Investment markets and key developments over the past week
The past week has seen a real roller coaster ride for shares, with sharp falls early in the week – which is par for the course as I had a few days annual leave and markets invariably turn sour when I am away! Worries about Chinese/global growth and the Federal Reserve’s (the Fed’s) interest rate decision helped initially push the US share market back down to near its August low, which in turn pushed several markets to new lows, including Australian shares. However, shares rebounded mid-week from oversold levels, with US shares given a big push along on Friday by expectations that softer than expected jobs data for September will further delay Fed tightening. For the week this still saw Eurozone shares end down 0.8%, Japanese shares fall 0.9% and Chinese shares fall 1.3%, but Australian shares rose 0.2% and US shares gained 1%.
Bond yields fell sharply over the last week as expectations for a Fed rate hike were pushed out, commodity prices were flat to up as the US dollar fell and the Australian dollar managed a modest gain after recovering from a fall back below $US0.70.
From their highs earlier this year to recent lows, US shares have had a fall of -12%, Australian shares -18%, Eurozone and Japanese shares -19%, Emerging market shares -22%, Asian shares -23% and Chinese shares -43%. Interestingly the weakness over the last week has seen emerging market, Asian and Chinese shares hold above their August lows.
September and the September quarter have clearly lived up to their reputations as poor periods for shares, with worries about global growth and the Fed driving the worst September quarter for global shares (-8.1%) and Australian shares (-8%) since the September quarter 2011. We are still at risk of more weakness in the next few weeks as global growth and Fed concerns remain. This is particularly so for the US share market that has had the smallest decline but is the most vulnerable in terms of valuations on some measures and the only major market with a central bank getting closer to tightening.
However, with the seasonally weak September quarter behind us and October known as a “bear killer” month ahead of seasonal strength into year end and, our broad view is that the cyclical bull market in shares will resume thanks to attractive valuations, very easy global monetary conditions and extremely bearish investor sentiment that is normally associated with market bottoms. It makes sense to start averaging into shares over the next month or so for those looking to allocate cash. The failure of commodity prices and emerging market shares to go to new lows through the September pull back in shares is a positive sign in this regard. So far share markets seem to be following a very similar pattern to that seen in both 1998 and 2011, that saw initial sharp falls into August, followed by a bounce and then a retest or new lows around late September/October, followed by gains into year end. History may not repeat but it does rhyme.
Soft US payrolls for September mean no chance of an October Fed rate hike and a December hike is 50/50. The September jobs data in the US were weak all round: jobs growth was just 142,000, which was well below the expected 200,000; previous months’ jobs growth was revised down; unemployment only remained at 5.1% because participation fell and wages growth was flat in the month and just 2.2% year on year. The failure of wages growth to pick up much, despite the fall in unemployment, suggests that the so-called NAIRU (non-accelerating inflation rate of unemployment) is lower and that deflationary pressures remain intense. While it’s dangerous to read too much into monthly data, the soft jobs report for September means there is no chance of an October rate hike and a December hike is 50/50.
Further stimulus from China and potential signs of growth bottoming. News early in the week that Chinese industrial profits fell nearly 9% over the year to August didn't help share markets, but thereafter the news out of China improved a bit. Firstly, China is continuing to announce more stimulus measures; in particular a sales tax cut on small cars and another reduction in the required deposit ratio for first home buyers. Secondly, economic data took on a slightly better tone, with consumer confidence rising to its highest since May last year, the official manufacturing PMI rising slightly in September, the Caixin flash PMI being revised up and average home prices continuing to rise in September. While it’s hard to see a big rise in Chinese economic growth, the downside risks may be starting to recede a bit.
US Government shutdown averted for now. US Congress passed a bill extending US Government financing out to December 11, averting the threatened October 1 shutdown. Of course this just means that the issue will now come up again later in the year when it will get rolled into the need to raise the debt ceiling again, which now looks like being reached by November 5. This could see more brinkmanship as 30 or so ultra conservative house Republicans still seek to defund Planned Parenthood. However, the vast majority of Congressional Republicans and their leadership are likely to remain more focussed on next year's elections and so a shutdown/debt ceiling crisis is likely to be avoided.
Australian mini-summit on the economy a positive sign. The combination of a slowing population and productivity growth and the end of the commodity boom has clearly cut into Australia’s growth potential. Our own assessment is that potential growth has fallen to around 2.75% pa and the IMF appears to have come to a similar view. The best way to turn this around is with a reinvigorated economic reform agenda – focussing on the tax system, labour and product markets, government spending and infrastructure. Explaining the need for reform and building community support for it is essential so having the mini-summit in the last week between the Government and various community groups is a good move.
Major global economic events and implications
US economic data continued to point to an economy with growth averaging around 2-2.5% pa. No boom, but no bust either. On the solid side consumer confidence surprisingly rose in September (despite share market noise), vehicle sales rose to their strongest in 10 years and construction spending rose more than expected. Against this, pending home sales fell in August, a worsening goods trade balance points to a detraction from September quarter GDP growth and jobs growth was much weaker than expected. National manufacturing conditions PMIs painted a mixed picture with the ISM index falling to 50.2 but the broader Markit manufacturing PMI remaining solid at 53.1. Meanwhile, the Fed's preferred inflation measure, the core private consumption deflator, remained low at 1.3% year on year in August.
Eurozone economic data remained pretty good, with overall economic sentiment in September rising to its highest in more than four years and at a level consistent with a pick-up in growth. While CPI inflation went negative again in September, at -0.1% year on year, core inflation was unchanged at 0.9% and on its own this is not enough to move the ECB to step up its quantitative easing program. While Catalan pro-independence parties won a majority of the seats in the Catalonian regional election in Spain, they failed to receive a majority of the vote indicating that the case for independence has not been advanced. Spanish bonds and equities outperformed over the last week as a result.
Japanese economic data was mixed with weak industrial production and the Tankan business survey showing softer conditions for manufacturers but against this stronger housing starts, continuing solid jobs data, stronger household spending and the Tankan survey showing stronger conditions for non-manufacturing businesses.
Australian economic events and implications
In Australia, building approvals fell more than expected in August. While they are still strong, they do look to have peaked along with new home sales, suggesting that the contribution to growth from housing construction will slow next year. Retail sales bounced back in August after a July fall but still look to have lost a bit of momentum relative to last year. Against this, ongoing growth in job vacancies (up 10% over the year to August) and the manufacturing PMI rising further to 52.1 in September are positive signs. National average home price growth remained strong in September, but annual price growth out of Sydney and Melbourne remains poor with four cities seeing falls. Expect to see a slowing in Sydney and Melbourne home price growth in the months ahead as APRA measures impact, with credit data for August already showing a significant slowing in investor lending in the last two months. The latter will be easing RBA concerns on the housing front and providing more flexibility on the interest rate front.
What to watch over the next week?
In Australia, the RBA (Tuesday) is expected to leave interest rates on hold. Not enough has changed since RBA Governor Steven's indicated a few weeks back that he was "pretty content" with current monetary policy settings. However, it will be interesting to see whether the RBA has become more concerned about the risks to global growth from the emerging world. With growth running well below potential, spare capacity in the economy is continuing to build and despite the lower Australian dollar, will likely put more downwards pressure on inflation and ultimately tip the RBA into cutting rates further. This could come as early as November, when the RBA will review its economic forecasts or early next year. On the data front expect another large trade deficit (Tuesday) and further weakness in investor housing finance (Friday). ANZ job ads will also be released.
In the US, the focus is likely to be on the minutes from the Fed's last meeting (Thursday) which are expected to reiterate yet again that the Fed still expects to raise interest rates later this year, but that it will take account of the threat to US growth and inflation from global economic and financial developments. On the data front expect the ISM non-manufacturing conditions index (Monday) to remain strong and the August trade deficit (Tuesday) to show some deterioration.
The Bank of Japan meets Wednesday but is unlikely to make any changes to monetary policy.
Outlook for markets
While October is likely to remain volatile, with the risk of further weakness, it’s also likely to see share markets end higher as the cyclical bull market in shares resumes into year end. 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 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 will take its lead largely from ongoing swings in global investors’ risk tolerance, but the broad trend in the Australian dollar 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 Australian dollar is expected to fall to $US0.60 in the next year or so, with a risk that it will go even lower.