Investment markets and key developments over the past week
The “risk off” tone in markets continued over the past week with mixed US economic data and earnings results along with a continuing fall in oil prices early in the week maintaining downwards pressure on US shares which fell 1.2% for the week, Japanese shares which fell 1.9% and Australian shares which lost 3%. Bonds benefitted from a flight to safety and deflation worries with yields continuing to fall. However, European shares bucked the trend and gained 4.6% over the last week on expectations for European central bank (ECB) quantitative easing and Chinese shares rose 2.8%. While the Euro continued to slide against the $US, the $A managed a small gain helped by a strong jobs report.
While US shares remain under pressure, falling 1.9% year to date, European shares have been outperforming and are up 1.8% year to date reflecting expectations the ECB will announce a widening in its quantitative easing (QE) program at its January 22 meeting. Expectations on this front were boosted by an opinion from the European Court of Justice that ECB sovereign bond buying does not violate EU treaties and by the Swiss central bank (SNB) abandoning the 1.20 currency floor for the Euro against the Swiss Franc.
Switzerland is a small country so it’s hard to get too excited by the surge in the Swiss Franc and fall in Swiss shares (unless you were the wrong side of those moves) that resulted from the SNB’s action. That said there are some global implications. First, it provides a reminder that such exchange rate fixings are hard to sustain. Second, it demonstrates there is more scope for negative interest rates in the face of deflationary pressure globally with the key SNB interest rate being cut to 0.75%. Third, and related to this, it highlights that other small countries may be forced into further monetary easing if ECB QE pushes their currencies higher. Finally, it likely reflects SNB expectations that the ECB is about to expand its QE program.
For Australia, the Swiss gyrations underline the problem that outside the US lots of countries would like to get their currencies down, making it harder for the $A to fall on a trade weighted basis which in turn means it will have to fall further against the $US.
Shock, horror, the World Bank revises down its global growth forecasts - but nothing new! Over the last few years organisations like the World Bank, IMF and OECD have been forecasting a pick-up in global growth to around 4% or so, only to revise estimates down to around 3-3.5%, usually well after smart investors had already allowed for it. The World Bank kicked off the process again for this year, shaving its 2015 global growth forecast to 3.6% (against our own view of 3.5%) and continuing to expect a bounce to 4% in 2016 (which is probably again too optimistic). There is nothing new in this. In fact, I prefer a world of constrained and uneven growth because the opposite of strong and synchronised global growth would only mean an increased risk of overheating, inflation and monetary tightening.
But while there is no reason for alarm at the latest World Bank revisions, the plunge in bond yields is worth keeping an eye on. US 10 year yields are now zeroing in on their 2012 lows and in other countries have fallen below 2012 levels to record lows. This includes Australia. While the bond markets could be over-reacting again like they did in 2012 and setting up for a sell, which is my base case, they are also providing a reminder that deflation is more of a threat than inflation.
Source: Global Financial Data, Bloomberg
Major global economic events and implications
US data releases were mostly solid with a rise in consumer sentiment to an 11 year high, a further rise in job vacancies and stronger conditions amongst small business and New York region manufacturers, but weaker conditions in the Philadelphia region and softer than expected December retail sales. December quarter retail sales though were strong, once lower consumer prices are allowed for. Of more importance was a 0.4% fall in December consumer prices taking annual inflation to just 0.8% and flat core inflation indicating that the fall in inflation is broader than just lower fuel prices. Weakening core inflation will make it hard for the Fed to justify a mid-year rate hike, suggesting it will be delayed until the second half.
The US December quarter profit reporting season kicked off with a good beat by Alcoa, but some mixed bank results. So far 86% of results have beaten earnings expectations, but only 53% have beaten on sales. But its early days as only 40 S&P 500 companies have reported so far.
Chinese trade data rebounded in December helped by the end of APEC related shutdowns but money and credit data was mixed. While credit bounced back this looks temporary with a downtrend in annual credit growth likely to remain in place. We continue to expect further PBOC interest rate cuts this year.
While Russia and Brazil look poor (causing a rethink of the BRIC concept) India is looking good with industrial production strengthening and inflation falling, with the latter allowing the Reserve Bank of India to cut its key interest rate by 0.25% to 7.75%. Expect further cuts this year as inflation continues to moderate.
Australian economic events and implications
In Australia, the highlight over the last week was another booming jobs report. December jobs growth was far stronger than expected for the second month in a row, pushing the unemployment rate down to 6.1%. While great news, it’s hard to believe nearly 100,000 new jobs were created over the last 3 months. Very weak hours worked also call into question the reliability of the jobs data. Given usual volatility and recent data problems the jobs data is best treated with caution. Rising job vacancies tell us employment growth should be okay, but nowhere near as strong as has been reported over the last few months.
Meanwhile, a surge in dwelling starts in the September quarter points to a rebound in housing investment in the December quarter but this may slow this year as housing finance is clearly losing some momentum.
Given the various cross currents – strong jobs, a lower $A/$US rate and the boost to spending from lower fuel prices versus inflation threatening to break below target, a still too high $A on a trade weighted basis and sub-par growth overall – the RBA is likely to sit on its hands at its February meeting, but is still likely to cut the cash rate once more in the months ahead.
What to watch over the next week?
The main focus in the week ahead will be the ECB meeting (Thursday) which is expected to announce an expansion in its quantitative easing asset purchase program to include corporate and sovereign bonds. This should help the ECB reach its target of expanding its balance sheet by around €1trillion. While the initial QE program may be for a fixed amount, President Draghi is likely to indicate that this will be extended if needed. Meanwhile, Eurozone PMIs for January (Friday) will be watched for a further improvement after the slight gain seen in December. And on January 25 the focus will shift back to Greece with its election, albeit it may take a while to determine the new government. See the January 9 Weekly for our views on Greece.
In the US, expect to see gains in the NAHB home builders’ conditions index (Tuesday), housing starts (Wednesday), house prices (Thursday) and existing home sales (Friday) and the Markit manufacturing conditions PMI (Friday) to remain reasonably solid.
The flow of US December quarter earnings reports will pick up. Market expectations remain for profits to be up 2% year on year but this still looks too cautious.
The Bank of Japan meets Wednesday but no change in monetary policy is likely given the huge further easing announced several months ago. Japan’s manufacturing PMI will be released Friday.
Chinese December quarter GDP (Tuesday) is likely to show a further moderation in growth to 7.2%, resulting in 7.3% GDP growth for 2014 as a whole which is in line with the official target for growth of “about 7.5%”. Meanwhile, December data is expected to show growth slightly weaker for investment, flat for retail sales and up slightly for industrial production. The flash HSBC manufacturing conditions PMI for January will be released Friday.
In Australia, expect to see a bounce in consumer confidence (Wednesday) on the back of lower petrol prices and the reported fall in unemployment. Data for car sales and new home sales will also be released.
Outlook for markets
Uncertainties associated with the plunge in oil prices and the impact on energy producers, the January 25 Greek election and Europe and the Fed’s move towards a rate hike could result in a volatile first half in share markets with the risk of a 10-15% correction at some point along the way. This may already be getting underway.
However, the broad trend in shares is likely to remain up as: valuations, particularly against the reality of low bond yields, are good; economic growth is continuing; and monetary policy is set to remain easy with further easing likely in Europe, Japan, China and Australia and only a gradual tightening cycle in the US. As a result share markets are likely to see another year of reasonable returns.
The Australian share market is likely to do better than in 2014 as growth continues to rebalance away from resources helped by low interest rates and the fall in the $A. However, it will probably continue to lag global shares as commodity prices remain in a long term downtrend. Expect the ASX 200 to rise to around 5700 by end 2015.
Commodity prices may see a bounce from very oversold conditions, but excess supply for many commodities is expected to see them remain in a long term downtrend.
Very low bond yields point to a soft medium term return potential from sovereign bonds, but it’s hard to get too bearish on bonds in a world of too much saving, spare capacity & low inflation.
The downtrend in the $A is likely to continue as the $US trends up, reflecting the long term downtrend in commodity prices and Australia’s relatively high cost base. Expect a fall to around $US0.75. However, the $A is likely to be little changed against the Yen and Euro.
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