Investment markets and key developments over the past week
- Share markets rose over the past week helped by good US economic data, signs the European Central Bank (ECB) is likely to broaden its quantitative easing program, a stabilisation in energy shares after their plunge the week before and growing investor interest in Chinese shares. US shares rose 0.4%, European shares gained 1.1%, Japanese shares rose 2.6%, Australian shares gained 0.4% and Chinese shares surged 9.5%. Bond yields mostly rose after the previous week’s oil-driven plunge. The oil price fell only slightly after its plunge the week before and other commodity prices saw gains. However, the Australian dollar continued to drift lower against the US dollar as the latter continued its broad upwards trend and as expectations for another interest rate cut in Australia intensified.
- Chinese shares spring back to life, but there is more to go. After a four-year bear market that started in August 2009 and took them down 44%, Chinese shares have sprung back to life big time since July and are now up 39% year-to-date, making them one of the world’s strongest markets this year. The upturn looks to have caught many by surprise but it’s typical of the way the Chinese share market – which remains very retail-driven and speculative – works. Recent gains are now leading to a surge in new share market account openings in China as investors swing back from property to shares. Inevitably it will go too far but right now we are a long way from that as the forward price-to-earnings ratio is just 10 times and the historic price-to-earnings ratio around 12 times which are both low against their own history and globally. So we remain overweight Chinese mainland shares.
- While the Reserve Bank of Australia (RBA) left interest rates on hold again, it’s increasingly clear that the balance of risks have shifted in favour of the next move in rates being a cut. Commodity prices have fallen much faster than expected, the Australian dollar has not fallen enough on a trade weighted basis to compensate thanks to significant monetary easing in Europe and Japan, the non-mining sectors of the economy are improving but not fast enough and are at risk of stalling in the face of a national mode of pessimism. As a result it’s become increasingly clear that more monetary easing is required in the form of a further significant fall in the Australian dollar and lower interest rates. Without the latter the Australian dollar may not fall enough. Fortunately, low inflation and a loss of momentum in house prices provide the RBA with plenty of flexibility. As a result, I now expect a 0.25% cut in the March quarter and see a 50% chance of another cut in the June quarter.
- There are a few big events ahead on the policy front in Australia. First up will be the reaction to the Murray Financial System Inquiry, particularly in relation to its recommendations regarding bank capital requirements and superannuation, although the final decision will be made by the Government. Second, the Government’s discussion paper on the tax system will soon be released and will likely highlight the excessive reliance in Australia on income tax as opposed to indirect tax and the negative impact of this on incentive as average workers are pushed into ever higher tax brackets. Finally, the Mid-Year Economic and Fiscal Outlook (mid-December) is expected to reveal another A$5-10 billion per annum deterioration in the budget deficit over the next four years (or A$30 billion in total) reflecting an estimate of savings that will remain blocked by the Senate and the impact of slower economic growth and the slump in commodity prices, delaying the return to surplus to around early next decade. Fortunately, the Treasurer has implied that savings to make up the gap won’t be announced straight away but action is likely to be taken in the May budget. The government has also most recently announced that it will restructure its paid parental leave scheme in an effort to secure Senate support in 2015.
Major global economic events and implications
- US data remains solid with strong readings for November business conditions indices, construction activity, vehicle sales and jobs. The stronger-than-expected November payroll report highlights the strength in the US economy and slightly adds to confidence regarding a mid-2015 US Federal Reserve rate hike, as opposed to later. That said wages growth remains low at 2.1% year-on-year and inflation is likely to drift lower in the months ahead.
- No widening in the ECB’s quantitative easing program to include corporate and public debt yet, but it looks on track for early next year. Clearly the ECB Governing Council is not there yet, but waiting to see the results of the 11 July targeted long-term refinancing operation (TLTRO) auction of cheap funding for banks and the 14 January European Court of Justice decision in relation to sovereign bond buying is understandable. However, there are numerous signs it’s on the way: the ECB has lowered its growth and inflation forecasts; President Draghi remains very dovish and has indicated support for an expanded quantitative easing program does not have to be unanimous; and reports from the ECB suggest that a package of broad-based asset purchases including public debt will be considered at its 22 January meeting. Meanwhile Eurozone economic data was soft with slight downward revisions to purchasing managers’ index (PMI) business condition readings for November and weaker-than-expected growth in retail sales.
- Japanese wage growth data remained subdued in October but services sector conditions improved and September quarter business investment came in stronger than expected.
- China’s official manufacturing PMI fell slightly in November in line with the HSBC PMI, but it’s stuck in the same range it’s been in for three years now and services sector conditions actually improved slightly.
- India is looking better. While the situation in Russia is just going from bad to worse and Brazil isn’t so flash either with another rate hike, stubborn inflation and falling growth prospects, India is continuing to look better with its manufacturing conditions PMI improving significantly in November and the Reserve Bank of India revising down its inflation expectations and looking like it’s on track for interest rate cuts early next year.
Australian economic events and implications
- Australian economic data painted a very messy picture. On the positive side building approvals reversed the decline seen in September, momentum in retail sales remains solid and the trade deficit fell in October. But against this though, September quarter gross domestic product (GDP) growth was disappointingly weak at just 0.3% quarter-on-quarter (qoq) and once the slump in the terms of trade is allowed for real gross domestic income fell for the second quarter in a row. Meanwhile, the TD Securities Inflation Gauge indicated that inflation is benign and RP Data on home prices showed a continued loss of momentum. The basic message is that non-mining activity is picking up and helping offset the mining downturn but not yet quickly enough.
What to watch over the next week?
- In the US, expect to see a 0.3% gain in October retail sales (Thursday) and a fall in producer prices (Friday) as lower oil and gasoline prices flow through. Data for small business optimism (Monday) and consumer sentiment (Friday) will also be released.
- In Europe the focus will be on how much bank interest there will be in the ECB’s second TLTRO auction of cheap funding (Thursday). With the stress tests out of the way, hopefully the banks will feel more confident in expanding their balance sheets.
- In Japan, September quarter GDP growth is likely to be revised up to -0.1% qoq from the -0.4% decline initially reported thanks to stronger-than-expected September quarter business investment data.
- Chinese data for November is likely to show a slight slowing in export growth (Monday), a pick-up in lending reflecting People’s Bank of China (PBOC) easing measures but flat to slightly softer momentum in fixed asset investment, retail sales and industrial production (all Friday) as it’s a bit too early to see the impact of recent easing measures. At the same time consumer price index inflation (Wednesday) is likely to remain low at 1.6% and producer price deflation is expected to intensify to -2.4%, all of which leaves plenty of room for further PBOC interest rate cuts.
- In Australia, expect to see a slight fall back in the National Australia Bank business conditions index for November (Tuesday), continued subdued consumer confidence (Wednesday), flat housing finance (Wednesday), flat jobs growth and a rise in unemployment to 6.3% (Thursday).
Outlook for markets
- While there are a few uncertainties around (as always), shares are well placed to see gains into year-end and through next year as the cyclical bull market that started in 2011 remains alive and well. While the first two weeks of December are often constrained, seasonal strength associated with the ‘Santa rally’ usually kicks in during the last two weeks and then runs through January. More fundamentally, valuations particularly against the reality of low bond yields are good and monetary policy is set to remain easy with quantitative easing in Europe and Japan and rate cuts in China replacing quantitative easing in the US, the RBA is now likely to cut rates early next year and rate hikes in the US are still a long way off. Australian shares are likely to remain a relative laggard though as commodity price weakness continues to impact, but the positive global lead, Chinese monetary easing, the prospect of more RBA rate cuts and the lower Australian dollar should help push the ASX 200 up into year-end and through next year.
- Low bond yields will likely mean soft medium-term returns from government bonds. However, in a world of too much saving, spare capacity and low inflation it’s hard to get too bearish on bonds.
- The Australian dollar is likely to head even lower over the year ahead with the US dollar trending up, weak commodity prices, RBA rate cuts and the Australian dollar still too high given Australia’s high cost base. This is also necessary to help the economy rebalance. US$0.75 is likely to be seen in the next year or so. A relatively greater fall in the Australian dollar/US dollar rate is necessary as the Australian dollar is unlikely to fall much against the yen and euro given their monetary stimulus programs.
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