Investment markets and key developments over the past week
- Share markets were mixed over the past week with good economic data propelling the US share market to record highs and hopes of more ECB stimulus helping in Europe, but with soft data and profits weighing in Japan and Australia and increased Ukraine tensions weighing across the board. Bond yields generally fell back again on the prospect of more monetary stimulus in Europe. While the gold price rose slightly, oil and metal prices fell. Notable on the commodity front has been the renewed fall in the iron ore price partly on the back of worries about the Chinese housing market. Despite this, the seemingly Teflon coated Australian dollar rose over the week.
- The somewhat messy and desynchronised global growth environment remains clearly evident with good news out of the US, but Europe and Japanese data disappointing and geopolitical issues continuing to hover in the background. This all means occasional bouts of uncertainty for investors but as long as the broad trend in global growth is one of improvement, desynchronisation is not bad because it means central banks will stay supportive. Perhaps the bigger risk is that the longer rates stay low, the longer investors will expect this to remain the case which could set up bubble like conditions in various assets as investment yields (be they bond yields, dividend yields, rental yields, etc) get pushed ever lower as investors search for yield. However, for growth assets we look to be early in this process.
- In Australia, the June half profit reporting season is now wrapped up. While aggregate earnings growth in 2013-14 came in slightly lower than expected at the start of the results season thanks to misses by some large cap stocks (notably BHP), at around 12% it was still solid with two thirds of companies seeing gains in profits on a year ago. Rising dividends suggest amongst other things that the corporate sector is reasonably confidence in the outlook. See below for details
Major global economic events and implications
- US economic data was pretty favourable. While home prices were mixed in June and new home sales fell in July, pending home sales rose strongly, the Markit services conditions PMI remained strong, consumer confidence rose and durable goods orders surged. While a 23% rise in July durable goods orders owed to strong aircraft orders, the underlying trend is solid particularly for capital goods orders pointing to solid growth in business investment. Stronger investment also drove an upwards revision to June quarter GDP growth to 4.2% annualised from 4% initially reported.
- While momentum in money supply and bank lending improved a bit in July in the Eurozone, various confidence surveys softened in August confirming the loss of momentum seen recently in European growth adding pressure on the ECB to do more to stimulate growth. Quantitative easing focussed on the ECB using printed money to buy securitized bank loans looks likely to be launched soon.
- Japanese data for July disappointed with a smaller than expected gain in industrial production, continued softness in household spending, a rise in the unemployment rate and inflation falling slightly to 3.4% year on year, or 1.4% after the sales tax hike is allowed for. That said, the jobs to applicant ratio held at its highest since 1992 suggesting companies must be reasonably comfortable. Nevertheless, the soft July data will put more pressure on the Bank of Japan to consider further monetary easing.
- Korea was a bright spot though reporting a much stronger than expected gain in July industrial production.
Australian economic events and implications
- Australian economic data was a bit soft with falls in June quarter construction and equipment investment and a fall in new home sales in July. Private credit growth softened a bit after a stronger than expected rise in June with housing related credit looking like it has peaked on a monthly basis. Business investment plans for the current financial year also point to another decline on the back of falling mining investment. However, this has long been expected and there are some positive signs on the investment front. In particular, residential construction is continuing to rise and investment in what the ABS refers to as “other selected industries” looks like rising solidly in the year ahead. So dwelling construction and non-mining investment are helping to provide an offset to the slump in mining investment.
- The profit reporting season is now over and while the quality of results trailed off at the end as usual, overall it was pretty good. Particularly compared to the nervousness ahead of the results being released. 54% of companies have exceeded expectations (compared to a norm of 43%), which is the best result in nine years; 68% of companies have seen their profits rise from a year ago (compared to a norm of 66%); 65% of companies have increased their dividends from a year ago (up from around 60% in the last two years); and 59% of companies have seen their share price outperform the market on the day they released results, which is the best result in four years. Key themes have been strong profit growth for resources (notably Rio, although BHP disappointed a bit), banks doing well (with a good result from CBA) but no better than expected, ongoing cost control making up for still soft revenue growth and strong growth in dividends reflecting investor demand for income and corporate confidence in earnings prospects. Australian earnings growth for 2013-14 looks to have come in around 12%, which while down a bit from expectations a few weeks ago due to the BHP result causing a slight downgrade for resources, is still a solid outcome. Resources led with a 27% gain, followed by banks up 9% and the rest of the market up around 5%. Consensus expectations for the current financial year remain for 5% earnings growth, but this looks a bit low to me.
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- In the US, expect more solid readings from the ISM and Markit manufacturing conditions PMIs (Tuesday) and services conditions PMIs (Thursday), but the main focus is likely to be on jobs data (Friday) which is expected to show another strong gain in payrolls of 220,000 and the unemployment rate falling back to 6.1%. The Fed’s Beige Book of anecdotes on the economy (Wednesday) and trade data (Thursday) are also due for release.
- In Europe, the main focus will be on the ECB’s meeting on Thursday, where, following President Draghi’s recent comments regarding falling inflationary expectations, there is a 50/50 chance that it will unveil a quantitative easing program involving the purchase of private sector asset backed securities or if not allude that it’s on the way.
- The Bank of Japan also meets Thursday but it’s unlikely to make any changes to monetary policy.
- In China, the official manufacturing conditions PMI for August (Monday) is likely to have fallen back a bit in line with the HSBC flash PMI already released.
- In Australia, the RBA is expected to leave interest rates on hold yet again. Nothing much has changed since Governor Steven’s recent Parliamentary testimony where he expressed comfort with current interest rate settings. Rates have already been cut to record lows and the housing sector has led the response but with mining investment still slowing, non-mining capex still soft and the $A still strong its way too early to consider raising rates.
- It’s also going to be a bit of a data avalanche in Australia. The main focus is likely to be on the June quarter GDP data and here the news is unlikely to be good. Our expectation is for GDP growth of 0.5% quarter on quarter (or 3.1% year on year), but weak readings for net exports, consumer spending and investment suggest the risks are all skewed to the downside. In fact there is a high risk of a slight contraction in GDP. Inevitably this would invite talk of a recession, but as was the case with the previous three negative quarters seen in the last 23 years, a recession is unlikely. First, the soft June quarter result will be payback for the unexpectedly strong trade driven growth seen in the March quarter. So best to average the two quarters out. Second, a range of timely indicators relating to housing, retail sales, consumer confidence and the jobs market point to stronger conditions in the September quarter.
- In terms of other Australian data releases expect to see a further rise in house prices (Monday), a -0.7% contribution to growth from June quarter net exports, weak public demand and a bounce back in building approvals (all Tuesday), another large trade deficit and modest growth in July retail sales (both Thursday). The AIG’s business conditions PMI’s will also be released.
Outlook for markets
- While shares have seen a strong recovery from the mini-slump seen in early August, the correction season consistent with the old adage “sell in May, go away and come back on St Leger’s Day” is still upon us with September historically being the weakest month of the year for US shares partly due to tax loss selling and the September-October period often being tough in Australia.
- However, despite the risk of another correction the cyclical bull market in shares likely has a lot further to go as we still don’t see the signs of shares being over valued, over loved and over bought normally seen at major market tops.Valuations remain okay particularly once low interest rates and bond yields are allowed for, global earnings are continuing to improve on the back of gradually improving economic growth, monetary conditions are set to remain easy for some time and there is no sign of the euphoria that comes with major share market tops. In fact, in terms of the latter there still seems to be a lot of wariness regarding shares. Our year-end target for the S&P/ASX 200 remains 5800.
- Low bond yields, eg 10 year yields of just 0.5% in Japan and 3.5% in Australia, will likely mean soft returns from government bonds.
- The combination of soft commodity prices, the likelihood the Fed will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down. Expect to see $US0.80 in the next few years, but getting the timing right is hard.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist, AMP Capital
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