Weekly market Update – 19th September 2014

Investment markets and key developments over the past week

• Global share markets mostly rose over the last week helped by indications from the Fed that it’s still in no hurry to raise interest rates, expectations that the ECB might have to provide more stimulus, the Scottish No vote removing risks over UK assets and the continuing slide in the Yen to a six year low providing a boost to Japanese shares. US shares rose 1.3%, Eurozone shares gained 0.9% and Japanese shares rose 2.6%. Chinese shares fell on soft data but only by 0.1% thanks to signs of monetary easing. The combination of poor Chinese economic data and the falling $A weighed heavily on the Australian share market which lost 1.8% as foreign investors tend to retreat to the sidelines whenever the $A is under threat. Bond yields were mixed but the $US continued its ascent which in turn saw the Australian dollar remain under pressure, falling below $US0.90.

• The US Federal Reserve provided no surprises with another $US10bn taper to its QE program leaving it on track to end next month and an ongoing assessment that considerable labour market slack remains and that a “considerable time” is likely to elapse between the end of QE and the first rate hike. However, the Fed is incrementally continuing to become less dovish with Fed officials’ “dot plot” of interest rate expectations getting revised up slightly and Janet Yellen highlighting that the timing of the first rate hike is dependent on how the economy performs. Our assessment remains that the Fed can afford to take it’s time for now, but in the June quarter next year it will start to gradually raise rates. The anticipation and then the reality of this could cause bouts of share market volatility – particularly whenever there is a run of strong US economic data, but it’s unlikely to derail the bull market as rate hikes will be reflecting strong economic and profit conditions. Only when interest rates reach onerous levels will there be a significant problem, but that will be a fair way off.

• In Scotland the No vote won. This is good news for UK and Scottish assets and more broadly for the Eurozone as other pro-independence movements like the Catalonians in Spain weren’t given the encouragement a Scottish Yes vote might have provided. Catalonia’ s potential referendum for November will be the next one to watch though. News of the No vote didn’ t have a lasting effect on the British Pound though, as the focus quickly returned to the rising $US which saw the Pound fall in value.

• The Ukraine crisis may be heading towards a resolution of sorts, with the Ukrainian Parliament granting a degree of autonomy to the eastern regions currently in conflict. There may still be more to go before the conflict is resolved, but with Russia describing the move as positive we may be getting to the point where Ukraine starts to recede as an issue for investment markets.

• In Australia, the minutes from the RBA’s last meeting repeated the “period of stability” mantra on interest rates but expressed more concern about the growth in investor housing credit and house prices. The RBA is stuck between a rock, in terms of the risk of accelerating house prices, and a hard place in the form of the Australian dollar which remains too high, despite recent falls. The best approach is likely to be more jawboning to the effect that home buyers need to be cautious and that the $A remains overvalued. If the property market does not cool down a bit and the $A remains too high, we suspect that the RBA may then be tempted to go down the path of encouraging APRA to raise the risk weighting for home loans rather than start raising interest rates.

• Right now the Australian dollar is going in the right direction helped by the Fed’s gradual move towards monetary tightening. There is a bit of technical support around $US0.89 but we expect 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 provide a shot in the arm for trade exposed sectors of the economy at a time that we need them to perk up as mining investment slows.

Major global economic events and implications

• US economic data was mostly favourable with solid growth readings but low inflation. Industrial production unexpectedly slipped in August, but strong regional manufacturing surveys point to a bounce back this month. While housing starts and permits fell, this was only after a huge surge in July and a stronger than expected gain in the NAHB homebuilder index points to strength ahead. Finally, jobless claims fell, the leading index rose for the seventh month in a row and household net wealth rose 10% over the last year, providing a strong wealth boost. Meanwhile, inflation remains low with headline and core CPI inflation falling to 1.7% year on year in August, which partly explains why the Fed is in no hurry.

• Bank take-up of the ECB’s first auction of cheap funding under its new Targeted Long Term Refinancing Operation (TLTRO) program was around half expectations at €83bn, which may partly reflect bank caution ahead of the ECB’s review of the quality of their assets. So hopefully the next auction in December will see more interest, but in the meantime it puts pressure on the ECB to quickly ramp up its quantitative easing program.

• In China a sharp fall in the MNI business indicator suggests that the growth slowdown may have continued into September and home prices continued to fall in August with average prices down just over 1% with virtually all cities seeing falls. Meanwhile, the Chinese central bank may be reacting to the growth slowdown with reports that it is providing RMB500bn to the major banks and a fall in the 14 day money market rate. While a cut to the PBOC’s 12 month benchmark interest rate would be more appropriate as Chinese interest rates remain too high for the Chinese private sector, its latest moves are welcome and highlight that the authorities are prepared to support growth.

Australian economic events and implications

• There were only secondary data releases in Australia and they were all soft. Auto sales and the Westpac leading index both fell in August and the weekly ANZ Roy Morgan consumer confidence index fell slightly.

What to watch over the next week?

• Globally, the main focus in the week ahead will be the release of September business conditions PMIs (Tuesday) in China, Europe and the US. The flash HSBC manufacturing PMI for China will be watched to see whether the latest slowdown continued into September, Eurozone PMIs are expected to remain off their previous highs and the US PMI is expected to remain strong.

• In terms of other US data, expect further gains in existing homes sales (Monday) and new home sales (Wednesday), a fall back in headline durable goods orders (Thursday) after the aircraft inspired surge seen in July but a continuing trend rise in underlying orders and another upwards revision to June quarter GDP growth (Friday) to 4.6% annualised from 4.2%.

• Japanese inflation data will be released Friday, but is being boosted by the April sales tax hike. Excluding this it’s likely to remain around 0.5% year on year on a core basis, which is better than the deflation that prevailed for a long time but still has a fair way to go to reach the 2% inflation target.

• In Australia, the RBA’s half yearly Financial Stability Review (Wednesday) is likely to indicate that the financial system remains in good shape, but express concern that the residential property market may be getting too hot and potentially posing risks for financial stability in the future if it continues to hot up. Speeches by RBA Governor Stevens (Thursday) and Assistant Governor Richards (Friday) will be watched for further comments on how the RBA sees the risks around the property market, the broader economic outlook and the $A. They are likely to reinforce the rates on hold message. Data for job vacancies will also be released.

Outlook for markets

• Shares are still at risk of occasional corrections particularly ahead of the end of US quantitative easing next month, the US mid-term elections in November and with September and October often proving volatile 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, occasional corrections are healthy in 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 overvalued, 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 is no sign of investor euphoria.

• Our year-end target for the ASX 200 remains 5800. Although the falling $A is initially a drag for 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 will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down.

• Eurozone shares gained 0.1% on Friday, but the US S&P 500 was flat amidst volatile trading associated with the “quadruple witching hour” expiry of futures and options contracts. The flat global lead combined with falls in most commodity prices saw ASX 200 futures decline 18 points or 0.3% pointing to a weak start to trading for the Australian share market on Monday.

 

Source: AMP CAPITAL ‘Weekly Market Update’

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