Investment markets and key developments over the past week
The bounce back in global shares continued over the last week led by the US share market which broke above its 50-day moving average and cut its year-to-date decline to -4.7% from -10.5%. For the week US shares rose 1.6%, Eurozone shares gained 1.8% and Japanese shares rose 1.4%. This was helped by a 10% gain in oil prices and metal prices also gained. However, Australian shares fell 1.5% and Chinese shares lost 3.3%. Bond yields rose marginally in the US on higher inflation data, but fell elsewhere. Higher-than-expected US inflation pushed the US dollar up slightly and this saw the Australian dollar fall back towards US$0.71.
The G20 finance ministers and central bankers meeting in Shanghai said all the right things in terms of acknowledging the risks to the global outlook, committing to do more to boost global growth and agreeing to consult closely on currencies. However, it’s doubtful we are about to see a new round of globally-coordinated policy stimulus like we saw at the time of the global financial crisis. It’s a premature to expect that.
Will there be a crash in Australian property prices? Foreign hedge funds and various commentators have been calling such an event for a decade or so now and have proved wide of the mark. Yes Australian home prices are likely to see yet another 5-10% cyclical fall at some point in the next few years, and yes home prices are overvalued posing a downside risk. But a 50% crash is unlikely. The latest crash call aired on 60 Minutes has raised nothing that wasn’t already well known. Australian property is no more overvalued than it was a decade or so ago. The ratio of household debt to income is about the same as it was prior to the global financial crisis, but interest costs have collapsed and there are no signs that Australians are having trouble servicing their debts.
Source: ABS, RBA, AMP Capital
Sure, there has been some easing in lending standards – but I just don’t accept that Australian banks don’t regularly check for proof of income (mine does) in processing loan applications, particularly with the Australian Prudential Regulation Authority breathing down their necks on ‘bubble’ worries. More fundamentally, Australia has not seen the growth in low doc and sub-prime loans that don’t even require people to lie about their lack of income which were central to the US housing crisis that triggered the global financial crisis. To get a crash we will either need a massive rise in interest rates (which is unlikely because the Reserve Bank of Australia is not stupid) or a deep recession in the economy which seems unlikely. It seems to me that some people have just seen the movie The Big Short and want to be film stars (or are least desperate to find the next big short). The trouble is that shorting Australian banks is becoming a rather crowded trade.
Major global economic events and implications
US economic news was a mixed bag. On the downside, February data showed falls in consumer confidence and the Markit manufacturing and services conditions purchasing managers’ indices. These could all be in response to recent share market turbulence and bad weather or they could be indicative of a fundamental deterioration in the economy. On the upside though, durable goods orders rebounded in January, consumption spending was strong in January, consumer confidence appears to have improved in late February, existing home sales and home prices are solid and the trend in unemployment claims is continuing to reverse the rise seen into January. Q4 2015 gross domestic product growth was revised up to 1% annualised from 0.7%, but it was driven by inventories. Finally, a stronger-than-expected gain in inflation as measured by the core private consumption deflator for January adds to evidence that deflationary pressure are receding in the US supporting the case for the US Federal Reserve to raise interest rates. Given the mixed data though and ongoing global uncertainties it still makes sense for the US Federal Reserve to back off on raising rates for now. The market is attaching a 12% probability to a March hike, but a 52% probability to a hike by December.
Eurozone purchasing managers’ indices and confidence readings also dipped in February adding to the case for the European Central Bank to ramp up its stimulus next month, even though the level of the purchasing managers’ indices is still consistent with reasonable growth. Bank lending picked up in January but it’s too early to see the effect of recent market turmoil on bank lending.
Japan’s manufacturing conditions purchasing managers’ index also fell in February, and with core inflation falling to 0.7% year-on-year pressure remains on the Bank of Japan to provide more stimulus.
China’s stimulus efforts can be seen in a blowout in its budget deficit to a record -3.5% of gross domestic product last year from -1.8% of gross domestic product in 2014. Over the year to January public spending is up 24% year-on-year versus just 6% for revenues. Meanwhile, the People’s Bank of China Governor Zhou has described China’s monetary policy as having an “easing bias” for the first time this cycle indicating that more monetary easing is more likely than not.
Australian economic events and implications
In Australia, wages growth slowed further in Q4 2015 and the business investment outlook remains weak, but it’s not all bad. Low wages growth partly reflects the loss of high-paying mining jobs but the creation of lower (more normally) paid jobs in Sydney and Melbourne. It means that there is no inflation pressie from labour costs but has also allowed jobs growth to be higher than might otherwise have been the case. The message from business investment plans is that the unwind of the mining investment boom is continuing at the rate of about -35% per annum. However, by the end of the next financial year this will have largely run its course with non-mining investment back to its pre-boom level as a share of gross domestic product, so the drag on gross domestic product growth will abate.
The Australian December half profits reporting season is now basically done. As always the quality of the results tailed off through the last week, but overall results were much better than feared. 47% of results have bettered expectations (against a norm of 44%) with only 21% coming in worse than expected (against a norm of 25%), 65% have seen profits up on a year ago and 63% have raised their dividends (against a norm of 62%). It’s tough out there for resources stocks but no more than expected. Meanwhile, most of the big banks are seeing reasonable results and stocks exposed to the Australian economy, led by housing and the consumer, are doing well. The better-than-feared nature of the results to date has been reflected in 65% of stocks seeing their share price outperform the market the day results were released. Overall profits are on track to fall around 5% this financial year but this is due to a 65% slump in resources profits. Outside of resources, profits are rising by around 5%.
Source: AMP Capital
Source: AMP Capital
Source: AMP Capital
What to watch over the next week?
In the US, various business surveys and jobs data will be watched for clues as to how the US economy is progressing. Expect the manufacturing Institute for Supply Management survey (Tuesday) and non-manufacturing Institute for Supply Management survey (Thursday) to show slight improvements and growth in payroll employment to pick up to around 195,000 after January’s softer result. Data for pending home sales (Monday), construction spending (Tuesday) and trade (Friday) will also be released along with the US Federal Reserve’s Beige Book of anecdotal evidence.
Eurozone inflation data for February to be released Monday is expected to have remained low, with January unemployment data remaining around 10.4%.
In Japan, expect January industrial production (Monday) to rebound after a poor December, labour market data to remain solid and household spending (both Tuesday) to have remained weak.
In China, the fourth session of the National People’s Congress starting Saturday may see more stimulus measures announced with a bigger budget deficit (it was 3.5% of gross domestic product in 2015), more infrastructure and social spending, new investment projects and some details around supply side reforms. Ahead of this the monthly round of business conditions purchasing managers’ indices starting Tuesday will be watched for signs of stabilisation with expectations for a slight rise but some private surveys pointing to weakness.
In Australia, the Reserve Bank of Australia is expected to leave interest rates on hold yet again. While it has an easing bias, there has not been enough bad news since the last meeting to cause it to act on it. Australian economic data has mostly been okay and financial markets have settled down a bit. However, I remain of the view that the combination of sub-par growth, the bleak outlook for business investment, low inflation and the threat of a rising Australian dollar as the US Federal Reserve delays easing will prompt the Reserve Bank of Australia to ease again – probably around May.
Meanwhile we will see the usual Australian data avalanche that accompanies the release of quarterly gross domestic product data. Expect continued moderate credit growth (Monday) as owner-occupiers replace investors in housing loans, building approvals (Tuesday) to fall 5% after a strong December, modest growth February home prices (also Tuesday), Q4 2015 gross domestic product growth (Wednesday) to have slowed back to 0.4% quarter-on-quarter or 2.5% year-on-year after the strong trade driven contribution seen in Q3 2015, a continued large trade deficit (Thursday) and 0.3% growth in January retail sales (Friday).
Outlook for markets
Shares have seen a decent rebound from oversold levels which may have further to go. But with global growth worries remaining it’s still premature to say we have bottomed. Beyond the near-term uncertainties, we still see shares trending higher this year helped by a combination of relatively attractive valuations compared to bonds, further global monetary easing and continuing moderate economic growth.
Very low bond yields point to a soft medium-term return potential from sovereign bonds, but it’s hard to get bearish in a world of fragile growth, spare capacity, weak commodity prices and low inflation.
Commercial property and infrastructure are likely to continue benefiting from the ongoing search by investors for yield.
National capital city residential property price gains are expected to slow to around 3% this year, as the heat comes out of Sydney and Melbourne. Prices are likely to continue to fall in Perth and Darwin, but growth is likely to pick up in Brisbane.
Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5% and the Reserve Bank of Australia expected to cut the cash rate to 1.75%.
An ongoing delay in US Federal Reserve tightening poses short-term upside risks for the Australian dollar. However, any short-term strength in the Australian dollar is unlikely to go too far and the broad trend is likely to remain down as the interest rate differential in favour of Australia narrows as the Reserve Bank of Australia eventually resumes cutting the cash rate, commodity prices remain weak and the Australian dollar undertakes its usual undershoot of fair value. We continue to expect a fall to around US$0.60 by year-end.