Key events of the past week and implications

  • The past week saw more good gains in most share markets helped by dovish comments from US Federal Reserve (Fed) chair nominee Janet Yellen and news of aggressive reforms on the way in China.
  • While the vague nature of the initial communiqué from the Third Plenum in China disappointed some, the details released later in the week indicate it was a big success in delivering President Xi’s promised “master plan” for reform. Key reforms include: expanding farmers land rights and relaxing the household registration system both of which will further encourage urbanisation; loosening the one child policy; encouraging more private investment in state businesses; faster financial and exchange rate deregulation; fiscal reform to reduce the imbalances between local and central governments; and more market-determined pricing of oil, water, electricity etc. It’s clear that the focus of the Chinese leadership will be on reforms to allow market forces to play a more decisive role in the economy. If the reforms are implemented - and there is no reason to suggest they won’t be - they will be hugely positive for sustaining solid Chinese growth over the medium term. This, in turn, is hugely positive for Chinese shares which are currently trading on global low price-to-earnings ratios.
  • In the US, fears of an imminent Fed tapering continue to wax and wane following the stronger-than-expected jobs report and comments from various Fed officials. But the key message seems to be that while tapering is likely to be discussed in December, it’s a long way from being a sure thing. Voting Fed Presidents have given the impression that it’s too early. Also, importantly, vice-chair Janet Yellen has commented that the economy is performing short of potential and needs to improve if the Fed is to reduce monetary stimulus. Dr Yellen’s comments don’t preclude a tapering in December (as tapering could simply be offset by more dovish guidance on interest rates) but they do suggest that the probability of a December move is a bit less than 50/50. More broadly, Dr Yellen sees the benefits of quantitative easing exceeding the costs, indicated little change in the approach the Fed has pursued under Ben Bernanke and her testimony and the reaction of senators to it suggests little risk she will not be confirmed.
  • More broadly, Dr Yellen’s comments, combined with indications from both the European Central Bank (ECB) and the Bank of Japan, mean that global monetary conditions will remain very easy through next year. This, along with stillreasonable valuations and improving global growth, means a very positive environment for shares.
  • Australian politics descended into a bout of silliness with talk of a government shutdown should the federal debt ceiling not be increased. Some Australian politicians seem to be going through a bit of ‘me tooism’ after the shutdown and debt default talk in the US. The bottom line is that whether the debt ceiling is raised to A$400 billion as the Opposition suggests for now or the A$500 billion the Government is demanding is of no consequence as federal debt is only around A$275 billion at present and unlikely to reach the lower level of A$400 billion by 2016 or 2017. So forget the shutdown talk – it’s not going to happen. In fact it would make more sense to abolish the ceiling as it has no effect in terms of constrainingdebt anyway. The issue is a giant ‘ho-hum’ for financial markets.

Major global economic events and implications

  • It was a light week for US economic data but what was released was soft. There was a fall in small business optimism and manufacturing conditions in the New York region, soft industrial production data, a further decline in new mortgage applications, a slightly worse-than-expected trade deficit and only a marginal fall in jobless claims. Good news from a major retailer about sales though helped boost confidence, and the past week’s soft data needs to be seen in the context of the much stronger data released the previous week.
  • The Eurozone economic recovery continued in the September quarter but only very slowly with a 0.1% quarterly rise after the 0.3% gain in the June quarter. Germany, Spain and Portugal grew slightly but France and Italy contracted slightly. Obviously, this is not enough to deal with massive unemployment, high debt levels and falling inflation. Fortunately, though, the pick-up in business conditions purchasing managers’ indices (PMIs) and confidence measures seen over the last year points to further growth ahead and more monetary easing is likely on the way from the ECB.
  • Japanese gross domestic product growth slowed pretty much as expected in the September quarter to 0.5% quarteron-quarter from 0.9% in the June quarter on the back of slower growth in consumption and investment. Leading indicators point to a rebound in the current quarter though. Other Japanese data was mixed with a slight fall in confidence and a tertiary activity index but a rising trend in machinery orders and falling bankruptcies.
  • Another interest rate hike in Indonesia, along with Indian data showing with much weaker-than-expected industrial production and 10% consumer price inflation highlighted the problems facing some key emerging countries.

Australian economic events and implications

  • Australian economic data was mixed with a stronger-than-expected gain in housing finance, confirming that the housing recovery remains intact, and a rise in consumer confidence but a fall in the National Australia Bank’s (NAB) measure of business confidence and very soft wages growth. Weakness in wages growth is to be expected given the soft labour market and as such is not surprising. What it does mean though is that there is no inflation pressure coming through from labour costs so it helps confirm that there is plenty of scope for a further rate cut if needed. But what is clear though is that the broad bounce in business and consumer confidence remains intact - the NAB measure remains well above recent lows - and construction finance and building approvals indicate the housing recovery includes an upswing in dwelling construction. As such we see the Reserve Bank of Australia (RBA) remaining on hold.

Major market moves

  • While share markets initially had some wobbles on the back of tapering talk in the US and the vague communiqué from the Third Plenum in China they bounced back strongly after dovish comments from Fed chair nominee Yellen and as details of an aggressive reform agenda flowing from the Plenum emerged in China. US shares rose 1.6%, Eurozone shares rose 0.5%, Japanese shares gained a whopping 7.8% and Chinese shares rose 1.4%. Australian shares were flat though as banks consolidated recent gains.
  • Commodity prices were weaker, including the oil price which is being weighed down by increasing US supply. In fact the US produced more crude oil than it imported last month. Soft commodity prices weighed on the Australian dollar.
  • Bond yields rose in Australia but fell in the US and Europe on the back of Yellen’s dovish comments.

What to watch over the next week?

  • In the US, attention will likely focus on the release of the minutes from the Fed’s October meeting (Wednesday) for further guidance on the chance of a December tapering. The trouble is that it is now very dated given dovish comments by various Fed officials, particularly by Janet Yellen. On the data front, expect a modest rise in the November National Association of Home Builders conditions index (Monday) as a result of the ending of the government shutdown, but the shutdown is likely to have weighed on October data due Wednesday for retail sales resulting in just a 0.1% gain and existing homes sales which are expected to have fallen slightly. The preliminary Markit PMI for November (Thursday) is also likely to show a post shutdown bounce. Meanwhile, expect the consumer price index (also Wednesday) to show inflation running at just 1.1% year-on-year.
  • In the Eurozone the focus will likely be on preliminary November business conditions PMIs (Thursday) which are likely to show a continuing rising trend.
  • China’s flash HSBC manufacturing conditions PMI (Thursday) is expected to show a stabilisation around the October reading of 50.9 consistent with continuing solid growth and details from the Plenum will also be scrutinised.
  • In Australia, the minutes from the last RBA meeting (Tuesday) will likely confirm that it retains a mild easing bias and that it is more concerned about the strong Australian dollar than rising house prices at this stage. Attention will focus on the minutes of the RBA’s monthly policy meeting (Tuesday). Speeches by Assistant Governor Debelle (Wednesday) and Governor Stevens (Thursday) will also be watched closely.

Outlook for markets

  • After solid gains from early October lows and with technical and sentiment indicators a bit stretched a short-term correction or consolidation in shares would not be surprising. However, the trend in shares is likely to remain up as valuations remain reasonable, monetary conditions are set to remain very easy and profits are likely to improve next year as global and Australian growth picks up. Australian shares remain on track to hit 5500 or even higher by year-end, with a little help from a Santa rally.
  • Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to ensure the rising trend in yields remains very gradual.
  • Expect the Australian dollar to be buffeted in the short term between signs Australian rates have bottomed and stable growth in China but talk of Fed tapering and RBA jawboning. The medium-term trend in the Australian dollar is likely to remain down.

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