Investment markets and key developments over the past week
While Australian shares were little changed over the last week, other markets saw good gains. US shares gained 0.6%, Eurozone shares rose 1.3% helped by progress towards a Greek deal and better economic data and Japanese shares rose 2.3% to a 15 year high. Chinese shares also rose ahead of the New Year holiday. Australian shares rose only 0.1% with more mixed earnings results but support from a takeover of Toll by Japan Post and expectations there may be more such deals. Bond yields rose but commodity prices fell slightly. The $A managed to get back above $US0.78.
A provisional interim loan deal reached on Greece. Eurozone finance ministers have agreed to extend the current Greek loan program by four months pending the Greek Government providing a list of reforms it will undertake by Monday. There are still several steps: the IMF; European Commission and ECB must approve the list; finance ministers must also approve it; the deal will then need to be passed by several country parliaments; and then attention will turn towards negotiating a longer term program for Greece. So Greece will likely remain in the headlines for a while yet. However, cooler heads seem to be prevailing and so we remain of the view that there will be no Grexit. What is also clear is that this is no re-run of the 2010-12 Eurozone crisis. There has been no contagion from Greece to other countries with Italian and Spanish bond yields remaining at record lows and Eurozone shares are up 11% year to date making them star performers. With European economic data continuing to improve, Eurozone shares continue to look relatively attractive.
The Australian December half profit reporting season is now 60% done. While we have seen the usual pattern of good results being released early resulting in some deterioration over the past week, overall results remain better than feared. 57% of results have beaten expectations against a norm of 45%, 68% have seen profits rise from a year ago, 54% have seen their share price outperform the day results were released and 62% have increased their dividends. Key themes have been falling profits amongst resources and mining services companies, but continued strength for the banks, ongoing cost control and solid growth in dividends. With the share market now trading on an above average forward PE of 15.5 times, the market has become very sensitive to companies that under or over deliver relative to expectations and so we have seen some significant share price reactions.
Through all the noise though, consensus Australian earnings expectations for this financial year and next are little changed from where they were before the results started to flow. The consensus is for earnings growth this financial year of 1% with resources -25% but industrials +10% and banks +8%.
Major global economic events and implications
In the US, the minutes from the last Fed meeting offered little that was new. The Fed is clearly grappling with cross currents in terms of economic activity data and inflation and feels that it can be patient in moving to raise interest rates. Arguably there was a slight bias away from June for the first rate hike out to around September. Economic data released in the US if anything added to the case for a later move. While jobless claims fell and the Markit manufacturing conditions PMI rose, the NAHB home builders survey, housing starts and permits and a couple of regional manufacturing conditions surveys all softened slightly, industrial production rose less than expected and both headline and core producer prices came in weaker than expected.
The Eurozone continues to look like its picking up pace with further gains in the Markit composite business conditions PMI for February and in consumer confidence.
After the sales tax driven recession mid last year, Japan has returned to growth. However, December quarter GDP was weaker than expected at just 0.5% quarter on quarter. While the Bank of Japan made no changes to monetary policy as they are still waiting to assess the impact of the expanded measures announced last November, more easing is likely to be required this year which in turn is likely to maintain downwards pressure on the value of the Yen.
Chinese residential property prices continued to fall in January but at a slower pace. Average prices fell 0.4% month on month, compared to 1% monthly falls earlier last year and tier 1 cities saw a 0.1% price gain. However, while property price declines have slowed prices are still falling and pose a threat to the economy. Given the soft start to growth indicators and inflation this year we remain of the view that further Chinese monetary easing is likely ahead.
Australian economic events and implications
The minutes from the last RBA Board meeting offered little that was new and in any case they were pretty dated anyway given that the Statement on Monetary Policy and Governor Steven’s Parliamentary testimony had been released since. It’s not really surprising to learn the RBA had debated whether to ease in February or March - many of those looking for an easing grappled with the same issue. The RBA’s sub-trend outlook for growth, low inflation and assessment that a lower $A is likely needed all point to an easing bias. We continue to see another rate cut in the months ahead.
What to watch over the next week?
In the US, the main focus is likely to be on Fed Chair Janet Yellen’s Congressional testimony (Tuesday and Wednesday) which is likely to confirm that the Fed remains on track to raise interest rates this year, but can be patient in doing so. Meanwhile, data for new and existing home sales (Monday and Wednesday) are likely to show slight falls after strong December gains but with pending home sales (Friday likely to be up, home prices (Tuesday) are likely to have risen further in December and durable goods orders (Thursday) are likely to show a decent rise after a few soft months. Of particular significance, December quarter GDP growth (Friday) is likely to have been revised down further to a 2% pace and inflation is likely to fall to -0.1% year on year at a headline level with core inflation falling to just 1.5% year on year. Both of which are likely to add to the case for the first Fed rate hike to come later in the year rather than in June.
In the Eurozone, the focus will be on whether the interim loan deal with Greece is finalised.
In Japan, January data for household spending, industrial production and the labour market will be watched on Friday for signs that the recovery that commenced last quarter is continuing. January inflation data will also be released.
The flash HSBC China manufacturing PMI (Wednesday) will likely remain softish.
In Australia, December quarter data is expected to show that wages growth (Wednesday) remains at record lows with annual growth of just 2.5%, December quarter construction data (also Wednesday) is likely to be weak with strength in housing offset by weakness in mining related engineering construction and business investment data (Thursday) will be watched for signs of improvement in non-mining investment plans. Private credit data will be released Friday with the main interest being whether housing investor credit is breaching APRA's 10% growth limit.
The Australian December half profit reporting season will wrap up with over 80 major companies reporting including BHP, QBE, Worley Parsons, Qantas and Woolworths.
Outlook for markets
Notwithstanding the risk of a correction – potentially as the Fed eventually moves to raise interest rates - the broad trend in shares is likely to remain up as: valuations, particularly against bonds, are good; economic growth is continuing; and monetary policy is set to remain easy with further easing in Europe, Japan, China and Australia and only a gradual tightening in the US. As such, share markets are likely to see another year of reasonable returns.
Commodity prices have been seeing a bounce from very oversold conditions, with oil in particular looking like it may have built a short term base around $US45/barrel. However, excess supply for many commodities is expected to see them remain in a long term downtrend.
Low bond yields point to soft medium term returns from sovereign bonds, but it’s hard to get too bearish on bonds in a world of too much saving, spare capacity and deflation risk.
Short term gyrations aside, the downtrend in the $A is likely to continue as the $US trends up and reflecting the long term downtrend in commodity prices and Australia’s relatively high cost base. We now expect a fall to around $US0.70, with the risk of an overshoot. However, the $A is likely to be little changed against the Yen and Euro.