Weekly Market Update – 17th March 2014

Investment markets and key developments over the past week

• The past week saw worries about Chinese economic growth and tensions regarding Ukraine ahead of the referendum in Crimea combine to push shares and industrial commodity prices sharply lower. At the same time, bonds benefited from safe-haven demand. Over the week US shares fell 2%, Eurozone shares fell 3.1%, Japanese shares fell 6.2%, Chinese shares fell 2.6% and Australian shares fell 2.4%. Oddly though, the normally China-sensitive Australian dollar held up well, helped by unbelievably strong February employment data in Australia.
• My view on Ukraine remains that some form of negotiated solution is ultimately likely with the US and Europe unlikely to want to wade in too heavily. That said, the situation looks like it could easily get worse before it gets better. Unsurprisingly, Crimeans appear to have voted to join Russia, so the key will be how Russia responds. If it uses it as a bargaining chip in negotiations the crisis could settle down. Alternatively, it may make it emboldened to do more bringing into play retaliatory trade sanctions. Trade sanctions will have little impact on the US, but could dampen Eurozone growth a bit. Tensions with Ukrainian forces in Crimea after the vote and in eastern Ukraine also risk escalating the crisis. So it looks like Ukraine will remain a threat for investment markets for a while yet.
• There is no denying that Chinese economic data has been much weaker than expected. January/February exports, industrial production, retail sales, investment and housing starts were all worse than expected and growth in credit continues to moderate. Quite clearly efforts to reduce credit growth are having an impact.
• However, while the recent weak Chinese data is concerning, there is too much angst about the Chinese growth slowdown. Sure, a halving in Chinese growth this year would have a big negative impact globally, but whether its 7.5% or around 7% is neither here nor there. Chinese growth has been trending down for four years now and the world has been getting used to it. As the Chinese economy is almost twice as big as it was in 2007, 7% growth today implies a similar incremental increase in real economic activity as 13% growth did in 2007. By the same token the slowing in Chinese growth coming at a time when commodity supply has picked up means there is less chance of a surge in commodity prices that would pose a major problem for the US, Europe and Japan. Finally, while recent Chinese data has likely been distorted by the timing of the Chinese New Year, the slowdown in Chinese growth has been by design to head off imbalances in the economy, i.e. it’s not out of control. And the Chinese authorities have plenty of scope to support growth should it fall much below their 7% floor. This could involve a cut to banks’ required reserve ratios and measures to boost consumer spending. In fact, the fall in the renminbi and much lower money market interest rates recently suggests the People’s Bank of China may already be starting to ease. In terms of corporate defaults, of which there should and likely will be more – particularly in troubled industries like steel, cola, cement and solar – Premier Li has pointed out they can’t be avoided but that the Government will aim to control any systemic risk.
• On a positive note the improvement in some peripheral Eurozone countries is worth noting with Portugal seeing economic growth rebound to 1.7% through last year and the latest Manpower Employment Outlook surveys suggesting that Greece, Ireland and Spain are all likely to see employment growth over the year ahead.
• In Australia, recent comments by both the Prime Minister and the Treasurer provide a bit of confidence that the Government will be focusing on long-term spending cuts in the May Budget rather than a short-term slash and burn. Time will tell, but it’s clear that cutting too heavily in the short term will only threaten the economy and could prove self-defeating in terms of getting the budget under control. So while the May Budget is likely to be tough its toughness is likely to be spread over many years.
• Across the Tasman, New Zealand became the first developed country to raise interest rates (by 0.25% to 2.75%). Its rates have been lower for longer than in Australia and its economic recovery is far more advanced.

Major global economic events and implications

• US economic data was light on and messy with weaker than-expected-wholesale sales, a fall in small business and consumer confidence and reduced mortgage applications on the one hand but slightly better-than-expected February retail sales and a fall in jobless claims on the other. The weather is continuing to play havoc with US data releases, but the picture should start to look clearer – and a bit stronger – in the month ahead.
• In Japan while machinery orders rebounded, bankruptcies fell and a tertiary activity index rose, various confidence indicators were softer, bank lending slowed and December quarter gross domestic product growth was revised down. The Bank of Japan left monetary policy unchanged as expected and is likely preserving its firepower till after it sees the impact of the April sales tax hike is clear.
• Indian production was stronger than expected in January but it’s only up just 0.1% year-on-year and consumer price index inflation came in less than expected but it was still 8.1%. So the growth/inflation trade-off is not what it was last decade.

Australian economic events and implications

• Australian economic data was messy, but does not change our expectations for a pick-up in growth this year. The main negative was a further fall in consumer confidence in March with bad news on the labour market clearly having an impact. However, it’s still around its long-term average level and remains well up on its 2011 low. The National Australia Bank (NAB) survey’s measure of business conditions also fell in February but the trend remains up and business confidence only fell slightly from a reasonably solid level. Housing finance also fell in January but it’s still up 23% on a year ago and it looks more like a pause after several strong months. On the strong side though, employment jumped a very strong 47,000 in February with January employment revised up. This is a great gain, but it looks too good to be true with the Australian Bureau of Statistics warning that sample rotation may have distorted the jobs figures and the still-rising trend in unemployment telling us the jobs market is still soft. That said, while the February figures look too strong the previous months now look too weak with the truth in between, i.e. the labour market is soft but it’s not collapsing. The really good news is that forward-looking labour market indicators such as the ANZ job ads survey, skilled vacancies, the NAB employment intensions survey and the latest Manpower survey all suggest the labour market may be in the process of bottoming.

What to watch over the next week?

• The situation in the Ukraine after the Crimean vote will likely be the main focus globally in the week ahead.
• In the US, attention will be on the US Federal Reserve (Fed) (Wednesday) which is expected to cut its quantitative easing program by another US$10 billion to US$55 billion per month as the tapering process continues. While the Fed will no doubt debate the impact of recent poor weather in suppressing economic data, it is likely to conclude that the underlying momentum remains solid enough to press on with tapering for now. With the unemployment rate pushing down to near its 6.5% threshold it is likely to change its forward guidance regarding interest rates to reinforce that rates will remain near zero long after quantitative easing ends.
• On the data front in the US the March National Association of Home Builder’s conditions index (Monday) is likely to bounce back after weather-affected weakness, but February housing starts (Tuesday) and existing home sales (Thursday) are likely to have remained soft with poor weather still impacting in February resulting in only modest improvements. Inflation (Tuesday) is likely to have remained benign, albeit providing confidence that it’s bottoming. Data for industrial production and regional manufacturing conditions surveys will also be released.
• In Australia, the minutes from the last Reserve Bank of Australia Board meeting are likely to reiterate that the central bank is comfortable with the way the economy is responding to low interest rates but that uncertainty remains around the handover from mining investment to the rest of the economy and as a result a period of stability in interest rates remains appropriate. It is also likely to reiterate that it still sees the Australian dollar as high. Data for car sales, goods imports and skilled vacancies will also be released.

Outlook for markets

• With worries around various emerging markets – notably China and Ukraine at present – 2014 is already shaping up as a more volatile year for shares. More broadly, share market investors should allow for 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. Our year-end target for the ASX 200 remains 5800.
• 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 Australian dollar 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.

Source: AMP CAPITAL ‘Weekly Market Update’
AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer 

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