• The share market correction continued over the last week with a whole range of issues weighing on confidence including Russian retaliatory sanctions, increased fears of a Russian invasion of Ukraine, the US finally committing to air strikes on northern Iraq, poor data in Europe, strong data in the US continuing to feed Fed tightening fears and even the latest Ebola virus outbreak. From their recent highs US shares have now fallen 4%, Eurozone shares 10%, global shares 4% and Australian shares 3.5%. The risk off tone saw bond yields and metal prices fall and the gold price rise. The $A also came under pressure helped along by a sharp rise in unemployment in Australia and a dovish statement from the RBA.
• The share market correction may have a bit more to run, but we are getting close to a buying opportunity. To be sure, the combination of factors now roiling markets is scary. But this is the usually the case during periods of market volatility. Some of the factors floating around continue to look like an excuse for a correction: Russia’s ban on various agricultural imports will hurt but needs to be put in perspective – Russia only takes 0.3% of Australia’s exports (the same as Turkey), 0.7% of America’s and 4% of the European Union’s; US airstrikes on northern Iraq have been on the cards since June, do not signal a return of US ground forces to that country and are unlikely to threaten the bulk of Iraqi oil exports most of which comes from the south; and numerous pandemic scares have come along in recent years (SARs, bird flu and swine flu) only to fade reasonably quickly. Moreover, if Europe does weaken anew it will be met by more aggressive easing by the ECB and even if these considerations further dampen global growth they will just have the effect of further pushing out any Fed tightening removing what is probably the biggest source of nervousness for investors at present.
• More fundamentally, the absence of investor euphoria and reasonable valuations at recent share market highs, continuing easy global monetary conditions and the improving economic outlook are not consistent with the start of a major bear market. So while the share market correction could go a bit further, it’s likely to prove mild and the broad trend in shares is likely to remain up with new share market highs likely to be seen in the months ahead. The key is to look for signs of the selling exhausting itself in the days/weeks ahead as a signal to buy in. Rising levels of investor pessimism tell us that the complacency seen last month is getting washed out, which in turn will help set up a base for shares to start heading up again.
• Interest rates to remain on hold in Australia. There were no surprises from the RBA which continues to indicate that a period of interest rate stability remains prudent. While the RBA’s quarterly Statement on Monetary Policy had a more dovish tone with its growth forecasts revised down by 0.25% pa and growth not seen rising above 3% until 2016, it doesn’t appear to regard these changes as “material” enough to justify another rate cut. The improvement in housing indicators, business confidence and forward looking labour market indicators tells us that rates are low enough, but with unemployment still rising, the $A still strong and uncertainty remaining about the speed of the mining investment slowdown its hard to justify a hike in rates either. Particularly with inflation expected by the RBA to remain consistent with target helped by weak growth in wages. So while the dovish tone in the RBA’s SOMP implies a greater risk of a rate cut than a hike in the short term, the most likely outcome is an extended period on hold into next year until the cycle eventually starts turning up again. In fact, the first rate hike is unlikely to come until after the Fed has started to raise rates, in other words not until second half 2015.

Major global economic events and implications

• US economic was mostly solid with the Fed’s latest survey of banks revealing a further easing in lending standards and increased demand for credit, a stronger than expected rise in factory orders, a rise in the ISM non-manufacturing conditions index to its highest since 2005, another fall in jobless claims, a smaller trade deficit for June and the mortgage delinquency rate falling to its lowest since 2007.
• Meanwhile, US June quarter earnings results remain strong. 90% of the S&P 500 has now reported with 75% beating on earnings (against a norm of 63%) and earnings growth for the quarter now running around 11% year on year, which is about 6 percentage points above expectations at the end of June. The big improvement has been on sales with 64% beating expectations compared to an average of just 41% over the last three years.
• Eurozone data was soft with a sharp fall in German factory orders, mixed readings on industrial production and a fall in Italian GDP adding to growth concerns. As expected the ECB left policy on hold, clearly preferring to give the June easing measures a chance to work. However, ECB President Draghi clearly recognises the downside risks and reaffirmed the ECB’s commitment to use quantitative easing if necessary.
• In China, soft July services PMIs raised concerns that the stimulus measures seen so far haven’t spread much beyond manufacturing. With the latest property slump likely weighing economic policy will likely need to be eased further. Meanwhile trade data provided mixed signals with weaker imports but a double digit gain in exports.

Australian economic events and implications

• A bad run of Australian data, but not that bad. The past week saw a bad combination of Australian data with the unemployment rate spiking to 6.4%, the trade deficit remaining large in June and June quarter real retail sales falling 0.2%. Australia’s official unemployment rate is now above that in the US and as a result of the June quarter trade and real retail sales data there is a possibility that June quarter GDP growth will be negative. However, there are several reasons not to be too alarmed. First, just as the jobs figures at the start of the year looked unbelievably strong, they now look too soft. In particular the rise in the unemployment rate looks to have been exaggerated by a rotation in the ABS sample and a change in the ABS survey questions. Second, forward looking jobs indicators – such as ANZ job ads, skilled vacancies and the employment component of the NAB business survey – all point to stronger jobs growth. Third, the June quarter trade data looks to be payback for the strength seen in the March quarter. Fourth, June retail sales showed a solid bounce back from the Budget related hit in May. Fifthly, it’s worth noting that the AIG’s services, construction and manufacturing conditions indexes all rose in July. Finally, housing finance remained strong in June telling us the housing recovery remains on track.
• It’s way too early to draw any conclusions from the June half profit reporting season in Australia as only a few companies have reported. But so far so good with more companies seeing profits up than down and dividends continuing to increase with Rio being a standout on this front. The big miners are clearly responding to investor demand for dividends with Rio’s dividend yield now being 4.8% and BHP’s 4.9%.

What to watch over the next week?

• In the US, expect a 0.3% gain in July retail sales (Wednesday), a 0.3% rise in July industrial production, another solid reading in the Fed’s New York regional manufacturing index and a benign July PPI reading (all Friday).
• Eurozone June quarter GDP data (Thursday) is expected to show flat growth.
• Japanese June quarter GDP (Wednesday) is expected to fall by 1.8%, reflecting payback for the pull forward of demand ahead of the sales tax hike. This was expected and does not represent the start of another recession.
• Chinese July activity data (Wednesday) is expected to hold around the improved pace seen in June with retail sales expected to be up 12.5%, industrial production expected to rise 9.1% and fixed asset investment to come in around 17.4%. Money supply and credit growth is expected to have slowed back a bit from the strong June pace.
• In Australia, expect to see July business confidence hold around June’s reasonable levels according to the NAB business survey (Tuesday), a 1% rise in June quarter house prices (Tuesday), a further recovery in consumer sentiment (Wednesday) reflecting the gains already seen in weekly consumer sentiment surveys and continued modest wages growth in the June quarter (also Wednesday) of just 2.5% year on year.
• The Australian June half profit reporting season will ramp up with 36 major companies reporting. Consensus earnings estimates for 2013-14 are for 12% growth led by resources with +28%. The combination of the lower iron ore price, the higher $A and the hit to confidence from the Budget suggest a bit of downside risk to consensus estimates. Given relatively elevated PEs compared to a few years ago underperformers will be hit hard. Most interest is likely to be on outlook statements with a bit of upside potential for companies exposed to housing, non-mining construction & retailing. Consensus 2014-15 earnings growth estimates are modest at +5%.

Outlook for markets

• Shares have been at risk of a correction for some time and it now seems to be upon us. It may have a bit further to go but we see little evidence suggesting we have seen a major market top. Valuations were not onerous at recent highs, global earnings are continuing to improve on the back of gradually improving economic growth, monetary conditions are set to remain easy for some time and there is no sign of the euphoria that comes with major share market tops. As a result the current pullback should be seen as providing a buying opportunity as the broad trend is likely to remain up. Our year-end target for the ASX 200 remains 5800.
• Bond yields are likely to resume their gradual rising trend over the next six months as the US economy continues to strengthen. This and low yields is likely to mean pretty soft returns from government bonds.
• The combination of soft commodity prices, an increasing likelihood the Fed will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down.

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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Weekly petrol prices; Sharemarket trends

• Petrol prices lift: According to the Australian Institute of Petroleum, the national average Australian price of petrol rose by 6.3 cents per litre to 155.4 cents a litre in the week to April 20. It was the biggest weekly lift in petrol prices in four months.
• Regional price lifts: The key Singapore gasoline price is only marginally below the highest level in nine months.
• Banking shares headed for record high: The banking share price index was on track to fresh record highs today. Total returns on banking shares have risen 20 per cent over the past year.

What does it all mean?

• 

  Petrol prices on the increase.

  The bad news for motorists is that the petrol price is headed higher. The Singapore gasoline price is only just below the highest levels seen in the past nine months. And the Aussie dollar has also backed away from US94 cents, adding more upward pressure on the price of imported fuel. At this stage, the potential pain is still contained with the local price of Singapore fuel up only 2 cents a litre from recent lows.

• A higher petrol price is potentially bad news for retailers and other consumer-focussed businesses.
• In three capital cities in the past week the petrol price was unchanged. In four other capital cities the petrol price lifted by over 10 cents a litre in the space of a week. It is clear that the ACCC needs to re-visit petrol pricing in Australia to ensure that it is adequately and efficiently serving the general public. Not only does the average petrol price vary significantly from week to week and city to city but so does the gross retail margin where it has been below 6 cents in Melbourne over April but above 27 cents in Darwin.
• Firmer economic conditions in the global economy are likely to support world oil prices and keep the average price of petrol in Australia above $1.50 a litre.
• Many investors probably believe that residential property has been the best performing asset over the past year. But quietly in the background, bank share prices have been going up over the past year and recording better returns than home prices. Bank share prices have lifted around 15 per cent over the past year and total returns have lifted 20 per cent. The bottom line is that investors must always be alert to the trends and opportunities in financial assets.

What do the figures show?

Petrol prices

• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 6.3 cents a litre to 155.4 c/l in the week to April 20. The metropolitan price rose by 9.0 c/l to 155.0 c/l, while the regional average price rose by just 0.8 cents per litre to 156.2 c/l.
• Average unleaded petrol prices across states and territories over the past week were: Sydney (rose by 10.4 cents to 155.9 c/l), Melbourne (up by 10.8 cents to 152.9 c/l), Brisbane (up by 11.6 cents to 157.6 c/l), Adelaide (up by 10.9 cents to 154.6 c/l), Perth (up by 0.4 cents to 151.9 c/l), Darwin (unchanged at 173.0 c/l), Canberra (unchanged at 157.6 c/l) and Hobart (unchanged at 160.8 c/l).
• Today, the national average wholesale (terminal gate) unleaded petrol price stands at 143.0 c/l, up around 0.6 cents over the week to a 3-week high.
• Since the start of April the gross retail margin (retail pump prices less the terminal gate price) has averaged 8.2 cents per litre. But the average margin ranged from 5.8 cents a litre in Melbourne to 14.2 cents in Hobart and 27.2 cents in Darwin.
• Last week the key Singapore gasoline price rose by US$2.05 (1.7 per cent) to a 7-week high of US$123.45 a barrel. The Singapore gasoline price is only 10c away from the highest levels in nine months.
• In Australian dollar terms the Singapore gasoline price rose by US$2.86 or 2.2 per cent last week to $131.82 a barrel or 82.91 cents a litre.
• Figures from MotorMouth show that petrol prices in Sydney, Melbourne, Brisbane, Adelaide and Perth trended lower last week. Based on a gross retail margin around 9 cents a litre, the national petrol price should average around $1.52 a litre.

Sharemarket update

• The banking sharemarket sub-index hit record highs last on April 10. But based on current strength in the broader financials index, the banks index was headed for fresh highs today. The broader Financials index was up 0.5 per cent in afternoon trade while shares in ANZ and Westpac both hit intra-day record highs today. The banking index has lifted around 15 per cent over the past year with total returns up by around 20 per cent.
• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum (AIP). National average retail prices are calculated as the weighted average of each State/Territory’s metropolitan and non-metropolitan retail petrol prices, with the weights based on the number of registered petrol vehicles in each of these regions. AIP data for retail petrol prices is based on available market data supplied by MotorMouth.
• Filling up the car with petrol is the single biggest purchase made by most families. (While the weekly grocery bill can be higher, it is made up of a raft of different items and the composition of the average shopping trolley can vary enormously from household to household.)
• The petrol price is headed higher and this should put retailers on alert to the possible consequences, especially for items that are at the far end of the discretionary section of the essential-discretionary purchasing line.
• Investors remain hungry for safe investments yielding relatively high returns. As a result, returns on bank shares have outperformed residential property over the past year.

What is the importance of the economic data?

• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum (AIP). National average retail prices are calculated as the weighted average of each State/Territory’s metropolitan and non-metropolitan retail petrol prices, with the weights based on the number of registered petrol vehicles in each of these regions. AIP data for retail petrol prices is based on available market data supplied by MotorMouth.

What are the implications?

• Filling up the car with petrol is the single biggest purchase made by most families. (While the weekly grocery bill can be higher, it is made up of a raft of different items and the composition of the average shopping trolley can vary enormously from household to household.)
• The petrol price is headed higher and this should put retailers on alert to the possible consequences, especially for items that are at the far end of the discretionary section of the essential-discretionary purchasing line.
• Investors remain hungry for safe investments yielding relatively high returns. As a result, returns on bank shares have outperformed residential property over the past year.

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The January 2013 Investor Intentions Index, released last week, is a monthly report that takes the pulse of Australian investors’ sentiment and investment intentions, and is based on the responses of over 800 investors per month.

Australian investors’ concern level (with the situation in the financial markets) has fallen to a 40 month low. Investors’ fear levels have been dropping steadily since late 2011, when they at levels last seen during the depths of the financial crisis.

“Up until the end of 2012, this decline in fear levels had not translated to an increase in investors’ 12 month market return expectations, which have been hovering around the 3% to 4% mark (excluding dividends) since the beginning of 2012,” said Investment Trends Senior Analyst Recep Peker. “Now, for the first time, we have seen a big spike in investors’ market return expectations.”

In January, the average investor was expecting the Australian stock market to rise by 7% (excluding dividends), jumping up from 5% in December. This corresponds to a rapid improvement in the stock market.

“Return expectations don’t predict returns, but they do predict investment activity, therefore this is a huge development,” said Peker. “January is the most positive we have seen investor return expectations in the last 20 months.”

“Half (49%) of investors say they plan to increase their exposure to Australian shares in the next month, up from 37% in December 2012,” said Peker. “There is a significant jump in the appetite for direct shares, and for the first time since the inception of this study there are more investors who intend to reduce their exposure to term deposits than increase their exposure.”

Australian sharemarket expectations

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The index is 12.2 per cent from record highs. Consumer Staples, Utilities and HealthCare indexes hit record highs yesterday.

What does it all mean?

• Traditionally, when investors have wanted to know how the sharemarket was travelling they would turn their attention to two key gauges: the S&P/ASX 200 index or the All Ordinaries index. But these indexes are just measures of share prices – they don’t take into account the dividends that investors have earned over time. And clearly dividends are a significant component of the returns achieved on shares or equities.
• In fact figures compiled by Mercer show that fund managers that invested in companies paying high dividends produced an average return of 23.6 per cent in 2012, ahead of the 20.3 per cent median return by fund managers.
• The S&P/ASX 200 index is currently 44.1 per cent below the record highs set in November 2007. But the S&P/ASX 200 accumulation index reveals a far different picture, a mere 12.2 per cent away from record highs. If the Australian sharemarket produces similar gains in 2013 to last year then record levels will be quickly in sight.
• In fact three of the key sector accumulation indexes are at record highs. Yesterday the ASX 200 accumulation indexes for Consumer Staples, Utilities and HeathCare hit record highs. The Telecom sector hit record highs on Monday and is just 0.3 per cent away from record levels. And the Financials (excluding REITs) and Information Technology sectors are just 3 per cent off record levels.
• Certainly total returns on shares have posted solid gains of around 20 per cent over the past year with HealthCare (up 55.1 per cent) and Telecoms (up 47.5 per cent) outperforming.

What are the implications for interest rates and investors?

• The key message for investors is to never lose sight of the total returns achieved on your investments. Clearly that advice doesn’t just apply to stocks. An investor buying an apartment certainly doesn’t just look at the potential capital appreciation on the property but also the likely rental returns over time. Of course when assessing total returns, it is also a case of keeping costs in mind. There are costs associated with buying, selling and maintaining investments as well as taxation implications. And those costs need to be totted up at the same time that prices and rental or dividend returns are being assessed.
• The sharp lift in sharemarket returns over the past year would no doubt come as a surprise for many Australians, particularly those with little interest in shares. But clearly the superannuation returns for Australian workers have posted solid gains over the past year, boosting wealth and income levels.

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• Economic data is generally coming in better than feared, German Chancellor Merkel has backed ECB President Draghi’s commitment to do whatever is necessary to maintain the common currency, Spain looks likely to soon receive funds to recapitalise its banks, Chinese Premier Wen Jiabao acknowledged the Chinese economy was under pressure and noted that falling inflation provides room to provide stimulus and Brazil announced plans to boost infrastructure investment.
• In China, we expect two more rate cuts and two more bank reserve ratio cuts in the months ahead.
• It’s good to see the Australian Treasury logically putting the case against RBA intervention to lower the Australian dollar on the grounds that it is not clear that its overvalued, likely to be futile and that a better alternative would be to cut interest rates if the $A is judged to be too high and harming the economy. I completely agree on all counts. Intervention to lower the $A is unlikely to have any lasting impact, likely to be
  very costly and would take us back to the failed macro economic policy approaches that prevailed prior to the $A float in 1983.

Major global economic releases and implications

• US data releases were mixed suggesting the soft patch in growth continues but with no sign of recession. The good news was that retail sales rebounded in July, consumer sentiment rose, industrial production is continuing to rise solidly, unemployment claims are trending down and home builders are still seeing a pick up in demand for housing and this is flowing through to a rising trend in starts and permits to build new homes. Against this though manufacturing conditions in the New York and Philadelphia regions are weak and small business optimism is slipping. Meanwhile, inflation remains benign suggesting plenty of room for the Fed to ease further if needed.
• The US earnings reporting season is now largely done with 68% of results better than expected which
  makes it a reasonable set of results.
• In terms of US budget deficit and debt problems, Republican Presidential candidate Mitt Romney’s choice of conservative Paul Ryan as his running mate increases the likelihood the November election will result in a mandate to produce a long term agreement to reduce the budget deficit as a Republican victory will commit Romney and it will likely force Obama into presenting his own plan which would then have a mandate if he wins.
• The Euro-zone economy contracted by an as expected 0.2% in the June quarter, highlighting that the recession continues but that it is relatively mild. Of course this masks deep contractions in southern Europe balanced by modest growth in core countries. Further weakness is likely and we remain of the view the Eurozone will contract 1% this year, worse than consensus but better than the GFC re-run many investors fear.
• Japan’s economy grew a less than expected 0.3% in the June quarter, but this was partly offset by an upwards revision to March quarter growth resulting in annual growth of 3.5%. With the recovery from the earthquake behind it and exports slowing, growth is likely to slow to a 1% pace going forward.
• Across Asia, India saw some better inflation numbers but its unlikely to be enough to speed up the Reserve Bank of India’s easing process as inflation is still very high and won’t be helped by a poor monsoon. The news out of Malaysia though is particularly good with 5.4% GDP growth over the year to the June quarter and inflation of just 1.4% over the year to July – a beautiful set of numbers.

Australian economic releases and implications

• Australian economic releases provided a mixed picture. The NAB survey for July reported a fall in business conditions presumably as the boost to retailers from the carbon tax compensation payments to households washed out, but an improvement in confidence, with both remaining at subdued levels. Consumer confidence surprisingly fell in August despite a run of better economic news since the July survey and leaves confidence below where it was when the RBA started easing last year. This would suggest that interest rates still need to fall further for consumers to become confident. Meanwhile annual wages growth perked up to 3.7% in the June quarter, but this was primarily due to strength in the mining sector and WA.
• The Australian June half profit reporting season is now one third complete and the results have become much better than was the case a week ago. So far 27% of results have come in better than expected which is still well down on the norm of 43%, but at least its up from just 22% a week ago and the proportion coming in worse than expected has fallen to 24% from 35% a week ago. Reflecting the improvement, 53% of companies have seen their share prices outperform the market on release day. So far 67% of companies have seen profit gains on a year ago and perhaps the biggest surprise is that outlook statements are mildly positive on balance (bottom right chart). Despite this, bottom up consensus estimates for 2012-13 profit growth has fallen by around 1% since the reporting season started but this is mainly due to analysts using the cover of the reporting season to revise down unrealistically high expectations for around 10% profit growth.
• The main themes have been pretty much as expected with expensive defensives underperforming if they deliver ok to sub-par results, but sold down cyclicals getting heavily rewarded with share price gains if they are better than feared (notably Bradken, JB HiFi, Downer EDI, Hills, AMP, Wesfarmers). The resources sector is seeing sharp falls in profits on lower commodity prices, capex spend and cost pressures, but the banks and nonfinancial industrials are seeing very modest growth. So far only 29% of companies have cut dividends with 71% raising them, highlighting the determination of companies to maintain and raise dividends despite weaker profits.

Major market moves

• Share markets mostly rose over the past week on better than feared economic and profit news and positive news from global policy makers. Indications that market leadership is at last starting to switch to cyclicals and away from defensive stocks is a positive sign although volumes and breadth are still low. US shares are close to a new post GFC high and Australian shares rose to their highest since early May.
• Commodity prices mostly rose, but the $A slipped as the Australian Treasury argued that it would be better
  to ease monetary policy than intervene in the foreign exchange market if it is judged the $A is too high.
• The improvement in investor confidence has seen a continued back up in bond yields in major countries with US 10 year bond yields up 0.4% and Australian 10 year bond yields up 0.6% from their July lows at the
  same time that Spanish and Italian bond yields have continued to fall.

What to watch over the week ahead?

• In the US, expect gains in existing home sales (Wednesday), new home sales and house prices (Thursday) and durable goods orders (Friday). The preliminary Markit PMI manufacturing conditions index (Thursday) will likely remain softish. The minutes from the Fed’s last meeting will be released Wednesday.
• Thursday will also see the release of preliminary August readings for Euro-zone PMIs which are expected
  to remain consistent with a mild recession in Europe.
• In China, the HSBC flash PMI for August (Thursday) is likely to remain around 49.
• In Australia, the minutes from the RBA’s last board meeting to be released Tuesday and Governor Stevens’ parliamentary testimony on Friday are likely to confirm that the Bank is reasonably comfortable with current interest rate settings, but will be watched closely for an indication as to how concerned the RBA is about the level of the $A and whether it is about to do anything about it.
• The Australian profit reporting season will move into its busiest week with 87 major companies reporting
  including Bluescope, Amcor, Oil Search, AGL, BHP, Coca-Cola, CSL, Woodside, Fortescue, IAG & Woolworths.

Outlook for markets

• After a period of strong gains, shares are a bit overbought and vulnerable to a short term setback maybe on implementation delays for the ECB’s plan and worries about poor economic data in Europe, the US and China as we approach the seasonally weak month of September. However, with the ECB on the brink of a major game changer, the Fed providing a win/win for the US sharemarket in that either the economy improves or it eases, further easing likely in China and shares cheap we remain of the view that shares will be higher by year end. As such any weakness over the next month or so will likely provide a good buying opportunity as the broader trend from June remains up.
• While sovereign bonds in safe countries are a good diversifier, bond yields in major countries remain very low and point to low medium term bond returns. Corporate debt is a better proposition for those after income but not willing to accept the volatility that comes with shares.
• Apart from normal volatility, the $A is likely to remain strong as global central banks undertake further
  monetary easing, commodity prices hold up and as central bank reserve diversification continues.

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To read the Group Monthly Activity Report for January 2012, click here.

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