Weekly market & economic update – week ending 13 June, 2014
16
Jun
2014
From Shane Oliver - AMP chief economist
Investment markets and key developments over the past week
- After four weeks of gains, the past week saw US and European share markets slip as a combination of worries from the World Bank’s global growth downgrades to concern about the impact of the conflict in Iraq triggered a bout of profit taking. While several Asian share markets rose, Australian shares remained under pressure not helped by retail sector earnings downgrades as the iron ore price remained under pressure. Bond yields were generally flat to up, but with the conflict in Iraq keeping a lid on them. Commodity prices were mixed with oil and gold up on Iraq but metal and iron ore prices down on metal financing concerns in China. Despite this, reinvigorated carry trades saw the $A rise further and the euro decline.
- Iraq is a potential correction trigger, but unlikely to be anything worse. Iraq has well and truly hit the headlines again with militants seizing several cities in the north and President Obama weighing America’s options. Quite clearly this is a “new” geopolitical risk for investors to worry about. There are two main concerns: the loss of Iraqi oil production which amounts to just over 3% of world oil production and the threat of wider (Sunni v Shia) Middle East conflict dragging in the US and its allies (again). However, it is worth bearing in mind that we have seen it all before: OPEC looks to have enough spare capacity to meet any short fall from Iraq; US shale oil has reduced the threat to the US which in turn is likely to mean only a limited intervention (eg air strikes as opposed to ground forces); and these Middle East conflicts seem to flare up regularly only to settle down again without turning into a broader conflict. So for these reasons, whilst Iraq could turn out to be the trigger for the mid-year correction that shares are at risk off, it’s hard to see it disrupting the broader global economic recovery and uptrend in share markets. Through time there’s numerous geopolitical threats – eg, North Korea, Syria and Ukraine in recent times – and most of the time after a short flare up they come to nothing.
- The World Bank’s downward revision to its global growth forecast for this year from 3.2% to 2.8% told us nothing new as it reflects long known softness in Brazil, Russia, India and China and the weather related soft patch in March quarter US growth that is now reversing. Expect the IMF and OECD to follow suite for 2014. Forward looking indicators of global growth point up though with the World Bank forecasting 3.4% growth for 2015 and 3.5% for 2016, which we wouldn’t disagree with.
- It’s hard to see a tea party resurgence. Another investor worry in relation to the US is that the primary defeat of House Majority leader Eric Cantor to a tea party candidate in some way represents a tea party resurgence which will work against electoral success in the mid-term Congressional elections for the market friendly Republican Party or lead to a return to more polarised US politics. This seems unlikely though as the Cantor loss looks like a specific case with tea party candidates not faring that well so far this year in other Republican primaries.
- The rise in the $A, driven by a reinvigorated carry trade out of Europe and Japanese bond investors refocusing their bond investments from Europe back to higher yielding Australian bonds is a bit of a concern. With the iron ore price down and consumer confidence hit by the Budget it will make rebalancing the economy harder. In the short term it could go a bit further (eg, back to the $US0.97 high of October last year) but ultimately its likely to see a renewed bout of RBA jawboning to bring it into back into line with soft commodity prices and high relative costs in Australia. As a result the broad trend in the $A is likely to remain down.
Major global economic events and implications
- US economic data remained consistent with a bounce back in growth, with a solid gains in retail sales over the last few months (May was weaker than expected but April was revised up and this followed a very strong March), a rise in small business optimism, an increase in job openings, jobless claims remaining at a low level and good bounce in weekly mortgage applications.
- In Japan there were some good signs that it is weathering its April sales tax hike reasonably well. March quarter GDP growth was revised up to 1.6% quarter on quarter due to stronger business investment which wouldn’t have occurred if business was uncertain about the outlook. More significantly May data showed stronger than expected machinery orders, a bounce back in consumer confidence, a continuing recovery in the Eco Watchers outlook survey to levels seen late last year and stronger than expected bank lending growth. As expected the Bank of Japan left monetary policy on hold.
- Chinese data for May added to confidence that growth has stabilised after the slowdown seen earlier this year and that the various mini stimulus measures are starting to work. While fixed asset investment growth continued to slow a bit, growth in industrial production, retail sales, money supply, bank lending and exports all met or bettered expectations and improved a bit from April readings. While inflation rose due to higher food prices, non-food inflation remained very low at 1.7% year on year indicating no barrier to further monetary easing if required. All up, Chinese growth remains on track for around 7.5% this year.
- There was good news from India that saw lower than expected inflation and faster industrial production.
Australian economic events and implications
- Australian data was a mixed bag with a further increase in housing finance in April, a neutral jobs report – with employment down but only due to part time jobs and unemployment flat at 5.8% and a very slight improvement in business confidence according to the May NAB survey, but the big negative was the that there was essentially no bounce back in consumer confidence after the hit from the May Budget.
- After jobs growth of 103,000 over the first four months of the year the May dip in employment was not surprising and leading labour market indicators such as employment intentions in the NAB survey point to stronger jobs growth ahead. More broadly a range of data indicates the economy has been rebalancing nicely as the mining investment boom has faded. The main uncertainty though relates to the Budget related slump in consumer confidence given the role stronger consumer spending needs to play in rebalancing the economy.
- Hopefully, compromises to get the Budget through the Senate may soften some of the harsher Budget measures and this combined with the realisation by many that the impact is not as bad as feared will see confidence gradually recover, particularly as the housing recovery continues and interest rates remain low. But given the uncertainty and the potential threat from a rising $A, RBA interest rate hikes are unlikely until next year.
What to watch over the next week?
- In the US the main focus will be on the Fed (Wednesday) which is expected to taper its monthly asset purchases by another $US10bn taking them to $US35bn a month, consistent with a run of better economic data lately. However, most interest will likely be on the Fed’s economic projections and Janet Yellen’s press conference. The economic projections may be seen as confusing as they are likely to show downwards revisions to growth and unemployment rate forecasts but an upwards revision to inflation forecasts, some Fed officials bringing forward their timing for the first rate hike and some reducing their projected long run level for the Fed Funds rate. However, Janet Yellen is likely to reiterate that the Fed has a way to go yet to meeting its unemployment and inflation objectives and thus that a considerable time is likely to lapse between the end of quantitative easing and the start of rate hikes. My best guess for the first rate hike remains mid next year, but this doesn’t mean financial markets won’t start to worry about it earlier.
- On the data front in the US, expect to see more solid readings from regional manufacturing surveys (Monday and Thursday), a 0.5% gain in May industrial production (Monday) and further evidence housing indicators are picking up again in terms of NAHB home builders’ conditions (Monday) and housing starts and permits (Tuesday). Expect CPI inflation for May (Tuesday) to have remained benign, albeit confirming inflation has bottomed.
- In Australia, the minutes from the RBA’s last Board meeting (Tuesday) will likely add little to perceptions that interest rates will remain on hold for a while yet.
Outlook for markets
- Shares remain vulnerable to a mid-year correction, just as we have seen in each of the last four years now, with worries about Iraq providing a potential short term trigger. However, in the absence of global monetary shocks as we saw in mid 2010, 2011 and 2013 and with shares having been in a bit of a stealth correction through much of this year, any pull back may well be mild. In any case the broad trend in shares is likely to remain up. Share market fundamentals remain favourable with reasonable valuations, global earnings improving on the back of rising economic growth and monetary conditions set to remain easy for some time. So any dip should be seen as a buying opportunity. Our year-end target for the ASX 200 remains 5800.
- Bond yields are likely resuming their gradual rising trend as its becoming increasingly clear that US inflation has bottomed and this combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.
- While the boost to the carry trade from the ECB risks pushing the $A higher in the short term the combination of soft commodity prices and relatively high costs in Australia are expected to see the broad trend in the $A remain down over the medium term. RBA jawboning is likely to return if the $A goes up too much further.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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