Key events of the past week and implications

  • The past week has seen shares and growth related trades rally strongly as the US budget crisis came to an end. As a result, all of the major policy and geopolitical threats facing investors a couple of months ago – Syria, Italy, the German election, the US Federal Reserve’s (Fed) taper decision, the replacement of Bernanke at the Fed, the US fiscal threats – have been consigned to the rear view mirror for now, clearing the way for further gains in share markets and other related trades into year end.
  • While the budget and debt ceiling deal in the US is only a temporary solution – funding the Government out to January 15 pending agreement on a new budget and raising the debt ceiling out to February 7, it would be wrong to expect a re-run of the latest budget fight early next year. The odds are that Republicans, who got most of the blame, will not want to push things too hard next year as it is a mid-term election year and they risk losing control of the US House of Representatives.
  • Overall, the decision to end the US budget impasse is good news. It shows that when push comes to shove, US politicians will do the right thing (which is another reason not to be too fearful of the deadlines early next year). It means the impact of the shutdown on US growth once workers get back pay and government spending plays catch-up will be minor and a threat to global economic growth has been averted. In short, the global economic recovery can continue and this is positive for growth assets. The increased likelihood that the Fed will delay tapering its monetary stimulus into early next year only adds to the positive investment backdrop.
  • The US debt ceiling debacle has seen the usual calls to “de-Americanise” the world. Sure the events in the US of the last few weeks were not great. But which other major country doesn’t have its own policy imperfections (usually worse)? Europe was painfully slow in bringing its crisis under control, Japan took 20 years to get serious about fixing its problems, Russia has actually defaulted in the past and while China has no problems with democracy and that’s only because it’s not a democracy.

Major global economic events and implications

  • US economic data was a bit soft, possibly reflecting the impact of the partial Government shutdown. The New York and Philadelphia regional manufacturing conditions surveys both slipped in October, new mortgage applications fell, initial unemployment claims remained elevated and the NAHB home builders’ conditions index slipped. However, the damage looks to have been minor and it is worth noting that the fall in the Philadelphia manufacturing index was trivial, with several components actually rising. Unemployment claims are likely to fall as Federal public servants return to work and the fall in the NAHB index just looks like normal volatility, with the broad trend remaining up strongly. So overall, expect the shutdown to knock a little off the December quarter US gross domestic product (GDP) growth, but not enough to derail the economic recovery.
  • The US September quarter profit reporting season is looking good. Out of 100 S&P 500 companies to have reported so far, 70% have exceeded earnings expectations and 55% have exceeded sales expectations.
  • In Europe, industrial production rose in August, although somewhat less than had been hoped for, while investment analyst sentiment rose and car sales rose the most in over two years.
  • Chinese data presented a pretty benign picture, with September quarter GDP growth bang in line with expectations at 7.8% year on year, up from 7.5% in the June quarter. Healthy gains were recorded in the September data for retail sales, industrial production, fixed asset investment and electricity production. While a slight loss of momentum in the September data suggests that GDP growth will slow a touch in the current quarter, the strength in money supply and lending growth suggests growth will remain solid. Overall, growth for 2013 looks like coming in around 7.7% which is slightly above the official 7.5% target. While inflation rose in September, this was mainly due to higher food prices with non-food inflation was benign at just 1.6% year on year.
  • India continues to disappoint with inflation rising in September, making it hard to justify any central bank monetary easing, despite recent weak industrial production data. Australian economic events and implications.
  • In Australia, the Reserve Bank of Australia (RBA) reinstated its easing bias in the minutes from its last meeting after appearing essentially neutral on the rate outlook in its last post-meeting statement. This has been the pattern over the last three months, which now leads one to wonder whether the RBA has become somewhat contradictory. What is clear though is that the RBA feels no urgency to act on its easing bias. In fact, our view remains that with various domestic indicators showing signs of responding to past rate cuts, the RBA will remain on hold ahead of the next move being a rate hike, but not till around next September/October.
  • While it’s not our base case, one factor that could bring on another rate cut is a continued strong rise in the A$, possibly in response to a move back above parity. The RBA would prefer a lower currency with Governor Stevens commenting on Friday that “a lower currency would be helpful”. This didn’t stop it rising to US$ 0.9676 on Friday night though.
  • On the data front, housing finance fell in August but the trend remains up and finance for construction rose strongly. This all suggests the housing recovery remains on track.

Major market moves

  • Share markets surged higher as the US budget crisis came to an end. US shares rose 2.4%, Eurozone shares gained 2%, Japanese shares rose 2.6% and Australian shares gained 1.7%. The rally in shares over the past week as the US budget crisis came to an end has been very impressive - US shares have broken out to new record highs, global and Australian shares have surged to new cyclical highs and the gains have been accompanied by good volumes and breadth. In other words, the rally has good support from investors searching for higher returns than is available from cash. This all points to further gains ahead.
  • While the oil price fell, most commodity prices gained on the back of resolution to the US budget crisis and the fall in the US$, partly on the back of an increasing likelihood that Fed tapering will be further delayed. This saw the A$ rise strongly, pushing towards US$0.97. > Bond yields also fell, particularly in the US as the small risk of default was priced out. Credit spreads narrowed further.

What to watch over the next week?

  • In the US, the highlight is likely to be the delayed September employment report which is now due to be released on Tuesday and expected to show a 185,000 gain in payrolls with unemployment holding at 7.3%. In terms of other data, expect a slight fall back after strong gains in August for existing home sales (Monday) and new home sales (Thursday), a continuing gain in house prices (Wednesday), a fall in the Markit manufacturing conditions PMI (Thursday) reflecting the impact of the Government shutdown and debt ceiling uncertainty, and a soft final reading for October consumer sentiment (Friday). Durable goods data due to be released Friday may be delayed because of disruptions to data collection due to the shutdown.
  • The US earnings reporting season for the September quarter will continue. Consensus expectations for 2% growth year on year are likely to be surpassed after the usual upside surprise and come in around 4 to 5%.
  • In the Eurozone, preliminary business conditions PMIs (Thursday) will be watched for a continuation of the rising trend evident over the last year or so.
  • Japanese inflation data (Friday) is likely to show further signs of a return to inflation.
  • The October HSBC flash manufacturing PMI for China will be released on Thursday and is likely to show that growth has stabilised or maybe even slowed a notch, rather than continued to accelerate.
  • In Australia, September quarter inflation data is likely to show a sharp rise in the quarter of 0.8%, reflecting a 6% rise in petrol prices due largely to the mid-year fall in the A$, but because the impact of the start of carbon pricing a year ago will drop out of the data, the annual rate of inflation will fall to around 1.8%. Despite these gyrations, the underlying measures are expected to show a quarterly increase of 0.6% as pricing power remains weak and annual inflation of just 2.2% indicating that inflation remains benign and is certainly not a constraint to further monetary easing if that proves necessary.

Outlook for markets

  • The ending of the US budget crisis has cleared the way for shares to have a solid rally into year end with further gains next year. Share market valuations remain reasonable, monetary conditions are set to remain easy and profits are likely to improve next year as global and Australian growth picks up. Australian shares look on track to hit 5500 or even higher by year end, with a little help from a Santa rally.
  • Government bond yields are likely to resume a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually comes back into focus either later this year or early next. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead.
  • Signs that Australian interest rates are bottoming, a delay in Fed tapering, stable growth in China and improving global growth at a time when short A$ positions remain extreme suggest that in the months ahead the A$ is likely to see more upside, probably up to around US$0.98, before the medium term downtrend resumes.

 

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.