Investment markets and key developments over the past week
It’s been another volatile week in financial markets with most share markets dragged lower as global growth worries continue, highlighted by more weak Chinese data, sharp falls in some emerging market currencies, a miss by Caterpillar and ongoing uncertainty regarding the Fed. Australian shares retested their late August lows and European shares briefly slipped below them, not helped by VW, refugees and uncertainty regarding the Catalonian election. For the week US and European shares fell 1.4%, Japanese shares lost 1%, Chinese shares fell 0.2% and Australian shares lost 2.5%. Commodities have held up a bit better but this didn't stop the $A from falling back to around $US0.70. Bond yields were mixed but generally little changed.
Fed Chair Janet Yellen indicated the Fed still expects to tighten this year – which was the message from last week’s Fed meeting anyway - but left plenty of wiggle room in that "surprises" may delay this with ongoing reference to "global economic and financial developments” and talk of gradual tightening. While there has been much criticism lately of the Fed (mostly sour grapes from those who bet wrong I think), they are only responding to the same information and risks everyone else sees. Maybe we should turn down the noise on all the over-analysis of the Fed. Meanwhile, other central banks are still easing – Norway and Taiwan being the most recent.
It’s still too early to say that the lows in share markets have been seen. The volatility and consolidation we have seen in share markets since late August could be a sign of base building but it could also just be a pause before another dip to new lows. This is particularly so, given that worries about global growth and the Fed remain and concerns about a US Government shutdown might start to impact. September is historically the worst month of the year for US shares - and the US share market invariably sets the direction for other markets.
However, beyond near term uncertainties we see the cyclical bull market in shares as likely to resume. Shares are getting even cheaper relative to bonds; monetary conditions are set to remain easy with the latest global growth scare already driving further easing and keeping the Fed cautious. This in turn should help see the global economic recovery continue; and finally investor sentiment is around the levels of pessimism that provides great buying opportunities. October is often seen as a "bear killer" month, i.e. a month where share market falls finally bottom out giving way to seasonal strength into year-end. It’s likely we will see something similar this year. The key for investors is not to be thrown off well thought out long term investment strategies and to recognise the opportunities that share market falls provide, e.g. shares are now a lot cheaper than they were around April and May and yet are still paying the same (or higher) dividends.
The decision by the Speaker of the US House of Representatives, John Boehner, to retire in October highlights the tensions amongst House Republican Party representatives regarding agreeing to fund US Government spending for the new fiscal year that begins on October 1.The risk is that the desire by a group of about 30 extreme Republicans to tie budget funding to the defunding of planned parenthood could lead to the usual brinkmanship and another government shutdown. The GOP leadership knows that it will end up getting blamed by the American people for any shutdown, and this is something they are keen to avoid given next year's elections. So our base case is a last minute deal but no shutdown, with Speaker Boehner's resignation enabling him to pass a continuing resolution next week that continues Government funding out to December. However, this will then see the budget funding issue get rolled into the need to again raise the debt ceiling as the latter will be reached again in late November/early December. Again it’s likely that the GOP leadership, then with a new speaker, will act to avoid a shutdown or debt default, but the risk of brinkmanship is certainly there so the issue is worth keeping an eye on. It’s also worth noting though that the two week US Government shutdown/debt ceiling brinkmanship last seen in October 2013 had no discernible negative impact on the US economy at the time. December quarter 2013 GDP growth of 3.8% annualised was the strongest quarter for the whole year.
The European refugee crisis is unlikely to have major negative economic implications, but will generate lots of noise (just like refugee boats coming to Australia). The past week saw the European Union vote to distribute 120,000 refugees across its membership but with some fearing that the vote against such a move by four countries reflected dangerous disunity and that this and the imposition of border restrictions threatens the EU. This is all a bit too negative as a big majority of EU countries supported the refugee plan and temporary border restrictions have always been allowed (and don't appear to prevent the free movement of labour that helps underpin the EU). The migrant crisis is a big one but needs to be put in perspective against the EU's 500 million population. In the short term it may provide a boost to anti-establishment parties but I suspect it will result in Europe becoming a lot more motivated to put an end to the war in Syria (which will probably involve siding with Russia in supporting a solution involving President Bashar al-Assad) as this is where the bulk of the refugees are coming from. It is also likely to involve more government spending (less austerity) and ultimately "more Europe, not less" (as it comes together to help secure its external borders).
While Eurozone shares have been hit hard by worries about global growth, the VW scandal, refugees, the Catalonian election, etc. - down 19% from their April high, making new lows in the last week, they look very attractive for when the dust settles. Our valuation indicators show them to be very cheap, the ECB remains very supportive and economic indicators like PMIs and business surveys remain solid.
Major global economic events and implications
US economic data was again mixed. Existing home sales fell and new home sales surged. While regional manufacturing conditions indices point to weakness, the national Markit manufacturing PMI was unchanged in September at a solid level of 53. While durable goods orders fell in August, core capital goods orders are reasonable. June quarter GDP growth was revised up to 3.9% annualised, but is likely to slow again in the current quarter due to an inventory detraction. The US growth story remains one of solid but unspectacular growth leaving plenty of scope for the Fed to take its time.
Eurozone business conditions PMIs slipped in September, but given the concerns about global growth the fall was modest and leaves them well up last on year’s lows and still solid. Meanwhile, ECB President Mario Draghi remains dovish indicating that more time is needed to assess the emerging market slowdown and in particular that the ECB "would not hesitate to act if downside risks to inflation materialise".
Japan’s manufacturing PMI softened to a still ok 50.9 in September and Japanese inflation rose to 0.8% yoy on a core basis in August, but is still well below the Bank of Japan's (BoJ) 2% target. The case for more BoJ easing remains strong.
The flash Chinese manufacturing PMI fell further in September. While it could be distorted by the early September Beijing area factory shutdowns, it nevertheless highlights that small and medium sized manufacturers are still struggling.
Australian economic events and implications
In Australia, the main development was a strong 9% bounce in consumer sentiment according to ANZ-Roy Morgan index, with the elevation of Malcolm Turnbull to PM having the predictable favourable impact. This is good news but we have seen several bounces before. For it to be sustained, the government needs to avoid a return to the accidents that seem to have characterised Australian governments since 2010 and put in place a positive economic reform agenda. Meanwhile, ABS data confirmed that home price growth remained very strong in the June quarter but this was mainly driven by Sydney and Melbourne and is likely to slow as APRA measures bite. Slowing population growth to 1.4% over the year to the March quarter from 1.8% yoy three years ago, mainly due to lower immigration, will also take pressure off house price growth. It’s also one reason along with lower productivity growth why potential growth in the economy has slipped from around 3-3.25% pa to around 2.75% pa. The RBA is still likely to have to cut interest rates again.
What to watch over the next week?
In the US the focus will no doubt be on whether Congress passes Budget funding to avoid a Government shutdown when the new fiscal year starts on Thursday. Our base case is that it will, but there is often a bit of argy bargy over these things. On the data front, the focus is likely to be on the September manufacturing conditions ISM (Thursday) which is expected remain around a solid but moderate 51 and jobs data (Friday) which is expected to show solid jobs growth of 200,000, flat unemployment of 5.1% and a lift in wages growth to around 2.4% yoy. Meanwhile, the core private consumption deflator is expected to show September inflation of 1.2% yoy which is well below target, existing home sales are likely to show a modest gain (both Monday) and consumer confidence (Tuesday) is expected to fall back.
In the Eurozone, the outcome of Sunday's Catalonian election may generate interest with pro-independence parties likely to win, but with polls showing a majority of Catalonians preferring to stay in Spain this issue may not go anywhere fast. Expect economic confidence indicators (Tuesday) to fall back a bit but remain solid and September inflation (Wednesday) to remain well below target.
Japanese industrial production (Tuesday) is expected to show a gain and labour market data (Friday) is likely to remain solid.
China's official manufacturing conditions PMI (Thursday) will be watched to see whether it followed the Caixin flash PMI lower in September.
In Australia, expect credit data (Wednesday) to show ongoing modest growth but with evidence of a slowing in lending to property investors, building approvals (also Wednesday) to fall back after a strong July, the Core Logic-RP Data home price indicators (Thursday) to show further signs of slowing in home price growth and retail sales (Friday) to show a modest gain.
Outlook for markets
It’s still too early to say that we won’t see a further leg down in shares with worries remaining around global growth, the Fed, the US budget, etc. But beyond near term uncertainties we see the cyclical bull market in shares as likely to resume: shares are cheap relative to bonds; monetary conditions are set to remain easy; this in turn should help see the global economic recovery continue; and finally investor sentiment is around the levels of pessimism that provides great buying opportunities. As such, despite near term uncertainties, developed country share markets are likely to resume 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.
The recent bounce in the $A proved short lived, only reaching $US0.7280. In the short term, the $A will take its lead largely from ongoing swings in global investors’ risk tolerance, but the broad trend in the $A is likely to remain down as the Fed is still likely to raise interest rates sometime in the next six months whereas the RBA is likely to cut rates again and the trend in commodity prices remains down. The $A is expected to fall to $US0.60 in the next year or so, with the risk that it will go even lower.