Among the countries where inflation has moderated, the majority are in the Eurozone, where inflation was forced down by euro appreciation, weak domestic demand and relative cost adjustments (see chart 1).

The currency’s more recent reversal will put some upward pressure on inflation over the coming year, but declining commodity prices, a weak economy and futher relative price changes will work in the other direction.

If the ECB wants to lift inflation out of the danger zone, it will have to follow Japan’s lead sooner rather than later. India and Indonesia are the only large emerging economies where inflation has declined significantly over the period.

Unlike Europe though, weaker inflation is a positive development that will relieve pressure on their central banks and make it easier to push through needed reforms. The recent plunge in oil and agricultural commodity prices will lower inflation further in the coming months, as energy and food prices make up more than 50% of their price baskets.

The countries where headline inflation has increased since mid-2013 fall into two main camps. In the first camp are Brazil, Russia and Turkey. All are plagued by the structurally high inflation that results from poorly designed product and labour market regulations, entrenched high inflation expectations and central banks that have paid insufficient attention to their inflation targets.

Turkey will benefit from the recent falls in commodities, but it is a mixed blessing for Brazil and Russia. While they will likely enjoy some moderation in headline inflation, both are net exporters of commodities and the resultant deterioration in their terms of trade will weigh on their already very weak domestic economies.

Meanwhile, inflation is likely on a long upward trajectory in the US and Japan. In the US, domestic inflation pressures are gradually building as labour market slack continues to erode. In Japan, the jump in inflation has been triggered by the April sales tax hike and the Bank of Japan’s massive policy stimulus, which has led to a 28% depreciation of the exchange rate over the past two years and a tightening in the labour market.

The post Global Outlook – Inflation decoupling appeared first on AdviserVoice.

• Share markets were mixed over the past week with good economic data propelling the US share market to record highs and hopes of more ECB stimulus helping in Europe, but with soft data and profits weighing in Japan and Australia and increased Ukraine tensions weighing across the board. Bond yields generally fell back again on the prospect of more monetary stimulus in Europe. While the gold price rose slightly, oil and metal prices fell. Notable on the commodity front has been the renewed fall in the iron ore price partly on the back of worries about the Chinese housing market. Despite this, the seemingly Teflon coated Australian dollar rose over the week.
• The somewhat messy and desynchronised global growth environment remains clearly evident with good news out of the US, but Europe and Japanese data disappointing and geopolitical issues continuing to hover in the background. This all means occasional bouts of uncertainty for investors but as long as the broad trend in global growth is one of improvement, desynchronisation is not bad because it means central banks will stay supportive. Perhaps the bigger risk is that the longer rates stay low, the longer investors will expect this to remain the case which could set up bubble like conditions in various assets as investment yields (be they bond yields, dividend yields, rental yields, etc) get pushed ever lower as investors search for yield. However, for growth assets we look to be early in this process.
• In Australia, the June half profit reporting season is now wrapped up. While aggregate earnings growth in 2013-14 came in slightly lower than expected at the start of the results season thanks to misses by some large cap stocks (notably BHP), at around 12% it was still solid with two thirds of companies seeing gains in profits on a year ago. Rising dividends suggest amongst other things that the corporate sector is reasonably confidence in the outlook. See below for details

Major global economic events and implications

• US economic data was pretty favourable. While home prices were mixed in June and new home sales fell in July, pending home sales rose strongly, the Markit services conditions PMI remained strong, consumer confidence rose and durable goods orders surged. While a 23% rise in July durable goods orders owed to strong aircraft orders, the underlying trend is solid particularly for capital goods orders pointing to solid growth in business investment. Stronger investment also drove an upwards revision to June quarter GDP growth to 4.2% annualised from 4% initially reported.
• While momentum in money supply and bank lending improved a bit in July in the Eurozone, various confidence surveys softened in August confirming the loss of momentum seen recently in European growth adding pressure on the ECB to do more to stimulate growth. Quantitative easing focussed on the ECB using printed money to buy securitized bank loans looks likely to be launched soon.
• Japanese data for July disappointed with a smaller than expected gain in industrial production, continued softness in household spending, a rise in the unemployment rate and inflation falling slightly to 3.4% year on year, or 1.4% after the sales tax hike is allowed for. That said, the jobs to applicant ratio held at its highest since 1992 suggesting companies must be reasonably comfortable. Nevertheless, the soft July data will put more pressure on the Bank of Japan to consider further monetary easing.
• Korea was a bright spot though reporting a much stronger than expected gain in July industrial production.

Australian economic events and implications

• Australian economic data was a bit soft with falls in June quarter construction and equipment investment and a fall in new home sales in July. Private credit growth softened a bit after a stronger than expected rise in June with housing related credit looking like it has peaked on a monthly basis. Business investment plans for the current financial year also point to another decline on the back of falling mining investment. However, this has long been expected and there are some positive signs on the investment front. In particular, residential construction is continuing to rise and investment in what the ABS refers to as “other selected industries” looks like rising solidly in the year ahead. So dwelling construction and non-mining investment are helping to provide an offset to the slump in mining investment.
• The profit reporting season is now over and while the quality of results trailed off at the end as usual, overall it was pretty good. Particularly compared to the nervousness ahead of the results being released. 54% of companies have exceeded expectations (compared to a norm of 43%), which is the best result in nine years; 68% of companies have seen their profits rise from a year ago (compared to a norm of 66%); 65% of companies have increased their dividends from a year ago (up from around 60% in the last two years); and 59% of companies have seen their share price outperform the market on the day they released results, which is the best result in four years. Key themes have been strong profit growth for resources (notably Rio, although BHP disappointed a bit), banks doing well (with a good result from CBA) but no better than expected, ongoing cost control making up for still soft revenue growth and strong growth in dividends reflecting investor demand for income and corporate confidence in earnings prospects. Australian earnings growth for 2013-14 looks to have come in around 12%, which while down a bit from expectations a few weeks ago due to the BHP result causing a slight downgrade for resources, is still a solid outcome. Resources led with a 27% gain, followed by banks up 9% and the rest of the market up around 5%. Consensus expectations for the current financial year remain for 5% earnings growth, but this looks a bit low to me.

 What to watch over the next week?

• In the US, expect more solid readings from the ISM and Markit manufacturing conditions PMIs (Tuesday) and services conditions PMIs (Thursday), but the main focus is likely to be on jobs data (Friday) which is expected to show another strong gain in payrolls of 220,000 and the unemployment rate falling back to 6.1%. The Fed’s Beige Book of anecdotes on the economy (Wednesday) and trade data (Thursday) are also due for release.
• In Europe, the main focus will be on the ECB’s meeting on Thursday, where, following President Draghi’s recent comments regarding falling inflationary expectations, there is a 50/50 chance that it will unveil a quantitative easing program involving the purchase of private sector asset backed securities or if not allude that it’s on the way.
• The Bank of Japan also meets Thursday but it’s unlikely to make any changes to monetary policy.
• In China, the official manufacturing conditions PMI for August (Monday) is likely to have fallen back a bit in line with the HSBC flash PMI already released.
• In Australia, the RBA is expected to leave interest rates on hold yet again. Nothing much has changed since Governor Steven’s recent Parliamentary testimony where he expressed comfort with current interest rate settings. Rates have already been cut to record lows and the housing sector has led the response but with mining investment still slowing, non-mining capex still soft and the $A still strong its way too early to consider raising rates.
• It’s also going to be a bit of a data avalanche in Australia. The main focus is likely to be on the June quarter GDP data and here the news is unlikely to be good. Our expectation is for GDP growth of 0.5% quarter on quarter (or 3.1% year on year), but weak readings for net exports, consumer spending and investment suggest the risks are all skewed to the downside. In fact there is a high risk of a slight contraction in GDP. Inevitably this would invite talk of a recession, but as was the case with the previous three negative quarters seen in the last 23 years, a recession is unlikely. First, the soft June quarter result will be payback for the unexpectedly strong trade driven growth seen in the March quarter. So best to average the two quarters out. Second, a range of timely indicators relating to housing, retail sales, consumer confidence and the jobs market point to stronger conditions in the September quarter.
• In terms of other Australian data releases expect to see a further rise in house prices (Monday), a -0.7%  contribution to growth from June quarter net exports, weak public demand and a bounce back in building approvals (all Tuesday), another large trade deficit and modest growth in July retail sales (both Thursday). The AIG’s business conditions PMI’s will also be released.

Outlook for markets

• While shares have seen a strong recovery from the mini-slump seen in early August, the correction season consistent with the old adage “sell in May, go away and come back on St Leger’s Day” is still upon us with September historically being the weakest month of the year for US shares partly due to tax loss selling and the September-October period often being tough in Australia.

• However, despite the risk of another correction the cyclical bull market in shares likely has a lot further to go as we still don’t see the signs of shares being over valued, over loved and over bought normally seen at major market tops.Valuations remain okay particularly once low interest rates and bond yields are allowed for, 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. In fact, in terms of the latter there still seems to be a lot of wariness regarding shares. Our year-end target for the S&P/ASX 200 remains 5800.
• Low bond yields, eg 10 year yields of just 0.5% in Japan and 3.5% in Australia, will likely mean soft returns from government bonds.
• The combination of soft commodity prices, the 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. Expect to see $US0.80 in the next few years, but getting the timing right is hard.

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 29 August, 2014 appeared first on AdviserVoice.

• The global economy is still on the mend, but it’s still a two steps forward, one step back affair. Of the major regions the US is doing the best, but Europe is lagging.
• This means occasional bouts of uncertainty, but it’s not such a bad thing if it keeps central banks supportive.
• The main implications are: we are still in the sweet spot of the global economic cycle, which is good for growth assets; the lack of global synchronisation means that fundamentals for individual regions, assets and stocks matter; constrained global growth will mean constrained returns; and the big event to watch for is when the Fed starts to hike rates – but it still looks a way off at present.

Introduction

We are having yet another year where investors started off optimistic about the global economic outlook with talk of synchronised growth only to find that the global growth story remains patchy. In fact, so much so that it’s possible to paint wildly different pictures as to the outlook – some are worried about growth and inflation taking off, whereas others warn of imminent collapse. The truth is likely to remain somewhere in between these extremes. But, in a way, this is not a bad thing as it keeps central banks supportive.

This note looks at the major regions in terms of growth, inflation and interest rates and what it means for investors.

The US – looking good but not booming

After a contraction in the March quarter driven by mostly temporary factors, the US economy rebounded in the June quarter and looks on track for growth of around 3% in the current quarter. The jobs market and business investment are improving and the shale oil boom is providing a long term boost both directly and indirectly via cheap electricity costs for business. However, while the US is looking a lot stronger it’s a long way from booming, let alone overheating, with growth seemingly stuck in a 2-3% range as the housing recovery and consumer spending have slowed a bit of late.

Which brings us to what the Federal Reserve will do. On the one hand US growth has improved enough to allow the Fed to continue “tapering” its quantitative easing program which means it’s on track to end probably in October. On the other hand it’s unclear that conditions are strong enough to warrant interest rate hikes just yet. This is something the Fed is grappling with, but the conclusion seems to be that – with inflation remaining low at just 1.5% on the Fed’s preferred measure, wages/labour cost growth stuck around 2% and broad measures of labour market slack (ie allowing for the unemployed, underemployed and discouraged workers) remaining high – its unlikely to rush into raising rates.

Our assessment is that the Fed is gradually inching towards an interest rate hike, but it’s probably not going to occur until sometime in the June quarter next year.

The Eurozone – better but not great

The Eurozone returned to growth about a year ago but it is far from robust and stalled in the June quarter with weakness in Germany, Italy and France. Uncertainty regarding Russian sanctions and Ukraine are not helping. What’s more bank lending growth has remained negative and inflation has fallen to just 0.4% year on year. This has all led to concerns that Europe is sliding into Japanese style stagnation and that the ECB needs to do more.

Our assessment though is that Europe is gradually mending: growth has returned to Spain, Ireland, Portugal and Greece; these countries have all made significant structural reforms to their economies and France and Italy look to be gradually heading down that path; the troubled countries have all seen their bond yields collapse, eg Spain’s 10 year bond yield is now just 2.17%; the ECB announced further stimulus in June, but looks to be ready to launch into quantitative easing involving the purchase of private debt in the next few months; and bank lending should improve once the ECB’s bank stress tests are out of the way in a few months.

Japan – Abenomics on track

Japan’s growth was hit in the June quarter by the pull- forward effect of the April sales tax hike. However, a range of indicators suggest that despite the volatility the Japanese economy has weathered the sales tax hike well with ultra-easy monetary policy and economic reforms providing confidence growth will bounce back from the current quarter.

However, given the uncertainty, the Bank of Japan will either have to maintain its very easy monetary conditions or possibly have to ease further.

China running hot and cold

For the last three years now Chinese economic data has been running hot and cold every six months leading to periodic worries about growth. Another slowdown in the Chinese property market is adding to these concerns.

With the Chinese Government repeatedly indicating that there is a floor to growth of around 7%, and supporting this by mini-stimulus measures as they have done this year, our assessment remains that the Chinese economy is on track for growth of around 7.5%. But don’t count on more.

Emerging world

The emerging world more generally is a lot messier than it used to be. Of the major’s, China and Mexico look ok and the election of reform oriented governments in India and Indonesia is positive, but Brazil looks to have lost the plot under the current Government, and Russia already weakened looks to have shot itself in the foot over Ukraine. A lack of structural reforms over the last decade has led to lower growth potential in the emerging world. That said it’s still on track for growth around 4.5% this year and next.

Global growth – two steps forward, one back

Bringing this together, global business conditions indicators are consistent with good but not booming growth.

Although global growth is likely to pick up, it’s hard to describe global conditions as synchronised and the global economic expansion remains very much a process of two steps forward, one step back. This was clearly evident in the first half of the year with the US and Japan both having negative quarters, China slowing in the first quarter and Europe stalling in the June quarter. And of course geopolitical events continue to wax and wane and the threat from Ebola remains in the background – all of which impart a deflationary impact in terms of their dampening impact on confidence and spending. Against this backdrop it is hard to see the Fed wanting to rock the boat prematurely with talk of interest rate hikes, let alone actual hikes, and the ECB, Bank of Japan and People’s Bank of China are likely to maintain ultra-easy policy or ease further.

Investment implications

There are several implications for investors. First, gradually improving global growth, still benign inflation and easy monetary conditions tell us we are still in the sweet spot of the economic cycle which augurs well for growth assets.

Second, the desynchronised global economic and monetary cycles confirm that the “risk off, risk on” phenomenon of a few years ago where all growth assets move up and down together has faded. This should make it easier for fund managers and investors to benefit from opportunities in individual regions, assets or stocks. Eg we think there is currently good value in Chinese shares, European shares and commodities. The divergence in monetary cycles is also likely to mean upwards pressure on the $US but downwards pressure on the Yen and Euro.

Thirdly, the constrained global growth cycle provides a reminder not to expect double digit gains from growth assets year after year. It will still be a relatively constrained world in terms of sustainable returns.

Finally, the big thing globally to keep an eye out for will be when the Fed will start to raise interest rates. This, or rather its anticipation, will likely cause a few bumps (just like last year’s taper tantrum did), but it’s still a fair way off and when it does come its unlikely to spell the end of the cyclical bull market in shares as it will be a long while before monetary conditions actually become tight.

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

The post The global economic outlook – implications for investors appeared first on AdviserVoice.

• Global shares had a poor week with a range of issues reportedly weighing with more sanctions on Russia and worries about the Fed, earnings, Banco Espírito Santo and Argentina’s “default”. This dragged down global shares for July by 1%. While Australian shares got hit on Friday it came after a very strong month with the ASX 200 up 4.4% in July. The “risk off” move by investors weighed on the euro and $A, commodities were mixed with oil down but metals up and bond yields actually rose in the US and Australia.
• Many of the reasons reportedly unnerving investors look to reflect isolated instances rather than systemic problems, ie more like an excuse for a correction: Banco Espirito Santo’s situation is not indicative of other Eurozone banks; Argentina’s problems are well known and its “default” reflects a problem with a hedge fund rather than broader emerging market debt problems; tougher sanctions for Russia will harm it a lot more than the West with Russia unlikely to cut off gas supplies to Europe given the long term damage it will do to what is a key export earner for it; and overall US earnings reports have been very strong.
• That said, having not had a decent pullback since January/February US shares (and hence global shares) have become vulnerable to a correction and this may be it. We are also in the weakest quarter of the year for shares seasonally and worries regarding the Fed may be with us for a while yet. However, the absence of investor euphoria, reasonable valuations, easy global monetary conditions and the improving economic outlook suggest that what we are seeing is just a correction, not the start of a major bear market.
• While the Fed will remain an ongoing source of investor nervousness as the case for a rate hike gradually builds, there were no surprises from the Fed’s latest meeting. As expected the Fed announced another $US10bn cut its in quantitative easing program and it now sees less risk of too low inflation and recognises the stronger labour market. However, it still sees significant labour market slack and has not changed its assessment that the Fed Funds rate will remain in its current range for a considerable period after the end of QE. Expect to see a gradual hawkish shift over time, but no rate hike till around mid-2015.
• The justification for tax concessions in Australia – such as negative gearing, the capital gains tax discount, dividend imputation, superannuation – seems to be a hot topic these days. The often put arguments for their removal/curtailment are that the rich get the greatest advantage from them and it would help balance the Budget. Such views are frequently put by Treasury, which, according to Paul Keating, has long hated them. However, the arguments working the other way are more powerful. First, many of the tax concessions are fundamentally justified: negative gearing just allows for the legitimate costs of investing; dividend imputation removes the double taxation of dividends and puts shares on an equal footing with other Australian assets; and superannuation concessions encourage savings for retirement and helps provide patient capital. Second, that they are used so much by the rich is a reflection of Australia’s very high marginal tax rate and the fact that it cuts in at a relatively low income level. Cut the reliance on income tax for revenue and the top marginal tax rates, and the desire to minimise tax via concessions will fall. Removing or curtailing the concessions without cutting income tax rates will just reduce savings and incentive which will work against Australia’s long term growth potential.

Major global economic events and implications

• US economic data confirmed growth has rebounded. June quarter GDP growth rose at a stronger than expected 4% annualised pace after a 2.1% contraction in the March quarter, consumer confidence rose to its highest since October 2007, the Markit services sector PMI remained very strong and jobs data remains solid. However, the US economy is a long way from booming – inventory accumulation contributed 1.7 percentage points to June quarter GDP growth and housing indicators have been a bit mixed. So the recovery continues but I can understand why the Fed is a bit reticent about getting too hawkish. While employment costs rose more than expected in the June quarter, they are still up just 2% year on year which is stuck in the same range as the last few years. So not a lot of inflation pressure here.
• Meanwhile, US June quarter earnings results remain strong. 75% of the S&P 500 has now reported with 76% beating on earnings (against a norm of 63%), 66% beating on sales and earnings growth for the quarter now running around 10% year on year, which is about 5 percentage points above expectations.
• In the Eurozone, economic confidence drifted slightly higher in July consistent with ongoing economic recovery and the unemployment rate continued to drift down to 11.5%, from a high of 12%. That said inflation has fallen to a new cyclical low of just 0.4% year on year highlighting the need for easy monetary policy.
• Japanese data was mixed. Industrial production fell much more than expected in June and the unemployment rate rose slightly but against this real household spending rose more than expected in June, small business confidence rose and the ratio of job openings to applicants rose to its highest since 2002.
• China’s official manufacturing PMI rose further in July adding to confidence that growth is improving.

Australian economic events and implications

• Australian data provided a mixed but ok picture. On the downside a sharp fall in export prices saw the terms of trade resume its slide in the June quarter, resulting in an ongoing headwind to nominal growth and national income. Against this though, while building approvals fell in June, the level remains strong, new home sales rose in June, house prices continue to rise albeit at a more moderate pace than through the last half of last year, the AIG’s manufacturing PMI rose again in July and a weekly Roy Morgan survey indicated that consumer confidence continues to recover from its Budget related hit. What’s more private credit growth picked up further in June driven by a rebound in personal and business borrowing. So while the resources boom continues to fade, evidence continues to build that the economy is rebalancing towards a greater reliance on other sectors.

What to watch over the next week?

• In the US, the Fed’s loan officers survey (Monday) is expected to confirm that lending conditions are favourable, the ISM services index (Tuesday) is expected to show that services sector conditions remain solid and the trade deficit (Wednesday) is likely to be flat. Productivity growth (Friday) is expected to bounce back.
• Having just eased again two months ago the ECB (Thursday) is unlikely to make any changes, but is likely to restate its easing bias and that it is continuing to look into a quantitative easing program.
• Chinese inflation data for July (Saturday) is expected to be benign. Trade data will be released Friday.
• In Australia, as nothing much has changed over the last month the RBA at its Board meeting on Tuesday is expected to leave rates on hold and repeat that a period of interest rate stability remains prudent. Its quarterly Statement on Monetary Policy (Friday) is also likely to express a neutral inclination on rates.
• On the data front in Australia, expect to see June retail sales (Monday) bounce back 0.3% after their fall in May, the June trade balance to remain in deficit (Tuesday), labour force data to show a 10,000 gain in employment leaving unemployment unchanged at 6% and housing finance data (Friday) to show a slight bounce back.
• The Australian June half profit reporting season will start to get underway in the week ahead with 8 major companies reporting including Downer and Rio. Consensus earnings estimates for 2013-14 are for 12% growth led by resources with +28%, banks at +10% and industrials ex-financials at +3%. The combination of the lower iron ore price, the higher $A and the hit to confidence from the Budget in the June quarter suggest a bit of downside risk to consensus estimates for resource and industrial stocks, although the banks are likely to remain strong. Given relatively elevated PEs compared to a few years ago underperformers are likely to be slammed. Most interest is likely to be on outlook statements with resources companies at risk but a bit of upside potential for companies exposed to housing and non-mining construction and retailing. Consensus 2014-15 earnings growth estimates are relatively modest at +5%, with resources at 2%, banks at 4% and industrials at 10%.

Outlook for markets

• Shares have been vulnerable to a correction for a while and so the weakness seen over the last week may have a bit further go, but we continue to see little evidence suggesting we are at or near a major market top. Valuations remain reasonable, particularly if low interest rates are allowed for, 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. In terms of the latter, if anything there is still a lot of scepticism which is a long way from the sort of confidence normally seen when bull markets end. Given all this, any short term dip in shares should be seen as 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 led by increasing evidence that US growth is picking up pace. This combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.
• While the carry trade from ultra-easy money in the US, Europe and Japan risks pushing the $A higher, the combination of soft commodity prices, an increasing likelihood that 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

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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 1 August, 2014 appeared first on AdviserVoice.

Mark Burgess

Global equity markets were largely unchanged in April, although this masked a fairly wide dispersion in returns at the sector level.

Earlier in the month, for example, technology stocks came under pressure and triggered a general slide in equities due to fears that valuations were overstretched. Tensions between Russia and the West also undermined investor sentiment. However, equity markets subsequently rallied strongly on the back of encouraging US data and some easing of geopolitical tensions before some disappointing earnings releases in the US, a deterioration in the Ukraine crisis, and fresh concerns over the economic outlook in China weighed on risk assets in the final days of the month.

Treasury yields fell with the 10-year benchmark yield ending April at 2.66%, compared with the 2.72% level seen at the end of March. At the end of the month, and as expected, the Federal Reserve continued to reduce its monthly bond buying by US$10bn to US$45bn. The central bank said that growth in economic activity had picked up recently, having slowed sharply during the winter. The Federal Reserve also repeated its ambition of keeping interest rates at very low levels, saying it would maintain interest rates “below levels the committee views as normal in the longer run” even after the US economy has improved enough to hit target levels of unemployment and inflation.

In the eurozone, Portugal returned to the bond market for the first time in three years, holding a successful auction of €750m. The auction was three times oversubscribed and 10-year government debt yields fell sharply to an eight-year low of 3.58%. Greece also returned to the bond market for the first time since 2010. It sold €3bn of five-year bonds at a yield of 4.95% and said the issue was eight times oversubscribed. At the end of the month, the yield on the Portuguese 10-year bond had fallen to 3.64%, while that of the Greek equivalent was down to 6.64%. Eurozone bonds in general gained over the month on speculation that concerns over deflation could cause the ECB to adopt new stimulus measures.

The J.P.Morgan EMBI+ Index (on a total-return basis) delivered a positive return as emerging market bonds continued to recover. Russia proved an exception, however, with tensions between the West and Moscow over the Ukrainian crisis hurting investor confidence in the country’s bonds. Moreover, the credit rating agency Standard & Poor’s cut Russia to BBB- with a negative outlook, placing it on the brink of junk status. Meanwhile, the MSCI Emerging Markets Equity Index (total return, local currency) was largely unchanged over the month.

We made no changes to our investment strategy over the month. We remain overweight equities as valuations are largely reasonable, although less compelling than was once the case. We also remain underweight Asian equities on concerns over China, while we are overweight Japan as valuations are attractive versus developed world peers. Although we remain overweight equities, it would be fair to say we are less optimistic than we have been. Having said that, the recent pick-up in M&A activity in areas such as pharmaceuticals should prove supportive.

Within fixed income, core yields are going to grind higher, and there is much less value in credit given how far spreads have tightened. Only emerging market debt appears to offer any real value, but given the risks in terms of China, geopolitics and the macroeconomy, we are wary of increasing our weighting at present. The good news is that the current environment is likely to continue to provide opportunities for stock pickers, which we aim to exploit.

by Mark Burgess, CIO at Threadneedle Investments

The post Threadneedle’s latest investment strategy and market commentary appeared first on AdviserVoice.

• It’s been another somewhat mixed week for global and Australian shares as indexes flirt with post GFC highs and the situation regarding Ukraine remains uncertain, economic data continues to be rather confusing and Fed Chair Janet Yellen left the door open for a pause in slowing its monetary stimulus if needed. US shares saw good gains with the S&P 500 making a new record closing high, Japanese and European shares were little changed and Australian shares fell slightly not helped by poor business investment data. Most share markets, bar China and Japan, had a solid February though making up for the declines seen in January.
• Reflecting mixed economic data and worries about Ukraine, bond yields mostly fell over the last week and commodity prices were soft. The $A was little changed.
• Despite the demise of the Yanukovych government, Ukraine remains a source of uncertainty for markets. It’s way too small and its problems too specific to be a threat to global economic growth. The main risk worth keeping an eye on though is that it triggers some sort of conflict between the West and Russia, as Russia sees it as a brotherly country and does not appear happy at its recent swing back to the West, as evident by troop exercises along its border. That said while there may be a lot of bluster from Russia its doubtful that it can afford to do anything too drastic (like an invasion).
• Is the PBOC easing? Falling Chinese money market rates and a decline in the value of the Renminbi (RMB) seem to have created a bit of confusion over the last week. Both of these could just be normal market noise, eg the RMB  is only down around 2%, and the People’s Bank of China could just be providing a reminder that it can be volatile and is not a one way bet higher. Then again it could signal a slightly easier stance on monetary policy, which may be consistent with recent mixed economic data and clear signs that Chinese home price growth is cooling down. Time will tell.
• More jobs layoffs in Australia. News that Qantas will lay off 5000 workers adds to the sense of gloom hanging over the Australian jobs market. But it’s worth noting that the layoffs do not reflect a lack of demand but rather competitive pressures Qantas is facing, that they will be spread out over the next three years and that the coming housing construction recovery, the lower $A and improved business confidence and general hiring plans all point to a strengthening in jobs growth most likely during the second half of this year. So it’s not all doom and gloom.
• Hot internet start-ups and takeovers of such stocks with little revenue or earnings along with talk that the “number of users is the dominant driver” is all very reminiscent of 1999 in the tech space. Fortunately while there may be pockets of 1999 around, the broader US market is a long way from late 1990s valuations or euphoria with the forward PE today at 15 times compared to 24 at its tech boom peak and Nasdaq valuations around one third of tech boom peak levels.

Major global economic events and implications

• US economic data remained messy with soft readings for the Markit services conditions index, consumer confidence, regional manufacturing conditions surveys, mortgage applications (although falls here may be partly seasonal) and jobless claims but a surprisingly strong gain in new home sales, continued strength in home prices which rose 13.4% last year and slightly better than expected durable goods orders after allowing for volatile aircraft orders.  Fed Chair Yellen essentially repeated her message that tapering remains on track but indicated the Fed is trying to get a handle on whether the weather is driving recent soft data or something more worrying, with the implication being that the taper could be delayed or slowed if needed.
• Eurozone confidence indicators confirmed the ongoing economic recovery but weak lending and money supply data highlight the case for more ECB stimulus.
• Japanese activity for data for January was a good with very strong industrial production, a solid PMI pointing to more gains ahead, stronger than expected retail sales and household spending, unemployment remaining down at 3.7%, the job vacancy to applicants ratio rising a bit and core inflation remaining at 0.7% year on year. The main uncertainty though is around to what degree the approaching sales tax hike has pulled demand forward.
• While emerging market uncertainties still linger, it was good to see Brazilian GDP growth come in stronger than expected in the December quarter leaving it up 2.3% for the year. That said Brazil’s growth isn’t what it used to be and structural challenges remain and with the central bank raising interest rates yet again there are still downside risks to Brazilian growth.

Australian economic events and implications

• Australian construction and business investment data was depressingly soft pointing to a broad based fall in investment in the December quarter and intentions data pointing to sharp fall in business investment in 2014-15 as mining investment really starts to wind down. Comparing intentions for 2014-15 with those made a year ago for 2013-14 suggests a 17% fall in investment led by a 25% fall in mining and a 20% fall in manufacturing. However, the final outcome may not be that bad as such an approach looks to have exaggerated weakness this financial year. Secondly, investment intentions in industries outside of mining and manufacturing are starting to stabilise and improve. Thirdly, the impact on overall economic growth of the slump in mining investment will be partly offset by a slump in related imports, just as the mining investment boom was partly offset by surging mining related imports. Finally, while residential investment looks to have fallen in the December quarter, the strength in building approvals points to a strong upturn in dwelling related construction ahead.
• The Australian corporate earnings season has now wrapped up. As is often the case the companies with great results often go first followed by those not doing so well. That said, overall results remain pretty good and confirm the profit cycle has now turned up with large companies, notably the resources and banks, playing a bigger role than normal in driving growth. 54% of companies exceeded expectations (compared to a norm of 43%); 65% of companies have seen their profits rise from a year ago (compared to a norm of 66%); 64% of companies have increased their dividends from a year ago (which is up slightly from around 62% in the last two years); and 56% of companies have seen their share price outperform the day they released results. Key themes have been a massive turnaround for the resources stocks (notably Rio and BHP) leaving the sector on track for circa 40% 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 making up for still soft revenue growth, signs of improvement from some cyclicals (like Boral, JB Hi Fi, Fairfax and Seek) and strong growth in dividends. A 14% surge in dividends from a year ago was mainly driven by big companies such as Rio, CBA and Telstra. At 64% the dividend payout ratio is still not excessive for the overall market and higher dividends are usually a 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 40% surge in resources’ profits, a 10% rise in financials’ profits and a 6% rise in profits for the rest of the market.

What to watch over the next week?

• In the US, the main focus is likely to be on February manufacturing conditions indicators (due Monday) and employment data (Friday), but unfortunately both are likely to present a confusing picture given poor weather in February. The manufacturing conditions PMIs are likely to present a divergent picture with the ISM index likely coming in around 52 but the broader Markit index remaining solid around 56.7 in line with its advance reading. With a snowstorm affecting some of the US when the February employment survey was undertaken, payroll growth is likely to have remained relatively soft at 150,000 and unemployment is likely to be unchanged at 6.6%.
• In the Eurozone, the ECB (Thursday) is likely to finally act on its easing bias, possibly cutting interest rates a bit further and maybe announcing a form of quantitative easing involving the purchase of bank loans. While GDP is growing again it is still gradual, lending growth remains depressed and there is a risk of deflation. The Bank of England (also Thursday) is likely to leave monetary policy unchanged.
• In China, the National People’s Congress (starting Wednesday) will likely set a growth target for this year of 7.5%, but the key focus will be on the approval and enactment of further financial deregulation and various fiscal, administrative and welfare reforms flowing from the 3rd Plenum last year. Chinese data for February will also start to flow with trade figures (due March 8th) likely to be looked at very closely to see whether the circa 10% growth in exports and imports reported for January continued in February.
• The Reserve Bank of Australia (Tuesday) is expected to leave interest rates on hold for the sixth meeting in a row. The RBA has clearly indicated that with growth remaining low but tentative signs of improvement in some indicators, a period of stability in interest rates is appropriate. Since not enough has really changed since the last meeting, this remains the case. Soft jobs news and the poor business investment outlook do suggest though that our expectation for rate hikes to commence later this year may be premature with the risk being that they won’t occur till next year. Governor Steven’s Parliamentary testimony (Friday) will be watched closely for his views on the jobs and investment front.
•  Meanwhile, there will be a data avalanche in Australia with the AIG manufacturing PMI, house prices, new home sales and ANZ job ads all due Monday, January building approvals likely to gain 1% (Tuesday), December quarter GDP (Wednesday) expected to show just 0.3% quarterly growth (or 2.1% year on year) thanks in part to solid retail sales and trade offsetting poor investment, and retail sales (Thursday) expected to have fallen slightly after eight months of gains.

Outlook for markets

• This year will likely see returns from shares a bit more constrained and volatile than was the case last year, but the trend for share markets is likely to remain up nonetheless reflecting a combination of reasonable valuations, better 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 just concluded earnings reporting season in Australia confirming that the market is on track of good earnings growth this year, the ASX 200 is on track to meet our year-end target of around 5800.
• 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.

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• The transition from mining to non‑mining led growth is on track.  Next week’s data on housing lending, consumer sentiment, construction, employment and dwelling starts will provide further detail on the transition.
• US non‑farm payrolls could be stronger than expected.  Employment data is key for Fed tapering decisions over 2014.
• Other important US data over the week ahead are retail sales, CPI and industrial production.

Welcome to 2014! The Australian data flow has begun the new year quite positively with signals that the transition to non‑mining led growth is proceeding as loose monetary policy continues to work its way through the economy.  Our outlook for the Australian economy and financial markets for 2014 is included in the Perspective.

In Australia, housing‑related data points are expected to show that the recovery in the housing market is firmly entrenched. Total housing lending to owner‑occupiers and investors looks like it continued to increase in November, rising by around 4%.  The ABS’ QIII building activity release will detail the number of dwelling starts over the period.  We are looking for a 1% increase in commencements in QIII.  A surge in approvals towards the end of QIII and start of QIV will see stronger levels of commencements in the periods ahead.

The January reading of consumer sentiment may pick up given anecdotal evidence of solid retail sales growth over the Christmas period.  Stronger than expected retail sales data this week indicates that the period of weak retail outcomes are easing thanks to prior cuts to the cash rate and rising house prices.  Consumer unemployment expectations are likely to remain elevated while there are highly publicised news around large job losses.  The December employment report is the key release next week.  We expect modest jobs growth around 11K in the month The overall trend in employment growth has been soft.  But, despite this the unemployment rate has hovered around 5¾% due to a falling participation rate.

The engineering construction data provides additional detail on work done over the period.  The data provides useful information on mining capex and the progress of non‑residential construction, which is key for the non‑mining outlook.

New Zealand data includes the NZIER quarterly survey of Business opinion which should show a decent improvement in business confidence in line with the strengthening seen in the ANZ survey.  NZ retail card spending should show another lift, indicating a strong end to the year.  The outlook for the New Zealand economy in 2014 is included from page eight.

The Japanese current account is likely to be a deficit around ¥150bn.  This would be the third consecutive current account deficit for Japan.  The deterioration in the Japanese current account is one of the factors contributing to the depreciation in the Japanese Yen.

Tonight, the US non‑farm payrolls are expected to print around 197K, in line with recent outcomes.  The strong ADP employment report released earlier this week suggests an upside risk to December payrolls.  The unemployment rate looks like it will remain at 7.0%.  Outcomes in the labour market will be key for the Fed’s tapering decisions this year.

US advance retail sales are published next week and are expected to show a more modest rise in December following a strong outcome in the previous month.  December US CPI is expected to pick up thanks to rising fuel prices.  Annual core inflation however should stay sub 2%.  The pace of industrial production growth is expected to moderate in December given recent trends in the ISM.  The Fed also release their Beige Book which provides analytical insights into economic conditions in each Fed district and sectors of the US economy.

The only major Eurozone release is November industrial production.  The strong lift in German industrial production in November and the improvement in the Eurozone PMI suggest a bounce back  in Eurozone industrial production.  UK data includes CPI and retail sales.  UK CPI has eased recently but there may be some upward pressure over the next few months as utility prices have risen.  Retail sales growth should continue to edge higher towards its long‑run average as confidence lifts and the labour market strengthens.

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Brian Singer

The Eurozone, which has been the very centre of political instability, is where growth is most likely to emerge in 2014 and, in terms of currency, the Indian Rupee will be the place to be, according to Brian Singer, Head of Dynamic Allocation Strategies at William Blair.

On a recent visit to Australia, Mr Singer said that the Eurozone is becoming increasingly more stable, which is conducive to growth. “There is more stability there now and there is likely to be more stability there in the future than the market appreciates and that’s all supportive of growth,” he said.

Mr Singer said William Blair’s Dynamic Allocation strategies are currently overweight Italy and Spain and has other exposures across the Eurozone, including the Dutch and German equity markets and very limited exposure in France. “Those are the primary exposures,” he said.  “The implementation comes through a combination of futures and ETFs.”

Still in Europe, on a sector basis, Mr Singer has a little bit of a leaning towards the financials and does not incur the exchange rate exposure. “We are actually short the Euro and Swiss franc as well,” he said. “We are doing that as a matter of saying we do want equities exposure but we don’t want exposure to the currency. Not only do we not want exposure to the currency, we do want to be short the currency.”

However, speaking of currencies, it’s a different story in Asia, where William Blair has recently taken a long position in the Indian rupee.

“The largest exposure we have in Asia is a long position in the Indian rupee,” Mr Singer said. “It’s not everybody’s cup of tea but it is cheaper now than since about 2007. The discrepancy between the Indian rupee and what we would say is its fundamental value increased to such a degree that we were more comfortable taking a position.”

In addition, Mr Singer said the interest rate differential in India began to move higher, creating a greater incentive to step into the currency. “When you are getting that type of carry in owning the Indian rupee on a forward basis and picking up that interest rate differential, it’s compelling,” he said.

Mr Singer discounted the panic that has occurred in the Indian rupee over the last couple of months as the market’s attempt to perceive what’s going on from the perspective of the experience of the 1998 Asian currency crisis.

“We simply don’t believe the environment is the same as that environment. We aren’t dealing with rates that are coming off, we aren’t dealing with exploding current account issues and challenged reserve situations,” he said. “The Indian current account deficit has been in place for years and the market has become aware of it this year – good for them, it provides us with an opportunity to focus on that and creates the opportunity.”

William Blair is currently short the Australian dollar.

William Blair launched an Australian and New Zealand presence, headed up by Australian executive, Alex Francois a year ago.

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• The Euro-zone debt crisis is a long way from over, and it will be a long hard slog for Greece, Portugal, Ireland, Spain and Italy but I suspect that we may have passed the worst of the financial panic associated with it. With the exception of Greece, which may yet leave one day, ultimately I see the Euro-zone hanging together and becoming stronger, not weaker.
• With economic rationalist reforms being imposed across Europe, depressed European shares & assets are likely to be great value on a ten year horizon.
• Meanwhile, HSBC’s China manufacturing PMI was little changed in September coming in at 47.8, versus 47.6 in August. The good news is that it hasn’t become any worse, but the bad news is that it is yet to improve suggesting that Chinese economic growth and industrial production remain relatively soft. More aggressive policy stimulus is still called for, but it may have to wait till after the leadership transition is resolved.

To read the full report, click here.

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However, we are yet to see a detailed roadmap to Eurozone fiscal and political union and further policy action from the ECB is likely in an attempt to boosts the European Stability Mechanism’s (ESM) effectiveness.

“We view the measures taken at the EU Summit last week in Brussels as a significant step forward in stabilising European financial markets,” says Murphy.

“These measures should go a long way towards breaking the negative feedback loop between banks and sovereigns and be supportive of risky assets in the near term. However, they do not solve the problems of excessive debt and weak economic growth that are likely to continue to weigh on the Eurozone. More will be needed to permanently bring down funding costs for sovereigns to more sustainable levels,” he adds.

“While volatility is likely to persist in financial markets, the steps taken at the summit, combined with evidence of more supportive policy shifts from major central banks, give us confidence to increase the amount of risk we are willing to take, in particular in areas like corporate credit and emerging markets where valuations are attractive and fundamentals remain solid,” says Murphy.

Plans afoot
The following proposals have been made and will be considered by national governments:

The European Stability Mechanism (ESM) can be used to recapitalise banks directly

“This provision attacks the most contentious aspect of Eurozone policy coordination: explicit debt mutualisation,” explains Murphy.

“Core Eurozone countries have been reluctant to use the ESM as a direct bank recapitalisation tool because the liabilities within the banking system can be large, thus rendering them politically untenable. Yet, if handled properly – we are scant on details for the moment – this could break the financial links between banks and sovereigns, thereby freeing up sovereigns to focus on credible macroeconomic reform,” he adds.

“It is possible that this provision can be extended retrospectively to previous bank recapitalisations in Ireland, Portugal, Greece, and Spain. Furthermore, in reading the statement, we do not believe that this will require full ratification of the treaty by national parliaments. Nevertheless, the ESM itself still needs to be ratified by the parliaments of the majority of Eurozone governments.”

Establish a single supervisory mechanism for the banks in the Eurozone, which should involve the European Central Bank (ECB)

“We believe that this is a positive step in preventing future crises. However, critical measures to prevent inter-regional contagion are still missing, such as pan-European deposit guarantees.”

He continues, “The fact that the ECB is involved suggests that these regulatory efforts will pertain solely to the 17 countries participating in the monetary union, rather than the 27 members of the European Union as a whole.”

The Spanish bank recapitalisation will be financed through the European Financial Stability Facility (EFSF) and transferred to the ESM without assuming senior status

“The Spanish bank bailout will move from the EFSF onto the balance sheet of the ESM when it becomes functional, but the ESM will not hold senior status on the Spanish loan programme,” says Murphy.

“At this time, this provision is specific to the Spanish recapitalisation programme only,” he adds.

Establish a €120 billion fund for immediate growth measures. These measures will be financed via the European Investment Bank (€60 billion), the EU budget (€55 billion), and the new Project Bond issuance (€5 billion)

“The European Commission has pushed for growth financing for investment projects and jobs. While the amount is small and does nothing to alter the near-term outlook for the region as a whole – these funds represent just 1.3% of 2011 Eurozone nominal GDP – it could be helpful to the smaller programme countries,” explains Murphy.

“On balance, we believe that material progress has been made on breaking the financial link between the sovereigns and their banks, but there are few signs of a detailed roadmap to fiscal and political union.”

He continues, “We expect further easing from the ECB in response to this positive Summit outcome in order to provide the national governments time to implement the new measures related to the ESM’s expanded capabilities and create a new regulator. Our view is that these measures are a step forward in stabilising European financial markets and welcome this demonstration of policy coordination.”

10 July 2012

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