Investment markets and key developments over the past week
- Share markets continued to recover over the past week as QE3 ended in the US uneventfully, US profits and economic data continued to impress and news out of the Eurozone and Japan was a bit better than expected. US shares have now recovered 90% of the falls seen in their recent correction and Australian shares have recovered about 70%. Despite the rebound in share markets, bond yields were little changed. Commodity prices were mixed with gold sliding on the ending of US QE, but metal prices rose. While the Yen and the euro fell against the $US, the $A rose slightly.
- The main event over the past week was the Fed’s long anticipated ending of its quantitative easing program. The basic messages from the Fed are that the US economy, including the labour market, is continuing to improve justifying an end to QE but that there is no rush to raise interest rates signalling that it still anticipates a “considerable time” to elapse before the first rate hike. While the Fed is now dependent on how the data unfolds, our assessment is that the first rate hike won’t come till mid next year or later.
- While economic news in Europe remains messy there are two pieces of good news. First, the ECB’s bank stress tests are now out of the way with the results being slightly better than feared entailing capital raising of €5bn to be carried out over the next 6-9 months which is far less than has already occurred over the last year. More importantly, now that it’s out of the way Eurozone banks are likely to be less focused on shrinking their balance sheets and more focussed on lending. Second, a compromise appears to have been reached on French and Italian budget plans which may clear the way for a more relaxed fiscal approach in Europe.
- Geopolitical risks seem to be fading a bit: the threat from Ukraine is receding as the “ceasefire” seems to be holding and Russia has agreed to resume oil flows to Ukraine; the threat from the Hong Kong protests has faded; and there has been some more good news on Ebola with the WHO and others reporting signs that the number of new Ebola cases in Liberia may be peaking.
- The re-election of President Dilma Rousseff in Brazil highlights the messy outlook for the emerging world these days. Many badly need economic reforms, but while some like India seem to be embracing it, others like Brazil are opting for more of the same. In fact, Brazil and other countries in South America look to be sliding back into the old Latam populist ways that held them back for decades. The emerging world continues to offer huge opportunities for investors but you need to be a lot more selective than say a decade ago.
Major global economic events and implications
- US economic data continues to paint a picture of an economy not shooting the lights out, but doing okay. September quarter GDP growth was solid at 3.5% annualised, but was exaggerated by lumpy contributions from defence spending and trade and GDP is only up 2.3% year on year so it’s a long way from booming. More timely data shows the trend remaining up in durable goods orders, the Markit services PMI falling in October but to a still very strong level, home prices gradually rising nationwide and consumer confidence at a seven year high.
- September quarter earnings for US companies continue to impress. So far 348 S&P 500 companies have reported with 80% beating on earnings (compared to a norm of 63%) which look to be coming in around +10% year on year and 60% beating on sales where growth is running around 5% year on year.
- Eurozone economic data was if anything a little more positive than expected. The German IFO survey was worse than expected, but against this economic confidence amongst consumers and business rose in October confirming the earlier reported improvement in PMIs, there was a further improvement in the momentum of money supply and bank lending, the latest ECB bank lending survey showed increased loan demand and Spanish GDP rose in the September quarter for the fifth quarter in a row. So maybe Europe is not quite on the brink of the recession that many have been fearing lately.
- Japanese data provided signs it may be throwing off the hit to growth from the sales tax hike with September data showing good gains in industrial production and retail sales. That said labour market and household spending data was weaker than expected and core inflation ex the impact of the sales tax hike continues to run around just 0.5% year on year. Reports the Government pension fund will boost its share allocation is providing an additional boost to the Japanese share market.
Australian economic events and implications
- Australian data releases were light on. Export prices fell sharply again in the September quarter as had been expected given the falling iron ore price indicating a continuing fall in the terms of trade. Falling import and weak producer prices also highlight ongoing weak inflationary pressures. Meanwhile, investor credit for housing accelerated to 9.5% growth over the year to September which will likely serve to reinforce the RBA’s inclination to impose macro prudential controls. Against this though, while new home sales remain well up on their lows from two years ago, they were flat in September and have been basically flat all year now. There was some good news with a bounce in the weekly Roy Morgan consumer confidence index.
- While much excitement was generated by the Government’s increase in fuel excise next month the impact will be trivial, amounting to no more than a 0.3% increase in the price of petrol which will cost the average household no more than 20 cents a week. In fact, it will be swamped by the influence of the 20% fall in global oil prices over the last few months.
What to watch over the next week?
- In the US, the midterm Congressional elections (Tuesday) will be watched keenly because the Republicans will likely increase their House majority and get a small minority in the Senate. This is likely to be taken well by investors to the extent that Republicans are seen as more market friendly. While compromise with President Obama will still be needed it’s likely that the reduced Tea Party influence and President Obama’s desire for a positive legacy will see agreement reached on issues like raising the debt ceiling again in early 2015 (the current debt ceiling extension runs out in March 2015) and corporate tax reform. On the data front, expect more solid readings on the economy with the October manufacturing conditions ISM (Monday) to remain around the 56 level, the non-manufacturing ISM (Wednesday) to come in at around 58 and jobs data (Friday) to show a gain of 230,000 with unemployment remaining at 5.9%. Data for the trade balance (Tuesday) and productivity (Thursday) will also be released. September quarter earnings will also continue to be released.
- The ECB is unlikely to announce any further policy easing when it meets Thursday given its recent easing moves. Eurozone retail sales data will be released Wednesday.
- In Australia, the RBA is likely to leave interest rates on hold at 2.5% for the 16th month in a row as nothing much has changed since the October meeting and benign inflation in the September quarter, sub-par growth and the still high $A support the case for rates to remain low. The RBA’s Statement on Monetary Policy (Friday) is expected to imply that rates will remain on hold well into next year. The Statement will also be watched for more details on possible macro prudential measures to slow property investment. While 16 months on hold sounds like a long time it’s still short of the 20 month record that was set between December 1994 and July 1996, but it’s likely this record will be breached as a rate hike looks unlikely until around mid-next year.
- On the data front we will get the usual avalanche that accompanies the turn of each month with data for house prices, the TD Inflation Gauge, jobs ads, the manufacturing conditions PMI and building approvals (all Monday), the trade balance and retail sales (Tuesday), the services PMI (Wednesday) and employment (Thursday). Of these expect to see a slight fall in building approvals and modest growth in retail sales. Given recent problems the jobs data are anyone’s guess but expect the unemployment rate to remain 6.1%.
Outlook for markets
- Having had a decent correction over September and into early October, shares are having a good rebound and are well placed to put on further gains into year-end as the cyclical bull market that started in 2011 remains alive and well. Valuations particularly against the reality of low bond yields are good; monetary policy is set to remain easy with QE in Europe and Japan replacing that in the US and rate hikes in the US and Australia being a long way off; and investor sentiment remains bearish and cautious, with it seems everyone worried about global growth and the end of QE3, which is positive from a contrarian perspective. Australian shares will benefit from the positive global lead and will also benefit from the lower Australian dollar. While my guesstimate of 5800 for the ASX 200 at year end is a bit of a stretch it’s not out of the ball park anymore with the ASX 200 having risen 350 points in less than 3 weeks.
- 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.
- To its recent low of $US0.8640 the $A fell a bit too far too fast (just as the $US rose too far to fast), so a short covering bounce has been underway and could go further. 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.
By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
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