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Investment markets and key developments over the past week
- Share markets continued to recover over the past week as quantitative easing (QE) ended in the US uneventfully and US profits and economic data continued to impress. In addition, Japan announced a significant expansion in its QE program and that its Government pension fund would double its share exposure. News out of the Eurozone was a bit better than expected. US shares rose 2.7% to a new record high, European shares rose 2.1%, Japanese shares surged 7.3%, Chinese shares rose 5.1% and Australian shares rose 2.1%. Bond yields rose in the US, were flat in Australia and fell in Europe. Commodity prices were mixed with gold sliding on the ending of US QE, but metal prices rose. While the Japanese yen plunged and the euro fell against the US dollar, the Australian dollar was unchanged.
- The main event over the past week was the US Federal Reserve’s (Fed’s) long anticipated ending of its QE program. The basic messages from the Fed are that the US economy, including the labour market, is continuing to improve justifying an end to QE but that there is no rush to raise interest rates – signalling that it still anticipates a “considerable time” to elapse before the first rate hike. While the Fed is now dependent on how the data unfolds, our assessment is that the first rate hike won’t come till mid next year or later.
- But what the Fed took away the Bank of Japan (BoJ) added to, announcing a significant increase in its QE program to around ¥80 trillion annually. To put this in context and adjusting for the size of the Japanese economy its equivalent to the Fed buying bonds to the tune of about $US185bn a month, whereas QE at its peak was just $US85bn a month. Quite clearly the BoJ is determined to meet its growth and inflation objectives. This is likely to push the yen even lower to around ¥120 to the US dollar and is very positive for Japanese shares. It’s also positive globally as the BoJ is helping to fill the QE gap left by the Fed. The European Central Bank will help fill the rest.
- While economic news in Europe remains messy there are two pieces of good news. First, the ECB’s bank stress tests are now out of the way with the results being slightly better than feared. Now that it’s out of the way Eurozone banks are likely to be more focussed on lending. Second, a compromise appears to have been reached on French and Italian budgets which may clear the way for a more relaxed fiscal approach in Europe.
- Geopolitical risks seem to be fading a bit: the threat from Ukraine is receding with Russia agreeing to resume oil flows to Ukraine; the threat from the Hong Kong protests has faded; and there has been some more good news on Ebola with the World Health Organization reporting signs the number of new Ebola cases in Liberia may be peaking.
Major global economic events and implications
- US economic data was good. September quarter GDP growth was 3.5% annualised, but was exaggerated by lumpy contributions from defence spending and trade and GDP is only up 2.3% year-on-year so it’s a long way from booming. Meanwhile, the trend remains up in durable goods orders, the Markit services Purchasing Managers Index (PMI) fell but to a still very strong level and consumer confidence is at a seven-year high. The Fed’s preferred measure of inflation remains low at 1.5%, but there was a bit of an uptick in employment costs albeit to a still low 2.2% year-on-year.
- September quarter earnings for US companies continue to impress. So far 363 S&P 500 companies have reported with 81% beating on earnings (compared to a norm of 63%) which look to be coming in around +10% year-on-year and 60% beating on sales where growth is running around 5% year-on-year.
- Eurozone economic data was a little more positive than expected. The German Ifo business climate survey was worse than expected, but against this economic confidence rose in October confirming the earlier reported improvement in PMIs, there was a further improvement in the momentum of money supply and bank lending, the latest ECB bank lending survey showed increased loan demand and Spanish GDP rose in the September quarter for the fifth quarter in a row. So maybe Europe is not quite on the brink of the recession that many fear. However, inflation of 0.4% and an 11.5% unemployment rate highlight the need for the ECB to do more though.
- Japanese data provided signs it may be throwing off the hit to growth from the sales tax hike with good gains in industrial production and retail sales. That said, labour market and household spending data was weaker than expected and underlying inflation remains low. An increase in the exposure of the Government pension fund to shares is providing an additional boost to the Japanese share market.
Australian economic events and implications
- Australian data releases were light on. Export prices fell sharply again in the September quarter as had been expected given the falling iron ore price indicating a continuing fall in the terms of trade. Falling import and weak producer prices also highlight ongoing weak inflationary pressures. Meanwhile, investor credit for housing accelerated to 9.5% growth over the year to September which will likely serve to reinforce the Reserve Bank of Australia’s (RBA’s) inclination to impose macro prudential controls. Against this though, while new home sales remain well up on their lows from two years ago, they were flat in September and have been basically flat all year now. There was some good news with a bounce in the weekly Roy Morgan consumer confidence index.
- While much excitement was generated by the Government’s plan to increase fuel excise next month the impact will be trivial, costing the average household no more than 20 cents a week. In fact, it will be swamped by the influence of the 20% fall in global oil prices over the last few months.
What to watch over the next week?
- In the US, the midterm Congressional elections (Tuesday) will be watched keenly because the Republicans will likely increase their House majority and get a small minority in the Senate. This is likely to be taken well by investors to the extent that Republicans are seen as more market friendly. While compromise with President Obama will still be needed, it’s likely that the reduced Tea Party influence and President Obama’s desire for a positive legacy will see agreement reached on issues like raising the debt ceiling again in early 2015 (the current debt ceiling extension runs out in March 2015) and corporate tax reform. A speech by Fed Chair Janet Yellen on Thursday will be watched for clues regarding the timing of interest rate hikes. On the data front, expect more solid readings on the economy with the October manufacturing conditions ISM survey (Monday) to remain around the 56 level, the non-manufacturing ISM (Wednesday) to come in at around 58 and jobs data (Friday) to show a gain of 230,000 with unemployment remaining at 5.9%. September quarter earnings will also continue to be released.
- The ECB (Thursday) will be watched closely for signs that it will expand its QE program to include corporate bonds. A possible November 9th Catalonian vote regarding independence will also be watched closely.
- In Australia, the RBA is likely to leave interest rates on hold at 2.5% for the 16th month in a row as nothing much has changed since the October meeting and benign inflation in the September quarter, sub-par growth and the still high Australian dollar support the case for rates to remain low. The RBA’s Statement on Monetary Policy (Friday) is expected to imply that rates will remain on hold well into next year. The Statement will also be watched for more details on possible macro prudential measures to slow property investment. While 16 months on hold sounds like a long time it’s still short of the 20 month record that was set between December 1994 and July 1996, but it’s likely this record will be breached as a rate hike looks unlikely until around mid-next year.
- On the data front we will get data for house prices, the TD Inflation Gauge, jobs ads, the manufacturing conditions PMI and building approvals (all Monday), the trade balance and retail sales (Tuesday), the services PMI (Wednesday) and employment (Thursday). Of these, expect to see a slight fall in building approvals, modest growth in retail sales and the unemployment rate to remain at 6.1%.
Outlook for markets
- Having had a decent correction over September and into early October, shares are having a good rebound and are well placed to put on further gains into year-end as the cyclical bull market that started in 2011 remains alive and well. Valuations – particularly against the reality of low bond yields – are good; monetary policy is set to remain easy with QE in Europe and Japan replacing that in the US and rate hikes in the US and Australia are a long way off. Investor sentiment remains bearish and cautious, with seemingly everyone worried about global growth and the end of QE, which is positive from a contrarian perspective. Australian shares will benefit from the positive global lead and will also benefit from the lower Australian dollar. While our guesstimate of 5800 for the ASX 200 at year end is a bit of a stretch it’s not out of the ball park anymore with the ASX 200 having risen 350 points in less than three weeks.
- Low bond yields will likely mean soft medium-term returns from government bonds. That said, in a world of too much saving, spare capacity and low inflation it’s hard to get too bearish on bonds.
- The Australian dollar fell a bit too far too fast to its recent low of $US0.8640 (just as the US dollar rose too far to fast), so a short covering bounce has been underway and could go further. That said, the broad trend in the Australian dollar is likely to remain down reflecting soft commodity prices, the likelihood the Fed hikes interest rates before the RBA and the relatively high cost base in Australia. Expect to see it fall to around $US0.80 in the next year or so.
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