• The past week saw major global share markets rebound on the back of mostly good economic data and favourable earnings reports in the US but with worries about Ukraine remaining a constraint. Bond yields were little changed but commodity prices fell slightly with the latter weighing on commodity currencies including the Australian dollar and talk of further easing in Europe weighing on the euro.
• March quarter GDP growth in China was not as bad as feared with the quarter likely representing the low point for growth this year. A fall in property related investment drove GDP growth down to 7.4% year on year and quarterly GDP growth to just 1.4%, the lowest in two years. However, this is likely to be the low point for the year. For the last two years growth has picked up after a weak first quarter, momentum in industrial production, retail sales and electricity consumption already appears to have started to pick up in March and ongoing policy fine tuning is likely to help as well. As such, Chinese growth remains on track to come in “around” 7.5% this year. This should be positive for the Chinese share market which with a forward PE of 8.5 times is priced for a hard landing and credit crunch. It’s also likely to be supportive for Australian resources stocks.
• US earnings reports in the next few weeks are likely to likely to be a source of support for shares. Earnings growth expectations for the March quarter were slashed from near 7% year on year in January to around 1% on the back of negative corporate guidance flowing partly from bad weather, but so much so that it has become easy for companies to beat expectations. Its early days yet with only 57 S&P 500 companies having reported, but so far so good with 67% of companies exceeding expectations.
• The ECB wants the euro lower. ECB President Mario Draghi has offered his strongest comments yet that the rise in the euro will necessitate further monetary easing. While it’s not clear that ECB quantitative easing is imminent it is clear the ECB is very focused on heading off deflation and will do what’s necessary to achieve that. This, at a time when the US is tapering and heading towards eventual rate hikes next year, indicates that the Euro is at least unlikely to be able to go up much more and is in fact more likely to decline.
• The crisis in Ukraine has reached a dangerous phase, but a solution of sorts may also be getting closer. The events in eastern Ukraine have clearly increased the risk of a civil war providing the pretext for a Russian intervention (as I am sure they have planned). However, my inclination remains that Russia is more focussed on keeping Ukraine out of the EU and NATO as opposed to further annexation, given the damage that the international backlash in the event of the latter would ultimately cause the Russian economy. A move to a federal structure in Ukraine, as the interim Ukrainian president has indicated he is open to, would virtually guarantee that Ukraine would stay out of the EU and NATO. Either way, apart from short term risks, Ukraine is unlikely to derail the global economic recovery with the US and Europe unlikely to want to get too involved even if it does escalate a lot further.

Major global economic events and implications

• The US economy looks to be gradually shaking off its winter chill. Only modest gains in the NAHB’s home builders’ conditions index and housing starts were disappointing but at least they rose and housing starts were also revised higher in February and mortgage applications for purchase are trending up. More significantly both retail sales and industrial production rose much more than expected in March suggesting that growth ended the March quarter on a strong note. This is consistent with the Fed’s Beige book which indicated signs of a rebound from bad weather. Meanwhile, inflation data remains benign but momentum appears to have bottomed.
• Comments by Fed Chair Yellen were mostly dovish, saying that there is more downside risk for inflation relative to the Fed’s target than upside, but she also came across very clearly as a pragmatic policy maker focussed on the economic outlook rather than as an ultra dove.This adds to confidence that when the time comes the Fed will raise interest rates rather than let inflation get out of control – that point still looks to be a fair way off though.
• A downwards revision to core Eurozone inflation in March to 0.7% year on year from 0.8%, with headline inflation of just 1% year on year adds to the case for further ECB easing.
• Indian CPI inflation of 8.3% year on year in March at a time when growth remains weak highlights the fundamental deterioration in its growth/inflation trade-off and need for significant economic reform. A likely change of Government offers hope on this front – explaining why the Indian share market is around record highs – but it won’t be smooth sailing and it will take several years for the benefits to show.

Australian economic events and implications

• The minutes from the RBA’s last meeting offered nothing new: its seeing further signs that low interest rates are helping the economy, sees the rise in the $A recently as being unhelpful and continues to see a period of stability for interest rates. Our view remains that rates will be on hold for another 4 or 5 months after which they will start to gradually head up as it becomes clear that economic growth is picking up and in order to put a lid of inflation and house price gains.
• An 8% rise in housing starts in the December quarter, reflecting the lagged response from last year’s rise in building approvals, with more to go, tells us a housing construction boom is on the way which will be good news for rebalancing the economy, good for employment and ultimately provide some relief in terms of housing affordability.

What to watch over the next week?

• It will be business conditions PMI day again on Wednesday, with the Chinese HSBC flash manufacturing PMI expected to show a slight improvement, the Eurozone PMIs likely to show further gains and a slight rise in the already strong US Markit manufacturing PMI.
• In the US, expect to see a further gain in house prices (Tuesday), a small fall in existing home sales (also Tuesday) based on already released pending home sales data, a bounce in new home sales (Wednesday) and an improvement in core durable goods orders (Thursday).
• Japanese inflation data (Friday) will likely show a further slight increase for March, with Tokyo inflation data for April expected to rise sharply on the back of the April 1 sales tax hike.
• In Australia, the March quarter inflation report (Wednesday) is of greater than usual importance because we have already seen two quarters in a row of higher than expected inflation and the December quarter release contributed to the RBA moving to a neutral bias on interest rates and dropping its jawboning on the $A. The March quarter CPI should be a bit more benign with a quarterly rise of 0.6% for both the headline and underlying measures as seasonal increases in prices for health and education and higher petrol prices are likely to be offset by price falls in clothing & footwear, household equipment and recreation. While annual rates of inflation will move up to 3% for headline and 2.8% for underlying, this reflects the elevated inflation readings in the previous two quarters and the RBA is already forecasting a rise to 3.25% for headline inflation and a rise to 3% for underlying inflation in the June quarter, so unless the inflation data is much worse than expected its unlikely to change the RBA’s stance on interest rates.

Outlook for markets

• While investors should allow for more volatility in share markets, with the likelihood of a 10 to 15% correction around mid-year or in the third quarter, the broad trend in shares is likely to remain up. 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.
• 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.
• With the $A having come close to our short term target of $US0.95 and short positions now unwound, it’s likely that the short covering rally is now largely over and that the broad downtrend is likely to resume. Commodity prices remain relatively soft and the $A is likely to revert to levels that offset Australia’s relatively high cost base. Renewed RBA jawboning in the months ahead is also likely to weigh on the $A. Our medium term view remains that the $A will fall to around $US0.80.

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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