Mark Burgess

“As we enter the new year, markets are more or less where we left off in December. Investor appetite for risk is up, liquidity is free flowing and credit markets are open for business, certainly from a new issues perspective.

As investors and commentators consider the year ahead it strikes me there are three issues we need to consider: the growth outlook, what a normalised yield curve means for emerging markets, and whether economic growth can drive corporate profit growth.

Is growth going to become embedded in the developed world?

In both the US and UK, economic growth is gaining momentum. In the US, the impact of last year’s fiscal drag is behind us, growth is building and job creation appears robust. The financial system is working with a strongly capitalised banking system lending to the real economy. One could argue that with QE still very evident we should expect no less (stimulus is running at $75bn per month). Nonetheless the US economy looks well placed for 2014 and beyond. UK growth is also taking hold; again private sector job creation is strong, leading indicators are all signalling significant expansion, and the housing market in the south east is particularly buoyant. On the current trajectory we can legitimately consider the need for an interest rate rise this year, something not currently discounted by markets. In Europe, again leading indicators are turning positive (with the exception of France). Even Spain appears to be finally emerging from years of austerity. Certainly peripheral bond markets have been on fire, with yields falling sharply as tail risks diminish. With a more robust global growth environment, policy measures will continue to normalise and long, and in turn short, rates will rise. Implications of this include rising borrowing costs for over-indebted governments and consumers, and a challenging headwind for fixed income investors. It’s also a scenario that lends itself to a stronger $US.

Will tapering, rising bond yields and a stronger US dollar challenge the emerging markets in the way that it did last summer? 

Last year’s car crash in EM debt and equities could be a pre-cursor to a full-blown motorway pile up later this year. Deficit countries more dependent on external financing have remained under pressure since then. Both the equity and debt markets were standout underperformers last year, although equities had a bounce in the second half. The regions’ woes have not been helped by the new Chinese government appearing to want to contain the explosive credit formation facilitated by the shadow banking sector. This has further undermined investor confidence, as has the prospect of a stronger dollar. Nonetheless, if the region can withstand tighter (or at least less loose) US monetary policy, then real value will begin to appear. Bond yields are significantly higher, equity PE ratios are much lower than the developed world and at some stage the region will become attractive. For now though we need to see evidence of stability before considering increasing our exposure.

The final question surrounds the prospects for corporate profits.

Equity markets have clearly performed extraordinarily well over the last few years; the S&P 500 is up by 50%, the Financial Times Actuaries All Share Index up by 33% and the world equity index up by over 40%. Corporate profits have grown, but not nearly as much as markets have risen. So returns have been driven by a re-rating, fuelled by increasing confidence, ongoing central bank stimulus and liquidity provision. For equity markets to progress further we need corporate profit growth to take up the running – it’s unlikely equities can go much further without that happening. Returning then to our first question, if global growth takes hold there is every reason to believe the backdrop for corporate profit growth will be provided, although we will need to be mindful of the impact of falling unemployment on margins given current elevated levels.

There is one final issue to consider. We are nearly six years away from the global financial crisis (although it feels much closer in investors’ memories). Looking at past cycles, history would suggest we are now closer to the next crisis than the last one. Let’s hope that proves not to be the case!”

Comment from Mark Burgess, Threadneedle Investments

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• 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.

• Fed taper fears dominated over the past week resulting in further increases in bond yields and volatile share markets. Some emerging share markets were hard hit as taper fears combined with worries about the economic outlook in countries like India, Indonesia and Brazil. Renewed concerns about Italy and Greece also weighed in Europe. However, improved business conditions indicators (or PMIs) in China, the US and Europe provided underlying support and signalled the global economic recovery was on track. In Australia, the minutes from the last RBA Board meeting made it clear that it retains an inclination to cut interest rates again, albeit the other side of the election, and not too good/not too bad profits continued to flow.
• The minutes from the Fed’s last meeting did nothing to change our view that it will start tapering or slowing its monetary stimulus at its September 17-18 meeting, but its far from a done deal with minutes reiterating that it is contingent on improving economic conditions. Given some mixed recent economic data, the first move could be just a reduction in monthly asset purchases from $85bn to $75bn and it may be positioned as a “one off” for the time being. Importantly the Fed is likely to try and use aggressive forward guidance to make it clear that it won’t be raising interest rates anytime soon and thereby contain the upwards pressure on bond yields. Taper fears could continue to weigh on investors in the near term but are unlikely to derail the broad upward trend in share markets.
• In Europe, fears about Greece and Italy reared their heads again. In Greece another bailout package is likely, but it’s likely to be relatively small and unlikely to be a major problem. The threat of Berlusconi’s party leaving the coalition Government in Italy is probably a bigger threat but may still settle down and the ECB’s “whatever it takes” commitment to preserve the Euro is likely to continue to keep any contagion across Europe to a minimum.
• Asian and emerging market assets came back under pressure over the last week. Fed taper fears are clearly not helping to the extent they are partly driving a flow of capital back to the US, but the broader malaise affecting the emerging world relates to the slower pace of growth in China along with inflation and current account problems (notably in India, Indonesia and Brazil). Underpinning all of this has been a lack of structural reforms. Our broad assessment is that the period of strong relative performance by emerging markets we saw last decade is over and the problems we are now seeing in the emerging world are just indicative of this.
• Meanwhile, in Australia, the minutes from the Reserve Bank’s last meeting make it clear that it still retains a bias to cut interest rates further. It’s also clear that the RBA sees the Australian dollar as being critically important in terms of the outlook for interest rates and by singling it out is continuing to try and “jawbone” it lower. Its understandable that the RBA won’t want to do anything at its September meeting as its just four days before the election, but I suspect that unless the $A falls sharply or Australian economic data picks up quickly the RBA will cut rates by another 0.25% in either October or more likely in November.
• Finally, its worth noting that the Reserve Bank of NZ’s move to limit high loan to valuation mortgage loans to 10% of banks’ new residential loans to control the property market without having to raise interest rates is a possible guide to what the RBA could do if our property market got too hot at a time when the rest of the economy is still subdued. The downside to such an approach though is that it mainly hits first home buyers not trade up buyers.

Major global economic events and implications

• US economic data was mostly solid with a very strong gain existing home sales, a further increase in home prices, an uptick in its manufacturing PMI (to a solid 53.9), an increase in a leading index and trend jobless claims remaining low.
• Eurozone business conditions PMIs rose again by more than expected, continuing the uptrend that began about a year ago. The composite PMI at 51.7 points to a continuing economic recovery.
• Chinese economic news was also good with the HSBC manufacturing PMI for August rising back above the 50 level, which is consistent with growth remaining around the 7-7.5% level. No boom, but no bust either!

Australian economic events and implications

• It was a light week for Australian economic data. On the positive side skilled vacancies rose in July after several months of falls, but the Westpac leading index was flat in June and motor vehicle sales fell.
• We are now about 80% through the June half profit reporting season. Results have been weak but not as bad as feared which partly explains why Australian share market has held up well. 39% of companies have exceeded expectations, which is down from the February reporting season but not bad compared to the last few years; 65% of companies have seen their profits rise from a year ago; 61% of companies have increased their dividends from a year ago and only 13% have cut them; and while corporate outlook comments have been subdued, the fact they haven’t been too gloomy is a good sign. Consequently, we haven’t seen the earnings downgrades some had feared. Earnings expectations for 2012-13 are little changed at -0.5% (with resources earnings down by around 20% but with earnings for the rest of the market up by around 7%) and for 2013-14 earnings growth expectations remain around 13%. Reflecting the better than feared results, 52% of companies have seen their share price outperform the market on the day their results were released. Key themes are ongoing cost control and weak revenue growth but a prospective boost to profits from the lower $A and for iron ore companies from a higher iron ore price.

Major market moves

• Shares had a volatile and mixed week. US and Australian shares were flat to up slightly, but several Asian and emerging share markets fell.
• Commodity prices were mostly softer and the combination of taper fears and the RBA’s renewed easing bias weighed on the $A.
• Bond yields generally rose as the rotation out of them continued, not helped by Fed taper fears.

What to watch over the next week?

• In the US, expect to see ongoing modest trend growth in durable goods orders (Monday), house prices (Tuesday), pending home sales (Wednesday) and personal income and spending (Friday). June quarter GDP growth (Thursday) is likely to be revised up to 2.2% annualised from the initially reported 1.7% thanks largely to stronger trade data. However, the back up in mortgage rates may result in a slight fall back in consumer confidence (Wednesday).
• In Japan, key consumer spending, labour market and industrial production data to be released Friday will be watched closely for signs Abenomics is working after a recent run of mixed data. However, inflation data is expected to show ongoing evidence that deflation is fading.
• China’s official manufacturing PMI (due September 1) is likely to edge higher adding to confidence that growth has stabilised around 7-7.5%.
• In Australia, the focus will be on business investment data to be released Thursday for an indication as to how quickly mining investment is slowing and whether non-mining investment is picking up. Expect June quarter capex data to show a 1.8% rebound after a sharp fall in the March quarter, but forward looking investment plans to remain subdued. June quarter construction data (Tuesday) is also expected to show a bounce after March quarter softness. New home sales data (Thursday) is expected to show an ongoing recovery and growth in private credit (Friday) is likely to have remained modest but with more signs of having bottomed.
• The Australian June half earnings reporting season will wrap up with 40 major companies set to report, including Boart Longyear, Caltex, Flight Centre, Seven Group AGL, Woolworths, Qantas, Westfield, Harvey Norman and Virgin.

Outlook for markets

• Shares are vulnerable to a further consolidation or correction over the next month or two with various events and risks that could cause volatility including the Fed’s September meeting where it may start to taper its monetary stimulus, US Government funding and debt ceiling negotiations, the nomination of the next Federal Reserve chairperson, various imbalances in the emerging world, political instability in Italy and the election in Australia.
• However, any pullback should be seen as a buying opportunity as the broad trend in shares is likely to remain up: valuations are not 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. An unwinding of years of massive inflows into bond funds runs the risk of resulting in a more aggressive rise in bond yields and hence losses on sovereign bonds.
• 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 23 appeared first on AdviserVoice.

Impact of Fed tapering to be felt in real estate market.

While there will be a ‘great rotation’ of capital out of bonds into other asset classes, it is likely that this will be unevenly spread across real estate quadrants, according to the Principal Global Investors US  real estate market report for Q2 2013.

The report highlights the upcoming prospect of Fed tapering of quantitative easing and the desynchronization of global economic growth as two dominant themes in the current market. These are positioning the US to assume a leadership role in economic growth and as its economy begins to gain momentum, investors will need to carefully monitor the interplay between shifting capital and space market dynamics as the monetary policy begins to make its presence felt.

Although those real estate quadrants whose trajectory of earnings growth is limited or fixed will be susceptible to downward variances in total return performance, the publicly traded REIT quadrant has the potential to provide leading indicator signals on the evolving interplay of capital and space market forces.

Included in the report is an economic outlook and extensive analyses of the four quadrants of the real estate capital markets.

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