Investment markets and key developments over the past week
Most share markets rose over the last week helped by a combination of good news on Greece, benign comments from Fed Chair Yellen and okay economic data and profit results. US shares lost 0.3%, but Eurozone shares rose 2.7%, Japanese shares rose 2.5%, Chinese shares gained 2% and Australian shares rose 0.8%. This capped off a strong month. Bond yields generally fell, but particularly so in parts of Europe ahead of ECB QE. Spanish 10 year bond yields are now just 1.25%. Commodity prices were mixed and the $A fell slightly.
Good news on Greece as it received approval for a four month extension of its current loan program. The negotiation of a longer term program will have its ups and downs but ultimately see agreement reached around allowing Greece to run a lower budget surplus after interest payments.
Investors should allow that the constant commentary of doom and gloom regarding the Eurozone is misplaced and Europe is on the mend. ECB President Draghi rightly reinforced the latter with his comment that the "outlook [for Europe] is more positive that it was a few months ago". This is evident in Greek risks subsiding again, rising bank lending and rising confidence all helped by ECB monetary stimulus, the lower Euro and lower oil prices. This is important for investors. Eurozone shares are star performers this year, up 14% already, and being unambiguously undervalued and likely to benefit from easy money, the lowered Euro and stronger growth are likely to see continued outperformance going forward.
The Australian December half profit reporting season is now complete and while there have been lots of hits and misses, overall results have been better than feared. While we have seen the usual slippage in the quality of results towards the end of the reporting period, 55% of results have beaten expectations against a norm of 45%, 66% have seen profits rise from a year ago, 52% have seen their share price outperform the day results were released and 62% have increased their dividends. Key themes have been ongoing tough times for resources and mining services companies, reasonable growth for the rest of the market helped by ongoing cost control, and solid growth in dividends. Earnings expectations for the current financial year are little changed. Sure resources profits are falling around 20%, but this is a bit less negative than earlier expected. Meanwhile, banks are seeing profit growth around 8% and industrials around 10%.
Major global economic events and implications
US data was again a mixed bag. Housing data was messy with weaker existing home sales, but rising new and pending home sales and a continued fall in the mortgage delinquency rate. Meanwhile, December quarter GDP growth was revised down (albeit only due to lower inventories) and consumer confidence fell but the services conditions PMI gained to strong levels and durable goods orders rose. The overall impression remains that the US economy is strong but it’s not taking off. Meanwhile, Fed Chair Yellen provided a balanced view regarding monetary policy. The Fed may be getting closer to replacing its "patient" comment regarding the first rate hike, but looks like replacing it with comments to the effect that the commencement of the tightening cycle will be dependent on further economic improvement and confidence that inflation will move back to its 2% target over the medium term. In terms of inflation, January saw a slight dip into deflation but this was due to lower fuel prices with core inflation unchanged at 1.6%. A US rate hike is still on the way and could come in June but the risks are still skewed to a bit later - maybe September.
Eurozone data was good with rising confidence and lending.
Japanese data for January saw weak household spending and a slight rise in unemployment but strong industrial production.
China saw some good news with the flash February HSBC business conditions PMI rising to 50.1 from 49.7. Hard to get too excited though as it’s been wiggling around the 48 to 50 level for several years now so really looks like noise.
Australian economic events and implications
Australian data was on balance a bit depressing. Sure skilled job vacancies gained nicely in January, credit growth is continuing to edge up and solidly rising residential construction is offsetting a slump in non-dwelling building and engineering activity, but the business investment outlook has deteriorated and wages growth has fallen to a new record low. In terms of capex, December quarter data showed another fall driven by the mining sector. But the really bad news was intentions data pointing to a roughly 8% fall this financial year and a 12 to 16% fall in 2016. While the ongoing slump is largely being driven by the mining sector where investment is falling at around 20% pa as the mining investment boom continues to unwind, the disappointment next financial year is that the nascent improvement in investment by other selected industries looks to be fading. Clearly the fall back in business confidence of late has taken its toll. The weakness in the capex outlook against a backdrop of low confidence, record low wages growth, a rising trend in unemployment and a still too high $A points to the need for further RBA rate cuts.
However, there is no reason to get too depressed as there are several positives flowing through the economy including: lower rates, lower petrol prices and the lower $A. All of which should help demand in the economy and over time help turn around non-mining capex. Comments by BlueScope CEO, Paul O’Malley are instructive: “As the Aussie dollar gets into the 70s we get competitive, and with a year or two of that under your belt, you start to get the confidence to invest.” But the RBA does need to do its part and make sure the $A stays down and preferably falls further. This will need more rate cuts.
What to watch over the next week?
In the US, expect the February ISM manufacturing conditions index (Monday) and non-manufacturing conditions index (Wednesday) to hold around reasonably solid levels and payroll employment (Friday) to show continued strength with 250,000 new jobs helping to push the unemployment rate down to 5.6%.
The ECB (Thursday) is unlikely to make any further changes to monetary policy having just announced a significant quantitative easing program in January. ECB February inflation data (Monday) will likely show continued deflation driven by the fall in fuel prices.
Chinese trade data (March 8) is likely to show a bit of an improvement after Lunar New Year holiday distortions contributed to weakness in both exports and imports in January.
In Australia, the RBA should, and most likely will, cut interest rates again by another 0.25% on Tuesday to ensure maximum impact from its February cut in boosting confidence and spending growth and in maintaining downwards pressure on the $A. The weakness in the business investment outlook has only added to the urgency to cut interest rates again. While surging Sydney property prices are a concern this should really be dealt with by macro prudential means, particularly with property price growth only modest in other cities. While it’s another close call, on balance the RBA will cut again on Tuesday.
On the data front, December quarter GDP growth (Wednesday) is expected to show the economy continuing to expand at a sub trend pace with weak investment but strength in consumer spending, dwelling construction and net exports. GDP growth is expected to be around 0.6% quarter on quarter or 2.5% year on year. Meanwhile, expect to see further gains in February home prices (Monday) helped by the latest rate cut, a modest rise in building approvals (Tuesday) and a 0.4% gain in January retail sales. Data for new home sales, trade and the business conditions PMIs will also be released.
Outlook for markets
Notwithstanding the risk of a correction after recent strong gains, 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.
Thanks to investor demand for yield, a stabilisation in commodity prices helping resources stocks and some reasonable profit results the Australian share market is looking like it will soon breach the 6000 level on the ASX 200.
Commodity prices have been seeing a bounce from very oversold conditions, with oil looking like it may have built a short term base around $US45/barrel. However, excess supply 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, the RBA continues to cut rates and reflecting the long term downtrend in commodity prices and Australia’s high cost base. We expect a fall to $US0.70 this year, with the risk of an overshoot. However, the $A is likely to be little changed against the Yen and Euro.