Weekly Market Update – 28th March 2014

• The past week has seen somewhat messy and mixed trading in share markets. Economic data has been mostly okay, there are hopes for some sort of stimulus in China and there has been no further escalation regarding Ukraine. While US shares fell -0.5%, shares gained +2.2% in Europe, +3.3% in Japan and +0.5% in Australia. Bonds rallied slightly, partly helped by a relaxation of fears that US Federal Reserve (Fed) tightening was coming earlier than previously expected. In fact, Spanish and Italian bond yields fell to their lowest since 2005. Commodity prices were mixed but the Australian dollar pushed higher partly on the back of somewhat upbeat comments from Reserve Bank of Australia (RBA) Governor Stevens which in turn has forced holders of shorts to close out their positions as the currency pushed through key technical levels.

• Ukraine tensions remain, but there has been no further escalation. The G7 agreed on further sanctions, but it looks like they will only be applied if Russia escalates the situation by moving to occupy more of Ukraine. Ethnic violence in east Ukraine is worth watching as it could still lead to civil war and become a pretext for Russian intervention on the grounds of “protecting Russians”. The border troop build-up by Russia is clearly maintaining the tension, although it could just be part of Russia’s strategy to pressure Ukraine to not move too far to the west. In short, the risks around Ukraine remain but I am still of the view that it’ s just another distraction for investors. It won’t derail the global economic recovery or the bull market in shares. Meanwhile Ukraine looks likely to get $US14-18 billion in International Monetary Fund support in return for economic reforms, but it will be a long process before its back on track (even if Russia backs off) – not that that’s much of an issue for global investment markets.

• In Japan, the long awaited April Fool’s Day sales tax hike from 5% to 8% is unlikely to drive Japan back into recession as occurred after the last hike in 1997. While it will leave an air pocket (as spending was pulled forward to avoid it) conditions are very different versus 1997. In contrast to 1997 Japan now has quantitative easing (with the Bank of Japan looking at doing more) and fiscal stimulus, unemployment is falling, property prices are rising and bank lending is rising. In addition, banks do not have large non-performing loans and business confidence has been rising.

• In Australia, while some economists are finally giving up on hopes for further rate cuts and RBA Governor Stevens can see encouraging evidence of a handover from mining-led growth to broader growth this does not mean a rate hike is imminent. Yes there is increasing evidence that non-mining activity is on the mend led by a likely boom in housing construction, but against this uncertainty remains about how smooth the transition from mining to non-mining driven demand will be. Worries about China and the resurgence in the value of the Australian dollar add to this uncertainty and meanwhile inflation is benign. Our view remains that the RBA will be leaving interest rates on hold at least for the next five months, ahead of rate hikes gradually getting underway around September/October.

• US economic data was okay. Home sales fell in February on poor weather and core durable goods were softish. Against this, December quarter gross domestic product (GDP) growth was revised up to +2.6% reflecting stronger sales, the flash Markit manufacturing and services purchasing manager indices (PMIs) were both strong at 55.5 in March, house prices continue to rise, consumer confidence rose to a six year high and jobless claims fell. And while core durable goods orders were disappointing in February various business surveys point to strong business investment ahead. Rising momentum in national accounts profits also augurs well for capex and employment. Overall, the US economy remains on track for stronger growth. Meanwhile, Fed clarification of Chair Janet Yellen’s comment about rates rising about six months after the end of quantitative easing has continued with the President of the Federal Reserve Bank of Chicago, Charles Evans, saying it is “at least six months”.

• Eurozone business conditions PMIs fell in March but only marginally and confidence levels rose solidly (despite Ukraine worries) with both pointing to continuing economic recovery.Interestingly it seems various European Central Bank policy makers are becoming more open to the idea of deploying some form of quantitative easing to head off deflation if needed. The gradual nature of the recovery, combined with very low inflation and soft money supply and bank lending growth mean further ECB easing is still on the table.

• In Japan, a rise in small business confidence, stronger retail sales, a fall in the unemployment rate, another rise in the jobs to applicant ratio and a rise in inflation to 1.5% are positive signs.

• While another fall in China’s HSBC flash manufacturing conditions PMI suggests growth continued to slow in March, it could be argued that it’s now so weak that it’s good. The PMI is now back at the low end of the range that it’s been in for the last three years or so; a level at which in the past has been associated with policy easing and I suspect the same will occur this time around. The falling renminbi and Premier Li’s comments about rolling out measures to support growth suggests that this may already be getting underway.

• There were no major data releases in Australia, so the focus was mainly on the RBA. The RBA’s Financial Stability Review indicated a degree of comfort with the Australian financial system highlighting that banks are well capitalised, their resilience to funding shocks continues to improve and that households are continuing to manage their finances with greater prudence. The RBA cautioned banks against easing lending standards, warned home buyers not to expect the cyclical upswing in house prices to continue indefinitely and noted that the housing market was an area to watch, however, overall it does not appear too concerned about a housing bubble. The housing market is not likely to be a trigger in the near term for higher interest rates.

• In the US, expect the ISM manufacturing conditions index (Tuesday) to improve slightly based on various regional surveys already released, a similar improvement in the ISM services index (Thursday) and a further pick up in non-farm payroll growth (Friday) to around +200,000, and a fall in the unemployment rate to 6.6%. Fed Chair Yellen is likely to use a speech on Monday to water down her comments about a six month lag between the end of quantitative easing and the first rate hike perhaps saying the gap is likely to be “at least” six months.

• The ECB (Thursday) will probably leave monetary conditions unchanged, but an easing cannot be ruled out and it is likely retain a clear easing bias. March inflation (Monday) is likely to have remained very low leaving the door open for more ECB easing.

• In Japan, February industrial production (Monday) is expected to have slowed a bit after a huge surge in January and the latest Tankan business survey (Tuesday) is expected to show solid conditions in the March quarter but a slight deterioration in the outlook on the back of fears regarding the 1 April sales tax hike.

• In China, the official manufacturing PMI (Tuesday) is expected to follow the HSBC flash PMI lower, but only fall to around 50 (from 50.2) given its focus on larger manufacturers and that the later timing of this survey means that it may have seen more of a pick-up in industrial production following the Chinese new year break.

• In Australia, the RBA (Tuesday) is expected to leave interest rates on hold for the seventh month in a row. While confidence is building that non-mining activity will take over from mining investment as a driver of growth, uncertainty remains about how smooth the transition will be with intensifying concerns about China and a stronger Australian dollar adding a bit to the uncertainty. As a result, the RBA is expected to reiterate that a period of stability in interest rates is appropriate. A speech by RBA Governor Stevens later in the week is likely to reiterate the same message. What will be interesting is whether the RBA will revert to describing the Australian dollar as “uncomfortably high” again as its now actually above the levels it was last December when the RBA last used those words.

• On the data front in Australia, expect to see continued signs of a gradual pick up in credit growth (Monday), a -1% fall in building approvals (Wednesday) as payback for a +7% gain in January, a slight slowing in retail sales (Thursday) after nine consecutive months of growth and another solid trade surplus in February (also Thursday). Data for new home sales, the TD Securities Inflation Gauge, the AIG manufacturing PMI, house prices and job vacancies will also be released.

• Worries about the emerging world – notably China and Ukraine at present – along with growing uncertainty as to when the Fed will start to raise interest rates as growth there recovers from its winter freeze are likely to ensure that 2014 will be a more volatile year for shares. A 10 to 15% correction is likely at some point along the way this year. However, the broad trend in share markets is likely to remain up reflecting the combination of reasonable valuations, better earnings on the back of improved economic growth and easy monetary conditions helping to entice investors to switch out of cash and bonds and into shares. Our year-end target for the ASX 200 remains 5800.

• A slow rising trend in bond yields on the back of gradually improving global growth, combined with low yields to start with, means pretty subdued returns from government bonds. Cash and bank deposits also continue to offer pretty poor returns.

• The short covering rally in the Australian dollar is likely to take it up to around $US0.95. However, the broad trend in the Australian dollar is likely to remain down reflecting softer commodity prices, a reversion to levels that offset Australia’s high cost base and a decline in Australia’s growth relative to that in the US.

AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer  

FinSec Partners Disclaimer