• Global shares had another rough week on worries about global growth and the Ebola scare continued to build. This saw most share markets fall, but Australian shares having led on the way down managed to rise over the last week as investors started to look for bargains. 8% yields on Australian banks are hard to resist. Global shares are now down 8.5% from their September high and Australian shares are down 6.8% (although this has been pared from an 8.9% decline to the low on Monday. Bond yields continued to slide on global growth fears and on the back of safe haven buying. Commodity prices remained under selling pressure but the Australian dollar rose slightly as the $US pulled back a bit on talk that the Fed may delay the end of QE and/or rate hikes.
• While doom and gloom is now rife, there are some signs that shares may be at or close to a low: the 8.5% correction in global shares is around the size of the average correction seen since the current bull market began; in fact US and Australian shares have had a healthy correction of nearly 10% top to bottom using intraday data; markets that led on the way down like Australian shares and US small caps have been clawing back in the last few days; the last few sessions have seen US and Australian shares rebound from intraday lows suggesting that bulls may be starting to get the upper hand; investor sentiment is now so bad that its good – with our composite measure of investor sentiment in the US having fallen to levels often associated with share market lows (see chart at left below); and the month of October is known for seeing shares start to turn back up ahead of a rally into year-end (chart at right). And the fall in share markets has seen shares move well into cheap territory (with the forward PE on Australian shares at around 13.7 times being well below its long term average) and lower bond yields also adding to the relative cheapness of shares.

• The Fed may delay ending QE and rate hikes. Various Fed officials have added to the message that the Fed will allow for the impact of softer global growth and the stronger $US and that it may result in a delay to rate hikes. I suspect that they might now get pushed into the September quarter next year. Two Fed officials even referred to possibility of more quantitative easing or a delay to the end of the current program if needed to head off falling inflation expectations. Fed President Bullards comment regarding extending QE are particularly significant because he often provides a lead on where the Fed is heading. The key is that the Fed is not on a pre-set path towards monetary tightening and there is now a good chance that QE will not end this month.
• In Australia, RBA Assistant Governor Guy Debelle reiterated the view that the $A is still too high and the RBA’s concerns about the potential for financial market volatility and in particular warning of a potential “violent” sell off in fixed income markets if the outlook for low interest rates changes. Of course the latter was taken out of context by the media in referring to financial markets generally – as they say bad news sells! At this stage though there is no sign of any end to the low interest rate environment. Yes we are getting the volatility, but bonds are rallying as global growth is yet again disappointing pushing out any eventual global monetary tightening/higher interest rates. More broadly central banks and the IMF need to be very careful in what they wish for here. In providing monetary stimulus a key aim was that investors take on more risk thereby spreading easier monetary conditions through the economy and facilitating economic recovery. Warnings to the effect that we are now seeing unsustainable bubbles (I don’t see many), frothy markets and the risk of violent sell-offs to the extent it adds to investor panic risks undoing all they have sought to achieve over the last few years.
• The risk around Ebola is clearly continuing to increase with more cases in the US after botched medical protocols. Our base case remains that it should be easier to control its spread in the US and in western countries and as such it will remain largely contained to Africa but with short term bouts of share market volatility around Ebola scares. But recent events in the US suggest that the risks have gone up.

Major global economic events and implications

• US economic data was mixed with retail sales falling more than expected in September, albeit after a strong August, manufacturing conditions deteriorating in the New York region, small business confidence down slightly and home builder conditions falling but against this jobless claims continued to slide, industrial production rose strongly, manufacturing conditions in the Philadelphia region remained strong and the Fed’s  Beige Book of anecdotal evidence described growth as modest to moderate. Weak producer price inflation highlighted the risk that US inflation will continue to undershoot the Fed’s 2% inflation objective. There was some very good news with the budget deficit in fiscal 2014 falling to 2.8% of GDP (lower than Australia’s budget deficit!) which is well down from its 10% peak in 2009. It’s also noteworthy that falling mortgage rates and gasoline prices are set to provide a boost to household finances.
• It’s still early days in the US reporting season for September quarter profits but so far so good. Of the 71 S&P 500 companies to have reported so far, 74% have beaten earnings expectations (against a norm of 63%) and 61% have beaten on sales.
• Eurozone data was mostly soft with industrial production down in August and the ZEW survey of investment analyst confidence falling sharply in October. German unemployment fell to 6% though providing some positive news.
• Chinese credit growth continued to slow, albeit remaining solid, but money supply growth picked up marginally and trade data provided positive news with much stronger than expected growth in exports and imports for September. Inflation data was also weaker than expected with CPI inflation at its lowest in more than four years and the annual rate of decline in producer prices accelerating. Quite clearly China is operating well below its potential adding to global deflationary risks and there’s significant potential for rate cuts.
• India also saw good news on the inflation front with both consumer and whole sale price inflation falling sharply suggesting the next move by the Reserve Bank of India will be a rate cut. That global interest rates are still going down, not up was highlighted by a cut in Korea’s policy rate to 2% from 2.25%.

Australian economic events and implications

• Australian economic data was somewhat subdued with a fall back in business conditions and confidence to below average levels (albeit at least up on last year’s lows) and only a modest rise in consumer confidence in October leaving it below average levels too. Dwelling commencements also fell in the June quarter but after two very strong quarters and with building approvals pointing to a rebound in the September quarter. Dwelling starts are running around 180,000 pa which is in line with underlying demand after many years of shortfalls.

What to watch over the next week?

• In the US, September inflation data (Wednesday) is likely to remain benign with inflation falling to 1.6% year on year adding to the lack of pressure on the Fed to eventually raise interest rates. Meanwhile existing home sales (Tuesday) and house prices (Thursday) are expected to show modest gains, but expect new home sales (Friday) to reverse some of the 18% gain seen in August. Markit’s manufacturing conditions PMI (Thursday) is expected to have remained strong at around 57.5.
• In the Eurozone, Markit’s business conditions PMIs are expected to remain down on the highs seen in July continuing to raise concerns about a loss of momentum in growth. The main focus though will likely be on the October 26^th release of the ECB’s much anticipated bank Asset Quality Review and Stress Tests. This will assess the adequacy of 130 Eurozone banks’ capital levels against both baseline and adverse scenarios and those that fail will be given 6 to 9 months to boost their capital ratios. Some failures are possible but mainly for unlisted and mutual banks, but not many of the major listed banks are likely to fail given pre-emptive capital raisings (€75bn since 2013) and conservative lending practices in the lead up to this review. In fact, just as occurred with the Fed’s stress test of US banks in 2009 it could prove to be a watershed event that helps restore confidence in Eurozone banks and clears the way for more bank lending.
• Chinese activity data for September (Tuesday) is expected to show a bounce in industrial production to 7.5% year on year growth from 6.9%, but a further slight loss of momentum for retail sales and fixed asset investment. Stronger exports are likely to have helped support GDP growth but not enough to prevent a further slight slowing to around 7.2% year on year. The HSBC flash manufacturing PMI for October (Thursday) is likely to have remained around the 50 suggesting relatively stable growth.
• In Australia, the focus will be on September quarter inflation data (Wednesday) and a speech by RBA Governor Stevens (Thursday). September quarter inflation is likely to be benign helped by lower petrol and fruit & vegetable prices and the removal of the carbon tax. Expect headline inflation of 0.4% quarter on quarter and 2.2% year on year and underlying inflation of 0.5% quarter on quarter and 2.6% year on year. RBA Governor Steven’s speech will be watched for any updated comments on the outlook for interest rates but he is likely to retain the on hold with a dovish tone evident in the RBA’s last post meeting statement. The minutes from the last meeting (Tuesday) and speeches by RBA officials Kent and Lowe will also be watched closely but are all unlikely to signal any deviation from the RBA’s “period of stability” stance on interest rates.

Outlook for markets

• Our assessment remains that recent falls in shares represent a correction and not the start of a new bear market. Share valuations have now pushed 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 (“not too hot, but not too cold”), 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 now very 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.  Seeing the ECB’s bank stress test results and the ECB start up its QE program (both later this month) are likely to help in this regard.
• Low bond yields will likely mean soft medium term 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.
• n the short term the Australian dollar has fallen too far too fast (just as the $US has risen too far to fast), so a short covering bounce could well emerge. That said the broad trend in the $A is likely to remain down reflecting soft commodity prices, the likelihood the Fed hikes interest rates 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.

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By Dr Shane Oliver, Head of Investment Strategy & Chief Economist

Important note:While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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