Weekly Market Update – 12th May 2014

Investment markets and key developments over the past week

• The past week saw more messy and volatile trading in share markets, with dovish comments by US and European central bankers and mostly good profit news providing support, but also worries about technology stocks and uncertainty about Ukraine continuing to drag. US and European shares fell 0.1%, Japanese shares fell 1.8% and Chinese shares fell 0.8%. Australian shares were little changed with fears regarding the 2014 Federal Budget continuing to drag on consumer stocks. Bond yields were mixed, but with yields continuing to fall in formerly-troubled Eurozone countries. The Australian dollar gained in response to stronger-than-expected jobs growth while talk of European Central Bank (ECB) easing weighed on the euro.

• Ukraine risks have receded a bit with Russian President Putin sounding more constructive. However, there has been no real progress in terms of resolving the crisis and so Ukraine still has the potential to cause volatility in investment markets.

• In Australia, it’s likely the Budget will contain income tax hikes but only applying to those earning more than A$180,000 so as to not hit those earning between A$100,000 and A$150,000 with a double whammy as welfare is cut back too. That makes sense and helps minimise the short-term blow to spending. But taking nearly 50% of extra income away from high income earners is a backward step in terms of incentive and the need to address poor productivity. A supposed temporary income tax hike along with a hike in fuel excise also does nothing to deal with what is really a structural spending problem.

• Our concern is that the Government has exaggerated the budget problem – it’s a problem, but far from an emergency – and that this combined with the political cycle which argues in favour of getting the budget pain over with early will result in the Government going too hard in terms of the fiscal austerity. The Organisation for Economic Co-operation and Development has rightly warned Australia that “heavy front loading of fiscal consolidation should be avoided”. Right now the economy is still a bit fragile with only tentative signs of improvement in the non-mining economy. But this could be snuffed out if the budget is too tough. The key is to put policies in place that bring long-term spending growth under control, as opposed to adopting too much austerity in the short term. Hopefully this will be the case.

• The clear message from the Reserve Bank of Australia’s (RBA) quarterly Statement on Monetary Policy is that interest rates will likely remain on hold for a while yet. The RBA only made minor changes to its economic forecasts – seeing growth this year and next of 2.75%, before rising to 3.25% in 2016/16, with near-term uncertainties remaining around the decline in mining investment and the pick-up in the non-mining economy. While the RBA is allowing for weak public demand it would probably be loath to have to respond to excessive fiscal austerity by cutting interest rates again for fear of over-stimulating the housing market.

Major global economic events and implications

• US data was relatively light but provided a mixed picture. The trade deficit narrowed in March but along with data for construction and inventories points to a revision to March quarter gross domestic product (GDP) growth into negative territory. That said June quarter GDP growth looks like being a strong 4% annualised or so and gains in the Institute for Supply Management and Markit services purchasing managers’ indices (PMI) for April were consistent with this. A survey of bank lenders pointed to easier conditions for business loans but weaker housing loan demand. US Federal Reserve (Fed) Chair Yellen’s overall message remained dovish saying there is no timetable for when interest rate hikes will occur.

• US March quarter earnings have continued to impress. 453 S&P 500 companies have reported and while bad weather depressed annual sales growth to 2.5%, 76% have exceeded earnings expectations which appear to be coming in at 5.5% year-on-year (yoy). This is good compared to expectations for a 1% fall a month ago.

• The ECB left monetary conditions unchanged as generally expected, but President Draghi signalled a clear willingness to ease in June to combat the problem of low inflation and the strong euro. However it is unsure whether the ECB is ready for quantitative easing and so any easing may take the form of fractional cuts to interest rates. Meanwhile, Eurozone data was mostly ok with a decent rise in the business conditions PMI confirmed for April and stronger-than-expected March retail sales.

• Chinese export and import data both unexpectedly rose slightly in April, which is a big improvement on previous months. Meanwhile inflation continued to subside in April to 1.8% yoy and producer prices continued to fall, suggesting along with the slowing housing market plenty of scope for monetary easing.

Australian economic events and implications