It’s been another volatile week in financial markets as investors continue to fret about the global growth outlook. Share markets remained under pressure but managed to rally off their lows helped by strong signs of further monetary easing from the ECB, with Australian shares actually seeing a small gain for the week despite most other markets being down slightly. The oil price plunged to a new low of $US26.6 but also managed to rally from its lows and metal prices managed to rise. The ECB inspired bounce in risk assets latter in the week also helped push the $A back up to around $US0.70, and saw bond yields little changed for the week.

From their highs last year many global share markets have already fallen into bear market territory (defined as a 20% decline from the high – which this time around was last year). Asian shares (down 28% from last year’s high) and emerging market shares (down 27%) entered bear market territory last year. Japanese shares have had a fall of 23% and Eurozone shares have lost 22%. Australian shares came close in the past week falling to a 19% decline from the high in April last year but US shares have only lost 13% from last year’s high.

With global growth worries likely to linger and US shares having only at a 13% fall despite having more valuation concerns than other markets it’s too early to say that we have seen the low. So the Australian share market could yet be tipped into bear market territory.

However, there were some more positives over the last week.

First, Chinese economic data for December was much better than feared and the Chinese Renminbi has remained relatively stable.

Second, share markets have become very oversold with some technical indicators (RSI’s for example) at levels often associated with at least short term lows.

Third, signs of extreme pessimism and investor capitulation are continuing to build, with our investor sentiment index on US shares nearing levels associated with bounces (see next chart).

Finally, central banks are turning dovish. This started with the Fed’s Bullard last week and now the ECB is signalling more easing at its March 10 meeting if things don’t improve. This is likely to take the form of a €10bn/month increase to the ECB’s quantitative easing program and another deposit rate cut. In the week ahead the Fed is likely to signal a pause in raising interest rates to allow it to reassess the outlook and the Bank of Japan is expected to either ease further or be more dovish.

Our high level view remains that if there is to be a US/global recession then share markets have much further to fall (eg another 20% plus), but if recession is avoided and global growth continues to muddle along around 3% pa then further downside in markets is likely to be limited and they are likely to stage a decent recovery by year end. We see a recession as being unlikely because we have not seen the normal excesses – massive debt growth, over investment or inflation – along with aggressive monetary tightening that invariably precede them.

While on global growth, the IMF downgraded its global growth forecasts for 2016 to 3.4% (from 3.6%) and for 2017 to 3.6% (from 3.8%). This was largely due to growth downgrades in the emerging world and the US. It’s worth noting that though that IMF growth downgrades have been pretty much the norm for the last five years now with the IMF typically starting off with a growth forecast of close to 4% for each year and then having to downgrade it to usually end up around 3%. On one level its negative as it highlights the fragile and constrained nature of global growth since the GFC. But it should also mean that the days of rising inflation and much higher interest rates leading to a sharp economic downturn is a still long way off.

Major global economic events and implications

In the US, home builder conditions and housing starts were a bit weaker than expected but remain solid and should be supported by rising household formation, manufacturing conditions in the Philadelphia region improved in January but jobless claims rose again. Meanwhile headline and core inflation was weaker than expected in December. So far only 67 S&P 500 companies have reported December quarter earnings with 79% beatings on earnings but only 51% beating on sales.

Chinese December quarter GDP growth at 6.8% year on year and December activity data were fractionally weaker than expected but not dramatically so. It tells us that growth is still soft but it’s not collapsing. Policy stimulus measures are helping but more is needed to help the economy as it transitions from a reliance on manufacturing and investment to services and consumption. This transition is evident in industrial production growth of 5.9% over the year to December (which is down from 10% plus up until about four years ago) in contrast to retail sales growth of 11.1% year on year.  That Chinese shares were able to rally on the news tells us that a much worse outcome had been “feared”. This year I expect Chinese growth to edge down to a 6.5% pace with policy stimulus measures continuing to help avoid a sharper slowing. Continued gains in Chinese property prices for December highlight that the risks from a property collapse in China are continuing to recede.

Australian economic events and implications

Australian economic data releases were but generally on the soft side. Consumer confidence fell in January, presumably in response to news of market turmoil, leaving it a bit below average and new home sales fell in again in November. While housing starts rose to a record high in the September quarter, the softening trend in building approvals and new home sales suggest they are likely to have peaked. Meanwhile the TD Securities Inflation Gauge for December points to continued low inflation.

What to watch over the next week?

In the US the big one to watch will be the Fed meeting on Wednesday. The Fed won’t be making any changes to monetary policy but is likely to be dovish in acknowledging the latest downside risks to inflation and support the view that a March hike is now unlikely. The US money market puts the probability of a March high at just 22% and the way things are going the Fed its increasingly likely that the Fed will struggle to put through even one 0.25% rate hike this year.

After the Fed the focus in the US will shift to the December quarter employment cost index which is likely show that wages growth remains benign at 2.1% year on year and December quarter GDP growth which is likely to show growth slowing to just 0.8% annualised due to a large detraction from inventories (both due Friday). In other data expect to see further gains in home prices and little change in consumer confidence (both Tuesday), modest gains in December new and pending home sales and soft December durable goods orders (Thursday).

Eurozone inflation for January (Friday) is likely to remain very low helped by the latest plunge in oil prices.

Expect Japanese data for December to be released on Friday to show continued labour market strength but softness in household spending and industrial production. Core inflation is likely to slip to around 0.8% year on year from 0.9% in November. The Bank of Japan (also Friday) is likely to either provide more stimulus or sound a lot more dovish.

In Australia expect a 6% drop in petrol prices to result in December quarter inflation of 0.3% quarter on quarter or 1.6% year on year (Wednesday). Despite the lower $A, ongoing discounting is expected to keep underlying inflation low at 0.5% quarter on quarter or 2.1% year on year. Inflation is not likely to be low enough to trigger another RBA rate cut in February by it will be no barrier either. The December NAB business survey will also be released Monday, December quarter export and import prices (Thursday) are likely to show a further fall in the terms of trade and credit growth (Friday) will likely show a further slowing in lending to property investors.

Outlook for markets

It’s still too early to say that shares have bottomed, but given increasing pessimism, indications that shares are oversold and more dovish central banks there is a good chance we will see at least a short term bounce. Beyond the near term uncertainties we still see shares trending higher again helped by a combination of relatively attractive valuations compared to bonds, continuing easy global monetary conditions and continuing moderate economic growth. But expect volatility to remain high.

Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get too bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5% and the RBA expected to cut the cash rate to 1.75%.

The downtrend in the $A is likely to continue as the interest rate differential in favour of Australia narrows, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value. Expect a fall to around $US0.60 by year end.

By Shane Oliver, AMP Capital

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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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