higher weighting to high yield shares like banks and financials (which led falls over the past week), a raft of capital raisings which are draining around $4.5bn from the market and a few profit warnings.
- Commodity prices had a mixed ride with gold down but oil and metals up helped by stronger growth data. Despite this taper talk weighed on the Australian dollar.
- Bond yields rose on the back of taper talk with the Australian ten year bond yield rising to a two year high.
What to watch over the next week?
- In the US, the main focus will be on November retail sales (due Thursday) as a guide to how holiday shopping got underway post Thanksgiving. Retail sales are expected to gain 0.4%. Producer price inflation data (Friday) will also be released and is likely to be benign.
- Chinese inflation data (Monday) is likely to show a fall to 3.1% on the back of lower food prices and benign non-food inflation. Data for industrial production, retail sales and fixed asset investment (Tuesday) is likely to have remained solid, albeit fractionally slower than in October. Lending data will also be released.
- In Australia, expect ANZ job ads (Monday) to show further signs of bottoming and housing finance (Tuesday) to continue to trend higher and modest increases in the NAB’s business confidence measure (Tuesday) and consumer confidence (Wednesday). Employment lags the cycle and November data (Thursday) is likely to have remained soft with a 5000 gain not being enough to prevent a rise in unemployment to 5.8%.
Outlook for markets
- The combination of Fed taper talk and excessively 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 are of course not helping in Australia. However, this is likely to be 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, 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. After a 6% fall since October highs, Australian banks are 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. The medium term trend in the $A is likely to remain down to $US0.80 though.
Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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