Key events of the past week and implications
- The wobbly start to the year for share markets continued over the past week. While the news out of Europe and the US was mostly good, a greater than expected fall in a Chinese manufacturing conditions PMI weighed globally along with worse than expected Australian inflation data locally. As a result global and Australian shares mostly fell and bond yields declined, particularly in the US. Globally, the biggest issue for investors in the short term remains a combination of profit taking after last year’s strong gains in share markets and high levels of investor sentiment that may need to be worked off a bit. But the fundamental outlook is fine.
- China was perhaps the biggest source of nervousness over the last week with various growth indicators showing a loss of momentum. GDP growth slowed to 7.7% in the December quarter, industrial production, retail sales and fixed asset investment also slowed a bit and the HSBC flash PMI for January slowed more than expected likely influenced by the slowdown in industrial production late last year. However, while uncertainty regarding China is high at present not helped by a lack of transparency from the People’s Bank of China regarding its periodic liquidity squeezes there are several reasons not to be too concerned. First, Chinese growth is still exceptionally strong, eg, GDP at +7.7% year on year, industrial production at +9.7% year on year and retail sales at +13.6% year on year. Second, the growth readings and the PMI have been bouncing around the same range for the last two years now and since growth is just above the Premier’s growth floor of 7% it would appear the Government is happy with this. Finally, there are no signs of the sort of excesses that normally presage a sharp collapse: inflation is low, the trade balance is in surplus, China is a global creditor, public debt is low by US, European, Japanese, Indian and Brazilian standards and property prices are up but not out of line with urban income growth which is running around 10% year on year.
- While Chinese growth scares may linger, it’s hard to see a hard landing and eventually investors will get used to circa 7.5% growth in China. With Chinese shares amongst the cheapest in the world (with a forward PE of 7.2 times), we continue to see good value there from a medium term perspective. Particularly so relative to say India which is trading at a circa 60% premium to China in terms of its PE ratio, but has much weaker growth and much higher inflation. Best to stay overweight China.
- In other news, the IMF followed the World Bank in revising up its global growth forecast for this year from 3.6% to 3.7%, after 3% growth in 2013. While the IMF is just playing catch up to what the economic indicators and share markets have been telling us, it is noteworthy that it’s the first time in several years that the IMF has started the year off with an upwards revision to its growth forecasts.
- The US Treasury provided a reminder the US debt ceiling needs to be increased, formally by February 7, but at the latest by end February after which the US Government will run out of money. While the usual brinkmanship can be expected, it’s virtually certain it will be raised again as Democrats and Republicans are in a temporary truce as highlighted by the bi-partisan budget deal to avert another Government shutdown, House Speaker Boehner has indicated he is determined to avoid default and given the mid-term elections it’s not in the Republican’s interest to get blamed for any crisis that would flow from default.
Major global economic events and implications
- US economic data was mixed with essentially flat jobless claims, a fall in the Markit manufacturing PMI albeit to a still reasonable 53.7 and a stronger than expected gain in existing home sales. The overall impression is that US growth has picked up pace to around 3% but is a long way from booming.
- While the headlines have been a bit messy, December earnings results in the US have improved over the last week with now 73% of results beating earnings expectations and 67% exceeding sales expectations. The consensus now estimates earnings growth for the quarter at 6.3%, which is up from 4.9% two weeks ago.
- While business conditions PMIs disappointed in China and a bit in the US too, this was not the case in the Eurozone where the composite PMI rose to its highest since June 2011 driven by both manufacturing and services and is now at a level consistent with quarterly GDP growth of around 0.4%, up from 0.1%.
- Reserve Bank of India proposals to introduce an inflation target of 4% are welcome given its chronic inflation problem, but concerns from the Finance Minister warn that it may not have Government support.
Australian economic events and implications
- Australian economic data was somewhat disappointing with a further fall back in consumer confidence and higher inflation. December quarter inflation, coming in at double consensus expectations with a 0.8% gain, or 2.7% for the year was disappointing, and substantially reduces the possibility of another interest rate cut. However, it’s not bad enough to bring on a rate hike either as inflation excluding volatile items (like fruit and vegetables) was just 0.6% quarter on quarter or 2.6% year on year, the big driver of inflation has been government decisions with government related prices and charges up 5.7% over the last year relative to private sector inflation of just 1.8% and finally there is no sign the economy is overheating warranting higher rates.
- Our view remains that the RBA will leave interest rates on hold for an extended period, ahead of a modest rate hike around September/October.
Major market moves
- Share markets mostly fell not helped by the weaker Chinese PMI.
- Bond yields mostly fell as share markets fell, except in Australia where higher inflation left them little changed.
- Commodity prices were mixed with higher gold and oil prices, but lower base metal prices on China worries.
- While the $A had a brief inflation inspired bounce, the weaker Chinese PMI meant it was short lived.
What to watch over the next week?
- In the US, the big focus will be the Federal Reserve which is expected to announce a further $US10bn tapering of its quantitative easing program on Wednesday, taking it from $US75bn a month to $US65bn. Recent US economic data provides confidence that the US economy is picking up pace in line with Fed expectations but with pockets of uncertainty remaining and inflation remaining very low there is no case to accelerate the pace of tapering. The Fed is expected to remind us that further tapering is conditional on sustained economic improvement and that rate hikes remain a long way off even though unemployment at 6.7% is approaching the Fed’s 6.5% threshold beyond which it would consider raising rates. It will also be the last meeting before Ben Bernanke hands over to Janet Yellen as Fed chair.
- On the US data front expect a slight fall in new home sales (Monday) but a continuing rise in house prices (Tuesday), a solid rise in durable goods orders (also Tuesday) and a 3% annualised gain in December quarter GDP data (Wednesday) driven by solid growth in consumption and investment and positive contribution from trade. US December quarter earnings results will continue to flow.
- In the Eurozone, business and consumer confidence data for January (Thursday) are expected to confirm the ongoing economic recovery. Unemployment (Friday) is expected to have remained at 12.1% in December and inflation is also likely to have remained below 1% in January (also due Friday).
- In China, the official PMI (Friday) is expected to fall a bit further consistent with the HSBC flash PMI.
- Japanese data due Friday is expected to show a pick-up in household spending, strong growth in industrial production, further labour market improvement and a further modest rise in core inflation.
- In Australia, the NAB’s business survey (Tuesday) is likely to show a further slip in confidence after its post-election bounce, new home sales (Thursday) are likely to be solid and credit growth (Friday) is likely to remain subdued. Export and import price data (Thursday) will likely to show a further fall in the terms of trade.
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 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 offer pretty poor returns given low interest rates.
- The $A looks messy with Fed tapering, China uncertainties and RBA jawboning all working against it. The break below December’s low of $US0.8820 also points lower – down to around $US0.85. The $A is likely ultimately on its way to around $US0.80 over the next few years.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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