Key events of the past week and implications

  • In Australia the focus in the week ahead will be on the aftermath of the Federal election which saw the election of a new Liberal/National Government. Based on stated policies key policy changes under the Coalition Government are likely to include the abolition of the mining and carbon taxes, reduced company tax— which will be offset by a levy on large companies to pay for paid parental leave—a refocusing of government spending towards infrastructure, a delayed increase in the superannuation contribution, a smaller government, a greater focus on returning the budget to surplus and a range of inquiries (including into the labour market and productivity), which will likely pave the way for less regulation and more economic reform. The change in Government towards what looks like being a more business friendly approach will probably provide a boost to business and investor confidence and past experience points to a post-election bounce in shares. This has averaged 5.4% in the three months after elections since 1983. However, much will depend on how hard the new Government goes in cutting spending with an announcement on this front likely in November and the make-up of the new Senate that will sit from July next year. The current Senate controlled by Labor and the Greens is extremely unlikely to pass legislation to abolish the carbon and mining taxes and success in the new Senate looks like it will depend on the Coalition requiring support from a variety of independents and minor parties. Failure to reach agreement will require a double dissolution election if the new Government is to implement key parts of its program.
  • Syria remains an issue with uncertainty over whether the US Congress will approve military action. (Support from the Senate seems likely for a limited strike, but support from the House of Representatives is less assured). As with all US led military interventions in the Middle East the concern is that it will lead to a wider confrontation threatening oil supplies. Russia has threatened to assist Syria and President Obama is under pressure to act to avoid risking a weakening of global perceptions of US leadership. Given this it would not be surprising to see further share market weakness and oil price strength in the run up to any strike, even though Syria only produces 300,000 barrels of oil a day. This is consistent with past experience which saw share market weakness and oil price strength in the run up to interventions followed by a recovery in share markets from around the time the strike 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%, 14.0% and 6.3% respectively in the run up only to see the losses recovered within two months. A similar pattern could be expected this time around provided it becomes clearer that any intervention will be limited and that surrounding countries are unlikely to become involved.

Major global economic events and implications

  • US data was confusing. August payrolls disappointed with just 169,000 jobs created and downwards revisions to previous months leaving the three month average pace of jobs growth at just 148,000. While unemployment fell to 7.3% this was only because the labour force fell by 312,000 taking the participation rate to its lowest since 1978. Against this, more forward looking indicators for the US economy were strong. The Institute for Supply Management (ISM) Manufacturing Conditions Index improved further in August, the non-manufacturing ISM rose to its highest since 2005, jobless claims fell to their lowest since 2007, construction spending rose solidly and auto sales rose to their highest since 2007. On balance, the US Federal Reserve (Fed) is still likely to start tapering its monetary stimulus at its meeting on the 17-18 September, but it is now a very close call and if it does taper it is likely to only reduce its asset purchases by US$10 billion a month.
  • Final Eurozone business conditions confirmed the economic recovery already evident in the flash purchasing manager indices (PMIs) readings. As expected the European Central Bank (ECB) and the Bank of England left monetary policy unchanged but with the ECB retaining a dovish bias. Italy remains a risk point though with the threat remaining that members of Berlusconi’s party will withdraw support for the Government if Berlusconi is forced out of his Senate seat.
  • In Japan, the Bank of Japan (BoJ) left monetary policy unchanged but Governor Kuroda made clear the BoJ can respond if a planned hike in the goods and services tax (GST) impacts growth. The Yen fell below 100 relative the US$ as a result.
  • Chinese business conditions PMIs mostly improved in August or stayed around solid levels adding to confidence that a 7.5% growth rate remains on track for this year. House prices continued to rise in August but the new Chinese leadership seems to be less concerned about it, perhaps concluding that demand curbs are ineffective and the only solution is via increases to supply.

Australian economic events and implications

  • In Australia, June quarter gross domestic product (GDP) data showed that growth remained sub-par at 0.6% quarter-on-quarter or 2.6% year-on-year, the same pace it has averaged since the June quarter 2012, reflecting soft consumer spending and investment. The bad news is that growth is below the pace necessary to stop unemployment rising, but the good news is that growth has not collapsed. Other indicators presented a soft picture as well with retail sales very weak, business conditions PMIs still soft and the trade balance back in deficit.
  • However, there are some positive signs: house prices continue to rise, building approvals rebounded in July, a move consistent with an ongoing recovery in dwelling construction, household savings remain high at 10.8% indicating a significant buffer in household budgeting, productivity growth is solid at 2.2% and inflationary // 3 pressures are weak with falling real unit labour costs and a benign reading on inflation from the latest term deposit inflation guage.
  • The Reserve Bank of Australia (RBA) surprised no one in leaving interest rates on hold. What was surprising though was that its post meeting statement was virtually identical to that from last month leaving out yet again any explicit easing bias. As a result the RBA has yet again missed an opportunity for a free kick in pushing the A$ down. The risks still point down for rates particularly if the A$ holds up from here, economic data remains soft and the post-election Government embarks on more spending cuts.

Major market moves

  • Share markets rose on the back of good economic data and the delay to any attack on Syria. Shares gained 1.4% in the US, 2.9% in the Eurozone, 3.5% in Japan, 2.0% in China and 0.2% in Australia.
  • The A$ rose as the RBA left out any explicit easing bias from its post-meeting statement and GDP growth was fractionally stronger than expected.
  • Bond yields rose in most countries, including Australia, as stronger US data fuelled expectations for Fed tapering.

What to watch over the next week?

  • Globally Syria will probably be the big one to watch with the upcoming US Congressional vote on approving a US strike. Do not expect much from the G20 leaders’ summit though other than the usual hot air from such events. It is unlikely to have any impact on what the Fed does or on what the US does regarding Syria.
  • On the data front the focus is likely to be on China with key activity data due Tuesday likely to show that the improvement in growth evident in July continued into August. In particular, growth in industrial production is likely to have continued to edge higher rising 9.9% year-on-year, up from a low of 8.9% in June. Meanwhile, inflation (Monday) is likely to show a slight moderation on the back of a fall in food prices.
  • In the US it is a pretty quiet week until Friday when August retail sales are expected to show a 0.3% gain and producer price inflation data is expected to remain benign. Consumer confidence data will also be released.
  • In Australia the aftermath of the election will likely dominate. On the data front it will be interesting to see whether the NAB business confidence survey (Tuesday) and the consumer sentiment survey (Wednesday) show an improvement on prospects given a change of Government. Odds are they probably will. Expect an ongoing rising trend to be evident in housing finance data (Monday) but another round of soft jobs data (Thursday) with employment likely to be flat and unemployment rising to 5.8% from 5.7%.

Outlook for markets

  • Shares are vulnerable over the next month or so 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 potential military intervention in Syria, political instability in peripheral Eurozone countries and possible post-election fiscal tightening in Australia.
  • However, any pullback in shares 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. Interest rates still are at risk of falling further in Australia. In addition, the gradually strengthening global growth outlook points to stronger profits ahead. So by year-end we see further upside in global and Australian shares.
  • Despite the bond sell off so far this year, sovereign bond yields still remain low and point to low mediumterm returns from bonds 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 economic, it is likely the A$ will fall further. Given its overvaluation in terms of relative prices, expect the A$ to fall to US$ 0.80.

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