Investment markets and key developments over the past week
- Despite a bounce on Friday in US and European shares, global share markets had a rough week as they were weighed down by worries about the US Federal Reserve (Fed), tough action against US companies seeking to reduce their tax by relocating outside the US, worries about Chinese growth, geopolitical concerns and worries about the loss of breadth in the US share market rally. US shares fell -1.4%, Eurozone shares fell -1.9% and Japanese shares fell -0.6% but Chinese shares continued to recover and rose 0.8%. In addition to the influence of falling global share prices, falling iron ore prices and the retreat of foreign investors to the sidelines saw the Australian share market fall another -2.2% giving up its gains for the year. Weakening share markets saw bonds rally suggesting in part that investors fear that talk of US rate hikes is premature. The outlook for relatively tighter monetary policy in the US versus other major regions saw the US$ continue to rise, leaving it up nearly +7% over the last three months. This is also weighing on commodity prices. The falling iron ore price and the rising US$ saw the A$ continue its slide.
- Geopolitical threats are continuing. While the global threat from the Ukraine conflict seems to be receding a bit, the conflict with ‘IS’ in the Middle East is hotting up bringing with it the threat of global terrorist activity. So far global oil supplies are not under threat, with the oil price running below the levels when IS in Iraq first started hitting the headlines. But increasing prospects for the deployment of ground forces in Iraq by the US and its allies and talk of the terrorist threat are weighing on investor confidence. Terrorist attacks are horrible in terms of their human consequences and there is no doubt that an IS terrorist attack in a western country would be taken badly by share markets. But the experience with various Al-Qaida related attacks (9/11, Bali Bombing, 2005 London bombings, etc) is worth recalling: after an initial negative impact share markets bounced back as it was clear that there would not be a major economic impact and it seemed the effect on markets weakened as the terror threat continued. It took just over a month for the US share market to recover from its -12% post 9/11 slump and it took the UK share market 1 day to bounce back from its -1.3% fall on the day of the July 2005 London bombings.
- In Australia, the Financial Stability Review of the Reserve Bank of Australia (RBA) expressed concern that the housing market is becoming too speculative and that if left unchecked it poses risks to the broader economy for when the property cycle turns back down. As a result Australian Prudential Regulation Authority (APRA) has stepped up its surveillance of the banks and given the desire to avoid a rate hike at this point the RBA is discussing with APRA further steps that may be taken to ensure sound lending practices are maintained, particularly with respect to property investors. The focus looks like it may be on tougher capital requirements and interest rate tests banks apply when assessing new loans rather than restrictions on loan to valuation ratios. It is likely that if the property market does not cool soon an announcement could be made in the next few months. To the extent that the use of macro-prudential controls might delay the first rate hike further into 2015 it could be good news for existing home borrowers.
- The term “macro prudential controls” is really just the latest buzzword for the failed credit rationing policies used prior to the 1980s. The RBA would be well aware of the risk of unintended consequences – eg, the potential impact on first home buyers many of whom are investors these days and in forcing borrowers into the shadow banking system – but it no doubt feels such controls are better than raising interest rates right now.
- The A$ is continuing to slide helped by an ascendant US$, the continuing slide in the iron ore prices (now down -41% year-to-date) and the possibility that the use of macro-prudential controls to slow the housing market will further delay the first rate hike in Australia. Comments by the Reserve Bank of New Zealand Governor Graeme Wheeler that the level of the NZ$ was “unjustified and unsustainable” also helped as they apply just as much to the level of the A$. I remain of the view that by year-end the A$ will have fallen through the January low of US$ 0.8660 on its way to around US$ 0.80 over the next year or so. A lower A$ will help rebalance the economy.
Major global economic events and implications
- US data remains mostly strong. While existing home sales fell in August new home sales surged to a six-year high, the Markit purchasing manager indices (PMIs) remained solid, consumer sentiment rose, June quarter gross domestic product (GDP) was revised up mainly on the back of stronger business investment and higher durable goods orders. While Fed officials are continuing to provide mixed messages on the timing of rate hikes its noteworthy that a couple of hawks will not be voting members at the Fed next year and so their calls for an earlier move by the Fed should be ignored. Our view remains that the Fed won’t start raising rates till the June quarter, but the +7% gain in the US$ since June has probably not been lost on Janet Yellen who would be thinking its delivering a de facto monetary tightening.
- Eurozone PMIs continued to edge down in September leaving them at levels consistent with only modest growth and European Central Bank (ECB) President Draghi described the recovery as losing momentum. There was a slight improvement in money supply and credit momentum, but not enough to allay the mounting pressure on the ECB.
- A slight fall back in Japan’s manufacturing conditions PMI for September was disappointing but leaves in place a gradual recovery after the April tax hike induced fall. Japanese core inflation excluding the impact of the tax hike is continuing to run around +0.5% year-on-year, which is better than deflation but not much of a buffer really. The latest leg down in the value of the Yen should help provide a further boost to inflation though.
- While Chinese officials continue to indicate there will not be any major policy stimulus, it is worth noting similar comments were made earlier this year before various mini-stimulus measures were introduced. An unexpected slight rise in the HSBC flash PMI for September helped relieve Chinese growth fears a bit.
Australian economic events and implications
In Australia, job vacancies fell slightly over the three months to August according to the Australian Bureau of Statistics but this followed a +5.3% gain over the previous six months and skilled vacancies rose in August for the 11th month in a row so the basic picture remains one of forward looking indicators are pointing to stronger jobs growth ahead.
What to watch over the next week?
- In the US, the main focus will be on the ISM manufacturing and services indices (due Wednesday and Friday respectively) which are both expected to remain strong and employment data (Friday) which is expected to show a 210,000 gain in payrolls for September and unemployment unchanged at 6.1%. Consumer spending data (Monday) is also expected to show that the Fed’s preferred inflation measure remained benign with a fall to +1.4% year-on-year.
- In the Eurozone, business confidence data (Monday) is likely to have weakened a bit further and September inflation (Tuesday) is likely to be just +0.3% year-on-year. Despite this, the ECB (Thursday) is unlikely to announce further monetary easing but may provide details of its proposed quantitative easing program involving asset backed securities.
- Japanese data for jobs, household spending, industrial production, labour cash earnings and housing starts due Tuesday will be watched for signs of further improvement following the impact of the April sales tax hike, but the September quarter Tankan business survey (Wednesday) is likely to have weakened slightly.
- In China, the official PMI (Wednesday) is likely to be little changed from the 51.1 reading for August.
- In Australia, given the RBA’s concern about the property market, credit data (Tuesday) and RP Data house price figures (Wednesday) for September may see greater than normal interest. Expect to see overall credit growth remaining modest but interest will be on whether growth in credit going to property investors accelerated from the roughly +10% annualised pace seen over the last few months. RP Data is expected to show that house price gains remained strong in September. Meanwhile, expect a modest gain in retail sales (Wednesday), a renewed deterioration in the August trade deficit (Thursday) and solid building approvals (also Thursday).
Outlook for markets
- Shares remain at risk of further short-term weakness particularly ahead of the end of US quantitative easing next month, the US mid-term elections in November and as we are still in a seasonally weak part of the year for shares. Australian shares are also vulnerable in the short-term to further falls in the iron ore price and as foreign investors stay on the sidelines as the A$ falls.
- However, this is likely to be nothing more than a healthy correction, allowing shares to let off a bit of steam, and so should be seen as a buying opportunity as the cyclical bull market in shares likely has further to go. We still do not see the signs of shares being over valued, over loved and over bought normally seen at major market tops. Valuations remain okay, global earnings are continuing to improve on the back of gradually improving economic growth, global monetary conditions are set to remain easy and there has been no sign of investor euphoria.
- Although the falling A$ is initially a drag on the Australian share market as foreign investors retreat to the sidelines, after a while it will start to become a source of support as it flows through to upwards revisions to earnings expectations. Roughly speaking each 10% fall in the value of the A$ boosts company earnings by +3%.
- Low bond yields will likely mean soft returns from government bonds, particularly as we continue to edge closer to the start of a gradual interest rate tightening cycle in the US.
- The combination of soft commodity prices, the likelihood the Fed rate hikes before the RBA and relatively high costs in Australia are expected to see the broad trend in the A$ remain down. Expect to see it fall to around US$0.80 in the next year or so.
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