Investment markets and key developments over the past week

The past week has seen a rebound in share markets, commodities and commodity related currencies like the $A gather pace. US and Australian shares have closed above the range they have been in since their sharp fall in August which is a very positive sign. The major driver has been diminishing concerns regarding both China and the Fed. The rebound in share markets has been reinforced by stronger commodity prices, which has helped energy and mining shares. Over the week US shares gained 3.3%, European shares rose 5%, Japanese shares rose 4%, Chinese shares gained 4.3% and the Australian share market rose 4.5%. Reflecting the “risk on” trade, bond yields have increased.

While global economic data releases over the past week were pretty mixed, a number of developments have come together to drive the rebound in growth assets like shares and commodities:

  • At their late September lows, shares had become ripe for a rebound as valuations had improved significantly and were technically oversold. Investor sentiment had become so negative that it only needed a bit of good, or less bad news, to spark buying;
  • The minutes from the last Fed meeting have reinforced the impression that the Fed is waiting to get comfortable regarding global growth and US inflation and that with September payrolls disappointing the first hike is likely to be delayed into 2016. The key point is not that the Fed is not going to raise interest rates per se, but rather that it won’t do so until the threat to US growth and inflation from global uncertainties has receded.
  • A slowing fall in China's foreign exchange reserves in September (down $US44 billion on an adjusted basis from down $US129 billion in August) suggests that capital outflows from China have slowed, as fears of a sharp depreciation in the renminbi have subsided (thanks partly to its stability of late and assurances from the Chinese Government that a sharp depreciation is not on the cards). This in turn provides scope for the PBOC to undertake further monetary easing in the months ahead.
  • More broadly, the ongoing flow of easing measures in China is adding to confidence that the risks from China’s share market and economy are coming under control.

With US shares breaking out of the range they have been in since their August falls and this dragging other markets (including the Australian share market) higher, more upside is likely ahead as we come into traditional seasonal strength into year-end, albeit with a few bumps along the way. The cyclical bull market in shares looks to be resuming.

The latest downward revisions to the IMF’s global growth forecasts - to 3.1% for 2015 (from 3.3%) and to 3.6% for 2016 (from 3.8%) – is nothing new or alarming. For the last five years or so, the IMF’s global growth forecasts for the year ahead have started near 4% only to end nearer 3%. So nothing new. On the one hand it highlights the ongoing constraints on global growth post the GFC. On the other hand, if growth did really take off it would only usher in worries about overheating, inflation and monetary tightening. So maybe uneven and constrained global growth is the best outcome.

Source:IMF, AMP Capital

News that 13 Asia-Pacific nations including the US, Japan and Australia have finally agreed the Trans Pacific Partnership free trade deal is to be welcomed, but don’t get too excited. Free trade is great but watching for the impact of new trade deals on overall economic growth or share markets is like watching grass grow. And of course, the TPP has to be passed into law in each country and there are some uncertainties on this front in the US. I won’t be changing any economic growth forecasts or investment market expectations as a result of it!

Major global economic events and implications

It was a quiet week on the data front in the US. Services conditions PMIs fell in September but remain solid, suggesting no problems in terms of growth on this front and jobless claims remain low. However, the trade deficit increased in August and points to trade detracting around 0.5% from September quarter GDP growth. This, plus a detraction from inventories, is likely to knock September quarter growth back to around 1.5-2% annualised after 3.9% in the June quarter. While final demand will be strong, the continuing hot and cold nature of US growth around a 2% or so trend is another reason why they Fed shouldn’t be rushing into a rate hike.

German factory orders fell in August raising fears about an impact from slower emerging world growth. With the German manufacturing PMI holding up reasonably well though in September it’s probably too early to get too concerned but is worth keeping an eye on.

The Bank of Japan left is quantitative easing program unchanged but with growth and inflation remaining too low – with weak machinery orders providing a reminder of the former – further BoJ easing likely remains on the cards for some time in the next six months.

Australian economic events and implications

In Australia, the RBA provided no surprises in leaving interest rates on hold, making very little change to its post meeting statement. However, it has acknowledged that APRA’s measures to slow investor lending seem to be working, which arguably provides it with more flexibility on interest rates. At this point the RBA still seems pretty comfortable with current interest rate settings but my view remains that the economy will still need a bit more help from lower RBA interest rates and a lower $A. Economic data over the last week was somewhat upbeat. Sure, the trade deficit blew out again on falling export values, but imports of consumer goods are very strong, housing finance rose strongly in August, the ANZ job ads index rose again last month and while the AIG’s services conditions PMI fell in September it remained ok at 52.

Housing finance data shows a continuing decline in lending to investors versus owner occupiers but the strength in lending to owner occupiers is likely to have been exaggerated by the reclassification of some loans from “investor” to “owner occupier”. I suspect that the reclassification relates to old loans that started as investor loans and then remained investor loans even though the borrower moved into the property. This did not matter pre the interest rate hikes on investor loans because the rate to the borrower was the same, but this is no longer the case so some borrowers would have wanted to be reclassified. From the ABS viewpoint, this would be seen as a new owner occupier loan hence distorting lending to owner occupiers upwards. No doubt APRA will be keeping a close eye on this.

Meanwhile, the TD Securities Inflation Gauge showed continuing very low inflation in September leaving plenty of scope for another RBA rate cut.

What to watch over the next week?

In the US, expect continued solid growth in retail sales (Wednesday), headline CPI inflation (Thursday) to fall back into modest deflation on the back of falls in the gasoline price, but with core inflation remaining at 1.8% year-on-year, September industrial production to have fallen 0.3% and consumer sentiment to rise after a fall last month (both Friday). Both the New York and Philadelphia regional manufacturing surveys will be watched for some improvement after recent weakness. September quarter profit reports will start to flow in earnest with 35 S&P 500 companies due to report. Consensus expectations are for a 5% year-on-year decline in profits but if the last two quarters are any guide they are likely to end up around flat.

Chinese economic data for September will start to flow with exports and imports (Tuesday) expected to remain weak, credit growth to show a further improvement and CPI inflation (Wednesday) to fall back to around 1.8% year-on-year from 2% in August reflecting some stabilisation in food prices.

In Australia, expect a gain in both the NAB business confidence index (Tuesday) and in the Westpac consumer confidence index (Wednesday) in lagged response to last month’s change in PM to Malcolm Turnbull and labour market data (Thursday) to show flat employment in September after several strong months, with unemployment rising 6.3%. The RBA’s six-monthly Financial Stability Review (Friday) is expected to show that the RBA is largely comfortable with the state of the Australian financial system particularly now that APRA measures are impacting to slow investor property lending and that banks will be required to hold higher capital ratios.

Outlook for markets

Shares are unlikely to continue going up in a straight line and October may yet see a bit of short-term volatility. But it’s also likely to live up to its reputation as a “bear killer” month. Shares are now starting to break up out of the ranges they have been in since their falls in August in a sign that the cyclical bull market in shares is resuming. More fundamentally, shares are cheap relative to bonds and monetary conditions are set to remain easy. This in turn should help see the global economic recovery continue; and investor sentiment remains so negative that it’s actually positive from a contrarian perspective. As such, despite lingering near-term concerns regarding China and the Fed, 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 $A is taking its lead from the swing back in investor risk tolerance and so looks like it’s on its way into the mid-high $US0.70s. 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 $A fall to $US0.60 in the next year or so.