• Share markets continue to recover from their recent falls helped by a combination of good earnings news in the US, better than expected economic data in Europe, China and Japan and as the ECB started up its quantitative easing program with indications that it might be widened. Global and Australian share markets have roughly recovered half the fall they saw in the correction, with the Australian share market also being helped by investors taking advantage of 6% grossed up dividend yields. Bond yields were flat to up slightly over the past week, commodity prices were mixed with oil flat but metals up and the $A was little changed.
• Events in Canada provided a reminder of the terror threat posed to countries participating in the efforts to combat IS. (A colleague has pointed out that the term “Islamic State” should be avoided in referring to the Insurgent Savagery currently threatening Iraq, Syria and beyond as it defames one of the world’s great religions – he’s right, so I won’t).Terrorist attacks are horrible in terms of their human consequences and there is no doubt that IS related terrorist attacks in western countries will be taken badly initially by share markets, as we saw with the 1.5% dip in Canadian shares after the attack in Ottawa. But the experience with various Al-Qaida related attacks last decade is worth recalling: after an initial negative impact share markets bounced back as it was clear that there would not be a major economic impact and it seemed the effect on markets weakened as the terror threat continued. It only took just over a month for the US share market to recover from its 12% post 9/11 slump and it took the UK share market 1 day to bounce back from its 1.3% fall on the day of the July 2005 London bombings.
• The wall of worry (global growth, deflation risks, end to US QE3, the IS terror threat, HK protests, Ukraine, Ebola, etc) remains for investors but there were some positives in the last week: manufacturing conditions PMIs unexpectedly rose in the Eurozone,  Japan and China; the ECB has now started its quantitative easing program and looks to be thinking about expanding it to include corporate bonds which would allay any concerns that it may not be big enough to have a meaningful impact; and Nigeria was declared Ebola free after earlier being seen as the next country at risk in Africa – if they can contain it the West should be able to too.

Major global economic events and implications

• US economic data was mostly favourable. While the Markit manufacturing conditions PMI cooled it remains strong at 56.2, jobless claims continue to trend down, leading indicators rose and home sales are trending up. What’s more, continued low CPI inflation of just 1.7% leaves the Fed with plenty of flexibility on interest rates.
• Of greater interest for investors, September quarter earnings continue to impress. So far 192 S&P 500 companies have reported of which 79% have beaten earnings expectations (compared to a norm of 63%) and 61% have beaten on sales. Earnings growth looks likely to have come in around 10%, compared to market expectations for a 6% gain. Sales growth is running around 5% year on year.
• The Eurozone saw some good news on the economic front with unexpected gains, albeit modest, in manufacturing and composite business conditions PMIs for October. This suggests growth continues. That said, it’s still slow and with the risk of deflation the ECB will need to ramp up its quantitative easing program.
• Japan’s manufacturing conditions PMI rose in October suggesting the recovery from the sales tax hike inspired slump earlier this year is continuing.
• Chinese data remains relatively steady. September quarter GDP growth came in at 7.3% year on year, down from 7.5% in the June quarter but slightly stronger than expected. While retail sales slowed to 11.6% this was probably due to lower inflation and growth in industrial production accelerated to 8%. Growth in investment was little changed with slower property investment being offset by strength in manufacturing and infrastructure. Meanwhile the flash HSBC PMI for October improved slightly. While the property sector will remain a drag on growth various mini-stimulus measures already announced and likely more to come should be enough to see growth this year come in “around 7.5%”. No boom, but not bust either.

Australian economic events and implications

• Benign inflation supports the case for rates to remain low. The September quarter saw a broad based fall in inflation in with headline inflation falling to 2.3% year on year. While price rises in government related sectors remain the main driving force of inflation, inflation in market related sectors fell to just 1.8% year on year. The September quarter saw price weakness in areas like clothing (-2.7% year on year), furnishings and household equipment & services (+0.4% year on year), transport (+0.2% year on year) and communications (-1.8% year on year). Subdued wages growth and falling commodity prices suggest that inflation will remain. So no pressure for a rate hike here. The message from the Minutes from the last RBA Board meeting and various speeches from RBA officials remains unchanged: rates are on hold, the $A remains too high and measures to slow bank loans to investors are being considered by the RBA and APRA.

What to watch over the next week?

• First up will be the market reaction to the ECB’s Asset Quality Review and Stress Tests to be released Sunday (9pm Sydney time). This will assess the adequacy of 130 Eurozone banks’ capital levels against both baseline and adverse scenarios and those that fail will be given 6 to 9 months to boost their capital ratios. Some failures are likely but mainly for technical reasons (ie before allowance is made for 2014 capital raisings) and mainly amongst unlisted and mutual banks, but not many of the major listed banks are likely to fail given pre-emptive capital raisings (€75bn since 2013) and conservative lending practices in the lead up to this review. In fact, just as occurred with the Fed’s stress test of US banks in 2009 it could prove to be a watershed event that helps restore confidence in Eurozone banks and clears the way for more bank lending
• In the US, all eyes will be on the Fed (Wednesday) which is expected to end the final $US15bn of QE3 it is doing each month. There is a chance that the fall in US inflation expectations will prompt the Fed to just taper by $US10bn leaving QE alive at $US5bn a month. However, in the absence of more bad global news or market turmoil ahead of the meeting we would only attach a 40% probability to this. That said, the Fed is likely to restate that a “considerable time” is expected to elapse before it starts to raise interest rates and indicate that it will allow for the impact of softer global growth, the impact of a stronger $US in holding US inflation down and the recent fall in inflation expectations which will likely serve to reinforce market expectations that the first Fed rate hike won’t come till late 2015. It may also indicate that it will ramp up QE again if needed.  
• Meanwhile September quarter US GDP data (Thursday) is likely to show that growth slipped back to a 2.9% pace, which is good but not booming after just 1.3% growth in the first half. Expect reasonable growth in pending home sales (Monday) and durable goods orders (Tuesday) along with solid consumer confidence (also Tuesday). The Fed’s preferred inflation indicator (Friday) is likely to remain around 1.5% year on year, leaving plenty of scope for the Fed to keep rates down. More than 100 US S&P 500 companies will report Q3 earnings.
• In Japan, industrial production for September ((Wednesday) will be watched for a rebound after August weakness and data for household spending, unemployment and inflation will be released Friday.
• China’s official manufacturing conditions PMI for October (November 1st) will likely be little changed.
• In Australia, expect trade prices (Thursday) to show a further decline in the terms of trade, September quarter producer price inflation (Friday) to remain benign and private credit growth (also Friday) to remain moderate. The main focus in the credit stats will be on housing credit, in particular whether growth credit to investors in housing shows any signs of moderating given RBA concerns.

Outlook for markets

• Our assessment remains that the roughly 10% top to bottom fall in share markets seen from September highs to recent lows represents a correction and not the start of a new bear market. A retest of the lows cannot be ruled out but the cyclical bull market most likely remains intact. The correction pushed share valuations well into cheap territory, the global growth outlook remains for okay growth (“not too hot, but not too cold”), monetary conditions globally and in Australia look like they will remain very easy with Europe and Japan filling the quantitative easing gap that will be left by the US and US rate hikes looking even further away and investor sentiment remains very bearish which is positive from a contrarian perspective. October is often a month where market falls come to an end ahead of a Santa Claus rally into year end and I expect to see the same happen this year.  The winding up of ECB QE, getting the ECB’s bank stress tests out of the way and US November 4 mid-term elections which look like seeing the Republicans take both the House and the Senate are likely to help.
• Low bond yields will likely mean soft medium term returns from government bonds. That said, in a world of too much saving, spare capacity and low inflation it’s hard to get too bearish on bonds.
• To its recent low of $US0.8640 the $A fell a bit too far too fast (just as the $US has risen too far to fast), so a short covering bounce has been underway and could go further. That said the broad trend in the $A is likely to remain down reflecting soft commodity prices, the likelihood the Fed hikes interest rates before the RBA and the relatively high cost base in Australia. Expect to see it fall to around $US0.80 in the next year or so.

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

————-

Important note:While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

The post Weekly market & economic update – week ending 24 October, 2014 appeared first on AdviserVoice.

The Eurozone may be headed for stagnation: Fidelity.

When pessimists want to express the utmost gloom ahead for the eurozone they often cite Japan’s lost decades as their most-feared outcome for the 18-member area.

The worriers invoke a familiar tale when they talk of Japan’s endless stagnation since an asset-bubble popped from 1989. From the early 1990s, real estate values and stock prices plunged and banks wobbled under bad debts. Even though Japan’s export success persisted, the country’s economy failed to flourish despite massive fiscal stimulus, interest rates being slashed to almost zero and the invention of quantitative easing. A potent symbol of Japan’s malaise is that deflation became entrenched from 1995 to 2013 (with the exception of 1997).[1]

Europe’s economic performance is so lacklustre that the financial crisis that European Central Bank President Mario Draghi doused in mid-2012 with his “whatever it takes” pledge has become an economic and political crisis. The eurozone recorded no growth in the second quarter, when the Germany and Italian economies shrank 0.2%. Deflation is shadowing the region. Eurozone prices only rose 0.3% in the year to September, deflation having already taken hold in eight countries including Spain, Italy and Portugal. Deflation would prove Ebola-like for the eurozone because net government debt now amounts to 87% of output. All but two euro-users have net government debt ratios above the prescribed rate of 60% of output, while the number where net public debt exceeds GDP is six, now that Belgium (102%) has reached the triple figures that make default a possibility for a slow-growth economy. Unemployment for the eurozone is 11.5%, and soars as high as 27% in Greece and 24% in Spain. Eurozone banks reek with bad debts and are reluctant lenders. Needless to say, the economic calamity is poisoning politics. So is Europe heading for Japan’s popularly ascribed fate? You bet. But there are two twists when comparing the eurozone’s fate to the story of Japan’s lost decades. One of them may surprise investors. The other could calm their concerns.

There is always hope that eurozone policymakers will do more to resurrect their economy and puncture the pessimism. The split in France’s ruling Socialist Party over imposing austerity could spark a welcome backlash among euro users against the self-defeating fiscal straightjacket enforced by Berlin, whose resistance may weaken as Germany’s economy stagnates. The ECB, watching the collapse of inflation expectations, is sending signals that it will launch a quantitative-easing, or full-blown asset-buying, program before too long. Perhaps authorities will heed the calls from respected economists that, to boost growth, central-bank-financed fiscal stimulus is justified (real money printing via fiscal policy and a surefire way to generate inflation). The more the economic crisis intensifies, the greater the pressure on politicians to compromise over the political, banking, fiscal and other integration the eurozone needs to surmount its debt crisis and secure the euro’s future. The problem for the eurozone is that politically viable remedies, such as relaxing fiscal targets and quantitative easing, are only half-hearted solutions while true cures appear politically impossible. Thus the lost years since 2008 will turn into a lost decade soon enough.

The despair

Almost incredibly given the woes of the eurozone economy, many media reports and commentators refer to a eurozone recovery because they use the flawed system of judging the business cycle by looking at growth from one quarter to the next. (The flipside of this misleading oversimplification is to define a recession as two consecutive quarters of negative growth.)

The best way to adjudicate economic performance is to look at how an array of indicators such as output, employment, income growth, industrial production and retail sales perform over time. This is the flexible method by which the National Bureau of Economic Research declares recessions and expansions in the US to no dispute, often well after the troughs and peaks in activity have occurred. The same method is applied to the eurozone by the UK-based Euro Area Business Cycle Dating Committee. This body, rightly, won’t declare the eurozone out of recession even though its economy has expanded during four of the past five quarters. In a sense, what the body is saying it that it’s too early to say that activity has troughed.

While such informed judgements of business cycles are the most credible way to call recessions and expansions, they don’t readily allow for comparisons across regions or time. The best way to do that, for all its flaws is firstly to look at how long an economy takes to regain its previous peak in output in gross and per-capita terms and, secondly, to calculate the maximum drop in output over a recession. On this basis, for instance, the US regained its 2007 output peak in 2011 in gross terms and two years later on a per-capita basis. The worst of the downturn was in 2009 when GDP was 0.7% below 2007’s level. The US economy is thus rightly described as being in recovery, for output in 2013 was 5.9% above the level of 2007. (The National Bureau of Economic Research will call the end of a recession before GDP has fully recovered its previous peak when comparing quarterly output. It dates the most recent recession as ending in the June quarter of 2009 when GDP was 1.3% below that of the fourth quarter of 2007. It made this decision 15 months after the trough in activity occurred.)[2]

The eurozone’s GDP peaked in 2008 at 13.6 trillion euros (A$19.3 trillion) and it is yet to regain such heights for 2013’s output was 1.8% below the pinnacle of 2008. The worst of the slump occurred in 2009 when the eurozone’s GDP was 4.4% below the height reached the previous year. The IMF, which does not provide GDP-per-capita figures for the eurozone, predicts that the eurozone’s GDP will only regain its 2008 apex in 2015.[3]

Among the three biggest and most populous eurozone economies, Germany regained its 2008 peak in 2011 and by 2013 its economy was 2.3% above the highs of five years earlier. France reclaimed its 2007 high point in 2011 but by 2013 its economy was only 0.1% above its level of six years earlier. Alas, Italy’s GDP in 2013 was 9% below the record it set in 2007. On a per-capita basis, only Germany is ahead, having clawed back to 2008 levels by 2011. By 2013, Germany was 4.9% ahead on this, the best, measure of prosperity. Last year, France’s GDP per capita was 2.3% below its record of 2007 while Italy’s was 11% under on this basis.[4]

How does this compare with Japan? This may well be the surprise. Japan’s economy expanded in 16 of the 18 years from 1990 to 2007 – it contracted 2% in 1998 and shrank another 0.2% the following year – so there was never post-crisis drop in output. In the decade after the asset bubble peaked in 1989, Japan’s economy swelled 15.5% in gross terms. On a per-capita basis, Japan’s expansion was 12% over these 10 years, while the jobless rate only ever got as high 4.7% over that time, in 1999.[5]

Admittedly other economies outshone Japan over this period – Australia recorded 24% per-capita growth from 1989 to 1999, the US 22% and Germany 17%. But the figures for Japan show that talk of a lost decade in the 1990s is an exaggeration to say the least.

The same goes for the following 10 years. After the slight dip in 1999, Japan’s economy grew every year from 2000 to 2007, even though, it’s worth pointing out, the country was in mild deflation from 1999 to 2005 – the annual decline in consumer prices averaged 0.5%.[6] (The GDP deflator would show deflation stretched from 1998 to 2013 but it’s real economic growth that counts.) All up, from 1989 to 2008, Japan’s GDP jumped by 29%. The country’s output swelled 24% over these two decades on a per-capita basis. The highest the jobless rate ever climbed over these two decades was to 5.4%, in 2002.

Nobel-Prize-winning Paul Krugman is among those who call talk of Japan’s two lost decades a “myth”. He found that using GDP per working-age population – an adjustment that takes account of Japan’s shrinking and aging population – Japan recorded “not bad” growth of 1.2% a year from 1990 to 2007.[7]

If anything, Japan’s worst economic patch since 1989 has been the past six years because its economy contracted in 2008, 2009 and 2011. But since 2007, Japan has still performed better than the eurozone for by 2013 Japan’s GDP had regained its 2007 peak.

The consolation

Europe’s economy is thus already worse than Japan’s in just about every way, even if Tokyo’s net government debt stands at 144% of GDP.[8] So too is its political and social situation. Japan has its own currency and monetary policy (including its own central bank) and can make its own decisions on fiscal policy rather than operate within constraints set by Brussels. Asia’s second biggest economy is still a strong exporter. Government debt in the country is largely owned by locals, which helps insulate the country against foreign speculators. Japan has beaten deflation, for now at least, as consumer inflation excluding food reached 3.1% in the 12 months to August. Japan is a homogenous country, even if an aging one. It is politically stable and its low unemployment has never allowed extremists to flourish.

Sadly, the best comparison for the eurozone’s stagnation is the 1930s. As Nobel-Prize-winning economist Joseph Stiglitz says: “The only way to describe what is going on in in some European countries is depression.”[9] Even more startling perhaps, in terms of time taken to regain the previous peak, the eurozone is on track to surpass the worst-performing group of countries of that era; those that stayed on the gold standard, the closest thing to a fixed-currency regime as damaging as the euro. (The euro is worse because it’s proving impossible to quit.) The eurozone has already overtaken the time taken for the gold quitters of that era to recover.

Work by UK economic professor Nicholas Crafts shows that the group of European countries that stayed on the gold standard – Belgium, France, Italy, the Netherlands and Switzerland – while admittedly suffering a steeper contraction of 10%, took 7½ years to recover their previous group peak. In comparison, the so-called sterling bloc, namely Denmark, Norway, Sweden and the UK that quit the gold standard, only took 4 ½ years to recover. The eurozone’s downturn is five years old as of 2013.

But that doesn’t mean that stock investors should despair (though Europe’s unemployed can be forgiven for being despondent). There is something to the Japan story to calm investors. This comfort is how well the global economy and global share markets coped with the troubles of the world’s then-second-largest economy and the collapse of its stock market.

At the end of 1989, Japanese stocks accounted for 41% of the MSCI World Index.[10] After the Nikkei 225 Stock Average fell 80% from its peak on 29 December 1989 to its post-bubble low on 31 March 2003, Japan’s weighting in the MSCI World fell as low as 7.8% in May of that year.[11] How did global stocks fare over that time? They rose. The US S&P 500 Index surged 140% over those 14 ½ years, helping the MSCI World Index in US dollar to climb 32% over the period.

However you assess Japan’s economic performance over the decades after its bubble popped, these returns show that the global economy and a portfolio of global stocks can survive the stagnation of a big economy if the US economy is doing well enough, other parts of the world are expanding and no shocks emerge. As long as the woes of Europe don’t lead to jolts and no other shudders emerge, a US recovery and decent performance elsewhere – including in Japan! – should be enough to propel global stocks in coming years. By then, the most pessimistic outcome you could paint for a modern developed economy would be that it’s facing lost decades like the eurozone.

by Michael Collins, Investment Commentator at Fidelity

All GDP figures are real. As footnoted, GDP and GDP-per-capita figures come for the IMF World Economic Outlook Database. April 2014. http://www.imf.org/external/pubs/ft/weo/2014/01/weodata/index.aspx.

Figures on eurozone consumer inflation, unemployment and government debt come from Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home). Other financial information comes from Bloomberg unless stated otherwise.

The post Is Europe headed for “Japanese-style” stagnation? appeared first on AdviserVoice.

Central Bank Watch – October 2014

Principal Global Investors has released its monthly Central Bank Watch for October 2014.

The report outlines key concerns of the Reserve Bank of Australia which includes the slowing momentum in the Chinese economy, the strength of the Australian dollar and commodity prices.

The report includes graphs and analysis of current monetary policy in the US, England, Europe, Japan and Canada.

The post Central Bank Watch – October 2014 appeared first on AdviserVoice.

• Share markets had a rough week weighed down by a combination of worries about the Fed, tough action against US companies seeking to reduce their tax by relocating outside the US, worries about Chinese growth, geopolitical concerns and worries about the loss of breadth in the US share market rally. The poor global lead, falling iron ore prices and the retreat of foreign investors to the sidelines saw the Australian share market give up its gains for the year. Weakening share markets saw bonds rally across the board suggesting in part that investors fear that talk of US rate hikes is premature. The outlook for relatively tighter monetary policy in the US versus other major regions saw the US dollar continue to rally, leaving it up nearly 7% over the last three months, and this is also weighing on commodity prices. The falling iron ore price and the rising $US saw the $A continue its slide.
• Geopolitical threats are continuing. While the global threat from the Ukraine conflict seems to be receding a bit, the conflict with IS in the Middle East is hotting up bringing with it the threat of global terrorist activity. So far global oil supplies are not under threat, with the oil price running below the levels when IS in Iraq first started hitting the headlines. But increasing prospects for the deployment of ground forces in Iraq by the US and its allies and talk of the terrorist threat are weighing on investor confidence. Terrorist attacks are horrible in terms of their human consequences and there is no doubt that an IS terrorist attack in a western country would be taken badly by share markets. But the experience with various Al-Qaida related attacks (9/11, Bali Bombing, 2005 London bombings, etc) is worth recalling: after an initial negative impact share markets bounced back as it was clear that there would not be a major economic impact and it seemed the effect on markets weakened as the terror threat continued. It only took just over a month for the US share market to recover from its 12% post 9/11 slump and it took the UK share market 1 day to bounce back from its 1.3% fall on the day of the July 2005 London bombings.
• In Australia, the Reserve Bank’s Financial Stability Review expressed concern that the housing market is becoming too speculative and that if left unchecked poses risks to the broader economy for when the property cycle turns back down. As a result APRA has stepped up its surveillance of the banks and given the desire to avoid a rate hike at this point the RBA is discussing with APRA further steps that may be taken to ensure sound lending practices are maintained, particularly with respect to property investors. The focus looks like it may be on tougher capital requirements and interest rate tests banks apply when assessing new loans rather than restrictions on loan to valuation ratios. It’s likely that if the property market does not soon cool an announcement could be made in the next few months. To the extent that the use of macro-prudential controls might delay the first rate hike further into 2015, it could be good news for existing home borrowers.
• The term “macro prudential controls” is really just the latest buzzword for the failed credit rationing policies used prior to the 1980s. The RBA would be well aware of the risk of unintended consequences – eg, the potential impact on first home buyers many of whom are investors these days and in forcing borrowers into the shadow banking system – but it no doubt feels such controls are better than raising interest rates right now.
• The Australian dollar is continuing to slide helped by an ascendant US dollar, the continuing slide in the iron ore prices (now down 41% year to date) and the possibility that the use of macro-prudential controls to slow the housing market will further delay the first rate hike in Australia. Comments by Reserve Bank of NZ Governor Wheeler that the level of the $NZ was “unjustified and unsustainable” also helped as they apply just as much to the level of the $A. I remain of the view that by year end the $A will have fallen through the January low of $US0.8660 on its way to around $US0.80 over the next year or so. A lower $A will help rebalance the economy.

Major global economic events and implications

• US economic data remains mostly strong. While existing home sales surprisingly fell in August new home sales surged to a six year high, the Markit PMIs for September remained solid and durable goods orders continue to trend higher. While Fed officials are continuing to provide mixed messages on the timing of rate hikes its noteworthy that a couple of hawks will not be voting members at the Fed next year and so their calls for an earlier move by the Fed should be ignored. Our view remains that the Fed won’t start raising rates till around the June quarter, but the 7% gain in the $US since June has probably not been lost on Janet Yellen who would be thinking its delivering a de facto monetary tightening.
• Eurozone PMIs continued to edge down in September leaving them at levels consistent with only modest growth and ECB President Draghi described the recovery as losing momentum. There was a slight improvement in money supply and credit momentum, but not enough to allay the mounting pressure on the ECB.
• A slight fall back in Japan’s manufacturing conditions PMI for September was disappointing but leaves in place a gradual recovery after the April tax hike induced fall. Japanese core inflation excluding the impact of the tax hike is continuing to run around 0.5% year on year, which is better than deflation but not much of a buffer really. The latest leg down in the value of the Yen should help provide a further boost to inflation though.
• While Chinese officials continue to indicate there won’t be any major policy stimulus, it’s worth noting similar comments were made earlier this year before various mini-stimulus measures were introduced. An unexpected slight rise in the HSBC flash PMI for September helped relieve Chinese growth fears a bit.

Australian economic events and implications

• In Australia, job vacancies fell slightly over the 3 months to August according to the ABS but this followed  a 5.3% gain over the previous six months and skilled vacancies rose in August for the 11^th month in a row so the basic picture remains one of forward looking indicators pointing to stronger jobs growth ahead.

What to watch over the next week?

• In the US, the main focus will be on the ISM manufacturing and services indexes (due Wednesday and Friday respectively) which are both expected to remain strong and employment data (Friday) which is expected to show a 210,000 gain in payrolls for September and unemployment unchanged at 6.1%. Consumer spending data (Monday) is also expected to show that the Fed’s preferred inflation measure remained benign with a fall to 1.4% year on year.
• In the Eurozone, business confidence data (Monday) is likely to have weakened a bit further and September inflation (Tuesday) is likely to be just 0.3% year on year. Despite this, the ECB (Thursday) is unlikely to announce further monetary easing but may provide details of its proposed QE program involving asset backed securities.
• Japanese data for jobs, household spending, industrial production, labour cash earnings and housing starts due Tuesday will be watched for signs of further improvement following the impact of the April sales tax hike, but the September quarter Tankan business survey (Wednesday) is likely to have weakened slightly.
• In China, the official PMI (Wednesday) is likely to be little changed from the 51.1 reading for August.
• In Australia, given the RBA’s concern about the property market, credit data (Tuesday) and RP Data house price figures (Wednesday) for September may see greater than normal interest. Expect to see overall credit growth remaining modest but interest will be on whether growth in credit going to property investors accelerated from the roughly 10% annualised pace seen over the last few months. RP Data is expected to show that house price gains remained strong in September. Meanwhile, expect a modest gain in retail sales (Wednesday), a renewed deterioration in the August trade deficit (Thursday) and solid building approvals (also Thursday).

Outlook for markets

• Shares remain at risk of further short term weakness particularly ahead of the end of US quantitative easing next month, the US mid-term elections in November and as we are still in a seasonally weak part of the year for shares. Australian shares are also vulnerable in the short term to further falls in the iron ore price and as foreign investors stay on the sidelines as the $A falls.
• However, this is likely to be nothing more than a healthy correction, allowing shares to let off a bit of steam, and should be seen as a buying opportunity as the cyclical bull market in shares likely has further to go. 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, global earnings are continuing to improve on the back of gradually improving economic growth, global monetary conditions are set to remain easy and there has been no sign of investor euphoria.
• Although the falling $A is initially a drag on the Australian share market as foreign investors retreat to the sidelines, after a while it will start to become a source of support as it flows through to upwards revisions to earnings expectations. Roughly speaking each 10% fall in the value of the $A boosts company earnings by 3%.
• Low bond yields will likely mean soft returns from government bonds, particularly as we continue to edge closer to the start of a gradual interest rate tightening cycle in the US.
• The combination of soft commodity prices, the likelihood the Fed rate hikes before the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down. Expect to see it fall to around $US0.80 in the next year or so.

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

———–

Important note:While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

The post Weekly market & economic update – week ending 26 September, 2014 appeared first on AdviserVoice.

Nathan Lim

Australia Headlines

• Western Australia’s energy market is broken – wholesale electricity prices ($180 per megawatt hour) cost more than unsubsidised solar and wind, more than double rates in Eastern Australia
• Renewable Energy Target review delivers on preconceived conclusion – local renewable energy industry in peril

AEI Assessment

The Renewable Energy Target review lead by climate skeptic Dick Warburton has recommended changes that would effectively arrest renewable energy development in Australia. While the grandfathering option in the recommendation should provide some security for existing investments (assuming it is adopted), there is nothing to support further large scale developments. We are disappointed that the government seems to be deliberately ignoring the global trend whereby nations are reducing their emission intensity from power generation to address climate change. Support for this trend also comes from the added benefit that it also improves local air quality.

North America Headlines

• California oil refiners take in record oil-by-rail from Utah
• Colorado activists drop fracking opposition in return for new task force to address concerns regarding hydraulic fracturing
• Consolidated Edison sees nearly 100% growth in solar rooftop installation in 2013 – solar cheaper than residential electricity rate
• Democrats increasingly backing oil and gas industry
• Energy Information Administration (EIA) says imported oil to meet 22% of US demand, the lowest level since 1970
• Reinstatement of the Production Tax Credit by Congress before year end remains highly uncertain
• California, under Assembly Bill No.327, starts rulemaking process to integrate cost-effective distributed energy resources into the grid
• Department of Energy, 2013 Wind Technologies Market Report – Wind Power Purchase Agreements at record low of US$25 per megawatt hour
• California passes bill to streamline residential solar applications and installations
• Gina McCarthy, Environmental Protection Agency (EPA) head, says renewable fuel standard ruling out shortly and could be higher because of increased gasoline usage
• EPA to decide this year whether to regulate methane emission from drilling (fugitive emissions)
• FutureGen 2.0 (experimental near-zero emission coal plant) gets EPA approval for CO₂ injection wells
• EPA must rule by December 1 on Ozone standard. Tightening to 60-70 parts per billions will impact power generators through additional nitrogen oxides and volatile organic compound abatement equipment

AEI Assessment

The policy debate around shale oil and gas continues to swing towards the moderates and away from the critics. The growing realisation of its transformational impact on the economy has broadened its appeal as it seems to hold the promise of jobs, prosperity and energy security. As a result we have raised our assessment for oil to Positive.

Renewable energy support policy continues to slide but the cost of solar and wind has fallen so dramatically that financial supports are becoming decreasingly important. As noted above rooftop solar and large scale wind are now competitive in conventional energy markets. Even after deducting the benefits of various subsidies, the economics are not so drastically affected as to completely negate renewable energy’s competitive position. Scale in both technologies and sensible policy support (like California’s decision to make rooftop solar installations less bureaucratic), continues to drive cost down making renewables so close to being strongly competitive against conventional energy on an unsubsidised basis.

The EPA is signalling its strong desire to continue to improve air quality by all means possible with FutureGen now able to proceed to construction and the department’s finding that ozone levels still too high.

Europe Headlines

• UK Department of Energy and Climate Change, less than one-quarter of UK public support shale gas development
• German electricity price go negative again from high wind production
• Italy passes changes to Feed-in-Tariffs for solar, effectively a 20% retroactive cut
• European Commission expected to confirm 40% carbon emission target by 2030 in October, efficiency and renewable targets to be considered
• Ukraine and Russia moving towards a permanent ceasefire

AEI Assessment

The next major policy development for the EU is their 2030 targets. Preliminary discussions continue to suggest efficiency and renewable targets will only be binding at the EU level and not at the country level. Given the ongoing divergence in energy policy amongst member states (Poland versus everyone else essentially), this seems to be a reasonable compromise as it recognises that some countries are more willing than others to migrate to higher levels of renewable energy and take responsibility for their contribution to climate change. Countries have exceeded EU targets in the past so an aggregate target does make sense as long as there are not too many other countries looking to get a free ride. Making the efficiency target non-binding is disappointing though as these are easily the most direct and least difficult technologically to reduce a nation’s energy intensity.

A political resolution in the Ukraine, at the time of publication, appears to be in the making which will substantially reduce the political risk in this region.

China Headlines

• Beijing cuts coal consumption 7% in first six months of 2014
• Smaller cities steer away from GDP as primary performance metrics, focus on raising living standards for poor, reducing poverty and environmental protection
• 70% of Chinese coal companies losing money as coal price at seven year low
• China appeals mixed World Trade Organisation ruling on US duties levied on solar panels, wind towers
• National Development and Reform Commission says China will start national carbon trading by 2016

AEI Assessment

It is becoming abundantly clear that China has recognised that business-as-usual will further aggravate the economic, societal and environmental imbalances in the country. Bringing forward its national carbon trading market and the move away from solely using GDP as a measure of success is tacit recognition by the government that externalities cannot be ignored forever. This will continue to put downward pressure on energy intensive, high emission industries.

Japan Headlines

• Japan has added 9,770 megawatts of clean energy since July 2012 – 98% is solar
• Minister of Environment, Japan should target 30% renewables by 2030
• Abe appoints new cabinet with the popular Yuko Obuchi tasked to push through the unpopular nuclear re-start agenda

AEI Assessment

Japan’s version of President Obama’s “all of the above” energy policy is best demonstrated by the expansion of solar power over the past two years. Over this time, Japan has approved an astonishing 65 gigawatts of new solar projects which actually exceeds Australia’s entire installed base of all forms of generation. The comment made by the Minister of Environment hardly seems necessary but is an important recognition by the government of the role of renewable energy in the energy mix. Yuko Obuchi appointment as the first female Trade and Industry Minister is hoped to appeal to the broader electorate as a recent Nikkei newspaper poll found 65% of female respondents opposed restarting Japan’s nuclear fleet.

Global Headlines

• India is considering adopting a Feed-in-Tariff regime for solar
• India proposing 10,000 megawatts of wind per year
• Brazil energy auction attracts offers of 26 gigawatts of wind, solar
• Africa to install more renewable power in 2014 than in previous 14 years
• 2,200 cellphone towers in India to be powered exclusively with solar
• India does not impose solar dumping duties
• Global solar installations on track for record for 2014, 52 gigawatts
• India’s Prime Minister Modi says good governance and clean energy are top priority

AEI Assessment

Momentum is building for an energy transformation in India and Africa. The deployment of solar cellphone towers in India is significant because it was needed to address the lack of dependable power in the area. This is a reflection of the larger problem facing the developing world where a centralised grid strategy has failed to lift nations out of energy poverty. Building a distributed energy grid around where energy is consumed instead of where resources are located is expected to be a fundamental principle in grid deployment in the developing world.

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Shinzo Abe’s “third arrow” radical plan to revive Japan’s economy.

Japan’s parliament in June began debating legislation that would allow for the country’s first casinos. Whatever the merits casinos are as tourist attractions as the bill’s backers claim versus the social ills that opponents allege will flow from their opening, they form part of the so-called third arrow, or economic reform part, of Prime Minister Shinzo Abe’s radical plan to revive Japan’s economy.

Other measures are more standard fare in a package of economic reforms that was announced in June by Abe, who started his second term as prime minister in December 2012. They include changes for the labour market, cuts to company taxes, plans to enter into more trade agreements to open up sectors such as agriculture, special zones where red tape is reduced and changes that allow for economies of scale in the ownership of farm lands.

The third arrow could well be the most revolutionary in terms of how it could change Japanese society and the economy for years, bearing in mind that it can include (and exclude) any of the proposed regulatory changes or economic reforms that are often announced ad hoc. The first two arrows of Abenomics are fiscal stimulus, which is now being reduced, and further loosening of monetary policy – a radical change in itself because it involves central-bank asset purchases that aim to double the monetary base within two years to turn deflation into inflation and achieve consistent GDP growth per capita.

The Abenomics experiment was begun in May last year to resuscitate the economy of a politically stable country beset by two decades of stop-start growth, a decade or so of deflation, the world’s biggest pile of government debt, falling real wages and a shrinking and aging population. The results, so far, are promising for an economy that Bloomberg estimates is 3.5% smaller than when Abe first came to power in September 2006. (He lasted two years.) The economy has expanded for five straight quarters and generated inflation. Investment, production and business confidence have improved and a lower yen is helping exporters. Readings of these measures, however, are not improving enough to lift Japan’s long-term growth projections.

One big challenge for the economy now is that, in an effort to tackle its debt, the government boosted the sales tax by 3 percentage points to 8% on April 1 this year. The resulting drop in consumer spending is expected to shrink the economy over the second quarter. (The tax rise boosted core consumer inflation to a 23-year high of 3.2% in the 12 months to April this year. Core consumer prices are rising at an estimated 1.3% pace when tax effects are excluded.) This means the vague third arrow has taken on greater significance as a means for reviving Japan’s economic future, particularly as Tokyo wants to become a stronger regional economic and political counterweight to China.

Shadowy arrow

The reforms announced in June were generally vague. The government, however, was most specific in saying that it wants to reduce the corporate tax rate from 35.6% to below 30%, where Australia’s rate sits. It is still to outline, however, how it will replace the lost revenue to stop adding to the government’s gross debt that amounts to about 240% of GDP.

The more-abstract announcements cover tougher corporate governance rules, including measures to untangle crossholdings among companies, to boost shareholder returns. They embrace enhanced ability for super funds to buy equities. Among others are changes to farming that allow for the consolidation of small farms and proposals to end utility monopolies to make the energy industry more efficient. Proposals for the labour market could be among the most contentious because they comprise proposals to allow more immigrants in a monocultural and homogenous society, tax changes to encourage higher female participation and steps to boost their numbers at executive level (which might be counterproductive to the government’s hopes to boost the birth rate) and more flexible labour laws. “In my growth strategy, there are neither taboos nor sacred cows,” Abe said in a televised address on June 24.[1]

Abe’s government needs to prove it can turn announcements into regulatory and legal achievements. The vested interests Abe confronts are significant. The severity of the challenges facing Japan may well give him the best-possible environment to succeed.

The fate of the legislation covering casinos may well provide a gauge as to whether or not Abe can overcome vested interests. For among the opponents of Las Vegas-styled and owned casinos are the Japanese businesses that operate various forms of legal gambling, from lotteries and gaming machines to sports betting, who fear foreign competition more than they are troubled by any social ills that might come with casinos.

Financial information comes from various media sources including The Wall Street Journal and Bloomberg.

[1] The New York Times. “Shinzo Abe’s bid to shake up corporate Japan.” 24 June 2014. http://www.nytimes.com/2014/06/25/business/international/shinzo-abes-bid-to-shake-up-corporate-japan.html?hpw&action=click&pgtype=Homepage&version=HpHedThumbWell&module=well-region&region=bottom-well&WT.nav=bottom-well&_r=0

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• Japan’s economy appears to be weathering the April sales tax hike well and Abenomics looks to be working.
• Third arrow supply side reforms are very positive.
• The success of Abenomics augurs well for Japanese shares, which are now cheap. It’s also positive for Australia as Japan is our second largest export market.

Introduction

It’s now over 18 months since Japan embarked on a program designed to reinvigorate its economy under Prime Minister Shinzo Abe, which has become known as “Abenomics”. Growth has rebounded, deflation has given way to inflation and Japanese shares are up around 70%. But is Abenomics working or are we just seeing another cyclical bounce? And what does it mean for investors?

Three arrows

Since the Japanese bubble economy burst at the end of the 1980s, it has wallowed with sub-par growth, six recessions, chronic deflation and a secular bear market in shares and property. Many reasons have been given: a failure to realise how serious the problem was; a conservative approach to policy making; a focus by the dominant Liberal Democratic Party on protecting special interests; revolving door political leadership with 16 prime ministers since 1990; and a declining population.  Regardless of the drivers, Shinzo Abe and the LDP were elected with a mandate to fix up Japan in December 2012 and with voters giving him control of the upper house of the Diet, Japan’s parliament, in July 2013.

Abe is both an economic rationalist and a Japanese nationalist. A key motivation is likely his desire to see Japan’s regional standing strengthened in the face of China’s rise and North Korean threats. He has acted very decisively. His policy response has been characterised by “Three Arrows”: fiscal stimulus, monetary stimulus and supply side economic reforms. All with the aim of boosting inflation to 2% pa and real economic growth to 2% pa.

Given Japan’s large public debt, any fiscal stimulus has to be modest and supply side reforms always take time so the initial focus has been on monetary stimulus. On this front, the approach has been very aggressive with the Bank of Japan announcing a 2% inflation target in January last year, Abe appointing ultra dove Haruhiko Kuroda as central bank governor and the BoJ announcing a massive quantitative easing program (pumping cash into the economy by purchasing $US75bn/month of assets using printed money) in April last year. Adjusted for the size of the economy this was more than double the size of the Fed’s then quantitative easing program and with the latter being reduced now swamps it. The program has seen the Yen fall by 21%.

The initial response has been positive with the economy growing 3% over the year to the March quarter and inflation (ex the impact of an April 1 sales tax hike) running at 2.2%. But concerns remain: that the sales tax hike from 5% to 8% will drive a slide back into recession as the last sales tax hike in 1997 arguably did; that boosting inflation has only led to a fall in real wages; that the BoJ’s success in achieving sustained inflation will depend on the Yen continuing to fall; that Japan’s poor fiscal position dooms it long term; and that the Government has not delivered enough in terms of the third arrow reforms. Let’s look at each of these in turn.

Japan weathering the sales tax hike well

A return to recession as followed the 1997 sales tax hike is unlikely because unlike in 1997 Japan now has quantitative easing, unemployment is falling, property prices are rising, bank lending is rising, banks now have small non-performing loans and business confidence has been rising.

A range of indicators have bounced back solidly from their recent sales tax related fall:

• The Economy Watchers outlook index is up strongly;

• The outlook components of the BoJ’s Tankan survey are strong and business investment plans have improved;
• The unemployment rate has fallen to 3.5%, its lowest since 1997, and the ratio of job vacancies to applicants is at its highest since 1992.

• While overall household spending remains weak after the tax hike, retail sales rose solidly in May.

The overall impression is that the Japanese economy has weathered the sales tax hike reasonably well and that a re-run of the 1997 experience is unlikely.

Ending deflation is key

Rising real wages, when inflation was negative, didn’t exactly help Japan. Rather, deflation was the much bigger problem because it zaps spending – why spend or invest today when you know it will be cheaper tomorrow? The key was to first end deflation and institute an inflationary mindset and Japan has done this with the introduction of a 2% inflation target for the BoJ and backing this up with unprecedented monetary printing. Inflationary expectations are now starting to rise in response and with the labour market stating to look tight wages growth is likely to pick up. Large firms already seem to be starting to put through faster wage increases.

More domestic focus going forward

The decline in the Yen was clearly important in initially driving inflation higher. Our assessment is that a further decline in the Yen is likely – as the BoJ’s huge money printing program, which likely won’t be increased but will be extended beyond its two year timeframe, and the Fed’s taper means that the supply of Yen is rising relative to the supply of US dollars. However, with an inflationary mentality starting to become more entrenched a falling Yen won’t be as important in driving Japanese inflation going forward. In fact this is evident in a breakdown in the negative correlation between the Japanese shares and the Yen recently.

Japan’s fiscal problems bad, but not that bad

Japan’s public debt looks horrible with gross public debt of 244% of GDP (compared to just 31% in Australia!). However, it’s not nearly as bad as it looks. First, its gross public debt of 244% of GDP falls back to 137% once assets such as Japan’s foreign exchange reserves are allowed for. Second, Japan borrows from itself, with public borrowing being a mirror image of private sector savings. Thirdly, various reforms over the last decade will limit growth in pension and health spending. Fourthly, tax as a share of GDP is low by OECD standards in Japan and there is plenty of scope to further increase the sales tax rate from 8%. Finally, while some fret that rising bond yields will blow out Japan’s interest bill this won’t be a problem if the back up in yields reflects stronger growth & inflation as it will mean higher tax revenue.

Third arrow reforms are being understated

A critique of Abe seems to be that he has been lax in delivering “third arrow” reforms. But several points are worth noting. First, it was always second order. Japan’s problem is a lack of demand not supply, as evident in falling prices. And supply side reforms often make things worse before they get better. So it was right to first focus on reflation.

Second, Japan’s third arrow reforms may seem more like a “thousand needles” but they are adding up. A range of reforms have been announced in recent months, eg easing visa requirements, cuts to rice subsidies and eased factory regulations. On top of this the Government has released its “New Growth Strategy” which includes a range of measures including a plan to cut the corporate tax rate from currently 36% to in the 20-30% range, measures to boost female workforce participation and measures to allow more foreign workers in certain sectors. These are all far reaching and while one “big bang” reform should not be expected the gradualist “thousand needle” approach is very positive. For example, the cut to Japan’s corporate tax rate could boost Japanese earnings per share by between 10 to 30 percentage points over the next 4 years.

Finally, Abe’s huge popularity, stable Government, control of both Diet houses and fading resistance to reform – eg farmers, who have been strong resisters of allowing a more efficient agricultural sector, now have an average age of 70 – means the reforms have a strong chance of success.

Good reason for optimism on Japan

Japan will not grow as fast as China as it is already a rich country and the success of Abenomics should not be judged mechanically by the 2% inflation and growth targets (as they are just lights on a hill). But when assessed broadly there are good reasons to believe Japan is throwing off the malaise of stop start growth and deflation seen over the last 20 years: the BoJ is doing all the right thinks to entrench inflation, the longer term reforms it is introducing are broad based and Abe appears to have the support required to deliver.

Implications for investors

There are two major implications for investors. First, a reinvigorated Japan is positive for Japanese shares. After a 57% gain last year, Japanese shares had become overbought and due for a correction, which is what we have seen this year with a 15% fall into April. Having worked off the excess, Japanese shares are now attractive again. While the boost to Japan’s economy and share market last year was driven more by monetary easing, economic reform looks likely to be a major driver over the longer term.

Second, Japan is still the world’s third largest economy, so stronger more sustainable growth in Japan is positive for the global economy at a time when Europe is gradually recovering and the pace of growth in the US is picking up. This in turn is positive for global shares generally.

Japan and Australia

Japan takes 16% of Australia’s exports and is our second largest export market, so a continuing exit from deflation and stronger growth in Japan is positive for Australia. This also comes at a time when a free trade deal with Japan is being signed. While the trade deal does not change the near term growth outlook for either country, its benefits will accrue over time. The main beneficiaries are beef and dairy farmers, service industries (such as finance) and consumers as tariffs on imported cars, household and electronic goods from Japan fall to zero.

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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Mark Burgess

In this latest outlook, Mark Burgess, Chief Investment Officer at Threadneedle Investments, assesses market activity so far this year and provides an asset allocation update.

• Threadneedle halves overweight in equities
• Increases underweight in Asian equities on China concerns
• Increases overweight in Japan

In our last asset allocation update, we framed the outlook for 2014 in the context of how bond markets deal with policy normalisation; what happens to emerging markets as a result; and whether corporate profits will meet expectations?

The first quarter has been a testing time for markets as they have grappled with the above, overlaid with an escalation in geopolitical risk, and ongoing concerns regarding the burgeoning Chinese credit bubble. Markets took serious fright in January and February, but risk appetite has returned and investor sentiment improved. In equities, with the exception of Japan, developed markets are now flat on the year, having been considerably weaker, whilst in emerging markets the picture is more mixed, albeit with a very significant rally in the last week. In fixed income, core yields are now rising again although at much lower levels than the beginning of the year, and are comfortably off the lows. Credit grinds ever tighter (can we still call it high yield at a 4 % yield?), and emerging market debt like its equity counterpart, has rallied strongly in the recent period.

When we consider the macro economic backdrop, the developed world is still on an improving trend, albeit at a slightly slower pace than we had expected at the beginning of the year. The Fed remains committed to an orderly ending of QE and expectations are now for short rates to start rising in H1 2015. It is difficult to know the impact of policy normalisation on the economy but it will be a headwind and debt remains stubbornly high. In Europe, deflation is rearing its ugly head and with a similar debt concern the ECB must surely be considering more imaginative policy options than hitherto. We would consider any new measures to be acting from a position of weakness. Arguably, given weak economic activity, a profoundly fragile periphery, and stubbornly low inflation, any new measures should have already been introduced. In Japan, Abenomics appears to have stalled, and the currency has stopped depreciating. Nervous of the impact of the consumption tax, the Nikkei has fallen sharply relative to other developed markets, in contrast to last year.

Perhaps the biggest conundrum is China. Over the last few years there has been an explosion of credit, facilitated by the shadow banking system. Retail investors have been enticed into an array of savings products promising heady returns where the underlying investments are often opaque. It is clear that the authorities are now concerned about this and investors are surely going to see an increasing number of these funds go bust. Looking back through history at economies that experienced a similar growth in credit, it is difficult to find one that ended well. At best we are likely to see a material reduction in China’s growth rate, however it could be much worse. Clearly the prolonged underperformance in Chinese equities has discounted some of this, and valuations are low relative to other markets. However the unwinding of the Chinese credit bubble could severely test the Chinese financial system, and unnerve investors further.

Consequently we have decided to halve our overweight in equities and move to a neutral position in cash. Equity valuations remain attractive, but they are less compelling than they were. We increased our underweight to Asian equities on the China concerns and increase our overweight to Japan on the belief that the impact of the consumption tax will be lower than feared. Although we remain overweight equities, it would be fair to say we are less optimistic than we have been for some time. 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 markets look like they offer any real value. But given the China issue and geopolitical and macro risks, we are wary of increasing our weighting at present. If there is good news, it is that the environment is likely to throw up opportunities for stock pickers which we aim to continue to exploit.

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Abenomics Wealth Effect’ has started to play a key role in Japan’s economy: Nikko AM

The latest research from Nikko Asset Management (Nikko AM), a related company to Tyndall Investment Management Limited (Tyndall AM) shows that Abenomics is exceeding its targets and consensus expectations on the road to reform.

Prime Minister Shinzo Abe’s ‘Three Arrows’ policy, dubbed by Nikko AM as ‘Super-Abenomics’, is providing a clear boost to Japan’s household finances.

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“Super-Abenomics” on the horizon: Nikko AM

Nikko AM uses the expression ‘Super-Abenomics’ to describe our expectation that Japan will exceed its own targets, as well as consensus expectations, for its new economic plans and reforms. 

Of course, not every improvement desired in Japan will occur, and those who are looking for wide-open immigration, headline corporate tax cuts, or aggressive labour reform are likely to be disappointed. However, in our view:

• The amount of monetary stimulus in the first arrow has exceeded expectations;
• Due to the Olympics, the fiscal stimulus will be larger than targeted; and
• Economic and regulatory reforms of the third arrow will exceed consensus expectations, with the Trans-Pacific Partnership (TPP) negotiations (and the associated farm tariff reduction and other reforms) being the most closely watched imminent item.

We believe that Japan is already ‘different this time’ and change will continue accelerating as Prime Minister Abe has more power than any other Prime Minister in the last few decades and resistance to his strong ‘all-in’ beliefs is dissipating from other factions. For instance, even though previous Prime Minister Koizumi was popular with the people, he had strong resistance from his political rivals and the bureaucracy and despite some successes, his long reign did not achieve much reform. Conversely, Abenomics is not just one man’s belief, but a shift in the view of the large majority of the citizenry. In our view, it is durable and also supported by major global geopolitical re-alignments.

The Abenomics Wealth Effect

One area that is not highlighted enough is the role of the wealth effect. Inflating asset prices, while keeping interest rates down, has been the hallmark of the US economic recovery (and a trend for past three decades, along with higher leverage ratios).  The wealth effect is hardly covered in most economics text books, mostly because equity and housing prices are so difficult to predict and because they are reflexive with the economy (higher risk asset prices equal a better economy and vice versa). While simplistic (and dangerous, if carried too far), the underlying logic is similar to our knowledge that consumer and business confidence is key to economic growth.

When asset prices are rising, as they are in the US with nearly USD 4.5 trillion (27% of GDP) of household net worth being created in H1 2013, consumer confidence clearly rises, as does the economy via consumption, residential capex, etc. This leads to higher income taxes and higher business capex. Coupled with tax hikes and the US sequester, this has cut the US fiscal deficit by almost half in the past two years.

Japan is well advanced in this process too, with more than Yen 71 trillion (USD 720 billion) of household financial net worth (excluding real estate) created in the 12 months to June 2013, totalling Yen 1.2 quadrillion of net financial assets. Many analysts will likely be surprised to see that it is at a record high. The data including all household net assets is frustratingly lagging (only 2011 full year data is available), but total net assets are nearly twice the size of financial net worth.

Total household net assets have been nearly flat since 1993. Indeed, assuming that real estate was the vast portion of the non-financial net assets, this would imply that since 1997, its Yen 1.4 quadrillion level has declined to Yen 1.0 quadrillion. This is a 28% decline in non-financial net assets since 1997, with the Yen 0.4 quadrillion increase in net financial assets mostly offsetting it.

2012 likely showed a moderate rebound in net assets, but in 2013, with land prices rising along with equity prices, one can expect that the wealth effect has started to play a key role and will have an even stronger positive effect on Japan’s economy and tax revenue in future.

 Tyndall AM – part of the Nikko Asset Management group (Nikko AM , a leading independent asset manager in Asia – has access to on-the-ground insights and research from the global Nikko AM offices. This paper has been compiled from interviews and papers developed by the Nikko AM investment experts.

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This document was prepared and issued by Tyndall Investment Management Limited ABN 99 003 376 252 AFSL No: 237563 (“Tyndall AM”). The information contained in this document is of a general nature only and does not constitute personal advice. It is for the use of researchers, licensed financial advisers and their authorised representatives. It does not take into account the objectives, financial situation or needs of any individual. Tyndall AM is a owned by Nikko Asset Management Co. Limited.

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