Weekly market & economic update – week ending 5 September, 2014
08
Sep
2014
From Shane Oliver - AMP chief economist
Investment markets and key developments over the past week
- Share markets were mixed over the last week with Eurozone shares up on the ECB’s monetary easing and talk of a ceasefire in Ukraine, Japanese and Chinese shares up but US shares down partly on worries that strong data might bring forward a Fed rate hike and Australian shares down. Bond yields mostly rose, but yields in peripheral Eurozone continued to slide. The ECB easing saw the euro continue to slide with the rising $US weighing on commodity prices, but the $A remaining stubbornly strong despite a sliding iron ore price.
- ECB announces quantitative easing (QE). In response to poor growth and the rising risk of deflation the ECB eased more than expected in announcing a 0.1% cut to its official interest rate taking it to just 0.05% and that it will begin buying asset backed securities with the aim of expanding its balance sheet by €1 trillion. The ECB won’t announce the details of its asset buying program till next month, but by indicating it will include mortgage backed securities and covered bonds it has effectively allowed a much larger scale program. It’s not US style QE as the ECB will not be buying government bonds (at this stage anyway), but it will have the same effect in pumping cash into the economy, displacing investors from relatively low risk investments and forcing them to take on more risk which will lower the cost, and improve the availability, of funding throughout the economy. And its latest rate cut will lower the cost of cheap four year funding for the banks to just 0.15% pa. Will it work? It will certainly help, particularly all the talk of money printing will head of a deflationary mentality taking hold.
- Ukraine is not over yet. While there was a bit of hope regarding a possible cease fire in Ukraine, this may be Russia’s attempt to look constructive ahead of a NATO summit. At this point the two sides still look far apart and so it’s too early to get optimistic. There are essentially three scenarios worth considering for investors regarding Ukraine. First a peaceful resolution soon, which would probably see Ukraine stay out of the EU and NATO to appease Russia. Second, an escalating war between Ukraine and Russia. Third, an escalating war that draws in direct military involvement from the West led by the US and Europe. Of these: the first would be a minor positive for global share markets but would quickly be forgotten; the second would be a source of volatility but like now would only be a major issue if sanctions get ramped up, but would ultimately not derail the global economic expansion; and the third would be a major concern for the global economy and hence could see a sharp fall in share markets. However, the chance of third scenario occurring – ie direct conflict between the West and Russia occurring is very low. The West may respond with escalating sanctions and NATO sabre rattling but it’s very unlikely to engage in anything approaching direct conflict with Russia for the same reason it didn’t through the Cold War (ie Russia is a nuclear power). So we remain of the view that Ukraine will likely remain a source of uncertainty for investors (and slower growth for Europe), but it’s unlikely to derail the global economic expansion.
- In Australia, there was nothing new from the RBA which left interest rates on hold for the 13th month in a row and reiterated that a period of stability remains prudent with this message effectively backed up by a speech by Governor Stevens. Right now the uncertainty around the economic outlook and the strong $A preclude any thought of a rate hike, but by the same token signs the economy is responding to lower rates and the risk of boosting financial risk and house prices preclude rate cuts.
- Meanwhile, there seems to be lots of doom and gloom on Australia lately with talk of the economy in the “danger zone” and even ads on my iPad apps screaming “Australian recession 2014 – why it’s unavoidable…” This is way over the top! Sure the fall in commodity prices and specifically the iron ore price is a blow to national income. But thankfully lower interest rates are helping to drive a bounce back in the sectors of the economy like housing and retailing that were suppressed by the mining boom. And there is still plenty of scope for interest rates to fall further if needed and for the Australian dollar to fall, which I think it will over time, providing a shock absorber for the economy. But the real story on the Australian economy – as evident in the data seen over the last week – is that the shift back to a more balanced economy is proceeding.
- It’s been a somewhat messy week for policy making in Australia. The mining tax hit the dust, but the increase in the super levy has been delayed yet again, leaving likely super retirement savings inadequate for most workers needs and there’s talk of a fund to bailout failing companies. While the latter is nice in theory, in practice such government intervention rarely works, so hopefully the Government will reject it.
Major global economic events and implications
- US economic data was pretty solid with the ISM indexes rising to very strong levels, construction activity and auto sales rising solidly and labour market indicators remaining strong. This is all keeping alive the prospect of a Fed rate hike coming earlier than mid next year.
- In Europe, economic news was mixed with a downwards revision to August PMIs albeit to levels still consistent with modest growth but a sharp rebound in German factory orders.
- The Bank of Japan made no changes to its super stimulatory monetary easing program. But there was good news on the economic front with nominal cash wages up 2.6% over the year to July suggesting wages growth and inflationary expectations are responding to the BoJ’s campaign to end deflation.
- Chinese economic data was mixed with the manufacturing conditions PMI for August falling back a bit, but services conditions PMIs strengthening suggesting that overall growth remains okay.
Australian economic events and implications
- The avalanche of economic data in Australia over the last week painted a reasonably hopeful picture for the economy. Sure the ongoing slide in the terms of trade is a blow and growth slowed in the June quarter, but the growth slowdown was nowhere near as bad as many feared and there are clear signs of improvement in the non-mining economy. Given that the main reason for the slump in quarterly growth from 1.1% in the March quarter to 0.5% in the June quarter relates to volatility in exports and imports it makes sense to average the two quarters which gives 0.8% quarter on quarter or 3.2% annualised, which is a pretty good outcome given the circumstances. More fundamentally, July data for retail sales point to a bounce back in consumer spending growth in the current quarter, the trade deficit also improved in July suggesting that net export volumes are likely to bounce back and continued strength in building approvals points to ongoing growth in dwelling construction.
- The June quarter National Accounts also included a couple of long term positives for Australia. First, productivity growth is solid at 3.2% year on year in the market sector, which will help minimise the hit to living standards from the fall in the terms of trade. Second, the household saving rate remains strong at 9.4% indicating households have a good buffer against shocks to income and are continuing to improve their net debt position.
What to watch over the next week?
- In the US, August retail sales data (Friday) are expected to show modest growth after the disappointingly flat outcome for July. This is likely to be supported by a further lift in consumer confidence (also Friday).
- In China, the focus will be on data releases for August. Expect trade data (Monday) to show exports up 10% and imports up 4%, lending and credit data to show a bit of a bounce back after weakness seen in July, CPI inflation (Wednesday) falling back to 2.2% year on year and slight moderations in growth for retail sales, fixed asset investment and industrial production (Saturday).
- In Australia, expect ANZ job ads (Monday) to show a further trend gain, housing finance (Tuesday) to rise 1%, the NAB business confidence and conditions measures (also Tuesday) to remain around the reasonably solid levels seen in July, consumer confidence (Wednesday) to show a further slight improvement and employment to show a 10000 gain with unemployment falling back to 6.3% after July’s partly statistical spike.
Outlook for markets
- While shares have seen a strong recovery from the early August mini-slump, 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 and the September-October period often being tough in Australia.Relatively high short term optimism readings in the US also warn of the risk of a correction and there is no shortage of potential triggers including worries about the Fed and Ukraine.
- 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.
- Low bond yields, eg 10 year yields of just 0.5% in Japan and 3.4% 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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