• The past week saw global shares continue their upward drift helped by mostly good economic data, good news regarding Iran and more favourable developments in Europe.
• The nuclear deal with Iran is a big positive as it substantially reduces the threat of a disruption to the 17 million oil barrels a day that flows through the Straits of Hormuz and hopefully will lead to Iran’s 1.5 million barrels of oil per day coming back on line. So potentially less upwards pressure on oil prices and this is good for global growth.
• There was also good news in Europe with: Merkel and the Social Democrat Party agreeing a coalition which (if ratified by SDP members) will see a minimum wage introduced which will help boost German consumption; the Greek budget deficit falling faster than targeted and on track for a primary surplus this year; and Berlusconi being expelled from the Italian parliament but with little consequence as the Government retained support.
• Chinese 10 year bond yields slipped over the last week, but are still up 100 basis points over the last six months adding to fears China is undergoing another growth threatening monetary tightening. I am not so worried though as: the back-up this year in Chinese bond yields just looks like a catch up to similar increases in global bond yields; it has resulted in a steeper yield curve (long rates rising relative to short rates) which is actually positive for growth; and not much corporate borrowing occurs in the bond market anyway (with corporate bonds only making up 15% of the total bonds outstanding in China) as corporates rely more on bank lending.
• In Australia, despite comments by RBA Deputy Governor Lowe indicating that the threshold for intervening to push the $A down was “fairly high”, the threat that it may occur has continued to weigh on the $A, which is just what the RBA wants to see. And it is worth noting that the RBA may be selling more $A/buying more foreign exchange in the months ahead simply to allocate the $8.8bn capital boost it received last month. Meanwhile Lowe re-emphasised the point that with the terms of trade boost to national income largely behind us, Australia will need to focus on boosting productivity in the years ahead if it wants to continue to see decent growth in living standards. This is not a new message but he is right. To this end proposed tax changes that will cost nothing but encourage state governments to privatise assets are a move in the right direction.
• Meanwhile, the Government’s decision to block the GrainCorp bid and possible plans to buy a stake in Qantas in preference to allowing foreign control will no doubt lead some to fear that Australia is less open to foreign investment and may be returning to a past of greater government involvement in the economy. The initial dip in the Australian share market and the $A in response to the GrainCorp announcement suggests this is the fear. But while one can debate the merits of such decisions, both should be seen as isolated cases reflecting particular circumstances and do not set a precedent. Just as the Woodside decision a decade ago did not signal a precedent. This is particularly so given the proposed tax agreement with the states to encourage the privatisation of more assets, which points to less government involvement in the economy, not more.

Major global economic events and implications

• US economic data was mostly okay. On the negative side pending home sales and durable goods orders both fell in October, but may have been affected by the shutdown. Against this though permits to build new homes rose strongly in September and October, house prices continue to rise, timely consumer confidence measures rose, the leading index rose, initial unemployment claims fell and a new Markit services sector PMI rose strongly. Overall this is consistent with a slight pick-up in the pace of US economic growth this quarter.
• Eurozone economic confidence measures rose for the seventh month in a row, but money supply and lending growth slowed further reminding that growth will remain weak and that further ECB help is likely required, a message the ECB seems with ECB officials alluding to the possibility of further monetary easing.
• Japan saw more good economic data with solid gains in industrial production, the manufacturing conditions PMI, the job to applicant ratio and household spending and core inflation rising further to 0.3% year on year, adding to confidence that Abenomics is working and deflationary pressures are fading.

Australian economic events and implications

• Australian business investment data for the September quarter provided good news. Construction investment rose solidly in the quarter pointing to a favourable contribution to September quarter GDP growth, but more importantly there are signs of life in the outlook for non-mining investment. To be sure the current financial year is likely to be pretty flat for business investment, but the last three months has seen the projected outlook rise from a 1% fall to a 1% gain. And the turn up is coming from non-mining investment, with investment in what the ABS calls “other selected industries” projected to grow 3%, compared to a projected 3% decline just three months ago. This adds to signs already evident from housing indicators and consumer and business confidence that interest rate cuts are getting traction and that the economic outlook is brightening.
• In other data, new home sales fell in October, but this followed a strong gain and with the HIA reporting another rise in housing affordability and housing finance commitments continuing to rise, the trend in new home sales is likely to remain up. Private credit growth remained weak in October, up just 3.5% year on year.

Major market moves

• Most global share markets pushed higher over the last week helped by good economic data, good news regarding Iran and favourable developments in Europe. Australian shares remained in correction mode though
• Commodity prices were little changed to down, with the oil price falling to a six month low.
• The threat of intervention continued to hang over the $A, helped along with fears of less foreign investment in Australia after the GrainCorp decision.

What to watch over the next week?

• In the US, the main focus will be on the payroll data due Friday as it will likely be important in determining whether the Fed will start to taper at its December meeting. The consensus is for a 185,000 gain which may not be strong enough to be decisive but if its 200,000 or above expect the probability of a December taper to rise significantly. Unemployment is expected to fall back to 7.2% after the distortion caused by the shutdown in October. Meanwhile, expect the manufacturing ISM (Monday) and the services ISM (Wednesday) to remain around levels consistent with reasonable growth, new home sales (Wednesday) to remain solid and September quarter GDP growth (Thursday) to have been revised up to 3.1%.
• After cutting its official interest rate last month the ECB may well do nothing at its Thursday meeting. But there is some chance it will go further and cut the deposit rate it pays on reserves to -0.1% in order to further encourage banks to lend. Inflation is running well below target in and this is likely to be concerning the ECB.
• China’s official PMI (Monday) is likely to fall slightly but remain at levels consistent with 7.5% or so GDP growth.
• In Australia, the RBA is expected to leave interest rates on hold at 2.5% when it meets Tuesday. Yes it retains an easing bias but it is only a mild one and in any case since the last meeting there has been more evidence the economy is responding to interest rate cuts and the Australian dollar has fallen in value, in part due to jawboning by RBA officials. So with things going in the right direction there is little reason for the RBA to cut rates again in the week ahead. We remain of the view that while the risk is on the downside for interest rates, they have most likely bottomed and will likely remain on hold out ahead of eventual rate hikes late next year.
• It will be a busy week on the data front in Australia. Expect a 2% fall in building approvals (Monday) after a 14% gain the previous month but retail sales (Tuesday) to continue the modest recovery evident in recent months. September quarter GDP growth (Wednesday) is expected to be around 0.7% quarter on quarter or 2.6% year on year helped along by modest growth in business investment and consumer spending and a small contribution from net exports. The AIG’s PMIs along with data for house prices will also be released Monday.

Outlook for markets

• Shares are at risk of a consolidation or mild correction phase after very strong gains from early October lows which have left them vulnerable. This appears to have already commenced in Australia with a rash of capital raisings not helping. However, this is likely to be just a pause ahead of the resumption of the rising trend as valuations are reasonable, monetary conditions are set to remain very easy, profits will improve next year as global & Australian growth picks up and there is still a lot of money sitting in cash and bond funds. The Australian share market remains on track to hit 5500 by year end, with a little help from a Santa rally. Note that the first half of December is often flattish for shares with the Santa rally usually starting around Christmas.
• 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 but talk of Fed tapering and RBA jawboning. The medium term trend in the $A is likely to remain down to $US0.80.

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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