Weekly market & economic update – week ending 17 January, 2014
20
Jan
2014
From Shane Oliver - AMP chief economist
Key events of the past week and implications
- The start to the year in share markets has been a bit messy, particularly in Japan, China and Australia, whereas bonds have generally rallied. The reason for the weak start to the year in share markets doesn’t appear to reflect the flow of economic data in advanced countries, which for the most part has been solid. And consistent with this, the World Bank and IMF are revising up their global growth forecasts – albeit with the normal lag that occurs in such organisations.
- Rather, the real issues in the short term appear to be: a combination of profit taking after last year’s strong gains; high levels of investor sentiment that may need to be worked off a bit, eg, according to one measure the ratio of bullish to bearish US investment newsletters has reached its highest since the mid-1980s; and continuing uncertainty regarding China weighing on Chinese shares.
- The exception is Europe where shares have had a good start to the year, driven in particular by Spain and Italy and other peripheral countries that have seen their bond yields continue to slide, providing confidence the Eurozone crisis continues to recede. As a result investors are snapping up still cheap Eurozone shares. Spanish and Italian long bond yields have now fallen below 4%, ie lower than in Australia. Even France seems to be starting to move in the right direction with President Hollande announcing that a “family welfare” tax on firms will be scrapped.
- Given the shaky start to the year for several share markets, there has been a bit of talk about the January barometer, which basically states that “as goes January for shares, so goes the year”. But does it work? The short answer is that its mixed. For the US S&P 500 there have been 22 positive Januarys since 1980 of which 19 saw positive years, indicating an 86% hit rate. But the hit rate for negative Januarys (of which there were 12) going on to negative years was only 42%. It’s a similar story if the January barometer is only based on the first five days of the year, ie 86% hit rate for positive first five days going on to positive years, but only a 31% hit rate for negative first five days. Similarly for Australia, since 1980 there have been 20 positive Januarys for the All Ords index of which 15 saw positive years, giving a hit rate of 75%. But of the 14 negative Januarys since 1980 only 5 saw negative years resulting in a hit rate of 36%. The bottom line is that based on the historical experience if January is positive it certainly augurs well for a positive year as a whole, but if January is negative it doesn’t really tell us much at all.
Major global economic events and implications
- US economic data was solid, providing confidence that the weak increase in December payrolls was an aberration. Retail sales rose strongly in December, small business optimism rose in December, manufacturing conditions improved in the New York and Philadelphia regions in January (although the detail of the Phily Fed survey was mixed), jobless claims continue to decline, mortgage applications saw a decent gain, the NAHB home builders index remained strong and the Fed’s Beige book of anecdotal evidence was a bit more upbeat than in previous months. On top of all this inflation readings remained benign.
- Its early days in the US December quarter earnings reporting season, but so far 63% have beaten earnings expectations and 65% have beaten on revenue. The earnings beat is okay, but as not as strong as the 70% plus upside surprise seen in recent quarters.
- In the Eurozone industrial production rose much more than expected, consistent with continuing economic recovery there.
- Japan saw good data for economic confidence and machinery orders indicating its recovery continues.
- Chinese money and supply and lending growth was a bit weaker than expected, but at 13.6% year on year for money supply growth, 14.1% for bank lending growth and 17.9% for growth in total credit it’s still very strong.
- Brazil’s seventh straight rate hike provides a reminder of the inflation problem facing key emerging countries (Brazil, India and Indonesia) and the need for economic reforms to encourage investment and remove structural inefficiencies if they are to restore their potential growth rates to the high levels seen last decade.
Australian economic events and implications
- Australian data was mixed. The good news was that housing finance continues to trend up solidly driven by both investors and owner occupiers. While first home buyers saw a record low share of total housing finance, there is no doubt that the housing construction recovery is continuing with finance for home construction trending up solidly. The bad news though was that employment fell sharply in December capping of 2013 as the worst year for jobs growth since 1996. Were it not for the continuing slide in the participation rate, which is largely driven by retiring baby boomers, unemployment would now be a lot higher – in fact at 7.1% if the participation rate had remained at its 2011 average level. However, while the jobs numbers are bad the labour market is always a lagging indicator and reflects the soft economic conditions and bleak outlook seen around mid-last year. With more forward looking economic indicators showing signs of improvement, eg housing approvals, retail sales and consumer and business confidence and the decline in job advertisements starting to slow, jobs growth should start to improve by around mid-year. Given the lagging nature of the labour market and that the unemployment rate is no worse than expected, the poor December jobs report is unlikely to trigger another rate cut from the RBA which we continue to see leaving the cash rate on hold at 2.5% for an extended period.
Major market moves
- Share markets saw a bit of volatility and were mixed: up in Europe, the US and parts of Asia but down in Japan and Australia.
- Bond yields generally fell. The 3% level has proven to be good resistance for the US 10 year bond yield and appears to have attracted some investor interest once it was hit again at year end.
- Commodities were generally soft, with oil prices down and copper pretty flat.
- The Australian dollar fell to its lowest since 2010 on the back of weak December employment report.
What to watch over the next week?
- China will be the main focus on Monday with December quarter GDP growth expected to have slowed to 7.6% from 7.8% in the September quarter, and data for retail sales, industrial production and fixed asset investment slowing marginally. However, despite the minor gyrations up and down China’s indicators are likely to remain consistent with still solid growth above Premier Li’s 7 to 7.5% floor. The HSBC flash manufacturing PMI (Thursday) is expected to remain around 50.5.
- In the US, expect to see a modest bounce back in existing home sales and continuing strength in the Markit manufacturing conditions PMI (both due Thursday). The US December quarter earnings reporting season will also hot up. The consensus estimate is for earnings growth of around 4.9% for the year to the December quarter last year, supported by improving economic conditions and contained costs.
- In the Eurozone, expect January’s flash business conditions PMI’s to be released Thursday to continue the recovery trend seen over the last year.
- In Australia, expect December quarter inflation data (Wednesday) to remain benign with a slight fall in petrol prices and seasonal weakness in health and education costs holding the headline CPI down to 0.3 % quarter on quarter and 2.3% year on year. Underlying inflation is expected to be 0.6% quarter on quarter or 2.3% year on year. Benign inflation is also suggested by the TD Securities Inflation Gauge. If we are right and inflation remains at the low end of the RBA’s target range then it will provide plenty of scope for the RBA to keep rates low, albeit it will unlikely be low enough to justify another rate cut.
Outlook for markets
- Global shares are likely to push higher this year underpinned by reasonable valuations, improving earnings on the back of the global economic recovery and easy monetary conditions helping to entice investors to switch out of cash and bonds and into shares. However, with shares no longer dirt cheap returns are likely to be a bit more constrained and volatile, particularly with investor sentiment now running at pretty high levels.
- Australian shares are likely to perform well as profits pick up and interest rates remain low. The ASX 200 is expected to rise to around 5800 by year end. Cyclical shares like resources and industrials that underperformed over the last year are likely to outperform in 2014.
- Government bond yields are likely to continue their gradual upward trend as global growth improves and investors switch to risky assets. Cash and bank deposits provide poor yield returns, with term deposit rates falling below 4%.
- Expect the $A to be buffeted in the short term between signs Australian rates have bottomed and stronger global growth supporting commodity prices, but Fed tapering and RBA jawboning. The $A is ultimately on its way down to around $US0.80 over the next few years.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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