Weekly Market Update – 11th April 2014

• The past week saw major global share markets fall with US shares down 2.7%, Eurozone shares down 3.5% and Japanese shares down 7.3% led by a further decline in technology stocks. Flight-to-safety demand, dovish signals from the US Federal Reserve (Fed) and ongoing risks regarding Ukraine saw bonds rally. Australian shares briefly made it to a new post global financial crisis high above 5500 though, helped by takeover activity and ended the week up 0.1%, and Chinese shares rose 3.5%. Commodity prices mostly rose helped by good economic data and the Australian dollar was pushed even higher by strong Australian jobs data.

• We are not on the brink of a technology-driven crash. The US tech heavy Nasdaq index has fallen 8% from its March high and – surprise, surprise – we have seen some of the usual perennial bears/Fed haters come out with more calls for share market crashes. Our view remains that a 10-15% correction in shares is to be expected at some point along the way this year, but it would be just a correction in a still-rising trend. There is no doubt some tech stocks have run too hard with a return to 1999 style price-to-sales metrics being used to justify silly valuations. This and the general outperformance of tech stocks over the last few years had left them at risk and the fall could still go further as hedge funds that were levered into tech overweights are forced to close their positions. However, price-to-earnings (PE) multiples on Nasdaq are one third their tech boom peaks and the broader US share market is trading on a forward PE ratio of 15 times which is a long way from 24 times at the time of the tech boom and is in line with longer-term averages. Other major share markets are trading on lower PE multiples.

• Ukraine remains a risk on two fronts with what looks to be orchestrated protests in eastern regions potentially providing a pretext for more Russian intervention if it desires and ongoing Russian threats to cut off gas supplies if Ukraine does not pay its debts. Our view remains that apart from short-term risks for markets, Ukraine is not likely to derail the global economic recovery with the US and Europe unlikely to want to get too involved. An escalation of tensions and sanctions though could seriously hurt the Russian economy which is at risk of recession.

• Australian trade deals with Japan and Korea are good news, but their benefits will accrue over time and don’t significantly change the near-term growth outlook. In Australia, the main beneficiaries are beef and dairy farmers and consumers as tariffs on imported cars, household and electronic goods from Japan fall to zero.

• In the US, the minutes from the Fed’s last meeting were dovish and economic data was good.The minutes indicated that the Fed did not mean to convey more hawkishness after its last meeting and remains focused on keeping the stimulus in place for longer. US data releases were favourable with lower jobless claims, a rise in small business optimism and consumer confidence, higher job vacancies and higher mortgage applications.

• Perhaps the highlight in Europe was the return of Greece to the debt market with a five-year bond issue that was seven times oversubscribed. Its 10-year bond yield is now 6.1%, as against a 2012 crisis high of above 30%. This is a big turnaround and adds to confidence that the Eurozone is back under control.

• Chinese trade data was worse than expected in March, but a 40% plunge in exports to Hong Kong and Taiwan suggests the fall is largely due to inflated exports from a year ago with exports to the rest of the world up 8% suggesting the underlying trend is fine. The fall in imports is arguably more of a worry as it reflects weak Chinese demand and it adds to the case for more policy fine tuning to support growth. Benign inflation, with non-food inflation of just 1.5% in March, indicates plenty of scope for further policy stimulus if needed.

• Australian economic data was mostly ok, with a fall in business confidence, but a slight rise in business conditions with both well up on last year’s lows, a slight rise in the Australian Industry Group’ s construction conditions index, a stabilisation in consumer confidence after several months of falls, a solid rise in housing finance in particular for new dwellings and another surprisingly strong jobs report for March which actually saw unemployment fall. While the last few months employment gains probably exaggerate to the upside they nevertheless tell us that the jobs market is far stronger than appeared to be the case late last year and with a range of forward-looking jobs indicators on the mend – e.g. ANZ job ads, Australian Bureau of Statistics job vacancies, skilled vacancies and employment intentions in the National Australian Bank survey – this suggests that the jobs market is gradually improving and that there is some chance that we may have already seen the peak in unemployment. This is all consistent with a gradual improvement in economic growth this year in Australia.

• We see no reason to change our expectation for a rate hike in September/October, with the risk of another rate cut now almost zero. The continuing rebound in the Australian dollar is likely becoming an increasing concern for the Reserve Bank of Australia (RBA), but we expect the central bank to respond by renewing its jawboning efforts to try and push it back down in the months ahead.

• In the US, expect a solid 0.8% gain in March retail sales (Monday), a post bad weather rebound in the National Association of Home Builders conditions index (Tuesday) and in housing starts (Wednesday), a solid rise in industrial production (also Wednesday) and another benign inflation report (Tuesday). The New York and Philadelphia regional manufacturing conditions indices are also likely to show improvement. The flow of March quarter earnings results will also start to ramp up with 54 Standard & Poor’s companies due to report. While bad weather is likely to have temporarily depressed profit growth, it is likely to come in stronger than market expectations that have collapsed to 0.9% growth for the quarter (from 6.6% earlier this year) on the back of a lot of negative corporate guidance. Usually when guidance has been so negative it makes it easier for companies to beat expectations.

• In China, expect March quarter gross domestic product growth (Wednesday) to show a slowdown to 7.2% year-on-year from 7.7% in the December quarter last year reflecting the loss of momentum already reported in the first few months of the year, but March data for industrial production, retail sales and fixed asset investment is likely to show a slight improvement from the soft growth reported in January/February.

• In Australia, the minutes from the last RBA meeting (Tuesday) will likely confirm their neutral bias on rates for now but will be looked at closely for signs of concern about surging house prices and the strengthening Australian dollar and hence for any renewed jawboning on either. Dwelling starts will likely show a solid bounce reflecting the lagged response to rising building approvals seen through last year.

• Investors should allow for a 10-15% correction at some point along the way this year. A trigger could be rising worries about when the Fed will start to raise interest rates as US growth recovers from its winter soft patch, but worries about Ukraine or tech stocks could also be triggers. However, just as we saw in the last two years this would just be a correction in a rising trend as share market fundamentals remain favourable with reasonable valuations, improving earnings on the back of rising economic growth and easy monetary conditions helping entice investors to switch out of cash and into shares. So any such dip should be seen as a buying opportunity. Our year-end target for the ASX 200 remains 5800.

• Bond yields are likely to resume their gradual rising trend and this combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits also continue to offer poor returns.

• The short covering rally in the Australian dollar is getting close to our target of around US$0.95, but still has a bit further to go. The broad trend in the Australian dollar is likely to remain down though reflecting softer commodity prices, a reversion to levels that offset Australia’s high cost base and a stronger recovery in economic growth in the US relative to that in Australia. Renewed RBA jawboning in the months ahead is also likely to weigh on the Australian dollar.

Source: AMP CAPITAL ‘Weekly Market Update’

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