Weekly Market Update – 6th June 2014

Investment markets and key developments over the past week

• Global share markets mostly rose over the past week on the back of further monetary stimulus from the European Central Bank (ECB) and solid US employment data. US shares rose +1.3%, European shares gained +1.5% and Japanese shares were up +3%. The ECB’s move also provided a boost to the Australian share market but not enough to fully reverse earlier weakness driven by worries about the fall in the iron ore price and the impact of the Federal Budget on retail stocks, so the ASX ended the week down -0.5%. Bonds generally continued to sell-off, except in peripheral Eurozone countries where the ECB’s measures pushed yields down to record lows. Worries about China continued to weigh on commodity prices. However, the iron ore price rose modestly after the previous week’s fall and the A$ got a boost as the ECB announcement boosted risk appetite. The euro also benefitted, possibly as the ECB’s moves are seen as boosting growth prospects in Europe, which is likely to have caused some consternation at the ECB which would rather see the euro lower.

• Super Mario to the rescue as the ECB delivers on stimulus expectations. The past week was largely all about the ECB with expectations riding high that it would deliver more stimulus and in the event it did not disappoint as it deployed virtually everything it could think of including, cutting its key interest rate to just 0.15%, cutting the rate of interest banks receive on excess deposits at the ECB to -0.10%, an extension of guidance as to how long rates will remain low, an extension of the commitment to supply unlimited short-term funds to banks at the 0.15% interest rate, a new long-term lending program to banks (called Targeted Long-Term Refinancing Operations or TLTRO), an end to the sterilisation of its existing bond buying program (which it calls SMP) and preparation for a program to purchase asset backed securities (which would amount to a US style quantitative easing program). The highlight was probably the TLTRO program which is effectively a “funding for lending” program that will allow banks to borrow to fund their non-mortgage lending at just 0.25% interest for four years.

• A big move in the right direction. To be sure the latest move by the ECB is not as momentous as its efforts in 2011 and 2012 (the first LTRO, “whatever it takes” and the Outright Monetary Transactions program) that ended the Eurozone crisis. It would also have been better to see a US style quantitative easing program straight away and there are doubts about how successful each of the measures announced by the ECB will individually be. But the ECB has more than met market expectations as reflected in the rally in shares and the collapse in bond yields in Spain, Italy and Greece. The scatter gun approach of deploying virtually everything at once adds to confidence that the whole should be worth more than the sum of the parts in terms of its impact on bank lending. The clear impression is that while interest rates have hit bottom it stands ready to do more if needed and this is likely to involve the purchase of private sector asset backed securities. Finally, there are signs that the bank deleveraging in Europe that has occurred in the run-up to this year’s asset quality review and stress tests has run its course. If so the ECB’s measures aimed at boosting bank lending have a good chance of succeeding.

• The bottom line is that the ECB’s measures, and commitment to do more if needed, add to confidence that the Eurozone economic recovery will pick up pace over the year ahead and that deflation will be avoided. This, in turn, is good for global growth and since Europe is China’s biggest single export destination, is also good news for China, which in turn of course is good news for Australia. All of this helps explain why shares got a boost and even the A$ had a bit of a spike.

Major global economic events and implications

• US economic data was good with solid employment growth in May, strong readings for the Institute for Supply Management (ISM) business conditions indicators, April factory orders and vehicle sales and a solid Beige Book of anecdotal evidence adding to confidence of a growth rebound in the current quarter. The +217,000 gain in US payroll employment in May was in line with market expectations and has finally seen employment recover all the losses from the 2008-2009 recession. Unemployment was unchanged at 6.3% with the participation rate looking like it is bottoming. Average hourly earnings gained +0.2% but annual growth remains modest at +2.1% year-on-year.

• The May jobs data will please the US Federal Reserve leaving it on track to continue tapering, but it’s not strong enough to bring on an earlier Fed tightening. Finally, a +10.7% gain in household net worth over the year to the end of the March quarter and a decline in the ratio of household debt servicing costs to income to the lowest on record augur well for consumer spending.

• Eurozone data was a bit mixed. Retail sales and German factory orders were stronger than expected, but slight downwards revisions to purchasing manager indices (PMIs) for May highlight that the recovery remains gradual. This, along with unemployment falling just -0.1% to a still high 11.7% in April and May inflation falling to just 0.5% year-on-year, all served to support the ECB’s decision to provide more monetary stimulus.

• A rise in Japan’s composite PMI added to confidence the impact from the sales tax hike will be temporary.

 

Australian economic events and implications

• Australian data presented a rather confusing picture, but on balance more good than bad. March quarter gross domestic product (GDP) growth was far better than expected a week or so ago and suggests the economy is adjusting to the mining investment wind down extremely well with increased resource export volumes, housing construction and consumer spending helping to rebalance the economy. The export surge, helped by the completion of new mines, also saw the current account deficit as a proportion of GDP fall to its lowest level in 34 years and an improvement in the AIG’s business conditions PMIs for May are welcome. Of course, while the March quarter growth figures are fantastic the rebalancing away from mining investment won’t be as smooth as the latest GDP data suggests. Growth is likely to slow back below trend in the short term as the hit to confidence from the May Budget flows through to consumer spending and the pace of growth in resource exports settles down. Softer April building approvals, albeit due to volatile multi-unit approvals, along with a fall in house prices in May, which likely signals slowing momentum in house prices and recent weakness in the iron ore price also add a bit of short term uncertainty. But cutting through all the noise, the big picture is one of the economy adjusting to the end of the mining investment boom without the collapse many had feared.

• Given the diverse array of indicators currently being seen the most likely outcome is an extended period of interest rates being left on hold. Clear evidence that the economy has been rebalancing has seen the number of economists looking for another rate cut dwindle to now just three, whereas the threats to growth from the Budget and the lower iron ore price means that those looking for rate hikes are pushing them into 2015.

• The past week also saw a 3% boost to the minimum wage in Australia. While it’s great to see low income earners get ahead I fear it may be a case of a well-intentioned move having the opposite impact as it will push Australia’ s minimum wage to the highest level in the world in US$ terms, further damage Australia’s international competitiveness and ultimately cost jobs for low income workers. Another reason the A$ needs to fall.

 

What to watch over the next week?

• In the US, expect a +0.4% gain in May retail sales (Thursday) and a moderation in producer price inflation (Friday).

• In the Eurozone, expect a bounce back in April industrial production (Thursday) and continued modest employment growth for the March quarter (Friday).

• Chinese economic data for May will likely be the global focus in the week ahead. Inflation data (Tuesday) is likely to show a rise to +2.4% year-on-year but only due to a bounce in food prices, but more importantly expect to see a slight pick-up in growth in industrial production, retail sales and investment (Thursday) consistent with the modest improvement seen in recent PMI readings. Money supply growth is likely to have picked up slightly.

• In Australia, the focus is likely to be on the May NAB business survey (Tuesday) to see how the Budget has affected business conditions and confidence and the June consumer sentiment reading (Wednesday) for signs of a bounce back after the initial negative reaction to the Budget. Expect to see a slight rise in housing finance (Tuesday) and a 10,000 gain in employment (Thursday) not being enough to prevent a rise in unemployment to +5.9%. A speech by Reserve Bank of Australia Governor Stevens will likely repeat the rates on hold message.

 

Outlook for markets

• Shares remain vulnerable to a mid-year correction, just as we have seen in each of the last four years. However, any pull back may well be mild in the absence of global monetary shocks such as the ending of quantitative easing programs such as QE1 in 2010 and QE2 in 2011 or Bernanke’ s taper talk in May and June last year as shares having been in a bit of a stealth correction through much of this year. In any case the broad trend in shares is likely to remain up. Share market fundamentals remain favourable with reasonable valuations, global earnings improving on the back of rising economic growth and monetary conditions set to remain easy for some time. Any dip should be seen as a buying opportunity. Our year-end target for the ASX 200 remains 5,800.

• Bond yields are likely to resume their gradual rising trend as it becomes clear that US inflation has bottomed and this combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.

• With A$ short positions now largely unwound, we remain of the view that the A$ will resume its downtrend. Commodity prices including the iron ore price are relatively soft, RBA interest rate hikes are getting pushed out and the A$ is likely to revert to levels that offset Australia’s relatively high cost base.

 

Source: AMP CAPITAL ‘Weekly Market Update’

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