Investment markets and key developments over the past week

The Greek population has voted NO in the referendum on agreeing to proposed austerity measures. Greece may now have to confront the prospect of Europe withdrawing financial support, which could result in a herculean task to address of stabilising its banking system, exiting the Euro and introducing a new currency. As with Greek mythology, there are few prosperous endings when debt and politics are involved.

Greece’s crisis has dramatically intensified with political squabbling, bank closures and a missed debt payment. The Greek Government called a referendum for July 5th to decide whether to accept the conditions required by the European Commission, European Central Bank and International Monetary Fund (IMF) as creditors. Essentially Greece wants their creditors to reduce the debt obligations and moderate the various budget, labour market and pension targets required. The Greek Prime Minister has accused Europe of using “blackmail” and advocated a NO vote to these bailout conditions at the referendum.

Greek banks have been closed since Monday June 29th. Given that Greek banks were heavily dependent on the European Central Bank (ECB) providing cash given falling deposits, the ECB decision to cap funding at Euro 89 billion has seen Greek banks close to avoid a cash crisis (also known as a “bank run”).

The Greek government has also missed a debt repayment to the IMF on June 30th. This effectively constitutes a default, although the IMF has diplomatically termed this debt as in “arrears”.

The US recorded solid jobs growth in June of +223,000, indicating that US economic activity continues to strengthen after a cold start to the year. The unemployment rate has fallen to 5.3%, the lowest since April 2008. This jobs data suggests the Federal Reserve (FED) is likely to start raising interest rates in September.

Australian economic data has been a mixture of strong and weak. May’s retail spending recorded only a modest monthly gain of +0.3% after April’s marginal -0.1% decline. However residential building approvals for May have responded favourably to the RBA’s interest rate cut. Total Housing approvals rose by +2.4% in May, with annual gains now registering at a robust +17.6%. The strength has been concentrated in the volatile private apartment sector where the annual gain is an astonishing +46%.

Global Shares have fallen over the past week. US shares (S&P 500 Index) have declined by -1.2%. Both Germany’s DAX (-3.4 %) and the broader European Eurostoxx Index (-4.4%) have recorded sharp declines given concerns over Greece. Japan’s TOPIX has fallen by -1%. China’s Shanghai Composite continues its roller coaster ride having fallen sharply by -9.6 % for the week.

Australia’s ASX 200 has proven more resilient with a modest -0.2 % fall for the week. Australian shares benefitted from takeover activity (Asciano A$9 billion takeover offer from Brookvine Infrastructure).

Major global economic events and implications

European data is generally positive despite Greece’s woes. European bank lending recorded positive annual growth at 0.5% in May. So Europe financial system is more supportive of growth than was the case in the 2012 crisis when bank lending was contracting while Italian and Spanish bond yields were under siege. European PMI manufacturing surveys for June are also more encouraging with the survey at a 14 month high. However European unemployment still remains too high at 11.1% in May while annual inflation is minimal at 0.2% in June.

US activity data is solid and suggestive of forthcoming US interest rate rises. US house prices recorded annual gains on circa +5% in the year to April. The ISM manufacturing survey rose to a 5 month high which indicates that US economic activity is rebounding after the harsh winter weather at the stat of the year.

China’s official PMI survey was stable in June while the “Non-Manufacturing” survey showed a healthy gain to a 3 month high. This suggests that Chinese economic growth is holding up at close to the 7% target for 2015 set by the Chinese government. Essentially the downside risks from China’s weak property market and high local government and business debt is being mitigated by lower interest rates this year.

Japan’s Tankan survey shows an encouraging gain in business confidence in the June quarter. This is supportive of Japanese shares and the mild economic recovery.

Australian economic events and implications

Australia trade deficit remains under pressure given the weakness in commodity exports. April recorded a record monthly deficit of A$-4.1 billion with only a modest improvement in May to a deficit of A$-2.8 billion.

The Federal government’s Department of Industry (DoI) released their updated commodity forecasts for the June quarter . DoI estimates that Australia’s commodity export earnings should decline “by 11% to $174 billion” in 2014-15 given “overcapacity” and “slowing consumption growth” in the Global economy. The current financial year 2015-16 forecast is to see export earnings rise by 2% to $178 billion. For Iron Ore, which is Australia’s most valuable commodity export, prices are expected to average only US$53 per ton in 2015-16 (prior forecast was for US$69 per ton) while iron ore export volumes should rise by 8.4%.

 

What to watch over the next week?

In the US, the main focus will be on June manufacturing and jobs data. Expect to see a 1% gain in existing home sales (Monday), further gains in home prices and consumer confidence (Tuesday), a slight gain in the ISM manufacturing conditions index (Wednesday) to 53, another solid 225,000 gain in June payrolls and a fall in unemployment to 5.4% (both Friday). Perhaps the main focus will be on whether the average hourly earnings data shows another uptick in wages growth.

In the Eurozone, expect to see modest gains in economic confidence (Monday) consistent with gains already reported in business conditions PMIs for June. June data for inflation (Wednesday) and retail sales (Friday) will also be released.

In Japan, expect a slight fall back in May industrial production (Monday) and the Tankan business survey (Wednesday) to show a further improvement.

China’s manufacturing conditions PMI for June (Wednesday) will likely show a modest gain reflecting support from the monetary easing.

In Australia, expect to see further strength in new home sales and continued modest growth in credit (Tuesday), a rebound in home prices in June after a weak May and a 1% gain in building approvals (both Wednesday), a sharp improvement in the May trade deficit (Thursday) after the partly weather related blowout seen in April and a slight rise in May retail sales (Friday). On the credit front the main interest will be in whether the growth in lending to property investors slows below APRA’s 10% target.

Outlook for markets

Much depends on Greece in the short term with a no vote likely leading to lead to more near-term weakness. Beyond this though, the combination of seasonal weakness and uncertainties around bond yields and the Fed are likely to make for continued volatility in the short term. Looking beyond near-term risks, the conditions for an end to the cyclical bull market in shares are still not in place: valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to see another year of reasonable returns, despite current uncertainties. It’s worth noting that we have seen similar bouts of uncertainty at some stage through most of the last few years, so in a big picture sense it’s nothing new.

Still low bond yields point to soft medium-term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving & spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance that the RBA will cut again and the long term trend in commodity prices remains down. We expect a fall to US$0.70 by year end, and a probable overshoot into the US$0.60s in the years ahead.