Weekly Market Update – 10th October 2014

 

 

 

 

Investment markets and key developments over the past week

• The correction in shares continued over the last week. While dovish minutes from the US Federal Reserve’s (Fed) last meeting provided mid-week support it was short lived as nervousness about growth in Europe and the broader global growth outlook, along with worries about the ending of the Fed’s third round of quantitative easing (QE3) later this month and Ebola weighed. This saw most share markets fall with US shares -3.1%, European shares -4.4%, Japanese shares -2.6% and Australian shares -2.4%. From their highs last month US shares have fallen 5%, global shares are down 6% and Australian shares are down 8%. The Australian share market has effectively led the global share markets on the way down reflecting falling iron ore prices, fears about Australian banks needing to raise more capital and the tendency for foreign investors to stay away as the Australian dollar falls. Reflecting falling global inflation expectations and safe-haven demand bond yields generally fell. The US dollar had a fall from overbought levels and this saw the Australian dollar bounce modestly. Meanwhile, commodity prices were mixed with oil prices down sharply but metal prices up slightly. World oil prices are now down 20% since the problems with the Islamic State in Iraq first hit the global headlines a few months ago.

• A downgrade to the International Monetary Fund’s (IMF) outlook for global growth is clearly weighing on sentiment. The downgrade was only modest taking its global growth forecasts down by just 0.1% to 3.3% for 2014 and down by 0.2% to 3.8% for 2015, but it nevertheless highlighted the softness in global growth momentum outside the US. However, it was hardly new news, as weakness in Europe, Japan, Brazil and Russia is well known, and is just a repeat of the pattern seen in the last few years where stronger global growth is forecast in the year ahead only to be revised down as we get closer to it. In some ways the uneven, “not too hot, not too cold” global economic expansion is not bad as it means we remain a long way from overheating, higher inflation and aggressive monetary tightening.

• The minutes from the last Fed meeting clearly recognise this with the Fed highlighting that its move towards rate hikes is not on auto pilot but dependent on how the economy performs. The Fed will also allow for the dampening impact on US growth and inflation from foreign weakness and the strong US dollar. If anything the timing of the first US rate hike, which we have been expecting to come in the June quarter next year, may be getting pushed back a bit (again). This is particularly so with US inflation remaining below target and bond yields falling on the back of falling inflationary expectations.

• The Reserve Bank of Australia (RBA) remained on hold with a dovish post meeting statement which highlighted that the central bank still sees the Australian dollar as historically high despite recent falls, domestic demand as still patchy and modest wages growth as keeping a lid on inflation. Relatively sanguine comments were also made regarding house prices. Given this the RBA looks set to leave rates on hold well into next year, with no hikes likely till after the Fed starts to hike. This is likely to mean no move until the second half next year. Rates have now been on hold at 2.50% for 15 months, which is still less than the 20-month record when rates were left at 7.50% from December 1984 to July 1996.

 Major global economic events and implications

• US economic data was light on but okay. Labour market indicators were good with job vacancies up in August and weekly unemployment claims continuing to fall. Falling import prices on the back of falling commodity prices and the rising US dollar point to downside risks to US inflation and a possible further delay in the timing of Fed rate hikes. Meanwhile, the September quarter earnings reporting season has kicked off with Alcoa, Costco and Pepsi all beating expectations. Market expectations for 6% year-on-year earnings growth for the year to the September quarter are likely to prove too conservative yet again.

• Eurozone economic data has been poor with sharp falls in German industrial production and factory orders and weak exports from both Germany and France with European Central Bank (ECB) President Mario Draghi under pressure to do more as he reiterated that the Eurozone recovery is losing momentum.

• The Bank of Japan left monetary policy unchanged, continuing to pump out cash at a faster rate than the Fed ever did, but mixed economic data – with a fall in economic sentiment but gains in machine/tool orders – leaving it under pressure to do even more.

• Chinese non-manufacturing purchasing managers’ indices (PMI’s) fell in September, but remain okay and ongoing mini-stimulus measures helped buoy the Chinese share market some more, which is now up 12.9% this year. In fact, after performing poorly for several years, Chinese shares are now one of the world’s strongest this year.

Australian economic events and implications

• In Australia, the confusion around monthly jobs data was heightened as the Australian Bureau of Statistics (ABS) concluded its seasonal adjustment process had distorted recent jobs data and so switched to reporting original or unadjusted data. While this has led to a mini-furore the monthly jobs data at the best of times has a big noise element and the ABS has long urged us to focus on the trend data. Statistical noise aside the basic picture is of modest jobs growth and a gradual rise in the unemployment rate – all of which is consistent with the RBA’s decision to leave interest rates on hold at record lows. The good news is that forward-looking jobs indicators like job ads and hiring plans in the National Australia Bank (NAB) survey, point to stronger growth at some point ahead. Other data was mixed with softer-than-expected housing finance, but a record high reading for the Australian Industry Group’s construction conditions PMI and another very low inflation reading from the TD Securities Inflation Gauge for September.

• Out of interest the ABS also confirmed what many have long suspected – that the share of housing finance going to new home buyers is way understated and we may not have a first home buyer crisis after all.

What to watch over the next week?

• In the US, the main focus is likely to be on a speech by Fed Chair Yellen (Friday) for anything new on the monetary policy outlook but she is likely to simply confirm that the timing of interest rate hikes remains dependent on the state of the economy and right now there remains significant slack in the labour market. On the data front: expect a modest pullback in September retail sales (Wednesday) as payback for strong gains seen in August, but underlying retail sales growth to remain solid; benign producer price inflation (Wednesday); solid growth in industrial production (Thursday) and continued strong readings in the New York and Philadelphia Fed manufacturing conditions surveys (due Wednesday and Thursday respectively); a further gain in the National Association of Home Builders index (Thursday); and a rebound in housing starts and permits (Friday). The Fed’s Beige Book will also be released.

• Chinese export and import growth for September (Monday) is expected to show an acceleration but inflation for September (Wednesday) is expected to have fallen to just 1.7% year-on-year with producer price falls intensifying highlighting significant potential for more monetary easing. Credit and money supply growth is likely to show a modest improvement after recent weakness.

• In Australia, the NAB business survey (Tuesday) will be watched to see if business conditions and confidence have remained around the reasonable levels seen in August and the Westpac consumer confidence survey (Wednesday) will be watched for a bounce after the weakness seen in September. June quarter data for dwelling starts (Wednesday) are likely to show further strength.

Outlook for markets

• The weakness we have seen in shares over the last month could well have further to run in the short term. While Australian shares have led with a fall of 8%, the pull back in US shares of just 4% to date is quite modest and nervousness is likely to remain in the near term regarding the Fed’s probable ending of quantitative easing later this month, the upcoming bank stress test results in Europe, Ebola and various geopolitical issues. We are also still at the tail end of a messy time of year for shares from a seasonal perspective.

• However, this is still likely to be just a normal correction rather than the start of a new bear market. Share valuations are already pushing well into cheap territory (the forward price-to-earnings ratio on Australian shares has fallen from 14.8 times to 13.7 times), the global growth outlook remains for okay growth, 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 is starting to get bearish again which is positive from a contrarian perspective. The lower Australian dollar will also help boost growth in Australia and eventually profits.

• Low bond yields will likely mean soft 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.

• In the short term the Australian dollar has fallen a bit too far too fast (just as the US dollar has risen too far to fast), so a short covering bounce could well emerge over the next month or so. That said the broad trend in the Australian dollar is likely to remain down reflecting soft commodity prices, the likelihood the Fed rate hikes before the RBA and the relatively high cost base in Australia. Expect to see it fall to around US$0.80 in the next year or so.

 

Source: AMP CAPITAL ‘Weekly Market Update’

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