Weekly Market Update – 16th July 2014

Investment markets and key developments over the past week

• Share markets retreated over the last week on worries that problems at some European banks might spark a return of Europe’s debt crisis and nervousness about a possible correction in the US. US shares fell 0.9%, Eurozone shares fell 3.7%, Japanese shares lost 1.3%, Chinese shares fell 0.5% and Australian shares lost 0.7%. Share market nervousness saw bonds rally, except in peripheral Eurozone countries where Portuguese bank problems weighed. The oil price fell another 2.9% as worries about Iraq abated and Libyan and Saudi supplies rose. The Australian dollar saw a brief bounce higher, but it was short lived.

• Just as investors were getting a little less concerned about oil supply disruptions from Iraq, along comes a scare about problems at European banks. A week ago Austria’s Erste Bank issued a profit downgrade and then the parent company of Portugal’ s largest bank Banco Espirito Santo delayed a debt payment. Investors fear this may be a sign of problems at other Eurozone banks, which might require public support leading to renewed budget blowouts. So far there is no evidence of this but the slow recovery in Europe does present risks, as does the European Central Bank’s (ECB) bank stress tests this year. It’s certainly worth keeping an eye on, but several considerations suggest we won’t see a return to the dim dark days of the Eurozone crisis. Firstly, the problems at both Erste Bank and Banco Espirito Santo (BES) appear to be specific to those organisations rather than indicative of broader systemic problems, e.g. issues in its Romanian and Hungarian businesses for Erste and a troubled parent and exposure to dodgy Angolan loans for Espirito Santo. The exposure of BES to its troubled parent group of companies is more than exceeded by the capital buffer it has relative to minimum capital requirements. Secondly, the backstop support for Eurozone banks is now huge compared to the situation three or four years ago, e.g. the ECB’s commitment to supply cheap funding to banks. Thirdly, the rally in Eurozone banks had arguably gotten ahead of itself. Eurozone banks are down 13% from their high in April this year, but from the Eurozone crisis lows in 2011-12 to their April high they rallied 122%, nearly double the 68% gain in Eurozone shares generally. So a correction was inevitable.

• Results from the Indonesian election may take a week or two to be finalised, but most exit polls suggest a win by Joko Widodo, who is the most market-friendly and reform-oriented of the two candidates, so if he has won it would be a positive for the Indonesian economy and assets. However, it would appear likely to be only a narrow win, so a strong reform mandate may be lacking, unlike in the case of the recent Indian elections.

• The first budget of the new Indian Government was a bit of a non-event in terms of announcing reforms. But it did present a sensible fiscal strategy and should be seen as just a start with significant reform still on the way in India.

Major global economic events and implications

• US data continues to point to stronger US growth. Job openings are at their highest since 2007, consumer credit continues to rise, weekly mortgage applications rose, jobless claims fell and a private survey of June retail sales pointed to solid gains. Meanwhile, the minutes from the US Federal Reserve’ s (Fed) last meeting offered little that was new with the Fed on track to end quantitative easing in October and nothing to change the view that the first rate hike is unlikely till around mid next year. Finally, the June quarter profit reporting season kicked off with a solid result from Alcoa auguring well.

• Japanese data was mostly okay with the June Economy Watchers outlook survey remaining solid, bank lending trending up, a rise in tertiary activity and higher consumer confidence but a sharp fall in machine orders.

• Chinese import and export growth were a little weaker than expected in June, but continue to pick up consistent with better growth. On top of this inflation remains low, posing no constraint to further easing in China.

• The divergence in the state of Asian economies was highlighted in the past week with Malaysia raising interest rates for the first time in three years citing strong growth and inflation risks, whereas the Bank of Korea left rates on hold but with a clear easing bias after revising its growth forecasts down. Korea seems to be more of a special case though with the ferry accident earlier this year having a negative impact on spending.

Australian economic events and implications

• Australian data was rather messy. Consumer confidence rose in July but only slightly and is yet to fully recover its Budget-related slide, but against this business confidence is running slightly above average. Employment also rose by more than expected in June but jobs growth is still not enough to bring unemployment down, with it bouncing back to the top of the 5.8 to 6% range it has been in for the last nine months. The good news though is that leading employment indicators such as ANZ job ads and the hiring component of the National Australia Bank survey are pointing to stronger jobs growth ahead. There was also good news for the construction sector with the Australian Industry Group’s construction purchasing managers’ index rising strongly in June. While housing finance slipped in May adding to evidence of a welcome moderation in momentum in the home buying market, it remains at a high level.

• With interest rates set to remain low and on hold probably into next year and the Budget likely to be softened to get it through the Senate, it’s likely that consumer confidence will gradually improve over the months ahead.

• According to Australian Property Monitors capital city rental growth over the year to the June quarter ranged between -6.6% (in Perth) and +5.6% (in Melbourne). The point though is that with dwelling prices up around 10% over the same period rental yields are continuing to fall.

What to watch over the next week?

• In the US, a key focus will be Fed Chair Janet Yellen’s Congressional testimony starting Tuesday. It’ s unlikely she will waver much from the message following the June Fed meeting which was basically that the economy is improving allowing continued tapering but that monetary tightening is still a considerable time away given slack in the economy. She may elaborate a bit on the risks around inflation and rates and the Fed’s exit strategy. On the data front, expect a 0.6% gain in June retail sales, a 0.3% rise in June industrial production (Wednesday), a further rise in the National Association of Home Builders conditions index (Wednesday) and gains in housing starts and permits (Thursday). Producer price inflation data will also be released.

• The US June quarter earnings reporting season will start to hot up. The consensus is for earnings growth of 6% year-on-year and sales growth of 3%. Given the downgrade from 8% three months ago and a high level of negative profit warnings it’s likely that earnings growth will come in stronger than this.

• Chinese activity data released Wednesday is expected to confirm a pick-up in growth, after the slowdown in the March quarter. June quarter gross domestic product growth is expected to grow 1.8% quarter-on-quarter (after 1.4% quarter-on-quarter) in the March quarter, leaving annual growth at 7.4%. June industrial production is expected to pick up to 9% year-on-year, with growth in retail sales expected to remain unchanged at 12.5%.

• In Australia, the minutes from the last Reserve Bank of Australia (RBA) Board meeting (Tuesday) are likely to express a more dovish bias than seen in the post meeting statement consistent with the more dovish tone seen in the previous minutes and in Governor Steven’s recent speech. Data for dwelling starts (Wednesday) will likely show a further rise.

Outlook for markets

• Could shares have a correction? Yes. As always there is no shortage of possible triggers with Eurozone bank issues back in focus and the potential for a Fed rates scare as the US economy continues to hot up. Are we at a major share market top? No. Valuations are not stretched, particularly if low interest rates are allowed for, global earnings are continuing to improve on the back of gradually-improving economic growth, global and Australian monetary conditions are set to remain easy for some time and there is no sign of the euphoria that comes with major share market tops. In terms of the latter if anything there is still a lot of scepticism – as evident in headlines about capital markets being out of step with reality (Financial Times) and markets being so high that the air is thin (Wall Street Journal) – which is a long way from the sort of confidence that is normally seen when bull markets come to an end. Given all this, any short-term dip in shares 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 led by increasing evidence that US growth is picking up pace. This, combined with low yields, is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.

• While the continuing carry trade from ultra-easy money in the US, Europe and Japan risks pushing the Australian dollar higher in the near term (potentially up to US$0.97), the combination of soft commodity prices, an increasing likelihood that the Fed will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the Australian dollar remain down. RBA jawboning is already making a bit of a comeback.

 

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer