Weekly Market Update – 16 October 2015

• While shares had a rough patch mid-week, they recovered into the end of the week helped by better US earnings reports and some positive signs out of China. Although Australian shares ended down 0.2% for the week, US shares rose 0.9%, Eurozone shares gained 0.1%, Japanese shares rose 0.8% and Chinese shares rose 6.5%. In fact, the Chinese share market is now up 16% from its late-August low. While shares did well, commodities were soft and bond yields fell as inflation remains (mostly) missing in action. The Australian dollar fell slightly.

• After the strong gains from the September low some volatility was to be expected and we have seen a bit of that over the last week. The share market recovery won’t go in a straight line, but with China risks receding, the US Federal Reserve (Fed) showing that it is keen to avoid a policy mistake in raising interest rates prematurely and shares cheap versus bonds the trend is likely to remain up as we go through the seasonally-strong period into year-end.

• Rising mortgage rates add to pressure on the Reserve Bank of Australia (RBA) to cut the official cash rate again. Westpac’s move to increase its variable mortgage rates next month by 0.2% for owner-occupiers and investors is not particularly surprising as it flows from the rise in the cost of funding that will result from higher capital requirements being imposed on the banks by the Australian Prudential Regulation Authority (APRA). The other big banks are likely to follow, although they may wait to see what the RBA does next month. With economic growth stuck around 2% and the mining investment downturn only about half way through, the last thing the economy needs now is a rate hike for the 30-40% of households who have a mortgage given the threat it will pose to consumer spending. The best way to avoid this is for the RBA to cut the official cash rate in order to offset the higher funding costs the banks now face. This may mean that there is only around a 0.05% pass through to mortgage holders from the banks (depending on what other banks choose to do) but it’s better than a rate hike. As such, a November (Melbourne Cup Day) rate cut is looking likely. If not in November, then early next year.

• A watershed moment for the Sydney and Melbourne property markets. Slowing auction clearance rates, slowing lending to property investors, more mainstream talk of potential property price falls ahead and now Westpac’s move to hike rates are all piling on the bad news for the hot property markets of Sydney and Melbourne. I don’t see prices starting to fall until around 2017, but it’s looking increasingly clear that the property cycle in Sydney and Melbourne is starting to turn down after a couple of years of very strong gains. Other Australian cities were already cool, but risk also being affected by talk of mortgage rate hikes, unless it’s quickly offset by the RBA.

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