Weekly Market Update – 2nd October 2015

• The past week has seen a roller coaster ride for shares. Early in the week worries about Chinese/global growth and the Federal Reserve’s (the Fed’s) interest rate decision helped push the US share market back down to near its August low, which in turn pushed several markets to new lows, including Australian shares. However, shares rebounded mid-week from oversold levels, with US shares given a big push along on Friday by expectations that softer than expected jobs data for September will further delay Fed tightening. For the week this still saw Eurozone shares end down 0.8%, Japanese shares fall 0.9% and Chinese shares fall 1.3%, but Australian shares rose 0.2% and US shares gained 1%.

• Bond yields fell sharply over the last week as expectations for a Fed rate hike were pushed out, commodity prices were flat to up as the US dollar fell and the Australian dollar managed a modest gain after recovering from a fall back below $US0.70.

• From their highs earlier this year to recent lows, US shares have had a fall of -12%, Australian shares -18%, Eurozone and Japanese shares -19%, Emerging market shares -22%, Asian shares -23% and Chinese shares -43%. Interestingly the weakness over the last week has seen emerging market, Asian and Chinese shares hold above their August lows.

• September and the September quarter have clearly lived up to their reputations as poor periods for shares, with worries about global growth and the Fed driving the worst September quarter for global shares (-8.1%) and Australian shares (-8%) since the September quarter 2011. We are still at risk of more weakness in the next few weeks as global growth and Fed concerns remain. This is particularly so for the US share market that has had the smallest decline but is the most vulnerable in terms of valuations on some measures and the only major market with a central bank getting closer to tightening.

• However, with the seasonally weak September quarter behind us and October known as a “bear killer” month ahead of seasonal strength into year end and, our broad view is that the cyclical bull market in shares will resume thanks to attractive valuations, very easy global monetary conditions and extremely bearish investor sentiment that is normally associated with market bottoms. It makes sense to start averaging into shares over the next month or so for those looking to allocate cash. The failure of commodity prices and emerging market shares to go to new lows through the September pull back in shares is a positive sign in this regard. So far share markets seem to be following a very similar pattern to that seen in both 1998 and 2011, that saw initial sharp falls into August, followed by a bounce and then a retest or new lows around late September/October, followed by gains into year end. History may not repeat but it does rhyme.

• Soft US payrolls for September mean no chance of an October Fed rate hike and a December hike is 50/50. The September jobs data in the US were weak all round: jobs growth was just 142,000, which was well below the expected 200,000; previous months’ jobs growth was revised down; unemployment only remained at 5.1% because participation fell and wages growth was flat in the month and just 2.2% year on year. The failure of wages growth to pick up much, despite the fall in unemployment, suggests that the so-called NAIRU (non-accelerating inflation rate of unemployment) is lower and that deflationary pressures remain intense.

• Further stimulus from China and potential signs of growth bottoming. News early in the week that Chinese industrial profits fell nearly 9% over the year to August didn’t help share markets, but thereafter the news out of China improved a bit. Firstly, China is continuing to announce more stimulus measures; in particular a sales tax cut on small cars and another reduction in the required deposit ratio for first home buyers. Secondly, economic data took on a slightly better tone, with consumer confidence rising to its highest since May last year, the official manufacturing PMI rising slightly in September, the Caixin flash PMI being revised up and average home prices continuing to rise in September. While it’s hard to see a big rise in Chinese economic growth, the downside risks may be starting to recede a bit.

• US Government shutdown averted for now. US Congress passed a bill extending US Government financing out to December 11, averting the threatened October 1 shutdown. Of course this just means that the issue will now come up again later in the year when it will get rolled into the need to raise the debt ceiling again, which now looks like being reached by November 5. This could see more brinkmanship as 30 or so ultra conservative house Republicans still seek to defund Planned Parenthood. However, the vast majority of Congressional Republicans and their leadership are likely to remain more focussed on next year’s elections and so a shutdown/debt ceiling crisis is likely to be avoided.

• Australian mini-summit on the economy a positive sign. The combination of a slowing population and productivity growth and the end of the commodity boom has clearly cut into Australia’s growth potential. Our own assessment is that potential growth has fallen to around 2.75% pa and the IMF appears to have come to a similar view. The best way to turn this around is with a reinvigorated economic reform agenda focussing on the tax system, labour and product markets, government spending and infrastructure. Explaining the need for reform and building community support for it is essential so having the mini-summit in the last week between the Government and various community groups is a good move.

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