• The past week saw US, European and Japanese shares fall led by a further decline in technology stocks and this along with dovish signals from the Fed and ongoing risks regarding Ukraine saw bonds rally. Australian shares briefly made it to a new post GFC high though helped by takeover activity and Chinese shares also had a good bounce. Commodity prices mostly rose helped by good economic data and the $A was pushed even higher by strong Australian jobs data.
• We are not on the brink of a tech driven crash. The US tech heavy Nasdaq index has fallen 7% from its March high and – surprise!, surprise! – we have seen some of the usual perennial bears/Fed haters come out with more calls for share market crashes. Our view remains that a 10-15% correction in shares is to be expected at some point along the way this year, but it would be just a correction in a still rising trend. There is no doubt some tech stocks have run too hard with a return to 1999 style price to sales metrics being used to justify silly valuations. This and the general outperformance of tech stocks over the last few years had left them at risk and the fall could still go further as hedge funds that were levered into tech overweights are forced to close their positions. However, price earnings multiples on Nasdaq are one third their tech boom peaks and the broader US share market is trading on a forward PE of 15 times which is a long way from 24 times at the time of the tech boom and is in line with longer term averages. Other major share markets are trading on lower PE multiples.
• Ukraine remains a risk on two fronts with what looks to be orchestrated protests in eastern regions potentially providing a pretext for more Russian intervention if it desires and ongoing Russian threats to cut off gas supplies if Ukraine does not pay its gas debts. Our view remains that apart from short term risks for markets, Ukraine is not likely to derail the global economic or share market recovery with the US and Europe unlikely to want to get too involved. An escalation of tensions and sanctions though could seriously hurt the Russian economy which is already at risk of recession.
• Australian trade deals with Japan and Korea are good news, but their benefits will accrue over time and don’t significantly change the near term growth outlook. In Australia, the main beneficiaries are beef and dairy farmers and consumers as tariffs on imported cars, household & electronic goods from Japan fall to zero.

Major global economic events and implications

• In the US, the minutes from the Fed’s last meeting were dovish and economic data was good. The minutes left the clear impression the Fed and Chair Janet Yellen did not mean to convey more hawkishness after its last meeting and remains focussed on keeping the stimulus in place for longer. US data releases were favourable with lower jobless claims, a rise in small business optimism, higher job vacancies & higher mortgage applications.
• Perhaps the highlight in Europe was the return of Greece to the debt market with a 5 year bond issue that was seven times oversubscribed. Its 10 year bond yield is now 5.8%, as against a 2012 crisis high of above 30%. This is a big turnaround and adds to confidence that the Eurozone is back under control.
• Chinese trade data was worse than expected in March, but a 40% plunge in exports to Hong Kong and Taiwan suggests the fall is largely due to inflated exports from a year ago with exports to the rest of the world up 8% suggesting the underlying trend is fine. The fall in imports is arguably more of a worry as it reflects weak Chinese demand and it adds to the case for more policy fine tuning to support growth. Benign inflation, with non-food inflation of just 1.5% in March, indicates plenty of scope for further policy stimulus if needed.

Australian economic events and implications

• Australian economic data was mostly ok, with a fall in business confidence, but a slight rise in business conditions with both well up on last year’s lows, a slight rise in the AIG’s construction conditions index, a stabilisation in consumer confidence after several months of falls, a solid rise in housing finance in particular for new dwellings and another surprisingly strong jobs report for March which actually saw unemployment fall. While the last few months employment gains probably exaggerate to the upside they nevertheless tell us that the jobs market is far stronger than appeared to be the case late last year and with a range of forward looking jobs indicators on the mend – eg, ANZ job ads, ABS job vacancies, skilled vacancies and employment intentions in the NAB survey – this suggests that the jobs market is gradually improving and that there is some chance that we may have already seen the peak in unemployment. This is all consistent with a gradual improvement in economic growth this year in Australia.
• We see no reason to change our expectation for a rate hike in September/October, with the risk of another rate cut now almost zero. The continuing rebound in the $A is likely becoming an increasing concern for the RBA, but we expect it to respond by renewing its jawboning efforts to try and push it back down in the months ahead.

What to watch over the next week?

• In the US, expect a solid 0.8% gain in March retail sales (Monday), a post bad weather rebound in the NAHB home builders conditions index (Tuesday) and in housing starts (Wednesday), a solid rise in industrial production (also Wednesday) and another benign inflation report (Tuesday). The New York and Philadelphia regional manufacturing conditions indexes are also likely to show improvement. The flow of March quarter earnings results will also start to ramp up and while bad weather is likely to have temporarily depressed profit growth, it is likely to come in stronger than market expectations that have collapsed to zero growth for the quarter (from 6% earlier this year) on the back of a lot of negative corporate guidance. Usually when guidance has been so negative it makes it easier for companies to beat expectations.
• In China, expect March quarter GDP growth (Wednesday) to show a slowdown to 7.2% year on year from 7.7% in the December quarter last year reflecting the loss of momentum already reported in the first few months of the year, but March data for industrial production, retail sales and fixed asset investment is likely to show a slight improvement from the soft growth reported in January/February.
• In Australia, the minutes from the last RBA meeting (Tuesday) will likely confirm their neutral bias on rates for now but will be looked at closely for signs of concern about surging house prices and the strengthening $A and hence for any renewed jawboning on either. Dwelling starts will likely show a solid bounce reflecting the lagged response to rising building approvals seen through last year.

Outlook for markets

• Investors should allow for a 10 to 15% correction at some point along the way this year. A trigger could be rising worries about when the Fed will start to raise in interest rates as US growth recovers from its winter soft patch, but worries about Ukraine or tech stocks could also be triggers. However, just as we saw in the last two years this would just be a correction in a rising trend as share market fundamentals remain favourable with reasonable valuations, improving earnings on the back of rising economic growth and easy monetary conditions helping entice investors to switch out of cash and into shares. So any such dip should be seen as a buying opportunity. Our year-end target for the ASX 200 remains 5800.
• The chart below breaks down the annual change in the Australian share market into that driven by earnings growth and that driven by changes in the ratio of share prices to profits – and clearly shows that profits have now taken over from multiple expansion as the key driver of share market gains. We expect this to continue.

• Bond yields are likely to resume their gradual rising trend and this combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits also continue to offer poor returns.
• The short covering rally in the $A is getting close to our target of around $US0.95, but still has a bit further to go. The broad trend in the $A is likely to remain down though reflecting softer commodity prices, a reversion to levels that offset Australia’s high cost base and a stronger recovery in economic growth in the US relative to that in Australia. Renewed RBA jawboning in the months ahead is also likely to weigh on the $A.

By Dr Shane Oliver, Head of Investment Strategy & Chief Economist

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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