The bounce back in global shares continued over the last week led by the US share market which has broken above its 50 day moving average and cut its year to date decline to -4.5% from -10.5%. This was helped by higher oil prices and metal prices also gained. However, Australian and Chinese shares fell, bond yields mostly fell and despite a slight rise in the $US the $A also managed to rise.

Will there be a crash in Australian property prices? Foreign hedge funds and various commentators have been calling such an event for a decade or so now and have proved wide of the mark. Yes Australian home prices are likely to see yet another 5-10% cyclical fall at some point in the next few years and yes home prices are overvalued posing a downside risk, but a 50% crash is unlikely. The latest crash call aired on 60 Minutes has raised nothing that wasn’t already well known. Australian property is no more overvalued than it was a decade or so ago. The ratio of household debt to income is about the same as it was prior to the GFC, but interest costs have collapsed and there are no signs that Australians are having trouble servicing their debts. Sure there has been some easing in lending standards – but I just don’t accept that Australian banks don’t regularly check for proof of income (mine does) in processing loan applications, particularly with APRA breathing down their necks on “bubble” worries.

To get a crash we will either need a massive rise in interest rates (which is unlikely because the RBA is not stupid) or a deep recession in the economy which seems unlikely. Seems to me that some people have just seen the Big Short and want to be film stars (or least are desperate to find the next big short). The trouble is that shorting Australian banks is becoming a rather crowded trade.

Major global economic events and implications

US economic news was a mixed bag. On the down side February data showed falls in consumer confidence and the Markit manufacturing and services conditions PMIs. These could all be in response to recent share market turbulence and bad weather or they could be indicative of a fundamental deterioration in the economy. On the upside though, durable goods orders rebounded in January and existing home sales and home prices are solid and the trend in unemployment claims is continuing to reverse the rise seen into January. Given the mixed data though and ongoing global uncertainties it still makes sense for the Fed to back off on raising rates. The market is attaching a 10% probability to a March hike.

Eurozone PMIs also dipped in February adding to the case for the ECB to ramp up its stimulus next month, even though the level of the PMIs is still consistent with reasonable growth. Bank lending picked up in January but it’s too early to see the effect of recent market turmoil on bank lending.

Japan’s manufacturing conditions PMI also fell in February, and with core inflation falling to 0.7% year on year pressure remains on the Bank of Japan to provide more stimulus.

China’s stimulus efforts can be seen in a blow out in its budget deficit to a record -3.5% of GDP last year from -1.8% of GDP in 2014. Over the year to January public spending is up 24% year on year versus just 6% for revenues.

Australian economic events and implications

In Australia, wages growth slowed further in the December quarter and the business investment outlook remains weak, but it’s not all bad. Low wages growth partly reflects the loss of high paying mining jobs but the creation of lower (more normally) paid jobs in Sydney and Melbourne. It means that there is no inflation pressie from labour costs but has also allowed jobs growth to be higher than might otherwise have been the case. The message from business investment plans is that the unwind of the mining investment boom is continuing at the rate of about -35% pa. However, by the end of the next financial year this will have largely run its course, so the drag on GDP will abate. And the good news is that the capex plans point to a rise in non-mining investment next financial year.

The Australian December half profits reporting season is now basically done. As always the quality of the results tailed off through the last week, but overall results were much better than feared. 47% of results have bettered expectations (against a norm of 44%) with only 21% coming in worse than expected (against a norm of 25%), 66% have seen profits up on a year ago and 64% have raised their dividends (against a norm of 62%). It’s tough out there for resources stocks but no more than expected. Meanwhile, most of the big banks are seeing reasonable results and stocks exposed to the Australian economy, led by housing and the consumer, are doing well. The better than feared nature of the results to date has been reflected in 64% of stocks seeing their share price outperform the market the day results were released. Overall profits are on track to fall around 5% this financial year but this is due to a 65% slump in resources profits. Outside of resources, profits are rising by around 5%.

What to watch over the next week?

In the US, various business surveys and jobs data will be watched for clues as to how the US economy is progressing. Expect the manufacturing ISM (Tuesday) and non-manufacturing ISM (Thursday) to show slight improvements and growth in payroll employment to pick up to around 195,000 after January’s softer result. Data for pending home sales (Monday), construction spending (Tuesday) and trade (Friday) will also be released along with the Fed’s Beige Book of anecdotal evidence.

Eurozone inflation data for February to be released Monday is expected to have remained low, with January unemployment data remaining around 10.4%.

In Japan, expect January industrial production (Monday) to rebound after a poor December, labour market data to remain solid and household spending (both Tuesday) to have remained weak.

In China, the fourth session of the National People’s Congress starting Saturday may see more stimulus measures announced with a bigger budget deficit (it was 3.5% of GDP in 2015), more infrastructure and social spending, new investment projects and some details around supply side reforms. Ahead of this the monthly round of business conditions PMIs starting Tuesday will be watched for signs of stabilisation with expectations for a slight rise but some private surveys pointing to weakness.

In Australia, the RBA is expected to leave interest rates on hold yet again. While it has an easing bias, there has not been enough bad news since the last meeting to cause it to act on it. Australian economic data has mostly been okay and financial markets have settled down a bit. However, I remain of the view that the combination of sub-par growth, low inflation and the threat of a rising $A as the Fed delays easing will prompt the RBA to ease again around May.

Meanwhile we will see the usual Australian data avalanche that accompanies the release of quarterly GDP data. Expect continued moderate credit growth (Monday) as owner occupiers replace investors in housing loans, building approvals (Tuesday) to fall 5% after a strong December, modest growth February home prices (also Tuesday), December quarter GDP growth (Wednesday) to have slowed back to 0.4% quarter on quarter or 2.5% year on year after the strong trade driven contribution seen in the September quarter, a continued large trade deficit (Thursday) and 0.3% growth in January retail sales (Friday).

Outlook for markets

Shares have seen a decent rebound from oversold levels which may have further to go. But with global growth worries remaining it’s still premature to say we have bottomed. Beyond the near term uncertainties, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.

Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get 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%.

An ongoing delay in Fed tightening poses short term upside risks for the $A. However, any short term strength in the $A is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the RBA eventually resumes cutting the cash rate, commodity prices remain weak and the $A undertakes it’s usual undershoot of fair value. We continue to 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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