Weekly Market Update – 8th May 2015

• Shares had a rough week on the back of a continuation of the global bond sell-off, some soft US data earlier in the week, comments by Fed Chair Yellen regarding equity valuations and concerns regarding Greece. However, while Chinese shares ended down 5.3%, Japanese shares lost 0.8% and Australian shares fell 3.1%, US and Eurozone shares rallied strongly on Friday in response to “just right” US jobs data. So over the week US shares gained 0.4% and Eurozone shares rose 0.9%. Bond yields rose but some of the increase was reversed on Friday. Most commodity prices gained, as did the $A on the removal of an explicit RBA easing bias.

• What’s driving the market wobble? It seems the global and Australian investment scene has hit another rough patch lately, with those share markets that have gone up the most year to date like China and Europe experiencing the biggest wobble. Several factors are driving this. First deflation fears have abated, which is good but it’s pushed up bond yields. This partly reflects the fall back in the $US (on Fed rate hike delays) which has allowed commodity prices and notably oil to rebound and so the acute oil price collapse driven fear of deflation from earlier this year has receded allowing bond yields to move higher. This has been given a push in Europe by stronger growth and higher German bond yields have also removed a lid on US and Australian bond yields. The back up in bond yields has in turn impacted high yield shares. Second, some share markets were due a correction notably Europe, Japan and China after very strong gains and were thus vulnerable. Third, we have entered a seasonally tougher part of the calendar year (“sell in May and go away”). Finally, Australian shares have also been hit by perceptions that the RBA may have finished easing, fears about a stronger $A and talk (and reality in NAB’s case) of bank capital raisings.

• Is it a correction or something worse? In the absence of unambiguous and broad based share market overvaluation, bull market extreme investor euphoria and excessively tight global or Australian monetary conditions that will drive bond yields rapidly higher or slow growth significantly the broad trend in shares is likely to remain up. However, periodic corrections are healthy and normal. For example, Australian shares are down 6% from their recent peak but they had a 9% pullback last September-October and an 11% pull back in mid 2013 all against a rising trend – so nothing new.

• Too early to say for sure that the RBA has finished cutting rates. While it was no surprise to see the RBA cut rates again taking the official cash rate to an historic low of 2%, it was disappointing to see the RBA drop its explicit easing bias, which has led many to conclude that the next move in rates is up. Our base case is that 2% is the low, but it’s way too early to be confident of this. With the mining investment boom still unwinding, non-mining investment remaining weak and the $A remaining too high and at risk of going higher the longer the Fed delays the risks are still skewed towards another rate cut. While the RBA has once again dropped its explicit easing bias the combination of its now lowered growth and inflation forecasts, its expectation that unemployment will be around 6.5% mid next year and its assessment that a further fall in the $A is necessary all suggest that it retains a soft easing bias. If the $A does not oblige and heads lower and the economic outlook starts to improve then it will be back threatening, and if necessary cutting rates again. At the very least rates are set to remain low for a long while. With the RBA not seeing growth above trend until 2017 a rate hike looks to be a long way off.

Major global economic events and implications