Investment markets and key developments over the past week
While shares had a rough patch mid-week, they recovered into the end of the week helped by better US earnings reports and some positive signs out of China. Although Australian shares ended down 0.2% for the week, US shares rose 0.9%, Eurozone shares gained 0.1%, Japanese shares rose 0.8% and Chinese shares rose 6.5%. In fact, the Chinese share market is now up 16% from its late-August low. While shares did well, commodities were soft and bond yields fell as inflation remains (mostly) missing in action. The Australian dollar fell slightly.
After the strong gains from the September low some volatility was to be expected and we have seen a bit of that over the last week. The share market recovery won’t go in a straight line, but with China risks receding, the US Federal Reserve (Fed) showing that it is keen to avoid a policy mistake in raising interest rates prematurely and shares cheap versus bonds the trend is likely to remain up as we go through the seasonally-strong period into year-end.
Rising mortgage rates add to pressure on the Reserve Bank of Australia (RBA) to cut the official cash rate again. Westpac’s move to increase its variable mortgage rates next month by 0.2% for owner-occupiers and investors is not particularly surprising as it flows from the rise in the cost of funding that will result from higher capital requirements being imposed on the banks by the Australian Prudential Regulation Authority (APRA). The other big banks are likely to follow, although they may wait to see what the RBA does next month. With economic growth stuck around 2% and the mining investment downturn only about half way through, the last thing the economy needs now is a rate hike for the 30-40% of households who have a mortgage given the threat it will pose to consumer spending. The best way to avoid this is for the RBA to cut the official cash rate in order to offset the higher funding costs the banks now face. This may mean that there is only around a 0.05% pass through to mortgage holders from the banks (depending on what other banks choose to do) but it’s better than a rate hike. As such, a November (Melbourne Cup Day) rate cut is looking likely. If not in November, then early next year.
A watershed moment for the Sydney and Melbourne property markets. Slowing auction clearance rates, slowing lending to property investors, more mainstream talk of potential property price falls ahead and now Westpac’s move to hike rates are all piling on the bad news for the hot property markets of Sydney and Melbourne. I don’t see prices starting to fall until around 2017, but it’s looking increasingly clear that the property cycle in Sydney and Melbourne is starting to turn down after a couple of years of very strong gains. Other Australian cities were already cool, but risk also being affected by talk of mortgage rate hikes, unless it’s quickly offset by the RBA.
Major global economic events and implications
US economic data was a bit disappointing over the past week . On the positive side, jobless claims fell, consumer sentiment rose, small business optimism improved slightly and the Fed’s Beige Book referred to “continued modest expansion”. But against this, retail sales and industrial production were weaker than expected, New York and Philadelphia regional manufacturing surveys were weak and the job openings rate declined. Inflation data was mixed with producer price inflation weaker than expected and the consumer price index flat over the year to September, but core inflation was a bit stronger than expected. Sub-par and falling capacity utilisation suggests little pricing power for manufacturers. Meanwhile, Fed Governors Brainard and Tarullo added to the view that the Fed won’t hike until 2016. Fed Governors tend to carry a greater weight than the regional Fed presidents and their dovish comments may be reflective of Fed Chair Janet Yellen’s sympathies. The US September quarter profit reporting season is off to a mixed start with a disappointing Wal-Mart result but good bank results. So far only 58 S&P 500 companies have reported, with 76% beating profit expectations.
Chinese trade data for September was a mixed bag with stronger-than-expected exports but weaker imports, although the latter may reflect lower commodity prices rather than reduced demand. Lending data was more positive though with both bank lending and credit up more than expected, indicating that the People’s Bank of China’s (PBOC) easing measures are working. Meanwhile, inflation was lower than expected in September with non-food inflation of just 1% year-on-year and producer prices down 5.9% year-on-year, providing plenty of scope for further monetary stimulus. In fact the last week saw more easing with the PBOC now making it easier for banks to obtain cheap funding from it to lend to small businesses and farmers.
Australian economic events and implications
Australia saw modest lifts in confidence – both for businesses and consumers, presumably in response to the change in Prime Minister to Malcolm Turnbull . However, consumer confidence remains pretty subdued and will likely fall back in response to all the talk about rising mortgage rates. September jobs data was uneventful with a fall in employment but after several solid months and unemployment unchanged at 6.2%.
A turn in property market sentiment is also recognised by the RBA’s Financial Stability Review. Overall the RBA sees the risks to the Australian financial system as being “comfortably manageable at this stage.” While the RBA expressed concerns about a weakening in bank property lending standards around the end of 2014/early 2015, it sees them as having been tightened more recently, presumably in response to enhanced pressure from APRA. As a result the RBA is also seeing some moderation in indicators of housing demand and “a few tentative signs that sentiment may be turning down in the housing markets” of Sydney and Melbourne. Our expected November rate cut is more about avoiding a hike in mortgage borrowing rates rather than providing more stimulus. If, as seems likely, signs continue to gather pace that APRA’s macro-prudential measures are working to cool the hot Sydney and Melbourne property markets, then it will provide more scope for the RBA to cut interest rates again next year if needed.
What to watch over the next week?
In the US, the indicator to watch will be the Markit manufacturing conditions index (Friday) for October given recent concerns about the US manufacturing sector. It’s likely to remain ok at around 53. Meanwhile, expect to see the home builders’ conditions index (Monday) to remain solid at around 62 and gains in housing starts (Tuesday), home prices and existing home sales (both Thursday). US September quarter earnings reports will continue to flow with 118 Standard & Poor’s companies due to report including IBM, Boeing and Microsoft.
In Europe, the European Central Bank is expected to leave monetary policy unchanged (Thursday) but retain a strong easing bias given global uncertainties and inflation continuing to run well below target. Expect business conditions purchasing managers’ indices (Friday) to remain around levels consistent with reasonable growth.
Chinese September quarter gross domestic product growth (Monday) is expected to show a further slowing to 6.8% year-on-year, from 7% in the June quarter. However, September data for retail sales, industrial production and investment (Monday) and the October Caixin manufacturing conditions purchasing managers’ index (Friday) may show signs of stabilising.
In Australia, the minutes from the RBA’s last Board meeting (Tuesday) will no doubt be watched for any clues regarding the interest rate outlook but they are now rather dated given the decision by Westpac to increase variable mortgage rates for owner occupiers and investors by 0.2%, which, particularly if followed by the other big banks, will amount to a de-facto monetary tightening. A speech by RBA Deputy Governor Edey on Thursday will be watched for a more up-to-date assessment. Data for goods imports, the Westpac Leading Index and skilled vacancies will also be released.
Outlook for markets
Shares won’t recover in a straight line and so more short-term volatility is likely. However, so far October is living up to its reputation as a “bear killer” month and we see the recovery as having further to go. 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 investor sentiment remains negative such that it’s actually positive from a contrarian perspective. As such, share markets are likely resuming a broad rising trend. This includes the Australian share market, where we continue to see the ASX 200 rising to around 5500 by year-end.
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, the Australian dollar could bounce a bit higher, particularly if the Fed continues to delay and if the RBA fails to cut or signal a cut next month. However, the broad trend 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 more likely to cut rates again and the trend in commodity prices remains down. This is expected to see the Australian dollar fall to US$0.60 in the next year or so.