Investment markets and key developments over the past week
- While tensions regarding Ukraine saw shares dip and safe haven assets like bonds and gold rally early in the week, this reversed as Ukraine tensions receded somewhat and markets returned to focussing on mostly favourable economic data. Most markets gained with US shares up +1.0%, making new record highs, and Australian shares rising +1.1% to their highest since June 2008. While Eurozone shares fell -1.3%, Japanese shares gained +2.9%. The return of confidence also saw bond yields mostly up, except in Spain and Italy where they continue to fall. The euro and the $A rose to their highest levels for the year with the latter pushed up by much better than expected Australian economic data.
- March 9 marked the five year anniversary of the GFC low in US shares after a -57% fall. Since the low the S&P 500 is up +178%. The GFC low for ASX 200 was March 6 after a -54% fall. Since then it is up +74%.
- Tensions regarding Ukraine have settled a bit after President Putin provided some moderate and constructive comments. However, risks remain, as highlighted by Crimea’s decision to have a referendum on joining Russia and Russia’s threat regarding gas supplies to Ukraine. Ukraine’s perilous economy is not a threat to the global economy as it’s too small. Rather the main concern relates to the 25% of Eurozone gas supplies that come from Russia, half of which is via Ukraine. Right now gas stockpiles are ample, but if Ukraine descends into civil war or Russia attempts to punish Europe for supporting Ukraine and this threatens these gas supplies for any length of time then it could adversely affect the Eurozone economy. Much will depend of how far the US and Europe are prepared to go in supporting Ukraine and hence in antagonising Russia. On this front recent offers of emergency aid from the US and European Union do not help. But with the EU and the US caring less about Ukraine than Russia does, I suspect they will remain wary of getting too heavily involved, particularly at a time when the Eurozone recovery remains fragile. My suspicion is that Ukraine is just another distraction with some sort of negotiated solution likely. But at the moment there is no sign of that and we may not know for several months and there may be a few more bumps along the way so it will remain a risk for markets for a while.
- There were no surprises from Chinese Premier Li’s announcement of +7.5% as the growth target for this year with +3.5% inflation. The growth target for 2012 and 2013 was also +7.5% and the growth outcomes were +7.8% and +7.7%, respectively, so it looks like more of the same from China. While some fret that the target is “about +7.5%” and so +7.2% or +7.3% could still be seen as consistent with the target, I would argue that this is just normal statistical noise and the key is that Premier Li sees +7.0% as the floor to growth. With inflation at risk of undershooting there is potentially some scope to provide stimulus if growth looks like undershooting in a meaningful way. Premier Li also announced various reforms including reducing business red tape, redressing the spending and revenue imbalance between the central and local governments, further deregulation of interest rates and plans to urbanise 300 million people in the next few years. The priority remains growth though as the reforms are contingent on growth remaining around target.
- Talk of a ‘Bear Stearns moment’ in China flowing from the interest payment default by a company that makes solar cells – the first corporate bond default in China – is way overdone. It seems everyone is on the lookout for such ‘moments’ in China right now. Yes, there is a risk of more defaults but the authorities are unlikely to allow a snowballing loss of confidence and the absence of layers of leverage. Complexity and financial linkages suggests the risks of it triggering a global financial crisis (GFC) style impact is low. In fact, allowing defaults to occur is long-term positive in allowing the Chinese corporate debt market to mature with a realistic risk pricing.
- Australia is almost starting to look like it’s going from gloom to boom. That may be a bit premature, but the run of mostly positive data over the past week indicates the economy is weathering the mining investment slump well. Against this backdrop it makes sense that Governor Steven’s Parliamentary Testimony implied a degree of comfort regarding the economic outlook with the Reserve Bank of Australia (RBA) continuing to signal a period of stability in the cash rate. This is likely to continue into the second half of the year, although if the economic data remains as solid as seen over the past week the debate will soon shift till when rates will start rising. Meanwhile the RBA has rightly returned to applying jawboning to the A$, describing it as ‘high’. Ideally it needs to fall to around US$0.80.
Major global economic events and implications
- US economic data continues to be weather affected – with soft services conditions indicators but improved readings for manufacturing conditions with gains in both the Institute of Supply Management (ISM) and Markit purchasing managers indices (PMIs) and better jobs growth. Despite poor weather in the survey week, the rise in February payrolls came in better than expected at 175,000 and payrolls for the previous two months were revised up by 25,000. While the unemployment rate rose to +6.7% this reflected a stabilisation in the participation rate which the doves in the US Federal Reserve will welcome. There was also a decent gain in mortgage applications for purchasing properties after a long weak period and a decline in jobless claims. The overall impression remains that while poor weather is continuing to play havoc with US economic data, underlying conditions are good. Tapering will continue.
- There was more good news in the Eurozone with PMIs revised up for February with the rising trend telling us the recovery is continuing and better than expected retail sales and German factory orders. While the European Central Bank (ECB) yet again left monetary conditions unchanged, with President Draghi siting the mostly positive data flow since the last meeting, the ECB retains a clear easing bias and is likely to move again if inflation and lending does not pick up.While Chinese exports fell -18% over the year to February this looks like a distortion caused by the high base a year ago when capital flows were disguised as exports and the timing of the Chinese New Year. It doesn’t gel with stronger growth globally and a rebound is likely in March. Meanwhile +10% import growth suggests the Chinese economy is doing ok.
Australian economic events and implications
- Australian economic data was surprisingly impressive. December quarter gross domestic product (GDP) growth showed the economy growing stronger than expected and consumer spending, housing investment and trade helping to fill the gap left by falling mining investment. More timely indicators helped add to optimism on the economic outlook with January building approvals rising to their highest since 2002, retail sales up for the ninth month in a row and annual growth of +6.2% being the strongest since late 2009, the AIG’s manufacturing and services conditions indicators rising solidly in February, ANZ job ads starting to trend up and the trade surplus rising to its best since August 2011. The improvement in the trade balance highlights a silver lining from the end of the mining investment boom – ie, rising export volumes from completed projects and less imports of mining related equipment. The bottom line is that the Australian economy looks to be weathering the mining investment slump well with reasonable prospects for a modest strengthening in growth through the year ahead.
What to watch over the next week?
- In the US, it will be a relatively quiet week on the data front but retail sales (Thursday) are expected to show continued modest growth and consumer sentiment data (Friday) will be watched for further modest improvement.
- The Bank of Japan is unlikely to make any changes to monetary policy when it meets Tuesday, preferring to hold its fire power till it gauges the impact of the April sales tax hike. Further easing is likely to be needed around mid-year though, in part to encourage a further leg down in the value of the Yen.
- Chinese activity data for the January-February period (Thursday) is likely to show a modest slowing in industrial production, fixed asset investment and retail sales. Lending and credit growth is likely to have slowed after the usual January surge.
- In Australia, the NAB business survey (Tuesday) will be watched for a continuation of the improvement in conditions seen in recent months, consumer confidence (Wednesday) might have a slight bounce on the back of better economic news lately, housing finance (Wednesday) is likely to continue its rising trend but employment (Thursday) is likely to see only a 5,000 bounce after two weak months with the unemployment rate staying at +6%.
Outlook for markets
- Investors should allow for more volatility in share markets ahead – including the likelihood of a -10 to -15% correction at some point along the way this year – and somewhat more constrained returns than seen over the last two years. However, the broad trend in share markets is likely to remain up reflecting a combination of reasonable valuations, better earnings on the back of improved economic growth and easy monetary conditions helping to entice investors to switch out of cash and bonds and into shares. With the concluded earnings reporting season in Australia and improving economic data confirming that the market is on track for good earnings growth this year, the ASX 200 is on track to meet our year-end target of around 5,800.
- The recent decline in global bond yields should be seen as a correction against the backdrop of a slow rising trend in yields on the back of gradually improving global growth. This will mean subdued returns from government bonds. Cash and bank deposits also continue to offer pretty poor returns.
- The broad trend in the A$ remains down on the back of softer commodity prices, a reversion to levels that offset Australia’s high cost base and a decline in Australia’s growth relative to that in the US. However, short positions in the A$ remain excessive and so it could still have more of a bounce before the downtrend resumes.
Source: AMP CAPITAL ‘Weekly Market Update’
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