Weekly market & economic update – week ending 10 October, 2014
13
Oct
2014
From Shane Oliver - AMP chief economist
Investment markets and key developments over the past week
- The correction in shares continued over the last week. While dovish minutes from the Fed’s last meeting provided mid-week support it was short lived as nervousness about growth in Europe and the broader global growth outlook, along with worries about Ebola weighed. This saw most share markets fall. From their highs last month US shares have fallen 4%, global shares are down 5% and Australian shares are down 8%. The Australian share market has effectively led the global share markets on the way down reflecting falling iron ore prices, fears about Australian banks needing to raise more capital and the tendency for foreign investors to stay away as the $A falls. Reflecting falling global inflation expectations and safe haven demand bond yields generally fell. The $US had a fall from overbought levels and this saw the $A bounce but commodity prices were mixed with oil prices down sharply but metal prices up slightly. World oil prices are now down 20% since the problems with IS in Iraq first hit the global headlines a few months ago.
- A downgrade to the IMF’s outlook for global growth is clearly weighing on sentiment. The downgrade was only modest taking its global growth forecasts down by just 0.1% to 3.3% for 2014 and down by 0.2% to 3.8% for 2015, but it nevertheless highlighted the softness in global growth momentum outside the US. However, it was hardly new news, as weakness in Europe, Japan, Brazil and Russia is well known, and is just a repeat of the pattern seen in the last few years where stronger global growth is forecast in the year ahead only to be revised down as we get closer to it. In some ways the uneven, “not to hot, not too cold” global economic expansion is not bad as it means we remain a long way from overheating, higher inflation and aggressive monetary tightening.
- The minutes from the last Fed meeting clearly recognise this with the Fed highlighting that its move towards rate hikes is not on auto pilot but dependent on how the economy performs and that it will allow for the dampening impact on US growth and inflation from foreign weakness and the strong $US. If anything the timing of the first US rate hike, which we have been expecting to come in the June quarter next year, may be getting pushed back a bit (again). This is particularly so with US inflation remaining below target and bond yields falling on the back of falling inflationary expectations.
- In Australia, the RBA remained on hold again as expected with its post meeting statement coming across as a bit dovish with it still seeing the Australian dollar as historically high despite recent falls, domestic demand remaining patchy, modest wages growth seen as keeping a lid on inflation and relatively sanguine comments regarding house prices. Given this the RBA looks set to leave rates on hold well into next year, with no hikes likely till after the Fed starts to hike. This is likely to mean no move until the second half next year. Rates have now been on hold at 2.5% for 15 months, which is still well below the 20 month record when rates were left at 7.5% from December 1984 to July 1996.
Major global economic events and implications
- US economic data was light on but okay. Labour market indicators were good with job vacancies up in August and weekly unemployment claims continuing to fall. Meanwhile, the September quarter earnings reporting season has kicked off with Alcoa, Costco and Pepsi all beating expectations. Market expectations for 6% year on year earnings growth for the year to the September quarter are likely to prove too conservative yet again.
- Eurozone economic data has been poor with sharp falls in German industrial production and factory orders and weak exports from both Germany and France with ECB President Mario Draghi under pressure to do more as he reiterated that the Eurozone recovery is losing momentum.
- The Bank of Japan left monetary policy unchanged, continuing to pump out cash at a faster rate than the Fed ever did, but mixed economic data – with a fall in economic sentiment but gains in machine/tool orders – leaving it under pressure to do even more.
- Chinese non-manufacturing PMI’s fell in September, but remain okay and ongoing mini-stimulus measures helped buoy the Chinese share market some more, which is now up 12.9% this year. In fact, after performing poorly for several years Chinese shares this year are now one of the world’s strongest this year.
Australian economic events and implications
- In Australia, the confusion around monthly jobs data was heightened as the ABS concluded its seasonal adjustment process had distorted recent jobs data and so switched to reporting original or unadjusted data. While this has led to a mini-furore the monthly jobs data at the best of times has a big noise element and the ABS has long urged us to focus on the trend data. Maybe we would be better off if it just published quarterly jobs data – less time would be wasted analysing noisy confusing data! Statistical noise aside the basic picture is of modest jobs growth and a gradual rise in the unemployment rate – all of which is consistent with the RBA’s decision to leave interest rates on hold at record lows. The good news is that forward looking jobs indicators like job ads and hiring plans in the NAB survey, point to stronger growth at some point ahead. Other data was mixed with softer than expected housing finance, but a record high reading for the AIG’s construction conditions PMI and another very low inflation reading from the TD Securities Inflation Gauge for September.Out of interest the ABS also confirmed what many have long suspected – that the share of housing finance going to new home buyers is way understated! So maybe we don’t have a first home buyer crisis afterall.
What to watch over the next week?
- In the US, the main focus is likely to be on a speech by Fed Chair Yellen (Friday) for anything new on the monetary policy outlook but she is likely to simply confirm that the timing of interest rate hikes remains dependent on the state of the economy and right now there remains significant slack in the labour market. On the data front: expect a modest pullback in September retail sales (Wednesday) as payback for strong gains seen in August, but underlying retail sales growth to remain solid; benign producer price inflation (Wednesday); solid growth in industrial production (Thursday) and continued strong readings in the New York and Philadelphia Fed manufacturing conditions surveys (due Wednesday and Thursday respectively); a further gain in the NAHB home builder index (Thursday); and a rebound in housing starts and permits (Friday). The Fed’s Beige Book will also be released.
- Chinese export and import growth for September (Monday) is expected to show an acceleration but inflation for September (Wednesday) is expected to have fallen to just 1.7% year on year with producer price falls intensifying highlighting significant potential for more monetary easing. Credit and money supply growth is likely to show a modest improvement after recent weakness.
- In Australia, the NAB business survey (Tuesday) will be watched to see if business conditions and confidence have remained around the reasonable levels seen in August and the Westpac consumer confidence survey (Wednesday) will be watched for a bounce after the weakness seen in September. June quarter data for dwelling starts ((Wednesday) are likely to show further strength.
Outlook for markets
- The weakness we have seen in shares over the last month could well have further to run in the short term. While Australian shares have led with a fall of 8%, the pull back in US shares of just 4% to date is quite modest and nervousness is likely to remain in the near term regarding the Fed’s probable ending of quantitative easing later this month, the upcoming bank stress test results in Europe, Ebola and various geopolitical issues. We are also still at the tail end of a messy time of year for shares from a seasonal perspective.
- However, this is still likely to be just a normal correction rather than the start of a new bear market. Share valuations are already pushing well into cheap territory (the forward PE on Australian shares has fallen from 14.8 times to 13.7 times), the global growth outlook remains for okay growth, monetary conditions globally and in Australia look like they will remain very easy with Europe and Japan filling the quantitative easing gap that will be left by the US and US rate hikes looking even further away and investor sentiment is starting to get bearish again which is positive from a contrarian perspective. The lower Australian dollar will also help boost growth in Australia and eventually profits. So for these reasons the correction should be seen as providing a buying opportunity. October is often a month where market falls come to an end ahead of the Santa Claus rally into year end and I expect to see the same happen this year. Getting the end of QE3 over with, seeing the ECB’s bank stress test results and the ECB start up its QE program (all due later this month) are likely to help in this regard.
- Low bond yields will likely mean soft returns from government bonds. That said, in a world of too much saving, spare capacity and low inflation it’s hard to get too bearish on bonds.
- In the short term the Australian dollar has fallen a bit too far too fast (just as the $US has risen too far to fast), so a short covering bounce could well emerge over the next month or so. That said the broad trend in the $A is likely to remain down reflecting soft commodity prices, the likelihood the Fed rate hikes before the RBA and the relatively high cost base in Australia. Expect to see it fall to around $US0.80 in the next year or so.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
————–
