Investment markets and key developments over the past week

The past week was messy and volatile in financial markets as Federal Reserve (Fed) worries waxed and waned, the US dollar surged to its highest since 2003, the European Central Bank (ECB) commenced quantitative easing and Chinese economic data was softer than expected. Against these cross currents, US shares fell 0.9% and Australian shares lost 1.4%, but Eurozone shares rose 1.4%, Japanese shares gained 1.5% and Chinese shares rose 4.1%. Bond yields fell particularly in Europe as QE started. Commodity prices generally weakened as the $US rose and this weighed on the $A which fell below $US0.76 at one point. The oil price fell 9% taking West Texas to a new low this year.

While negotiations in Europe with Greece aimed at unlocking funding are dragging on, it’s clear that the uncertainty around Greece is still having no flow on effect to other peripheral countries in the Eurozone. In fact bond yields in Spain, Italy and Portugal have fallen to new record lows – with 10 year yields now at just 1.1% in Italy and Spain and just 1.6% in Portugal. Clearly the start-up of the ECB’s QE program and the better shape peripheral countries find themselves in is having an impact. This also means that Greece’s bargaining power is a lot lower than what Syriza was hoping as the threat of a Grexit ‘ain’t what it used to be.’ Meanwhile, reflecting the flow of better news, ECB President Draghi has reiterated things are “pointing in the right direction”. All of this reinforces our positive view on Eurozone shares.

Major global economic events and implications

US economic data was mixed yet again with another month of soft retail sales but solid labour market indicators and a slight rise in small business optimism. I wouldn’t be too worried about US retail sales as the February figures look weather related and 5% plus growth in real household income growth and high levels of consumer confidence point to a bounce back soon. Meanwhile, producer prices are continuing to deflate.

While Japanese GDP growth in the December quarter was revised down, economic sentiment, machine orders and tertiary activity data were all better than expected.

Chinese economic activity data for the January-February period was soft with industrial production, fixed asset investment, retail sales and imports all weaker than expected. Chinese data at the start of the year should always be treated with some caution due to Lunar New Year distortions and strong export growth will provide an offset for GDP growth. Money supply and lending growth did perk up in February but allowing for New Year distortions and averaging across January and February they were still weaker than seen through last year. Overall the Chinese economy does appear to have started the year on a soft note – probably below the comfort zone of the Chinese Government and this is likely to support the case for more monetary easing. While Chinese CPI inflation rose to 1.4% in February this looks more like an aberration with soft domestic demand and an acceleration in producer price deflation pointing to lower inflation ahead.

Finally, the global monetary easing cycle is continuing with Thailand, Korea, Serbia and Russia cutting rates over the past week. So far this year there has been nearly thirty easing moves by central banks. This all helps add to confidence that deflation will recede as a threat.

Should first home buyers get access to their super to buy a home? Absolutely not. Like first home buyer grants, it will just push up house prices only benefiting existing home owners like me and worsening affordability. Further, it will deny young workers some of the power of compound interest right when it’s most beneficial, and lead to lower retirement savings for them. I can’t see we have to keep having this silly debate!

Australian economic events and implications

Good jobs data but soft confidence readings in Australia. While the February jobs report was a bit better than expected with employment up and unemployment down slightly and ANZ job ads are continuing to rise, the reality is that employment growth is still not strong enough to stop unemployment from continuing to trend up. Labour force underutilisation remains around its highest since 1997 at 14.9% which points to ongoing softness in wages.

Meanwhile, both consumer and business confidence are running at fairly mediocre levels reflecting the poor news flow of late.While the slight fall in housing finance in February is not really a problem, as it followed a strong rise in December, what does remain a concern is that the flow of finance is getting even more skewed towards investors.

The overall impression is that economic growth is continuing at a sub-par pace. This is not a disaster but it continues to highlight the need for lower interest and a lower $A.

Still no investor euphoria in shares. While Australian shares have benefitted from retail buying – mainly of high yield shares – it’s interesting to note that scepticism regarding shares more generally remains high with less than 8% of Australian’s nominating them as the “wisest place for savings” according to the Westpac/Melbourne Institute consumer survey. This is well down from the peak of 34% seen in 2000 suggesting that shares are a long way from the euphoria often seen before major market tops. Bank deposits, paying of debt and real estate (a worry) remain far more popular.

Finally, the renewed collapse in global oil prices over the last week points to a fall back in Australian petrol prices to near $1.10/litre. The circa $1.30/litre we have been seeing lately is way over the top.

What to watch over the next week?

In the US, the focus will be on the Fed’s meeting (Wednesday) where there is a good chance that it will drop the reference to being “patient” in moving to raise interest rates replacing it with comments to the effect that the commencement of the tightening cycle will be dependent on further economic improvement and more confidence that inflation will move back to its 2% target over the medium term. The Fed is getting closer to a rate hike but given the cross currents affecting the US economy June or September remain the most likely timing, with a coin toss between them!

On the data front in the US, expect to see solid readings from the New York and Philadelphia Fed manufacturing conditions indices (Monday and Thursday respectively), a modest gain in industrial production (Monday), gains in the NAHB home builder survey (also Monday) and in housing permits, but a weather affected fall in housing starts (both due Tuesday).

The Bank of Japan meets Tuesday but is unlikely to announce further easing just yet.

In Australia, it will be a quiet week on the data front with focus likely returning to the RBA with the minutes from its last Board meeting (Tuesday) expected to confirm that the RBA retains an easing bias and still sees the $A as being too high. A speech by Governor Stevens on Friday will also be watched for any clues on the interest rate outlook. We continue to expect another rate cut in the next month or so, with a high chance rates could fall below 2% thereafter.

Outlook for markets

Shares are at risk of a further correction with Fed progress towards a rate hike being the main potential trigger. However, 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. Eurozone, Japanese and North Asian shares are likely to outperform.

Commodity prices have been seeing a consolidation after becoming very oversold, 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.