Investment markets and key developments over the past week
Shares had a good week helped by reasonable economic data, better than feared US earnings, some slightly better news on Greece and further monetary easing in China. US shares rose 1.8%, Eurozone shares gained 1.2%, Japanese shares gained 1.9%, Chinese shares rose 2.5% and Australian shares rose 0.9%. While gold and metal prices fell, oil and iron ore prices rose with the latter helped by news that BHP will slow its iron ore expansion. Bond yields generally rose, except in peripheral Eurozone countries where yields fell. The Australian dollar rose slightly as the $US fell.
The tech heavy Nasdaq finally reached a record high but it took 15 years to surpass its tech boom peak, highlighting the importance of starting point valuations in driving long term returns. And for those worried about a return to the tech bubble, the price earnings multiple on Nasdaq at around 30 times is a fraction of the 190 times seen at the March 2000 tech boom peak levels.
Chinese shares continue to excel despite soft data and tougher margin restrictions. A move by the Chinese security regulator to tighten restrictions around leveraged share trading via trusts and allowing more short-selling had many worried about the Chinese share market a week ago. Continuing soft data are also a drag. However, it’s clear that the regulator is trying to promote a healthy share market and not trying to derail it. More importantly any negative effect was more than offset by an aggressive move by the PBOC to cut bank required reserve ratios. With the reserve ratio remaining high historically and monetary conditions remaining too tight several more reserve ratio and benchmark interest rate cuts are likely. Expect the later to fall to 4% from 5.35% currently. For Chinese shares we continue to see more upside, albeit a correction would be healthy. Chinese H shares remain very cheap, Chinese mainland shares remain cheap historically and Chinese institutional funds have relatively low exposures to shares and are likely to want to boost them which could ensure that any correction will be shallow.
The Greek mess is dragging on but is still unlikely to drive a return to the Eurozone crisis. While the Eurozone finance ministers’ meeting on Friday did not announce a break through on Greece none was expected and at least there are some signs of progress. Agreement on a funding release though looks like it will drag into May and possibly June. Meanwhile, the risk of a “Graccident” (Greece defaulting on either debt or social security payments) sometime in May is clearly on the rise. This will not mean that a “Grexit” (Greek exit from the Euro) will be inevitable and in fact it could help focus the mind of the inexperienced and unstable Greek Government on the tenuous situation they are in forcing them into an agreement. But it could result in a bit of market volatility. The good news is that the rest of Europe remains far stronger than it was a few years ago with significant budget repair and economic reforms in peripheral countries and the ECB's quantitative easing program. So a Graccident or even a Grexit is unlikely to derail the Eurozone economic recovery, but news around Greece has the potential to cause a few bumps in the months ahead.
More RBA easing is likely on the way but uncertainty remains around the timing. The message from the minutes from the RBA's last meeting was if anything a little more dovish, particularly in regards to the weaker outlook for business investment and exports. A speech by Governor Glenn Steven's was clearly dovish highlighting that the question of another rate cut has to be on the table, that the $A remains too strong and that commentary on house prices remains too focussed on Sydney. Meanwhile, March quarter inflation data was clearly benign and leaves plenty of scope for the RBA to cut again, but it was not low enough to make a cut in May a slam dunk. We think another cut is justified on the back of the weak investment outlook, the greater than expected fall in commodity prices and the upside risks to the $A at a time when it remains too high, but a May move is a very close call.
Major global economic events and implications
US economic data was mixed again. Data for existing home sales and home prices rose more than expected, weekly mortgage applications are starting to trend up again and jobless claims remained about as low as they ever get. However, underlying durable goods orders were weak, new home sales fell more than expected in March and the Markit manufacturing conditions PMI surprisingly fell, although it remains at a relatively solid level.
There is a danger in reading too much into weak US March quarter data though as the March quarter seems to be soft every year. Over the last twenty years, average annualised GDP growth has been 3% in December quarters, 1% in March quarters and 3% in June quarters suggesting that there may be something wrong with seasonal adjustment factors.
Meanwhile, first quarter earnings results in the US are not proving to be quite as weak as feared. Of the 201 S&P 500 companies to have reported to date, 77% have beaten earnings expectations and earnings growth expectations for the quarter have improved from -5.6% year on year a month ago to now being -1.6% year on year. The strong $US is still having a negative impact though, a point which is not being lost on the US Federal Reserve (the Fed).
Eurozone business conditions PMIs and consumer confidence unexpectedly fell in April. However, this needs to be seen in context as it followed several months of good gains since last year and the PMIs remain at levels consistent with improved economic growth and the German IFO index rose to a 10 month high in April. So there is no reason to get too concerned.
Japanese data was mixed with a weak leading index for February and another fall in its manufacturing conditions PMI in April, but a much better than expected trade surplus and stronger tertiary sector conditions.
The HSBC China flash PMI was softer than expected in April. It remains in the same 48-52 range it’s been in for the last four years, but nevertheless supports the case for more policy easing in China.
Australian economic events and implications
March quarter inflation was low at 1.3% year on year and 2.4% year on year for underlying inflation. Interestingly, "government affected" areas like health, education and alcohol and tobacco continue to see solid increases but areas indicative of private demand like clothing and household equipment remain weak reflective of soft underlying economic conditions. Meanwhile, skilled job vacancies rose modestly in March and are up 7.7% year on year but are down 5.6% year on year in Western Australia as the two speed economy continues to go in reverse.
What to watch over the next week?
In the US, expect the Fed (Wednesday) to remain relatively dovish and in no hurry to raise interest rates. The Fed and Chair Yellen have already signalled that no hike is likely in April so the focus will be on any signals in the post meeting statement as to how close a rate hike is. While some Fed officials still lean towards a June move, the majority are seeing September or later as the timeframe for a lift off. Sure recent inflation readings suggest it may be bottoming but the mixed run of economic data combined with the dampening impact of the rise in the $US over the last year indicate that there is no reason for the Fed to hurry. In fact a move as early as June could be very damaging for US and hence global growth. My base case for Fed lift off is September but the risks are skewed later.
March quarter US GDP growth of around 1% annualised (Wednesday), albeit partly weather related, is likely to highlight why the Fed is in no hurry. In terms of other data expect a further rise in home prices (Tuesday), a slight gain for consumer confidence, but a slight fall in pending home sales (both Wednesday), a benign reading for the core consumer price deflator inflation measure, a further increase in employment cost growth (both Thursday) and a slight improvement in the ISM manufacturing conditions index (Friday).
In Europe, the focus will be on progress towards an agreement regarding Greek funding with the risk of a "Graccident" (a payment default) rising as we go into May. Eurozone inflation (Thursday) is likely to rise, with energy prices confirming that deflation threats are receding, but remain well below target. Expect a slight fall in confidence indicators (Wednesday) consistent with the slight fall in April PMIs already released.
The Bank of Japan (Thursday) is expected to leave monetary policy unchanged but pressure for further easing remains. On the data front expect to see a rebound in industrial production and okay labour market data, but mixed readings for household spending and inflation excluding the impact of the sales tax hike running well below target (all Friday).
China's official manufacturing conditions PMI (Friday) may soften a bit just below the 50 level, consistent with the HSBC flash PMI already released.
In Australia, a speech by RBA Governor Glenn Steven's (Tuesday) will be watched for any clues regarding interest rates following the release of March quarter inflation data. On the data front, expect another moderate gain in March private credit data (Thursday), but the focus will be on whether housing investor credit continues to show signs of reduced momentum. Meanwhile, expect another mainly Sydney driven gain in RP Data home prices for March, continued weakness in the AIG's manufacturing conditions PMI and benign producer prices for the March quarter (all Friday).
Outlook for markets
We remain of the view that shares are likely to see a decent correction at some point this year. A Greek default is a potential near term driver and anticipation of the Fed’s first interest rate hike could be a potential trigger later in the year. However, the 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 US and Australian shares.
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.
The trend in the $A is likely to remain down as the Fed is still likely to raise rates this year whereas the RBA remains on track to cut and the long term trend in commodity prices remains down. We expect a fall to $US0.70 this year, and a probable overshoot into the $US0.60s in the years ahead.