Weekly Market Update – 16th May 2014

Investment markets and key developments over the past week

• The past week saw more messy and volatile trading in share markets with some mixed economic data and corporate news in the US and intensifying concerns about Ukraine weighing on US and European shares. US shares were flat, Eurozone and Japanese shares fell 0.7% but Chinese shares gained 0.8%. While the measures announced in the Australian Federal Budget were slightly milder than expected, the Budget provided some relief for the Australian share market. Overall its impact was negligible, with Australian shares up 0.3% for the week. Bond yields fell further, despite signs that US inflation looks to be bottoming. Commodity prices mostly rose, but the Australian dollar was little changed. However, the euro remained under pressure on increasing expectations for a European Central Bank (ECB) easing next month.

• The situation in Ukraine continues to deteriorate towards full blown civil war with no signs of a solution just yet. Whilst we remain of the view that the US and Europe will avoid getting too heavily involved in a way that threatens the global economic recovery, nevertheless the situation in Ukraine could cause volatility in markets to rise in the near term.
  The BJP-led alliance’s overwhelming victory in the Indian election is good news for India as it should usher in a new round of economic reforms – after they have been sadly lacking over most of the past decade, as evident in a now poor growth/inflation trade-off. This will likely include fiscal consolidation, cutting red tape and bureaucracy and re-starting stalled projects. A large parliamentary majority will help smooth the reform path, but even so in the short term it won’t be easy. After a huge surge to relatively high valuations, Indian shares are due for a correction and the realisation that the reform process will take a while to bear fruit may be the trigger. However, the new Government’s policies should be a big positive for Indian assets on a long term basis.

• In Australia, the Federal Budget (regardless of media hype) proved not to be as tough as feared with new budget savings amounting to just 0.1% of gross domestic product (GDP) in 2014-15 and 0.3% in 2015-16. While most of the key measures – welfare cut backs, tax hikes for high income earners, the reintroduction of fuel excise indexation, etc. were as expected, the phased introduction of many of the spending savings along with extra spending on infrastructure mean that the tightening builds over time , allowing some time for those affected to plan ahead. 

• The risks though are clear: the household sector bears a lot of the brunt of the budget savings and this could weigh on confidence in the short term and of course, some of the key budget measures may not pass the senate (at least without some compromise) and the next election poses a threat to many of the long term savings. An outworking of the threat to growth though via reduced confidence is that the first rate hike – which we have been anticipating for September/October – may be delayed into next year.

• New Zealand remains on track for a budget surplus in the next financial year, five years ahead of Australia on current projections. The country’s top marginal tax rate is just 33% (albeit it kicks in earlier than in Australia).

Major global economic events and implications

• US data was mostly positive. The key disappointments were another fall in the NAHB home builders’ conditions index and a fall in industrial production. Against this, the trend in retail sales growth remains strong, small business confidence rose, manufacturing conditions in the New York and Philadelphia regions were strong, housing starts and permits to build new homes rose strongly and unemployment claims fell. Inflation readings – with a stronger than expected gain in producer prices and consumer price inflation bouncing up to 2% year on year from 1.5% as a distortion from a year ago dropped out – add to evidence that inflation has bottomed. Core inflation remains low at 1.8% but nevertheless, debate is likely to increase over the next six months as to when the US Federal Reserve (Fed) will commence rate hikes. This might cause bouts of volatility in investment markets.

• Eurozone March quarter GDP data showed a softer than expected 0.2% rise, taking the annual growth rate to 0.9% which confirms that its recovery is continuing. However, the recovery remains patchy and slow. Inflation remains very low at 0.7% and together with slow bank lending and the strong euro, presents a concern for the ECB. Reports that the Bundesbank is ready to support various ECB easing measures excluding the purchase of sovereign bonds, add to expectations for an ECB easing in June. This is likely to take the form of further rate cuts, the additional supply of liquidity and possibly the purchase of private sector asset backed securities.

• Japanese March quarter GDP at 1.5% quarter on quarter was much stronger than expected reflecting strong growth in consumption and investment, but it was distorted by the bring-forward effect of the April tax hike, so it is likely to be followed by very weak growth this quarter. However, the fact that it was well above expectations is positive in suggesting underlying momentum is solid. Gains in the Economy Watchers outlook survey and April machine tool orders also provide confidence that the negative impact of the tax hike will be temporary.

• Chinese April economic activity data was disappointingly soft with industrial production, fixed asset investment and retail sales all a bit slower on a year on year basis. Clearly the property sector slowdown is continuing to weigh. However, business confidence reportedly rose to a five-month high, money supply growth picked up a notch and the softness in growth points to further policy fine tuning to ensure growth this year comes in around 7.5%. And we are seeing more cities ease property restrictions, now that property price momentum has faded. Expect the Renminbi to stay weak and a gradual easing in monetary conditions.

Australian economic events and implications

• Australian economic data told us nothing new. Business conditions remained around flat in April according to the latest NAB business survey but confidence and employment indicators improved. New housing finance slipped slightly in March but after a 40% or so gain over the last two years it should start to peak soon (otherwise we will really have to start worrying about a bubble). Finally, the ABS home price index gained another 1.7% in the March quarter but this is down from three very strong quarters and so may represent a healthy moderation in momentum. We anticipate house price gains to continue this year but at a slower pace than seen last year.

What to watch over the next week?

• In the US, minutes from the last Fed meeting and a speech by Fed Chair, Janet Yellen (both on Wednesday) will be watched for clues on the outlook for interest rates after tapering ends, but are likely to indicate the Fed still sees that rate hikes remain a fair way off. On the data front, expect the Markit manufacturing conditions PMI (Thursday) to have remained around the solid 55 level and April data for both existing home sales (Thursday) and new home sales (Friday) are likely to show bounces.

• Eurozone business conditions PMIs (Thursday) are likely to remain around the 53-54 level, consistent with continued economic recovery. European Union parliamentary elections (starting Thursday) are likely to see ‘euroskeptics’ do well, but this is unlikely to change policy directions much in Europe.

• The Bank of Japan meets Wednesday but is likely to remain on hold, awaiting more clarity on whether or not there has been any lasting impact from the sales tax hike.

• China’s flash HSBC PMI (Thursday) is expected to rise slightly, with an MNI confidence survey pointing up.

• In Australia, the minutes from the Reserve Bank of Australia’s (RBA) last Board meeting (Tuesday) will likely again confirm that the RBA sees rates remaining on hold for some time yet. Meanwhile, consumer sentiment data (Wednesday) will show households’ initial response to the Budget and it’ s likely to be negative given all the noise about cutbacks and tax hikes. Wages data (also Wednesday) is likely to show that wages growth remains very weak at an annual pace of around 2.5%, which should provide further comfort to the RBA that inflation will remain contained.

Outlook for markets

• Shares remain vulnerable to a 10-15% correction around mid-year, with worries about China, the risk of earlier than expected Fed rate hikes and the situation in Ukraine all being potential triggers. However, any mid-year correction is likely to be in the context of a continuing upward trend for shares. Share market fundamentals remain favourable with reasonable valuations, global earnings are improving on the back of rising economic growth and monetary conditions are set to remain easy for some time. So any dip should be seen as a buying opportunity. With the Budget proving not to be as tough as feared, our year-end target for the ASX 200 remains 5800.

• Bond yields are likely to resume their gradual rising trend as it becomes clear that US inflation has bottomed, 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.

• Cash and bank deposits also continue to offer poor returns.

• With A$ short positions now largely unwound, it’s likely that the short covering rally in the A$ that saw it rise from a low of US$0.8660 in January is over and that the broad downtrend is likely to resume. Commodity prices remain relatively soft and the A$ is likely to revert to levels that offset Australia’s relatively high cost base.

 

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer  FinSec Partners Disclaimer