Key events of the past week and implications

  • Global share markets had another rough week with concerns about a strike on Syria weighing on confidence and emerging market assets, particularly currencies, coming under significant pressure.
  • The concern in the run up to any US led military involvement in the Middle East is that it will lead to a wider confrontation threatening oil supplies. It’s no different in the case of Syria with worries that it may draw in Iran or Israel. So even though Syria is just a tiny oil producer (about 300,000 barrels a day), the talk of intervention has contributed to a small spike in oil prices and share market jitters. While such concerns invariably are not realised, past experience points to share market weakness/oil price strength in the run up to any intervention followed by a recovery in share markets from around the time it commences. The 1991 Iraq invasion, the December 1998 bombing of Iraq, the March 2003 Iraq invasion and the March 2011 Libyan bombing saw US shares fall 5.6%, 3.5%, 14% and 6.3% respectively in the run up to the events only to see the losses recovered within two months afterwards. I would expect a similar pattern this time around, particularly as it becomes clear that any intervention will be limited (as President Obama has already indicated) and that surrounding countries are unlikely to become involved.
  • Meanwhile, the rout in emerging markets, and notably the currencies of India and Indonesia, continued as the combination of US Federal Reserve (Fed) taper fears and current account and budget imbalances worried investors. Both Indonesia and Brazil hiked their benchmark interest rates again to combat inflation and support their currencies but this will only further weaken their growth outlook making them even less attractive to foreign investors in the short term. These problems in the emerging world look like having a way to run yet.
  • More broadly, Syria and emerging world uncertainty has added to an already longish worry list for investors in the short term that includes the Fed’s taper decision, upcoming negotiations to fund the US government and raise its debt ceiling, the nomination of the next Fed Chairperson, the German election, political instability in peripheral European countries and the prospect of a post-election fiscal tightening in Australia. This vulnerability is enhanced because September is normally the weakest month of the year for US shares (with an average monthly decline of 0.8% since 1985) and October is normally the weakest month of the year for Australian shares (with an average monthly fall of 0.7% since 1985). As a result, shares remain at risk of further weakness in the month or two ahead. However, most of these worries should ultimately be resolved in an unthreatening way allowing a strong rebound in share markets into year end as seasonal strength returns.

Major global economic events and implications

  • US economic data was mixed highlighting the difficult decision the Fed will face at its September 17-18 meeting in terms of whether to taper its monetary stimulus or not. On the positive side, consumer confidence and house prices rose, jobless claims fell and June-quarter gross domestic product (GDP) growth was revised up from 1.7% to 2.5% thanks to stronger contributions from trade and inventories. But against this, durable goods orders were weak (albeit with a reasonable underlying trend), pending home sales slipped again and personal spending and income were soft in July. Higher mortgage rates and now higher oil/gasoline prices are clearly a bit of a headwind for US growth. The net result may be that the Fed will either delay the start of tapering till later in the year or alternatively just cut it back by $10 billion a day.
  • A solid rise in Eurozone economic confidence confirmed the region’s ongoing recovery and at the same time very low inflation (just 1.1% at a core level) leaves plenty of scope for continued easy monetary conditions. Eurozone unemployment remains at 12.1%, but it is always a lagging indicator.
  • Japanese data for July was mostly favourable with falling unemployment, a rise in the jobs to applicant ratio, growth in household spending, a solid bounce back in industrial production with a higher August purchasing managers’ indicator (PMI) pointing to more strength and fading core pressures. Abenomics looks to be working although it has been a slow process.

Australian economic events and implications

  • In Australia, while business investment rose a much stronger-than-expected 4% in the June quarter, this masked a decline in plant & equipment investment which is what feeds into GDP estimates. More importantly, business investment plans were revised down for this financial year and now point to a 1% fall in investment this financial year using a comparison of past investment intentions with actual outcomes, or an 11% fall based on a comparison of investment plans for 2013-14 with those made for 2012-13 a year ago. However, whether it’s a 1% fall or an 11% fall, the outlook for business investment is poor with weakness pretty much across the board, highlighting the need for further monetary easing in Australia.
  • Meanwhile, credit growth remained subdued in July albeit with signs of a bottoming. There was mixed news in relation to housing with a fall in new home sales but another rise in housing affordability to its best in a decade, pointing to an ongoing housing recovery ahead.
  • The June-half profit reporting season is now essentially complete. Results have been weak but not as bad as feared and dividends have increased by 10% which partly explains why the Australian share market has performed reasonably well in August, managing a gain of 1.6%. Overall, results have been a little bit better than expected with 39% of companies exceeding analyst expectations as against 27% missing expectations. 63% of companies have seen their profits rise from a year ago and 60% of companies have increased their dividends from a year ago as against only 12% which have cut them. And while corporate outlook comments have been subdued, the fact they haven’t been too gloomy is a good sign.
  • Consequently, and because the bad news had already been factored in, we haven’t seen the earnings downgrades some had feared. Earnings expectations for 2012-13 are little changed at -0.5% (with resources earnings down by around 21% but with earnings for the rest of the market up by around 6%). And 2013-14 earnings growth expectations remain around 13%, made up of a 35% gain for resources and 8% growth for the rest of the market. As a result of increased dividends from resources stocks, dividend growth ran much stronger than earnings last financial year, rising by around 10%. Reflecting the better-than-feared results and increasing dividends, 54% of companies have seen their share price outperform the market on the day their results were released. Key themes have been ongoing cost control and weak revenue growth, but a prospective boost to profits from the lower Australian dollar (A$) and for iron ore companies from a higher iron ore price. Strong dividend growth reflects both a degree of comfort with the profit outlook along with pressure from shareholders for increased dividends.

All chart sources: AMP Capital

Major market moves

  • Global shares had a rough week, not helped by worries about a strike on Syria and problems in some emerging countries. US shares fell 1.8%, Eurozone shares fell 3.6% and the Japanese Nikkei Index was down 2%. Chinese shares bucked the trend, gaining 2% and Australian shares rose 0.2%.
  • Commodity prices were mixed with oil up on Middle East uncertainty, but metal prices down. A stronger US dollar (US$) and weaker metal prices saw the A$ fall.
  • Bond yields fell in the US, Germany, Japan and Australia partly as a bit of safe haven buying crept back in.

What to watch over the next week?

  • Syria will probably be the big one to watch, but on the data front in the US the focus is likely to be on the Institute of Supply Management (ISM) manufacturing index (due Monday) and payroll employment data (Friday) as guides to whether the Fed will commence tapering its monetary stimulus this month. Both may not provide decisive readings though with the ISM expected to slip slightly to 54 from 55.4 and payroll employment growth expected to be around 180,000 which is solid but not overwhelmingly strong. The Fed’s Beige Book of anecdotal indicators along with trade data and the non-manufacturing ISM will also be released.
  • In the Eurozone, final manufacturing PMIs (Monday) and services PMIs (Wednesday) are expected to confirm the recovery already reported in the flash estimates. The European Central Bank and the Bank of England are both likely to leave monetary policy unchanged when they meet Thursday, but indicate they retain easing biases.
  • The Bank of Japan is also expected to leave monetary policy unchanged on Thursday.
  • In Australia, the focus will no doubt be on the election to be held on Saturday 7 September. The Reserve Bank of Australia meets Tuesday but given the proximity to the election and its signal that another interest rate cut is not imminent, rates are likely to be left on hold. However, the post-meeting statement is likely to retain an easing bias, particularly with the capex outlook weakening further and inflation benign, which the RBA is likely to act upon at its October or November meetings unless the A$ falls rapidly.
  • On the data front, expect a solid bounce in July building approvals after a sharp fall in June, soft June quarter company profits and continued modest growth in RP Data’s house price series (all due Monday), continued weak growth in retail sales (Tuesday) and June-quarter GDP growth (Wednesday) to have remained subdued at 0.5% quarter-on-quarter or 2.4% year-on-year. While consumer spending and building activity look to have been weak in the June quarter, trade is likely to have provided a modest boost to GDP growth. Data for the June-quarter current account deficit, the trade balance and the AIG’s business conditions PMIs will also be released.

Outlook for markets

  • Shares are vulnerable over the next month or two with various events and risks that could trigger investor nervousness including the Fed’s September meeting where it may start to taper its monetary stimulus, US government funding and debt ceiling negotiations, the nomination of the next Federal Reserve chairperson, various imbalances in the emerging world, a possible military intervention in Syria, political instability in peripheral Eurozone countries and post-election fiscal tightening in Australia.
  • However, a pullback should be seen as a buying opportunity as the broad trend in shares is likely to remain up: valuations are not dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other developed countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.
  • Sovereign bond yields still remain low and point to low medium-term returns as yields gradually adjust higher in response to the improving global growth outlook. An unwinding of years of massive inflows into bond funds runs the risk of causing a more aggressive rise in bond yields and hence losses on sovereign bonds.
  • With commodity prices in a downtrend and the Australian economy deteriorating versus the US, it’s likely the A$ will fall further. Given its overvaluation in terms of relative prices and costs, expect the A$ to fall to $US0.80.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.