Weekly market & economic update – week ending 2 May, 2014
05
May
2014
From Shane Oliver - AMP chief economist
Investment markets and key developments over the past week
- The past week was mixed for share markets. US, European and Japanese shares rose slightly on the back of mostly good economic and profit news, but with worries about Ukraine acting as a constraint. Chinese shares remained weak though and this weighed on some Asian markets. Australian shares also fell with miners down on the back of the falling iron ore price and talk of a tax hike pushing retailing stocks down by around 2%. Bond yields were flat to down slightly, commodity prices weakened and yet the $A was little changed.
- US earnings reports for the March quarter are providing strong support for shares. 359 S&P 500 companies have reported so far, with 76% beating earnings expectations, by an average 6.2%, and 52% beating sales expectations. After earnings growth expectations for the quarter were slashed from +7% year on year in January to -1% a month ago on the back of bad weather, they have now bounced back to +4%.
- The situation in eastern Ukraine is clearly deteriorating with pro-Russian activists taking over more cities. The risk of civil war and Russian intervention is clearly high now and so Ukraine continues to pose a risk for global investment markets to the extent worries will rise about the impact on Europe. Beyond the potential for a short term impact on markets though, we remain of the view that Ukraine is unlikely to derail the global economic recovery or bull market in shares as the US and Europe are unlikely to get too heavily involved.
- In Australia, the thorough and wide ranging National Audit Commission has helped build the case for measures to bring long term spending growth under control. Reflecting this, the Budget is likely to introduce or flag measures to restrict access to the pension and welfare (tougher means tests and raising the retirement age to 70 by 2035), co-payments for Medicare services, reductions in the number of government bodies and more privatisation.
- While there has been much talk of a four year tax hike to help reduce the budget deficit this would be a serious mistake and is hopefully just pre-election kite flying. An increase in the top two marginal tax rates would seriously dent household spending and so threaten the economic outlook, further reduce incentive to work and participate in the labour force at a time when we need to boost productivity and participation and is not the right remedy for a long term spending growth problem.
- Australia is a long way from the sort of budget crisis that has racked parts of Europe and the US in recent times and near term nominal growth is likely to be higher than assumed in the Mid-Year Economic and Fiscal Outlook which should result in a slightly faster decline in the budget deficit than currently projected for this year and next. So right now the key is to put policies in place that bring long term spending growth under control, as opposed to adopting too much austerity in the short term which could threaten the economy and so make the deficit reduction task even harder.
Major global economic events and implications
- In the US there were no surprises from the Fed which continued to taper its quantitative easing program and sounded more confident about a growth pick-up after winter weakness. March quarter saw the US economy virtually stall with just 0.1% annualised growth, but given this was driven by a combination of poor business investment that will improve after being weather affected and negative contributions from inventories and trade which will reverse, growth in the current quarter is likely to bounce back strongly. Certainly this is the message from a rebound in the ISM index, stronger jobs growth and improved household spending in March. Pending home sales also picked up in March and house prices are continuing to gain.
- Eurozone economic confidence slipped slightly in April, with worries about Ukraine possibly weighing, but remains consistent with strengthening growth. While credit growth remained poor, an ECB survey of banks points to stronger loan demand which is a positive sign. Meanwhile inflation came in at just 0.7% year on year in April, but is not low enough to trigger quantitative easing by the ECB.
- Japanese economic data is messy, being distorted by the April sales tax hike. March household spending was strong but is likely to have fallen back in April, with small business confidence and the manufacturing PMI falling sharply in April after the sales tax hike. A positive sign though is that the jobs to applicants ratio rose in March suggesting employers have a degree of confidence regarding the post tax hike environment. It’s too early for the Bank of Japan to be able to assess the impact of the tax hike and so it left policy unchanged as expected. Conditions are stronger now than they were the last time the sales tax rate was hiked in 1997 – with quantitative easing, fiscal stimulus, rising property prices, bank lending and consumer confidence – so Japan is unlikely to be knocked back into recession this time around. If the BoJ does ease further it’s unlikely to move till around July.
- China’s official manufacturing PMI rose slightly in April providing some confidence that growth may have stabilised after the slowing in the first quarter. More broadly though it remains in the same range it has been in since late 2011, which is consistent with growth running around 7.5%. Meanwhile house price gains slowed further in April confirming that the housing slowdown continues and providing scope for more easing in restraints on home buyers.
Australian economic events and implications
- Australian economic data was mixed. Credit growth continued to trend modestly stronger in March led by housing investors. While the terms of trade rose in the March quarter this looks temporary given the fall in the iron ore prices. According to RP Data, house price growth slowed in April to just 0.3% month on month but this followed a 2.3% rise in March so could just be noise as opposed to a real slowing. Meanwhile, new home sales remained strong in March. Finally, the AIG’s manufacturing PMI fell again in April to 44.8 highlighting that the economic improvement remains patchy and certainly vulnerable to any mis-step by the Government on taxes.
What to watch over the next week?
- In the US, expect a modest increase in the non-manufacturing ISM index (Monday) and a decline in the March trade balance (Tuesday). Fed Chair Yellen will deliver a Congressional testimony on Wednesday.
- The ECB (Thursday) may unveil further monetary easing in response to weak bank lending, deflation risks and the still strong euro. However, this is more likely to take the form of more interest rate adjustments rather than quantitative easing as the ECB does not appear to be ready for the latter just yet.
- Chinese export growth (Thursday) is expected to return to positive territory after the weakness of recent months but imports are expected to remain subdued. Inflation data (Friday) are expected to show a fall back in CPI inflation to 2.1% and continued falls in producer prices.
- In Australia, the Reserve Bank (Tuesday) is expected to leave interest rates on hold for the eighth month in a row. While confidence has increased that non-mining activity will take over from mining investment as a driver of growth, uncertainty remains about how smooth the transition will be with talk of Budget tax hikes adding to the uncertainty. As a result, the RBA is expected to reiterate that a period of stability in interest rates is appropriate. The RBA’s quarterly Statement on Monetary Policy (Friday) is likely to reiterate the same message.
- On the data front in Australia, expect to see a 2% rise in building approvals (Monday), another solid trade surplus (Tuesday), a slight rise in retail sales (Wednesday), a slight 5000 fall in employment (Thursday) after three months of good gains and a bounce back in unemployment. Data for ANZ job ads and the TD Securities Inflation Gauge will also be released.
Outlook for markets
- While investors should allow for more volatility in share markets, including the likelihood of a significant correction around mid-year, 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 dip should be seen as a buying opportunity. For Australian shares much is riding in the short term on how aggressive the coming budget is with respect to the next financial year. Tax hikes and aggressive short term austerity would clearly be significant headwinds for the Australian share market.
- 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 $A short positions now largely unwound, it’s likely that the short covering rally in the $A, that saw it rise from a low of $US0.8660 in January to a high of $US0.9461 recently, 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. Tax hikes if implemented would likely also 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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