• Global, and particularly Australian, shares have seen a bit of a pull back over the last month which could have further to go in the short term.
• However, what we are seeing is likely a correction as opposed to a new bear market. From a fundamental point of view the cycle still looks okay with no sign of the overvaluation, overheating economic conditions, onerous monetary tightening or investor euphoria that normally precedes major bear markets.

Introduction

Share markets have seen a bit of volatility and a pullback over the past month. This has been particularly so for Australian shares. This note looks at the key drivers and whether it’s just a correction or a new bear market.

Drivers of recent volatility

Our view for this year has been that shares would have positive but more constrained returns than seen over 2012 and 2013 and that volatility would increase. Our basic reasoning was that with shares no longer dirt cheap, investors would have to depend more on earnings growth for share market gains and this would be more constrained and uncertain. Until recently it has been relatively calm though despite a range of worries and deep scepticism amongst many commentators. Lately though, it seems the worry list has intensified and this has been reflected in increased volatility. The list of worries includes the following:

• Top of the list has been unease about the gradual shift at the US Fed towards eventual monetary tightening. Ultra easy Fed policy has been a key source of support for the global economy and investment markets. Investors are naturally concerned about what will happen when this ends with the Fed’s third round of QE set to end later this month and the Fed talking about raising rates next year.
• The global economic recovery has proved yet again to be fragile and uneven: with the Eurozone flirting with deflation; Japan struggling after a sales tax hike; the Chinese economy going through another soft patch; and emerging markets generally remaining subdued.
• Meanwhile a range of geopolitical threats are causing nervousness including: the escalating involvement of the US and its allies in the conflict with IS in Iraq and Syria; the conflict in Ukraine; the protests in Hong Kong accentuating concerns regarding China; & the worsening Ebola pandemic in Africa & the arrival of cases in the US.
• A range of “technical” concerns regarding US shares have added to these worries including: the absence of a “decent” correction since 2012 and low levels of volatility (or VIX) leading to fears investors may be complacent and the narrowing breadth of the US share market rally.
• Finally, we have been going through a seasonally weak period of the year for shares. The September quarter is historically the weakest quarter of the year.

While US and global shares have had only modest pullbacks of around 3 to 4%, Australian shares have been particularly hard hit with a fall of 7% reflecting the overlay of global concerns along with:

• A sharp fall in the iron ore price and commodity prices generally on China worries;
• Increasing talk that Australian banks will be forced to increase their capital ratios; and
• Foreign investors retreating to the sidelines as the $A falls. They are 30-40% of the market and it’s quite normal for them to pull back as the $A falls as they fear a double hit to the value of their investments. Indeed $US based investors lost 12% in Australian shares last month.

The correction in shares could go further: US shares, which tend to lead global markets, are only off slightly so far whereas corrections often go to 5 to 10%; nervousness is likely to intensify in the run up to the end of QE3 later this month; nervousness in Europe may well continue until uncertainty is cleared up around banks with the ECB to announce results of stress tests later this month; and finally seasonal weakness often runs into October. However, we view this as a correction, not the start of a new bear market.

A correction, not a new bear

There are several reasons why what we are seeing is likely a correction, rather than a bear market. First, valuations are not extreme.

This is evident in the previous chart which is based on a range of measures including a comparison of the yield on shares with that on bonds. Recent share market weakness has pushed valuations well into cheap territory again.

Second, the global economic cycle is a long way from posing a major threat to shares. The global economy is growing, but it’s uneven and sub-par. This is a blessing in disguise:

• While the US looks to have recovered from a soft patch early this year, growth in Europe, Japan and China is dragging the chain. Europe is unlikely to slide back into recession with the ECB doing just enough to support growth but weak credit demand and a reluctance to ease fiscal policy growth will remain constraints. Meanwhile, China is doing better than most other regions but its stop/go approach to supporting growth in the face of pressure for long term reforms is likely to see growth stuck around 7%.

As a result global spare capacity and excess savings remain intense so inflationary pressures remain tame and bond yields low.

• In many ways the world resembles the 1990s after the early 90s recession with the US being a growth leader, other regions lagging and disinflationary pressure keeping a lid on inflation.
• The overall result is that global growth is strong enough to boost profits but a long way from the boom conditions that cause escalating inflation. In other words, the global growth cycle is still in the “sweet spot”.

As a result, global monetary policy is set to remain easy.

• While the US is edging towards monetary tightening, Europe, Japan and China are a long way from tightening and if anything are likely to see further easing.
• This means the US dollar will likely remain under upwards pressure, which in turn will have the impact of importing low inflation into the US and delaying/limiting the extent of US rate hikes once they do start to get underway (as occurred in the second half of the 1990s).
• Finally, although the Fed will likely end QE3 this month, a 15-20% fall in US shares as we saw in 2010 and 2011 with the ending of QE1 and QE2 is unlikely as the US economy is now on a much sounder footing.

Finally, we are still a long way from the sort of investor exuberance seen at major share market tops. It seems everyone is talking about share market corrections and crashes. In Australia, the amount of cash sitting in the superannuation system is still double average levels seen prior to the GFC and Australians continue to prefer bank deposits and paying down debt to shares and superannuation. There is still a lot of money that can come into equity markets as confidence improves.

So absent a left field shock the most likely outcome is that, while shares could see more downside in the next month, this is likely to be limited with the bull market to continue.

The threat from geopolitics and pandemics

Perhaps the main potential source of left field shocks are the current geopolitical threats, but our reading is that these are unlikely to pose a fundamental threat to global growth:

• The Islamic State seems unlikely to threaten oil supplies and while a terror attack is a risk, it’s worth noting that the progression of such attacks last decade seemed to have less impact on markets as investors got used to them.
• The threat from Ukraine may be receding.
• The protests in Hong Kong are certainly a risk to China, but there is a good chance that they will peter out as the people of Hong Kong grow frustrated at the disruption they pose to their ability to go about their business.
• The “arrival” of Ebola cases in the US and Spain is worth watching, but our base case is that it should be easier to contain in western countries with modern medical facilities and higher standards and ease of hygiene.

What does this mean for Australian shares?

If global shares have more short term downside then so too will Australian shares. However:

• The Australian share market is now quite cheap again with the forward PE now back below 14 times.
• The fall in the $A will further help the economy avoid recession as mining investment slows and provide a boost to corporate earnings as each 10% fall in the $A adds around 3% to earnings.
• Interest rates are set to remain at generational lows with inflation pushing back towards the low end of the RBA’s target range according to the TD Securities Inflation Gauge and the RBA looking at using credit controls to slow investor demand for housing rather than rate hikes.

As such Australian shares are likely to see a strong rally into year end. Just bear in mind though that Australian shares are no longer the relative outperformer they were last decade. This decade is likely to see continued underperformance versus global shares as the commodity price super cycle is now going in reverse resulting in a headwind for the local share market and the falling $A (which we see heading down to $US0.80 or lower) will boost the value of offshore shares.

Concluding comments

The rough patch we have seen in shares lately could go a bit further. However, the bull market will likely remain intact thanks to a lack of overvaluation, the benign economic cycle, easy monetary conditions and a lack of investor euphoria.

Shane Oliver, Head of Investment Strategy & Chief Economist, 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.

The post Share market correction appeared first on AdviserVoice.

Craig Mowll

The proportion of Australian investors planning to increase their exposure to overseas assets is higher this year compared with the same time last year, according to the Certitude Global Investing Index (CGIII). The CGIII, which collates the views of over 500 actively engaged leading investors and measures their net demand for global investments, increased over the 12 month period from end June 2013 to end June 2014.

Annual results taken at the end of June 2014 revealed a number of key insights into the global investing intentions of Australian investors:

• The appetite of all active investors for global investments rose over the year by 11% (from 157 to 175) and now sits above the 12 months average.
• Concern levels about global markets fell significantly year on year and remain at their lowest level ever, at 5.6 out of 10, down from 6.4 out of 10 at the end of June last year.
• When it came to international equities specifically, investors were slightly less bullish in their outlook this year compared with last year, with slightly fewer investors intending to increase their exposure (16% compared with 17%), but also fewer investors intending to decrease their exposure (2% compared with 5%).

Craig Mowll, CEO of Certitude Global Investment said: “Results from the CGIII over the past 12 months indicate that Australian investors remain positive about global markets generally, and have indicated that they are keen to increase their exposure to these markets.

“Even though monthly figures were volatile throughout the year, with the percentage of those intending to increase exposure to international shares reaching a high of 25% and a low of 16%, the bottom line is that the intention to invest was up on an annual basis, which may well indicate that Australian investors are continuing to actively look overseas for returns.”

US/North America most favoured market, again.

It was no surprise that the US/North America was once again the market of choice for overseas investment. The majority (46%) of investors who intend to invest overseas say they would choose the US. This was down from 50% at the same time last year, which may indicate that investors’ level of concern about other markets has dropped over the same period.

“The preference for the US as a market has been down over the past few months, so the fact that it is rising again may well indicate that investors are responding positively to better economic figures out of the US, in particular strong jobs growth. They are clearly becoming more comfortable with the pace of economic growth and with the US Federal Reserve’s management of the tapering of quantitative easing,” said Mr Mowll.

Gap closes between desire for Australian and international shares

Closer to home, the proportion of investors planning to invest in Australia fell over the year (34%, down 4% pts), whist the proportion planning to invest in international shares fell just slightly (16%, down 1% pts) over the same period.

What is more interesting is the fact that the gap between the net proportion of investors planning to invest in Australian shares (24%, down 5% pts) and those planning to invest in international shares (14%, up 2% pts) has been shrinking over time and is now much smaller than it was 12 months ago. This supports the trend that Australians are exhibiting a growing interest in international shares.

Investors again overwhelmingly favoured equities when it came to a decision about which investment class they prefer, and this preference rose over the year. Over 80% of investors favoured equities as at end June 2014, whereas the percentage was 70% at the same time last year.

Commenting on the findings as they regard international equities, Mr Mowll said: “Investors indicated that their preferred method of overseas investment was via direct purchase of shares (38% of those interested in investing overseas), although actively managed funds (36%) was only very marginally lower. These two methods of exposure have been the top two preferred all year, with each taking their turn at number one depending on the prevailing economic conditions at the time.

“The most common barrier cited by investors for not investing overseas was a lack of knowledge, with 25% saying they didn’t know enough about it. At end June 2013, over 30% of investors cited market volatility as the most common barrier to investment, now only one year later that has reduced to only 20%.

“Clearly investors are continuing to feel more at ease with international markets, and understand that an exposure to international markets is necessary in a balanced portfolio, and the fact that overall demand for international assets increased over the year really back this up.”

Mr Mowll concluded by saying that anecdotal evidence taken from the comments of investors participating in the CGIII indicated that right now their major areas of concern internationally are China and the Middle East.

“A number cited the economic slowdown and potential debt crisis in China worrying, particularly if this was to cause a sell-off in risk assets in Australia. In the same way, on-going conflict in the Middle East is sparking debate about volatility in oil prices and potential flow-on effects.

“Ultimately, however, it was great to see that Australians overall remain positive about global markets, despite some volatility during the year. Their appetite for overseas investments continues to increase, and we are hopeful that this positive trend will continue looking forward.”

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Economic & financial perspectives

• 

  Overall, it has been a positive year.

  A good year:  Total returns on Australian shares (All Ordinaries Accumulation index) are currently up 17.3 per cent over 2013/14. If returns hold at these levels through to June 30 then investors will have experienced the best back-to back returns in seven years.

• Other returns higher: Returns on dwellings are up 15.3 per cent while returns on government bonds have lifted by 4.2 per cent. A rare event – bonds, property and shares have all lifted over the past year.

What does it all mean?

The post A good year, or a very good year? appeared first on AdviserVoice.

• Global shares had a mixed week as investors digested the 5% or so rebound since early February amidst weather affected US data, signs the Fed will soon change its forward interest rate guidance with respect to unemployment, another fall in a Chinese manufacturing conditions PMI and as turmoil continued in the Ukraine and Thailand providing a reminder that issues remain in the emerging world. While US and Eurozone shares were basically flat, Japanese and Asian shares nevertheless saw good gains. Bond yields were also little changed, but commodity prices did see some strength with a strong rise in oil prices (partly due to poor US weather) and higher metal prices. The $A fell on the poor news from China, but only marginally.
• Australian shares continue their sprint higher gaining more than 7% from their early February low with mostly good earnings results over the last few weeks providing confidence that the long hoped for rebound in earnings is finally happening and as shareholders like the news of higher dividends.
• The minutes from the Fed’s last meeting point to ongoing tapering. Cleary the Fed viewed the recent run of soft US data as largely due to poor weather, which along with comments by various Fed officials suggest little change in the pace of tapering. Of course this could change in a few months if US data has still not improved. The Fed does appear to likely soon change its forwards guidance on interest rates with the unemployment approaching the Fed’s 6.5% threshold, but at this stage there appears to be little agreement on what form the new guidance will take. Looking further out, while markets may have become a bit concerned about the reference to “a few participants” raising the possibility that it may need to raise interest rates relatively soon, this is likely to refer to the usual hawkish regional presidents of Fisher, Plosser, Lacker and George and is likely to be of little consequence for now given they don’t drive Fed policy. That said, once the US exits its weather related soft patch and as the Fed nears the end of its QE program later this year, talk of sooner than expected interest rate hikes may start intensifying…maybe later this year.

Major global economic events and implications

• US economic data presents a confusing picture at present. Freezenomics clearly played a role in depressing the NAHB home builders’ survey (along with a lack of supply), housing starts and manufacturing conditions in the New York and Philadelphia regions. But against this the broad-based Markit manufacturing conditions PMI rose 3 points to a very solid 56.7 in February with strong gains in new orders and employment suggesting the overall manufacturing sector is in good shape and on top of this jobless claims fell and the leading index rose pointing to solid growth ahead. On top of all this inflation readings remain benign, with core and headline inflation of just 1.6% year on year. So beyond the freeze the US economy still looks ok.
• Eurozone flash PMIs slipped in February but only marginally (from 52.9 to 52.7 for the composite) and do nothing to change the outlook for continued gradual economic recovery. That said growth is still not strong enough to reduce deflation risks, so more ECB easing is still likely.
• Japanese December quarter GDP growth was much weaker than expected at just 0.3%, but this was due to a surge in imports as growth in domestic demand was a solid 0.8% driven by consumption and investment. As expected the Bank of Japan made no changes to its asset purchase program or its money supply targets but it did extent or expand various measures to boost bank lending, which could be interpreted as a baby step towards further easing which we expect to see in the next few months.
• China’s flash HSBC manufacturing PMI fell yet again in February pointing to the possibility of a further slowing in economic growth. That said it could have been distorted by the Lunar New Year holiday and pollution related factory suspensions and it’s still bouncing up and down in the same range it’s been in for the last two years, which period has seen GDP growth stuck in a range around 7.5% to 8%. So at this stage we see no reason to change our 2014 growth forecast of 7.5%.

Australian economic events and implications

• In Australia, a fall in annual wages growth to a record low of 2.6% through 2013 provides further confirmation that the labour market is very weak and means that poor household income growth will remain a constraint on consumer spending. Fortunately it also adds to confidence that inflation will remain low thanks to soft growth in wages costs and so adds to confidence the RBA can keep interest rates down. There is also a bit of light at the end of the tunnel for the labour market with skilled vacancies rising for the fifth month in a row in January
• The minutes from the RBA’s last meeting provided nothing new but by dropping any reference to the possibility of further easing, they confirmed that its bias on interest rates is now neutral. We remain of the view that the RBA will keep interest rates on hold out to around September with gradual rates hikes thereafter.
• The corporate earnings news was a bit more mixed over the last week. As is often the case the companies with great results often go first followed by those not doing so well. That said, with around 70% of companies having reported, overall results remain pretty good and confirm the profit cycle has now turned up. So far 54% of companies have exceeded expectations (compared to a norm of 43%); 67% of companies have seen their profits rise from a year ago (compared to a norm of 66%); 70% of companies have increased their dividends from a year ago (compared to an average of around 62% in the last two years); but only 52% of companies have seen their share price outperform the day they released results. Key themes are a massive turnaround for the resources stocks (notably Rio and BHP) leaving the sector on track for circa 35% earnings growth this financial year, banks doing very well (with good results from CBA, ANZ and NAB), help coming through from the lower $A, ongoing cost control, signs of improvement from some cyclicals (like Boral, JB Hi Fi, Fairfax and Seek) and strong growth in dividends. The surge in dividends – which are up about 15% from a year ago – is a good sign that companies are confident about the outlook. The bottom line is that Australian earnings look to be on track for growth of around 15% this financial year, with a 35% surge in resources’ profits, a 10% rise in financials’ profits and a 6% rise in profits for the rest of the market.

• In the US, house price data (due Tuesday) for December is expected to show continued strength but poor weather is likely to have weighed on January new home sales (Wednesday) and possibly consumer sentiment (Friday). Poor weather could also give a subdued result in durable goods orders (Thursday) and December quarter GDP growth is likely to be revised down to 2.5% annualised from the 3.2% initially reported thanks to softer trade and retail sales data than had originally been allowed for. Fed Chair Yellen’s delayed Senate testimony (Thursday) will be watched closely for any hint of a taper slowing following recent mixed data.

What to watch over the next week?

• In the Eurozone, confidence data (Thursday) is likely to confirm the continuing gradual economic recovery. Unfortunately the recovery to date is unlikely to have been strong enough to have pushed the January unemployment rate (Friday) below the 12% level.
• Japanese January data for household spending, the labour market and industrial production are likely to show continued growth, and a continuing rising trend in inflation (all due Friday).
• The official Chinese manufacturing PMI (Friday) is likely to have followed the HSBC flash PMI slightly weaker.
• In Australia, December quarter construction (Wednesday) and business investment data (Thursday) will provide important building blocks for the December quarter GDP data to be released on March 5. Both are likely to be a bit softer than was the case in the September quarter. The capex data will also provide a guide as to how quickly mining investment is slowing and whether non-mining investment is picking up. Private credit growth (Friday) is likely to have shown a continuing modest pick-up in growth. A speech by RBA Governor Glen Stevens (Wednesday) will likely reiterate the case for interest rates to remain on hold for now.
• This will be the final week of the Australian December half 2013 earnings reporting season with 60 major companies due to report, including Worley Parsons, Harvey Norman and Woolworths.
• Investment markets will also digest the outcome of the G20 finance ministers meeting to be held on February 22-23. G20 meetings are a great opportunity for a talkfest – and this one will see lots of interesting discussion around issues such as the impact of Fed tapering on emerging countries, global growth targets, boosting infrastructure investment, financial regulation and tax base erosion – but in the absence of a global crisis to fix, it’s hard to see it having much impact on financial markets. While ongoing concerns from some emerging markets about the Fed’s tapering of its stimulus program create interest, there’s virtually zero chance that the Fed will do anything differently and nor should it as it has to do the right thing by the US economy and emerging market problems are largely of their own making. And it can hardly be claimed that the Fed failed to communicate its plans to start tapering – in fact then Fed Chair Bernanke started flagging his tapering plans back in May last year, nearly six months before the Fed started doing anything.

Outlook for markets

• While returns will be more constrained and volatile, shares will nevertheless push higher this year helped by reasonable valuations, improving earnings on the back of improved economic growth and easy monetary conditions helping to entice investors to switch out of cash and bonds and into shares. With the current earnings reporting season pointing to solid earnings growth this year, the ASX 200 is on track to meet our year-end target of around 5800 by year end.
• The recent decline in global bond yields should be seen as a correction against the backdrop of a slow rising trend in yields on the back of gradually improving global growth. This will mean subdued returns from government bonds. Cash and bank deposits also continue to offer pretty poor returns given low interest rates/yields.
• The broad trend in the $A remains down on the back of softer commodity prices, a reversion to levels that offset Australia’s relatively high cost base and a decline in Australia’s growth relative to that in the US. However, short positions in the $A still remain excessive and so it could still have a bit more of a bounce before the downtrend resumes.

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

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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.

The post Weekly market & economic update – week ending 21 February, 2014 appeared first on AdviserVoice.

• The past week was dominated yet again by ongoing noise around when the Fed will start to taper its quantitative easing program. While the news that tapering will likely commence in coming months should hardly be new to anyone it still creates a bit of nervousness. This saw most share markets fall and bond yields rise.
• The basic message from the Minutes from the Fed’s last meeting and various Fed officials including Chairman Bernanke is that: the timing of the start to tapering remains dependent on improved confidence regarding the growth outlook; that if economic conditions improve as the Fed expects it could start in coming months (ie Decembers out to March) and that the Fed is working on strengthening its forward guidance to stress that interest rates will remain low for longer to offset the negative impact on bond yields of cutting back bond purchases. While our base case is for tapering to start early in the New Year as opposed to in December, in reality it’s too close to call and if the November payroll report due in two weeks is strong the odds will clearly favour a December taper, particularly if US politicians reach a budget deal by the December 13 deadline.
• While the prospect of tapering will likely continue to cause concern in financial markets we remain of the view that its impact will be less than many fear. First, it will only occur because the Fed is more confident the US recovery is sustainable. Second, tapering is not tightening as it will just mean a gradual reduction in the amount of asset purchases (maybe from $US85bn a month to $US75bn a month initially). Third, the Fed will likely couple the start to tapering with a move to further push out expectations for the first rate hike. Finally, by the time tapering happens it will be factored into most markets unlike when it was first talked about in May.
• While the Fed is debating when to taper it should be noted that the advanced world is set to have easy or even easier monetary policy for a long time. Bernanke has stressed that tapering does not mean interest rates will rise anytime soon. Moreover, both the ECB and Bank of Japan are on alert to provide more monetary stimulus, not less. This provides a reasonably supportive back drop to investment markets.
• Comments in a speech by RBA Governor Stevens that he is open minded on foreign exchange intervention to lower the $A combined with ongoing taper talk in the US helped push it lower. But it doesn’t look like the RBA is even close to undertaking intervention as Steven’s speech extolled the benefits of the free float, he was not sure by how much the $A is overvalued and he pointed out that intervention is not costless. The mere threat of intervention though helps strengthen the jawboning the RBA is trying to use to push the $A lower. My view remains that the broad trend in the $A is down and this will ultimately see it fall back to around $US0.80 in the years ahead.
• The debt ceiling noise continued in Australia but it’s a non-event for investors. Does the Federal Government’s debt ceiling need to be raised? Yes, as the current $300bn ceiling will be reached next month. Will it be raised? Yes, both sides of politics agree on this. Does it matter if it’s raised to $400bn or $500bn? No, as it will take 3 years or so to reach the $400bn level and once that’s reached it will just be raised again anyway.

Major global economic events and implications

• US economic data continues to point to a possible pickup in economic growth. Retail sales were solid in October despite the government shutdown, the Markit manufacturing conditions PMI rose to a solid 54.3 in November led by strong gains in new orders and production, unemployment claims fell sharply and weekly mortgage applications had a nice bounce. The NAHB homebuilder conditions index held at solid levels but is still down from past cyclical highs. Existing home sales fell again in October but this may have been due to delayed processing due to the shutdown. Meanwhile inflation remains benign with headline inflation falling to 1% year on year, which of course gives the Fed plenty of flexibility.
• The composite Eurozone business conditions PMI disappointingly fell slightly in November, due a fall in the services PMI even though the manufacturing PMI rose slightly. The composite is still well up from its lows, but still points to a slow recovery. It highlights the need for more ECB stimulus, which it seems to be considering.
• A weekend split in Silvio Berlusconi’s party in Italy, suggests the Italian Government is likely to remain stable for now.  As a result Eurozone risk has fallen another notch.
•  In China, the reaction to the detailed Plenum reforms was positive. Meanwhile housing inflation averaged across 70 cities accelerated further to 10.9% over the 12 months to October, but interestingly this masked a 0.1% decline in October itself so maybe it’s starting to slow. HSBC’s flash manufacturing conditions PMI fell slightly in November but remains in a very mild rising trend and points to growth remaining around the 7.5% level, so all ok.

Australian economic events and implications

• The minutes from the Reserve Bank Board’s last meeting added little that was new with the RBA seeing mounting evidence that the economy is responding to lower interest rates and continued benign inflation but noting again that the $A remains “uncomfortably high” and needs to fall. Once more it left open the door to another rate cut but our view remains that given the economy does seem to be responding to past rate cuts and that the full effect is not yet evident the RBA will keep rates on hold ahead of the next move being a rate hike, but not till around September/October next year. It is clear from the minutes though that the RBA is much more concerned about the high $A than rising house prices, which it sees as just the expected effect of low interest rates, all of which makes it clear that the risk is still on the downside for rates.
• Australian economic data was light on with skilled vacancies down but looking like they are stabilising and marginal gains in leading economic indicators put together by Westpac and the Conference Board.

Major market moves

• Share markets were under pressure again from taper talk over the last week, which resulted in a somewhat volatile ride. This didn’t help Australian shares which have also been under a bit of pressure lately due to 14 capital raising requiring about $3.5bn to be raised. Chinese and Japanese shares managed gains though, the former on the back of the Plenum and Japan on the back of renewed weakness in the Yen.
• Commodity prices were mixed, but the $A was pushed lower by a combination of taper talk in the US and more jawboning from the RBA including talk of intervention in the foreign exchange market.
• Bond yields rose virtually everywhere on the back of Fed taper talk.

What to watch over the next week?

• In the US, expect a bounce in pending home sales (Monday) after softness in September and reasonably solid housing starts data (Tuesday) along with continued gains in house prices (also released Tuesday). Expect underlying durable goods orders and consumer sentiment (both Wednesday) to show a bounce.
• Eurozone economic confidence data (Thursday) is likely to confirm that the economic recovery remains very gradual at this stage. Unemployment (Friday) is likely to have remained around 12.2% in October, and November inflation is likely to remain very low at around 0.8% year on year.
• Japanese household spending, labour market data and industrial production (all Friday) will be watched for further evidence that Abenomics is working, with CPI data likely to show further evidence that deflation is ending but that inflation remains very low.
• In Australia, the focus will likely be on September quarter investment data (Thursday) including investment intentions. Business investment in the September quarter is at risk of a fall given a 4% gain in the June quarter and capex plans are likely to confirm that mining investment has peaked and that the outlook for non-mining investment remains weak, but it’s doubtful the investment outlook will have changed much since the last survey three months ago. Meanwhile, September construction data (Wednesday) will also contribute to expectations for September quarter GDP growth. Private credit (Friday) is likely to show continued slow growth.

Outlook for markets

• Shares appear to have hit a consolidation or mild correction phase after very strong gains from early October lows which had left them vulnerable. A bring forward of the potential timing of the start to tapering in the US has largely been the trigger with a rash of capital raising not helping in Australia. However, this is likely just a pause ahead of the resumption of the rising trend as valuations are reasonable, monetary conditions are set to remain very easy and profits are likely to improve next year as global and Australian growth picks up. Australian shares remain on track to hit 5500 or even higher by year end, with a little help from a Santa rally.
• Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to help ensure the rising trend in yields remains gradual.
• Expect the $A to be buffeted in the short term between signs Australian rates have bottomed and stable growth in China but talk of Fed tapering & RBA jawboning. The medium term trend in the $A is likely to remain down.

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

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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.

The post Weekly market & economic update week ending 22 November appeared first on AdviserVoice.

• Global share and bond markets got a big lift over the past week as first Larry Summers dropped out of the race to replace Ben Bernanke as Fed chairman, reducing fears of a more bearish Fed, and more importantly the Fed surprised markets by maintaining its asset purchase program at $US85bn a month. The combination saw bonds, shares and commodities rally sharply and the US dollar fall.
• While the Fed may have confused investors, it clearly became concerned by the combination of mixed data recently, the rapid back up in bond and mortgage rates, the approaching government funding and debt ceiling debate and a concern that the leadership transition at the Fed may render its forward guidance less credence. As a result it elected not to taper. The key message from the Fed is very supportive of growth. It won’t risk a premature tightening in financial conditions via a big bond sell off and tapering won’t commence until there is more confidence that its expectations for 3% growth in 2014 and 3.25% growth in 2015 are on track. In terms of timing, it hard to see tapering commencing before the Fed’s December meeting and it may not come until early next year. The downside though is that the Fed has likely just delayed the inevitable and arguably an opportunity for a smooth reduction in quantitative easing has been lost with more volatility a likely consequence.
• The decision by Larry Summers to withdraw from the race to run the Fed and the re-elevation of current Fed vice-Chair Janet Yellen as the favourite has substantially boosted confidence that the Fed will continue with its current growth supportive approach. However, there is a fair way to go yet but at least the other alternatives are perhaps seen as a bit less uncertain than Summers might have been.
• In Europe, the focus in the week ahead is likely to be on the reaction to German Federal election (Sunday 22 September). This is likely to see the return of Angela Merkel as Chancellor with the main uncertainty relating to whether she will lead a coalition with the Free Democrats (as at present) or the Social Democrats (as over 2005-09). Either outcome is unlikely to pose a threat to Germany’s relationship with the rest of Eurozone and so is unlikely to have significant investment implications, beyond any initial kneejerk response.

Major global economic events and implications

• US economic data released over the last week indicated that tapering has just been delayed and is still ahead of us. Industrial production showed a nice gain and regional manufacturing surveys point to further improvement ahead. The NAHB home builders’ survey also held at a high level and existing home sales rose solidly suggesting that the softness seen in housing starts and permits is temporary. One thing is clear though and this is that inflation remains benign with August data showing headline inflation of 1.5% year on year and core inflation of 1.8%.
• In the Eurozone inflation also remained benign in August at 1.3% year on year and ECB officials remain rightly dovish.
• Chinese house prices continued to rise in August, but the authorities seem less concerned about it of late – perhaps realising that the only real solution is to address supply side constraints.
• While the pressure on India has faded a bit this month, with the Fed’s non-taper decision helping, its outlook remains problematic with inflation increasing again in August despite soft growth.

Australian economic events and implications

• It was a quiet week in Australia with the Minutes from the last RBA Board meeting being the main focus. Two key points emerged. First, the explicit easing bias is back after being absent yet again from the post meeting statement earlier in the month. While the RBA has reiterated that any move is not imminent, declining mining investment, restrained non-mining investment, soft consumer spending, rising unemployment, the bounce back in the $A and benign inflation indicate the risks are still tilted towards another rate cut. Second, the RBA looks to be getting a little bit more concerned about the risk of a new housing bubble – even though RBA Assistant Governor Edey and Board member John Edwards pointed out its not one yet – with the Board being briefed on RBNZ moves to limit high loan/valuation ratio loans, Board members agreeing it’s important banks maintain prudent lending standards and concern about property gearing in self-managed super funds. I must admit I am not a fan of old fashioned/back to the past “macro prudential controls” because they just distort the financial system. But a direct move to limit home lending growth (such as raising the capital banks are required to put aside for home lending) is preferable to raising interest rates if the property upturn is getting too hot. So far it’s not too hot (housing credit is running at just 4.7% versus 21% in 2003), but it’s worth keeping an eye on.
• Meanwhile the downgrading of WA’s credit rating to AA+ by Standard and Poors highlights how some Australian governments have squandered the mining boom. After a massive boom WA should have minimal debt and big budget surpluses but unfortunately that’s not the case. More broadly it highlights risks for the new Federal Government if it doesn’t maintain the path back to surplus. Privatisation should be back on the agenda big time as it is the quickest way to get public debt down, at the same time that it will help keep super funds in Australia and put public assets into private hands where they can be managed far more efficiently.

Major market moves

• Share markets had a strong week as investors celebrated good news from the Fed.
• Commodity prices were also buoyed by the continuation of QE3 at its current pace as did the $A.
• Bond yields fell sharply on the back of dovish news from the Fed.

What to watch over the next week?

• Monday is PMI day with preliminary business conditions PMIs being released in China, Europe and the US. All are expected to show a continued trend improvement consistent with improving global growth prospects.
• In the US, expect further gains in house prices (Tuesday) and rises in new home sales (Wednesday) and pending home sales (Thursday) after falls in July. Durable goods orders (Wednesday) are also likely to see a bounce after a fall in July, consistent with a broad recovery in business investment.
• The focus is now turning to Congressional negotiations regarding a new Budget (required by October 1) and an increase in the debt ceiling (required by mid-October). Expect the usual cantankerous argy bargy between both sides of politics to cause bouts of financial market nervousness ahead of the usual last minute deal. With the US budget deficit having fallen to 4% of GDP (from a 2010 peak of above 10%) it will be harder for the Republicans to push too hard without risking alienating the public, which they probably don’t want to do ahead of mid-term elections next year.
• Along with Eurozone PMI’s for September, the German IFO index (Tuesday) is expected to show a further improvement. Confidence indicators will also be released Friday and will likely show a further gains.
• Japanese inflation data (Friday) is expected to show further evidence that deflationary pressures are fading.
• In Australia, the RBA’s financial stability review (Wednesday) is expected to show that Australia’s financial system remains sound with banks seeing improvement in asset performance and funding, business balance sheets in good shape and households exercising prudence. However, the RBA is likely to reiterate the need for banks to maintain “prudent lending standards” and that it is keeping an eye on the increase in property gearing in self-managed super funds. August job vacancies (Thursday) are likely to have remained soft.

Outlook for markets

• Shares are still at risk of hitting a speed bump in the month ahead as we go through the seasonally weak September/October period with potential triggers being the budget and debt ceiling negotiations in the US and a return of Fed taper fears.
• However, any pullback is likely to be just another bull market correction which should be seen as a buying opportunity as the broad trend in shares remains up. Valuations remain reasonable, monetary conditions are set to remain easy, and profits are likely to improve next year as global and Australian growth picks up. So by year end we see further upside in global and Australian shares with gains continuing next year.
• Government bond yields are falling after having risen too far too fast, but are likely to resume a gradual upwards trend as it becomes clear that the global economy is picking up momentum and as Fed tapering comes back into focus. Low yields and an unwinding of years of massive inflows into bond funds point to poor sovereign bond returns ahead.
• The short covering rally in the $A was given a boost by the Fed’s decision not to taper, but the downtrend is likely to resume once extreme shorts have been squeezed out, tapering comes back into focus and as the RBA retains an easing bias.

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

The post Weekly market & economic update – week ending 20 September appeared first on AdviserVoice.

• The past week saw more good data out of the US and Europe, but share markets were mixed with worries about Fed tapering weighing and pushing bond yields higher globally.
• Several Fed officials have left the impression the Fed is on track to start tapering in September, but the initial move is likely to be modest with additional moves contingent on further economic improvement. Our view remains that while tapering is a potential short term threat to markets, its unlikely to derail the cyclical rally in shares as tapering will only occur in response to stronger growth and won’t signal higher interest rates.
• Although turmoil in Egypt has the potential to be a source of nervousness Egypt is not a major oil producer and only around 2% world oil consumption flows through the Suez Canal.
• In Australia, the Treasury’s Pre-Election Economic and Fiscal Outlook added nothing new to the economic and budget projections released in the Government’s economic statement two weeks ago. But it did provide another reminder of the latest budget blowout and how Australia’s public finances are in a rather unfortunate shape given the biggest boom in our history.

Major global economic events and implications

• US economic data was mostly ok.
• US economic data was mostly ok. To be sure mortgage applications remained weak on the back of rising mortgage rates and bond yields, industrial production was flat in July and manufacturing conditions slipped a bit in August according to a couple of regional business surveys. But this was more than offset by a fall in jobless claims to their lowest since October 2007, another sharp rise in home builders’ confidence, positive news on retail sales, a small rise in small business optimism and signs that inflation may be troughing in reinforcing expectations that the Fed will taper in September.
• The news out of the Eurozone was particularly good, with GDP rising 0.3% in the June quarter signalling an end to 18 months of recession. A rising trend in PMIs and business confidence points to continued recovery in the current half albeit at a soft pace. The return to growth has been led by France and Germany, but Spain and Italy are also seeing a slowing in the pace of their contractions.
• Japan’s June quarter GDP disappointed with 0.6% growth thanks largely to a detraction from inventories and weak business investment. Underling final demand was solid though, but it’s likely that further monetary stimulus to maintain downwards pressure on the Yen will be required. On this front the Bank of Japan’s balance sheet has been flat for two months now and needs to start rising again for the Yen to fall and Nikkei to rise.
• On the profit front, the US June quarter profit reporting season is now largely done with 72% surprising positively on earnings and 55% on revenues and earnings growth coming in at around 3.6% compared to expectations of 1% a month ago. In Europe, profit results are a bit more subdued with 54% better on earnings but 57% better on revenue. In Asia 60% have exceeded on earnings and 52% on revenue. Overall good but not booming.
• Indian economic data remained poor with weaker industrial production and worse than expected inflation.

Australian economic events and implications

• Australian economic data was a mixed bag with business confidence and conditions remaining weak but consumer confidence rising in August and continuing to trace out a gradual rising trend which should augur well for consumer spending. Interestingly the rise in confidence appears to reflect more cheery home owners, after the latest rate cut, and coalition voters presumably feeling happier at the prospect of a change in Government. Meanwhile wages growth remained benign in the June quarter suggesting no threat to inflation from labour costs.
• We are now about 30% through the June half profit reporting season. So far results have not been fantastic but they have not been as bad as feared which explains why the market has held up ok, nothwithstanding offshore influences. 41% of companies have exceeded expectations, which is down from the February reporting season but not bad compared to the last few years; 33% of results have been below expectations though which is well up; 68% of companies have seen their profits rise from a year ago; 65% of companies have increased their dividends from a year ago and only 9% have cut them; and there have been more positive outlook comments than negative. Reflecting the better than feared results, 55% of companies have seen their share price outperform the market on the day their results were released. Key themes remain ongoing cost control and weak revenue growth. The prospective boost to profits from the lower $A and for iron ore companies from a higher iron ore price may be helping investors look through disappointing results.

Major market moves

• Shares were mixed over the past week – down in the US on taper fears and in Japan, but up in Australia, China and most of Asia.
• Commodities rose on the back of good global growth news and oil prices helped a bit by turmoil in Egypt.
• Despite higher commodity prices the Australian dollar fell slightly.
• Bond yields were led higher as Fed taper fears intensified and as European economic data impressed.

What to watch over the next week?

• In the US, the minutes from the last Fed meeting (Wednesday) will likely be the highlight with investors searching for more clues as to when the Fed will start to taper its quantitative easing program. On the data front expect a 1% rise in existing home sales (Wednesday) but a fall in new home sales (Friday) after a surge in June, a continued gain in house prices (Thursday) and the flash Markit PMI for August (Thursday) to improve slightly.
• Preliminary August manufacturing PMIs will also be watched closely in the Eurozone (Thursday) and are expected to show a continuing trend improvement.
• The flash HSBC manufacturing conditions PMI for China will be released Thursday and is expected to show a slight improvement after falling sharply in recent months.
• In Australia, the focus is likely to be on the minutes from the RBA’s last Board meeting (Tuesday), which are expected to confirm that it retains an easing bias but that it has been weakened following the last rate cut.
• The June half Australian profit reporting season will hit its peak with 90 major companies due to report, including Amcor, Coca-Cola Amatil, BHP, QBE, Boral, Fairfax, IAG and Lend Lease. Consensus estimates for 2012-13 earnings growth have slipped to -0.5% from +12% earlier this year, so a lot of bad news is factored in. Domestically exposed cyclicals are vulnerable to further weakness. On the positive side though, ongoing cost control and the fall in the $A are likely to be supports for the profit outlook going forward, with the fall in the $A to date potentially boosting profits by around 4.5%.

Outlook for markets

• Shares are vulnerable to a near term correction after having become overbought following the rally from late June. Potential triggers include: the Fed tapering its monetary stimulus, US Government funding and debt ceiling negotiations, China and the profit reporting season in Australia. However, the broad trend in shares is likely to remain up: valuations are no longer dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other developed countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.
• Sovereign bond yields still remain low and point to low medium term returns as yields gradually adjust higher in response to the improving global growth outlook.
• With commodity prices in a downtrend and the Australian economy deteriorating versus the US, it’s likely the $A will fall further. Given its overvaluation in terms of relative prices, expect the $A to fall to $US0.80.

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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.

The post Weekly market & economic update: week ending August 16 appeared first on AdviserVoice.

• Positive global economic data was a mixed blessing over the last week as it combined with comments from various US Federal Reserve officials adding to expectations that the Fed will start to slow or “taper” its quantitative easing program when it next meets in September and this in turn resulted in a bit of volatility in financial markets, with share markets mostly a bit weaker.
• In terms of Fed tapering our view is that while a September timing for the first move is now looking a bit more likely, it will only occur if economic indicators continue to improve and that it won’t signal that the first Fed interest rate hike is closer. As such, while taper fears are likely to continue to periodically weigh on markets in the run up to the Fed’s September meeting, to the extent it comes with stronger economic growth it shouldn’t be a major problem for shares as any negative impact will likely be more than offset by stronger profit growth.
• In Australia, the RBA cut the official cash rate to a record low of 2.5% as widely expected and backed this up with a cut to its GDP growth forecast for this year to just 2.25%. What’s more the RBA’s comments that the $A remains “high”, that there is “considerable uncertainty” about the economy rebalancing away from mining investment to other sources of growth and that the inflation outlook remains benign leaves the door open for further rate cuts. However, its failure to explicitly retain its previous comment that there was “scope for further easing” was disappointing in that such a statement helped maintain downwards pressure on the $A without the RBA necessarily having to do anything. This partly goes to explain the bounce in the $A over the last week. For the next few months the RBA is likely to sit pat and a lot now depends on the $A. If it continues to fall with broadening signs of improvement in the economy then we have likely seen the low for interest rates, but if it remains around current levels or rises and there is little evidence of improvement in the economy then rates will likely fall to 2% over the next six months. An aggressive post election budget tightening would also increase the case for another rate cut. At the moment the risks are still skewed to the downside for official interest rates – not good news for those relying on income from bank deposits but good news for those with a mortgage.

Major global economic events and implications

• In the US, the run of better than expected economic data continued with the ISM non-manufacturing index rising solidly and better than expected trade data pointing to an upwards revision to June quarter GDP growth to around 2.5%. On top of this the Fed’s latest bank survey pointed to a further easing in bank lending conditions, and increased demand for credit, the mortgage delinquency rate fell to its lowest in five years years and unemployment claims remained low. The basic picture from the US is one of improving growth.
• The US June quarter earnings reporting season continues to impress. Its now 90% done with 72% of companies surprising on the upside regarding earnings and 56% surprising positively on revenue.
• There was also good news from the Eurozone with the final services PMI for July coming in stronger than initially reported which took the composite PMI to 50.5 which is consistent with a return to economic growth.
• Japan’s mixed run of data continued with softer than expected readings for some confidence measures but a further pick up in bank lending. Despite a mixed run of data recently and a back up in the value of the Yen, the Bank of Japan left its ongoing monetary stimulus unchanged. For the Japanese share market to resume its uptrend though some combination of structural economic reforms and further monetary stimulus is likely required.
• Chinese economic data for July mostly came in better than expected. Inflation remained low and growth in exports and imports returned to positive territory, industrial production expanded 9.7% year on year which was well up on 8.9% in June, electricity production accelerated, fixed asset investment remained solid and money supply growth and bank lending picked up. Overall, Chinese data remains consistent with a 7 to 7.5% growth rate for this year. No boom, but no bust either!
• Another interest rate hike in Brazil designed to cool inflation provided reminder though of the less favourable growth/inflation trade-off now being seen in key emerging countries.

Australian economic events and implications

• Australian economic data was a mixed bag. On the positive side housing finance continues to trend up and house prices rose strongly in the June quarter. However, we are a long way from the renewed house price bubble many seem to fear. House prices are up 5.1% over the last year, but at a similar stage following the interest rate easing cycles that started in 1996, 2001 and 2008 they were showing annual growth of 7.7%, 18.9% and 18.8% respectively. What’s more housing credit is very weak compared to past cycles. Moreover, on the soft side retail sales were flat in June and in the June quarter as a whole in real terms, employment fell in July and another fall in job ads points to more labour market softness ahead. While unemployment was unchanged in July this reflected a fall in labour force participation. The basic message remains that while rate cuts have helped the housing sector there is as yet not a lot of evidence of a flow on to other parts of the economy. This is likely to occur over time, but in the meantime a further depreciation of the Australian dollar is needed to boost sectors like manufacturing, tourism and higher education and the risks still point to further rate cuts.
• The June half Australian profit reporting season picked up pace. So far so good, with 42% of results having come in better than expected which is just below the long term average of 43%. But given that only 16 major companies have reported so far it’s too early to read much into this.

Major market moves

• Shares were mostly down over the last week partly on the back of Fed taper fears. Japanese shares were the hardest hit falling 5.9% as that market continues to consolidate after its 80% rise over six months into May and the Yen rose. US shares fell 1.1% and Australian shares fell 1.2%, but Eurozone shares gained 0.8%.
• Commodity prices generally rose though helped by better than expected Chinese trade data and a weaker $US. The combination of stronger commodity prices and the weakening of the RBA’s easing bias saw the $A bounce back to $US0.92.
• Bond yields were mostly little changed, but fell in Italy and Spain.

What to watch over the next week?

• In the US expect a 0.4% gain in retail sales (Tuesday) after a flat outcome in June, a 0.3% gain in industrial production (Thursday), continued strength in the home builders’ conditions index (Thursday) and solid gains in housing starts and permits (Friday). Manufacturing conditions according to the New York and Philadelphia regional surveys are likely to have remained solid and inflation is likely to have remained benign with signs that it may have bottomed albeit at a low level.
• In the Eurozone, the focus will be on preliminary June quarter GDP data (Wednesday) which is expected to show growth just ticking back into positive territory with a 0.1% gain, following six quarters in recession.
• Japanese June quarter GDP data to be released Monday is expected to show that the economy has continued to recover solidly with a 0.9% gain following a 1% gain in the March quarter.
• In Australia, the NAB business survey readings for business conditions and confidence in July (Tuesday) are likely to have remained weak but consumer confidence (Wednesday) may show a slight improvement after the latest interest rate cut. June quarter wages growth (Wednesday) is expected to have remained benign. The Treasury’s Pre Election Economic and Fiscal Outlook will also be published Tuesday and will be watched to see how it compares to the Government’s recent Economic Statement.
• The June half Australian profit reporting season will ramp up with 40 major companies due to report, including JB HiFi, CBA, Leightons, Worley Parsons, AMP and Wesfarmers. Consensus estimates for 2012-13 earnings growth have slipped to -0.5% from +12% earlier this year, so a lot of bad news is factored in. Resources profits may show signs of bottoming with a fall of 18%, but domestically exposed cyclicals are vulnerable to further weakness. On the positive side though, ongoing cost control and the fall in the $A are likely to be supports for the profit outlook going forward, with the fall in the $A to date potentially boosting profits by around 4.5%.

Outlook for markets

• We remain in a seasonally weak period of the year for shares and worries about the Fed tapering its monetary stimulus, US debt ceiling negotiations, growth in China, the profit reporting season in Australia and the Australian election have the potential to cause more volatility. However, the broad trend in shares is likely to remain up: valuations are no longer dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other developed countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.
• Sovereign bond yields still remain low and point to low medium term returns.
• With commodity prices in a downtrend & the Australian economy deteriorating versus the US, it’s likely the $A will fall further. Given its overvaluation in terms of relative prices, expect the $A to fall to $US0.80.

_____________

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.

The post Weekly market & economic update: week ending August 9 appeared first on AdviserVoice.

• 

  The impact of the federal election on the share market

  Historically election campaigns result in a period of flat lining for the Australian share market followed by a bounce once the election is out of the way.

• The likely end to three years of minority Government should be taken favourably by markets as it will likely result in more certain policy making.

The Federal Election

With the much anticipated Australian Federal election now set for 7 September it is natural to wonder what impact, if any, there might be on investment markets – both in terms of the uncertainty created by the election itself and in terms of the outcome. At present while opinion polls have Labor and the Coalition running at around 50% each on a two party preferred basis, according to bets placed on online betting agency Centrebet the Coalition remains the clear favourite.

The performance of markets around elections

Elections can potentially have a short-term impact on investment markets. This is because investors don’t like the uncertainty associated with the prospect of a change in government during the campaign and then there may be relief once the poll is out of the way and possibly optimism associated with the election of a new Government.

The next chart shows Australian share prices from one year before till six months after Federal elections since 1983. This is shown as an average for all elections (but excludes the 1987 and 2007 elections given the global share crash 3 months after the 1987 election and the start of the global financial crisis in 2007), and the periods around the 1983 and 2007 elections, which saw a change of government to Labor, and the 1996 election, which saw a change of government to the Coalition. The chart suggests some evidence of a period of flat lining in the run up to elections, possibly reflecting investor uncertainty before the poll, followed by a relief rally soon after it is over.

However, the elections when there has been a change of government have seen a mixed picture. Shares rose sharply after the 1983 Labor victory but fell sharply after the 2007 Labor win, with global developments playing a big roll in both. After the 1996 Coalition victory shares were flat to down. The point is that based on the historical experience it’s not obvious that a victory by any one party is best for shares in the short term and, in any case, historically the impact of swings in global share markets arguably played a much bigger role than the outcomes of Federal elections.

What is clear though is that after elections shares tend to rise more than they fall. The next table shows that 8 out of 11 elections since 1983 saw the share market up 3 months later with an average gain of 5.4%, which is above the 1.8% average 3 monthly gain over the whole period.

The next chart shows the same analysis for the Australian dollar. In the six months or so prior to Federal elections there is some evidence the $A experiences a period of softness and choppiness which is consistent with uncertainty about the policy outlook, but the magnitude of change is small – just a few percent. On average, the $A has drifted sideways after elections. While the $A fell soon after the 1983 Labor victory this was due to a policy devaluation in the dying days of the fixed exchange rate system.

The next chart shows the same analysis for Australian bond yields. Interestingly, on average bond yields have drifted down over the six months prior to Federal elections since 1983. The average decline has been around 0.75% which is contrary to what one might expect if there was investor uncertainty regarding the policy outlook. However, the tendency for bond yields to decline ahead of Federal elections appears to be more related to the aftermath of recessions, growth slowdowns and/or falling inflation prior to the 1983, 1984, 1987 and 1993 elections and the secular decline in bond yields through the 1980s and 1990s in general. More broadly, it’s hard to discern any reliable affect on bond yields from Federal elections.

Policy change and shares

Over the post war period shares have had an average return of 12.9% pa under Liberal/National Coalition Governments compared to 9.8% pa under Labor Governments.

Some might argue though that the Labor Governments led by Whitlam in the 1970s and Rudd and Gillard more recently had the misfortune to be affected by severe global bear markets beyond their control and if these periods are excluded the Labor average rises to 14.6% pa. Then again that may be pushing things a bit too far. But certainly the Hawke/Keating government defied conventional perceptions that conservative governments are always better for shares. Over the Hawke/Keating period from 1983 to 1996 Australian shares returned 17.3% pa, the strongest pace for any post war Australian government.

Once in government political parties of either persuasion are usually forced to adopt sensible macro economic policies if they wish to ensure rising living standards. Both the Coalition and Labor agree on the key macro fundamentals – i.e. the need to keep inflation down, to return the budget to surplus and in the benefit of free markets.

Policy differences

The main areas of difference between the two parties of probable economic significance relate to taxation, climate change, government spending & the budget and regulation.

• in terms of tax the Coalition has promised to cut the company tax rate (although for large companies this is partly offset by a paid parental leave scheme) and abolish the mining tax;
• the Coalition is proposing to abolish the carbon tax/Emissions Trading Scheme and will rather pay companies to reduce emissions;
• the Coalition is likely to take a lighter/more business friendly approach to regulation than a Labor government. This may involve some partial wind back of industry regulation; and
• the Coalition will likely try and speed up the return to a budget surplus by cutting government spending, much as it did under John Howard following the 1996 election.

As a result, perceptions that the Coalition will be lower taxing and less focussed on regulation and hence more business friendly than a Labor government may increase the chance a Coalition victory will result in a typical post election share market bounce. However, it’s worth noting that this may be partially offset if it announces aggressive fiscal tightening after the election (given the negative impact this could have on economic growth and profits at a time when the economy is already soft). What’s more if a returned Labor Government follows up on its commitment to a National Competitiveness Agenda working to seriously boost productivity growth then it could have a positive long term impact on growth, profits and ultimately share market returns.

However, it does seem that there is the potential for significant sectoral impacts with the Coalition’s policies likely to be positive for miners, heavy carbon emitters and small companies (due to the company tax rate cut).

Concluding comments

The historical record points to the strong chance of a post election share market bounce. This may also fit in as we move out of the September quarter, which is often the weakest of the year, into the normally strong December quarter, as the profits reporting season ends in Australia and as uncertainty is removed post a possible September decision by the US Federal Reserve to start tapering its monetary stimulus.

Another potential positive from the election is that it is likely to see the end of minority government in Australia as whoever wins is likely to have a clear majority in the House of Reps. This could help usher in a period of more certain and rational policy making. However, it’s not guaranteed as whoever wins may still not have control of the Senate.

– Dr Shane Oliver- Head of Investment Strategy and Chief Economist, AMP Capital

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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Scott Fletcher

Australian shares have outperformed other asset classes over the past 10 and 20 years, according to the latest Russell Investments/ASX Long-Term Investing Report, but Russell warns investors need to be truly diversified and take a more active approach to deal with an increasingly changing market environment for the next 10-20 years.

The 15th edition of the annual report, commissioned by the Australian Securities Exchange (ASX) and prepared by Russell Investments, found the two key themes dominating investment returns for the past 10 and 20 year periods were falling bond yields in Australia and globally, as well as strong domestic economic growth driven by the resources sector – two major factors that look to change going forward.

“This report offers investors some practical guidance on the performance of different asset classes and in particular the benefits of ASX-listed investments over the longer term,’’ said ASX Business Development Manager Jonathan Morgan.

The report demonstrates the benefits to be gained from diversifying across multiple assets. Comparing the results for the 10 year period in this year’s update to last year’s report, the ranking of asset classes has changed significantly. Last year’s winner – hedged global bonds slipped to third place this year with a return of 7.9% p.a. while last year’s runner-up – Australian residential property slipped to fifth place at 6.5% p.a.

Instead, Australian shares and hedged global shares took first and second prizes this year at 8.9% and 8.2% respectively, thanks to the very strong risk rally in 2012. In contrast, cash remained unchanged at 3.8% p.a. while unhedged global shares was back in the black at 1.4% p.a., but still suffering from the very strong appreciation in the Australian dollar over the last 10 years to 31 December 2012. All these returns were against an inflation rate of 2.8% p.a.

The report also considers the impact of tax, costs and borrowing on ultimate investment returns. The aim is to provide investors with insight into how different investments have performed over the medium to long-term, after-tax and expenses. The difference in after-tax returns between types of investors in the same asset class highlights opportunities to choose the right investment structure. For example, the value of investing in Australian equities via a superannuation vehicle rather than directly was an additional 2.4% in returns to high marginal tax rate investors over 10 years.

Triple-treat investment returns a rarity

Over the past 10 years investors exposed to a number of Australian assets enjoyed a ‘triple-treat’ of investment returns. This came from Australian shares, Australian currency and Australian residential investment property.

Scott Fletcher, Director Client Investment Strategies, Asia Pacific, at Russell Investments said “Australia has experienced less extreme market fluctuations during and recovering from the global financial crisis – compared to those in the Northern Hemisphere – as the strong resource sector activity offset weaker domestic growth,” he said.

The Australian dollar has doubled in the last 10 years starting from around US$0.50 off the back of phenomenal commodity prices.

Australians’ love affair with bricks and mortar, supported by relatively low unemployment, solid growth in disposable incomes and falling borrowing costs, has also seen housing prices increase persistently over most of the past two decades.

Forward looking glasses: the next 10-20 years

Going forward, Mr Fletcher said investors needed to substantially adjust their expectations and revisit the traditional approach to investment and asset class diversification going forward. In a supplement to the report, Russell explored how likely the historical returns would be repeated over the next 10-20 years.

“There are a number of aspects investors need to consider with forward looking glasses, rather than looking in the rear view mirror,” Mr Fletcher said. The conditions that produced the ‘triple-treat’ returns from domestic shares, currency movements and residential property were unlikely to be sustained.

“The two speed domestic economy driven by mining activities has slowed to a single pedestrian-speed growth outlook and this will impact returns from multiple domestic assets in the future.” Mr Fletcher said.

“Although the AUD has fallen more than 12% in Q2 2013, it is still overvalued relative to history. Looking to the next 10-20 years it is unlikely that the currency will appreciate much further, and boost hedged returns by the same amount as in the past.

Another trend that is very unlikely to continue is the multi-decade trend of falling government bond yields. While these have contributed to very strong performance in domestic and global bond markets for the last 20 years, especially providing investors with safe havens in volatile times, more realistic expectations for bond market returns for the next 10-20 years are in order.

With yields off historical lows and returns harder to come by, Russell Chief Executive Asia Pacific, Alan Schoenheimer, said that investors who have been heavily reliant on bonds in the past really need to move to other sources of returns outside traditional government bonds to generate sufficient returns going forward. ”We know these investors need exposure to growth assets, but may not be able to stomach the volatility from equity markets. This is why an active strategy that relies on truly diversified sources of returns from a range of assets makes sense.”

“In addition, innovative bond strategies that move away from conventional developed market exposures to include emerging market bonds and other strategies (such as currency, credit and long/short) that are less sensitive to interest rates will help,” he said.

“Russell is seeing a new breed of investment solutions being developed to meet the needs of these investors. Actively managed, multi-asset approaches are one way to long-term investing for the changing landscape.” Mr Schoenheimer concluded.

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