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Investment markets and key developments over the past week
- China’s rollercoaster Share market has been the main drama. The Shanghai Composite Index suffered a painful -8.9% fall during the week before managing to rebound with a remarkable +5% overall gain. However, from the peak set on June 12, the Shanghai Composite has declined by nearly 25% in the past month.Is this a major crisis for the Chinese economy? China’s share market needs to be placed in context. Most Chinese consumers have limited exposure to China’s share market. The average Chinese household has less than 15% of their assets in Chinese shares according to HSBC. Even with the recent correction, Chinese share investors who have held the benchmark portfolio for the past six months still have a +40% positive return. Indeed the performance of the Chinese share market over the past year had little influence on China’s economic growth as seen in the following chart. While Chinese shares were accelerating higher from mid-2014 to 2015, Chinese real economic growth was gradually slowing to a 7% annual pace.
- Essentially China’s economy is still experiencing a slowdown rather than a slump. There are key signs suggesting that China’s economic growth is progressively slowing rather than collapsing into a recession. China’s residential property market appears to be stabilising, with prices having recorded modest gains in May and June. China’s business surveys, such as the Purchasing Manager Indexes for June, suggest that China’s real economic growth is now running around the 6.5% pace. China’s central bank has also cut their key interest rates in June, which should be more supportive of Chinese economic growth over the next year.
- For Australia, the immediate implications of the weak Chinese share market are limited. More important for Australia is China’s growth prospects. Australia’s largest export in iron ore shows a clear direct linkage from China’s economic slowdown. Over recent years, China’s steel production has slowed from robust growth of above 10% per year to now being flat. This has moderated demand growth for Australia’s commodity exports, as China is our largest customer. Australia’s largest iron ore producers (BHP, Rio and Fortescue) have also significantly increased supply. Given more modest China demand, as well as increased supply, the iron ore price has been under significant pressure over the past year falling from US$120 per ton to approximately US$49. This has clearly having a direct negative impact on mining share prices, Australia’s economic activity as well as the Federal Budget in terms of company tax revenue.
- However this negative impact from lower commodity prices is being countered by a falling Australian Dollar which is beneficial for Australian exporters. Lower Australian interest rates have also supported the housing sector record robust gains in construction activity. Hence Australia should record modest 2.5% real economic growth in 2015 as the better export and housing performance offsets the weaker mining sector.
- Greece’s debt crisis has not yet been resolved with negotiations continuing with their creditors in the European Commission (EC), European Central Bank (ECB) and International Monetary Fund (IMF). The deadline of July 12 passed with no resolution. European leaders appear to have instructed Greece that pension and tax reform measures must be passed by Greece’s parliament by July 15 before further bailout financing is considered. Greek banks have been closed since June 29. As Greek banks are heavily dependent on the European Central Bank (ECB) providing cash, the ECB’s decision to cap funding at Euro 89 billion has effectively restricted Greek banks to limit cash ATM withdrawals to Euro 60 per day.
Major global economic events and implications
- The IMF has cut their 2015 Global growth forecast from 3.5% to 3.3% for 2015. America’s growth has been downgraded by -0.6% to 2.5% in 2015 given the March quarter contraction. Yet the IMF is still optimistic that this is a “temporary setback” given “easy financial conditions, lower oil prices and strengthening housing market”. Europe’s growth forecast has held steady at 1.5% for 2015, even allowing for Greece suffering a “heavier toll”.
- China’s inflation result for June shows mild consumer price rises at a +1.4 % annual pace. This should allow China’s central bank further scope to lower interest rates in coming months.
- America’s central bank meeting minutes for June gave no compelling signs on the likely timing and trajectory for US interest rate rises.
- Japan’s Tankan survey shows an encouraging gain in business confidence in the June quarter. This is supportive of Japanese shares and the mild economic recovery.
- Major Market Moves: Apart from China’s daily gyrations, Global Shares managed a late rally to end the week in positive territory. The European Eurostoxx 50 Index (+2.5%) and Germany’s DAX (+2.36%) recorded solid gains. American shares (S&P 500 Index) were essentially flat. However Japan’s TOPIX has experienced a sharper decline of -4.2 %. Australia’s ASX 200 declined by -0.8% for the week.
Australian economic events and implications
- Australia economic data has been positive. There was mild jobs growth in June, but this comes after a robust May result. June saw +7,300 extra jobs created, compared to May’s +40,000 jobs. Australia’s unemployment rate has edged up by 0.1% to 6.0 % in June.
- The Reserve Bank kept the official cash interest rate steady at 2% at July’s meeting. There was no forward guidance, suggesting a further interest rate cut is likely following May’s reduction. The RBA Governor’s statement noted Australia’s economy is growing “but at a rate somewhat below its longer-term average”. For the Australian dollar, the RBA considers that a “further depreciation seems both likely and necessary” given the “significant declines in key commodity prices”. So the RBA still wants a lower currency to support growth.
What to watch over the next week?
- The European Central Bank meeting next Thursday is particularly important for Greece in terms of receiving further financial assistance and being able to stay in the European monetary system.
- China will release fixed investment, production and retail sales results for June.
- American retail sales for June and housing starts for May should show a further pickup in activity.
Outlook for markets
- Global shares are currently in a correction phase. Greece’s Crisis, China’s slowdown and the approaching prospect of higher US interest rates have weakened global shares since mid-June. However global shares should recover given their attractive valuations and the very easy monetary policy stance of central banks. Global shares are more appealing on a return basis compared to low government bond yields. The known threats from higher US interest rates, Greece’s potential Euro-exit, political risk in the Middle East & Ukraine as well as China’s growth slowdown appear to be manageable for now. Accordingly, global shares should deliver solid returns later in 2015 allowing for this current bout of turbulence.
- Australian Shares have more modest immediate prospects than their global counterparts. Struggling commodity prices, with China’s growth slowdown and excess supply, as well as the possibility of higher bank capital requirements from APRA, are constraining risk appetites. Australian shares are likely to tread water over coming months until there are more encouraging signs that key commodity prices are stabilising.
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