Investment markets and key developments over the past week
Share markets have had another volatile week as worries about China and the US Federal Reserve (Fed) linger, but the major markets saw gains over the week. While expectations regarding the long talked about Fed interest rate hike continue to wax and wane, more stimulus measures and soothing words from China have helped. US shares rose 2.1%, Eurozone shares rose 0.5%, Japanese shares gained 2.7% (helped by talk of corporate tax cuts), Chinese shares rose 1.3% and the Australian share market gained 0.6%. Bond yields rose in the US and Australia but were flat to down in Europe. Oil and gold prices fell but metal prices rose and the Australian dollar had a decent bounce back above US$0.70.
For the next month or so, the going is likely to remain rough for shares with the risk of further falls as worries about the Fed and China linger. From a technical perspective the bounce in most major share markets over the last few weeks has lacked the conviction needed to firmly indicate that the lows have been seen. Concerns about the Fed could be resolved fairly quickly if in the week ahead it indicates that it is aware of the downside risks to global growth and inflation from China and the emerging world and is not going to do anything to exacerbate the threat. However, the problems in the emerging world could take longer to be resolved. These have been highlighted by the downgrading of Brazil’s credit rating to junk status by Standard and Poor’s. What a fall from grace that has been! With Russia also in the dog box we have clearly gone beyond the time when the notion of ‘Brazil, Russia, India and China’ conjured up favourable economic thoughts.
However, beyond the uncertain near-term environment I expect to see the usual seasonal strength into year-end. helped along by much-improved valuations, increasing confidence that China has got its growth under control and investors getting more comfortable that the Fed is not going to do anything to upset US/global economic growth.
Policy stimulus measures in China continue to flow with talk of more fiscal stimulus, including no personal tax on dividends for investors who hold shares for more than a year, and a change in the way the People’s Bank of China (PBOC) will assess bank reserves which should allow banks to run lower excess reserves. Premier Li also indicated that China has no intention of depreciating the renminbi. Consistent with this China’s foreign exchange reserves fell by US$90 billion in August, indicating that the PBOC has sold foreign exchange to defend the renminbi. The decline was less than many had feared though and still leaves foreign exchange reserves at a huge US$3.56 trillion, indicating plenty of scope to defend the currency around current exchange rates.
Major global economic events and implications
US data confirmed that its labour market remains very strong with record job openings, the ratio of job openings to the labour force at its highest since 2001, the ratio of unemployed to job openings at the lowest since 2001 and another fall in jobless claims. Taken on its own the strength in the US labour market clearly provides a strong case for a Fed rate hike. Against this, the pressures on US inflation remain down with import prices over the year to August down 11%, or 3% if fuel is excluded. Producer price inflation also remains weak. The combination of falling commodity prices and the strengthening US dollar points to the risks remaining on the downside for US inflation, which is contrary to what the Fed has been looking for and argues against a rate hike. A fall in consumer sentiment also indicates that the recent turmoil in share markets has affected consumer confidence in the US.
Eurozone June quarter gross domestic product (GDP) growth was revised up to 0.4% quarter-on-quarter (qoq) from 0.3%. Business conditions purchasing managers’ indices and confidence levels point to a further acceleration going forward. The combination of very attractive valuations, improving growth indicators and European Central Bank monetary stimulus argue strongly in favour of being overweight Eurozone shares.
Japanese June quarter GDP was surprisingly also revised up but only from -0.4% qoq to -0.3%, but this was mainly due to inventories. Weak machine orders and economic sentiment indexes suggest growth remains weak.
Chinese economic data for August improved a bit on balance. Imports were much weaker than expected and fixed asset investment slowed, but growth in retail sales, industrial production and exports all improved as did growth in money supply and credit suggesting that the monetary easing seen so far is starting to impact. While it’s dangerous to read too much into monthly data, the slightly better tone seen in August suggests that Chinese growth may be starting to stabilise or perhaps improve a bit. Inflation rose to 2% year-on-year (yoy) in August but this reflected higher pork prices with non-food inflation remaining just 1.1% and producer prices deflating by 5.9%, so there is nothing to stop further needed monetary easing here.
Australian economic events and implications
Australian economic data was messy. Jobs data for August was yet again surprisingly solid with employment up 2% on a year ago and unemployment falling back to 6.2% leaving in place a flat trend. July housing finance was solid but with continued indications that finance is at last rebalancing back towards owner occupiers. Further softness is likely in investor finance ahead as the real tightening in bank lending conditions to investors only kicked in late in July. Confidence readings were decidedly on the soft side though with business confidence falling in August even though conditions were solid and consumer confidence falling back to the low end of the range it’s been in for the last 18 months. With continued sub-par economic growth and confidence it’s likely that jobs growth will slow a bit in the months ahead resulting in the unemployment rate resuming a gentle rising trend.
What to watch over the next week?
In the US, it will be a big week for investors with the long-awaited Fed meeting ending on Thursday with a decision on whether to hike interest rates for the first time since 2006. This will be a tough meeting for the Fed. With the US jobs market so strong, with the Fed having talked about a rate hike for so long and to simply end the guessing game, there is powerful case to just get it over with and announce a hike and then manage market nervousness with reassurances that further moves will be gradual and dependent on continued economic strength and confidence that US inflation will pick up. For shares this could prove to be a case of sell on the rumour and buy on the fact, although this is not assured as the market is not anticipating a hike at this meeting. However, it’s more likely (with a 70% probability) that the Fed will move to delay lift off on the grounds that global uncertainties are too high and weakness in commodity prices and the stronger US dollar have added to downside risks to the US inflation outlook. Delaying the first hike will have the problem of just extending market uncertainty out to the Fed’s October meeting, but it may be taken well to the extent that it signals that the Fed is aware of risks emanating from China and the emerging world and that it’s not going to do anything that threatens global growth when inflation is still low. At the end of the day, it’s worth noting that even if the Fed does hike it will just take the Fed’s interest rate band from 0-0.25% to 0.25-0.5% which may not mean much change in the effective Fed Funds rate and it will still be very low.
On the data front in the US, expect continued reasonable growth in retail sales, a slight pull-back in industrial production (both Tuesday), a 0.1% yoy fall in headline inflation for August and the National Association of Home Builders’ conditions index remaining solid (both Wednesday) and a fall in housing starts but stronger permits (Thursday). The New York and Philadelphia Federal Reserve regional manufacturing conditions surveys will also be released.
In Japan, the Bank of Japan meets Tuesday and while it’s not our base case there is some chance that it will add to its quantitative easing stimulus program given recent weakness in Japanese growth and inflation and Chinese uncertainties.
In Australia, the minutes from the Reserve Bank’s (RBA) last Board meeting (Tuesday) are unlikely to show anything new but RBA Governor Glenn Steven’s appearance before the House of Representatives Economics Committee (Friday) will be watched closely for any clues on the interest rate outlook. Data for auto sales (Tuesday) and the Westpac leading index (Thursday) will also be released.
Outlook for markets
Share markets remain vulnerable to more downside in the short term. as we are still in a seasonally-weak period of the year for shares, uncertainties regarding China and the emerging world are likely to linger and uncertainty still remains around the Fed.
But beyond near-term uncertainties we see the cyclical bull market in shares as likely to resume: share market valuations against bonds are now even better; monetary conditions are set to remain easy with the latest global growth scare likely to drive further global monetary easing in some countries; this in turn should help see the global economic recovery continue; and finally investor sentiment has deteriorated rapidly into the sort of pessimism that provides great buying opportunities. As such, despite the recent set-back and nearterm uncertainties, developed country share markets are likely to remain in a broad rising trend. This includes the Australian share market.
Low bond yields point to soft medium-term returns from bonds, although the recent share market downswing which saw bonds rally provides a reminder that government bonds remain a great portfolio diversifier.
In the short term there is a good chance of a further bounce in the Australian dollar if the Fed proves to be dovish in the week ahead. However, the broad trend in the Australian dollar is likely to remain down as the Fed is likely to retain a tightening bias whereas the RBA is likely to cut rates again and the trend in commodity prices remains down. The Australian dollar is expected to fall to US$0.60 in the next year or so, with the risk that it will go even lower.