Weekly Market Update – 23rd May 2014

Investment markets and key developments over the past week

• Share markets rose over the last week, with US shares up 1.2% to a record closing high, Eurozone shares up 1.2%, Japanese shares gaining 2.6%, Chinese shares up 0.4% and Australian shares up 0.3%. However, the lack of decisive momentum seen all year remains a feature, with global and Australian shares up only 2% to 3% year-to-date. After the strong gains last year, shares have been undergoing a bit of a stealth correction with softer-than-expected global growth in the March quarter, the mess in Ukraine and uncertainty about China all playing a role globally and this being added to in Australia by uncertainty regarding the impact of the Federal Budget. The past week also saw bond yields move a bit higher, particularly so in peripheral Eurozone countries where it looks like their sovereign bonds had become a bit overbought. Meanwhile commodity prices were mixed with oil up but the iron ore price down. The Australian dollar fell further, not helped by the lower iron ore price and the fall in consumer confidence, as did the euro on increasing signs the European Central Bank is set to ease next month.

• The minutes from the US Federal Reserve’s (Fed) last meeting confirmed that the central bank is more confident regarding growth picking up and inflation bottoming but not so much that it is signalling an imminent rate hike, which still looks likely to be around mid-next year. That said, as part of its “prudent planning” process, the Fed has started to revisit how it will eventually exit from its extraordinary monetary stimulus measures. New York Fed President Dudley has suggested that it will not start unwinding its stock of bonds until after it first starts raising interest rates. But whatever the order, as the start of tightening approaches it will likely see bond yields move higher.

• Uncertainty remains high around China, but as yet there is still no evidence of a hard landing and we remain of the view that the authorities will do enough to ensure growth comes in around 7.5% this year (which means 7% at least). The combination of a further slowing in house prices in April with official measures to curb the interbank lending market added to fears of a hard landing. This arguably all contributed to a fall in the iron ore price below US$100 per tonne. Against this though a stronger-than-expected bounce back in the HSBC flash manufacturing conditions index for May supports the view that growth may be stabilising after the March quarter slowdown. More announcements of incremental loosening measures add confidence to this. These included announcements of support for employment and allowing ten provinces and cities to issue their own bonds.

• In Australia, a 6.8% slump in consumer confidence and evidence of a fall in retail sales in the last week confirms the Federal Budget has had a negative impact on sentiment. This may prove to be an overreaction, but clearly the Government needs to do a better job of selling the Budget.

Major global economic events and implications

• US data was mostly good. A fall in mortgage applications and a rise in unemployment claims were the main disappointments but the level of claims remains low. More significantly, the Markit manufacturing purchasing managers’ index (PMI) rose to a quite solid 56.2 in May, the leading index rose and home sales rose, albeit after several months of falls.

• European data was also reasonable with May data showing a rise in consumer confidence and in the Markit services sector conditions PMI. The manufacturing conditions PMI fell slightly but the combined services and manufacturing PMI was little changed at 53.9, which is consistent with Eurozone economic growth rebounding to around 0.4% in the current quarter from 0.2% in the March quarter.

• There were no surprises from the Bank of Japan which left monetary policy unchanged, as it’s too early for it to gauge whether the April tax hike has had anything other than a temporary impact on growth. In terms of the latter there are some positive signs with machine orders up in March and the May manufacturing PMI up slightly.

Australian economic events and implications

• In Australia, a slump in consumer confidence confirmed the Federal Budget has had a negative impact on sentiment, with Australian Labor Party voters and those earning between A$60,000 and A$80,000 showing the biggest drop. It does look like a bit of an overreaction though and a similar fall after last year’s Budget saw a bounce back in the subsequent month. This may occur next month as people may still be confused about the impact on their personal finances and many of the Budget measures will take a long time to phase in, even if they do get through the Senate. Meanwhile wages growth held at a record low of 2.6% year-on-year in the March quarter which is another drag on household spending, but at least confirms that labour costs are no threat to inflation.

• The slump in consumer confidence and low wages growth are consistent with the RBA remaining on hold. We were looking for the first rate hike to be around September/October but given the negative reaction to the Budget this is increasingly looking like it will get pushed into 2015. If consumer confidence does not bounce back in the months ahead it’s likely that there will be increasing talk that the next move in interest rates will be down.

What to watch over the next week?

• In the US, the bad news is likely to be that March quarter gross domestic product growth (Thursday) will be revised to -0.6% annualised from an initially reported 0.1% reinforcing that it was a poor quarter. However, a range of indicators suggest growth is bouncing back this quarter. Durable goods orders (Tuesday) are expected to fall slightly but this reflects a payback for the very strong gain seen in March with the underlying trend likely to remain strong. Consumer confidence (Tuesday) is expected to have increased slightly. House prices (Tuesday) are expected to show further gains but pending home sales (Thursday) are likely to be flat after a strong March.

• In Europe, the focus is likely to be on the results from the Ukrainian and European Parliamentary elections. Whether the Ukrainian election resolves the uncertainty hovering over the country is uncertain, but it might help. Low participation in Donetsk and Luhansk are negatives, but what looks to have been a clear victory for Petro Poroshenko is a good outcome. There were no surprises in the European Union elections with increased support for Euroskeptic parties, but leaving them well short of any majority. The protest vote for such parties is perhaps more of an issue for Greece and France, but unlikely to result in a significant change in policy directions beyond the reduced focus on austerity seen over the last year or so. May economic confidence indicators (Thursday) will be watched for an improvement after the slight setback seen last month.

• Japanese data for April will show the initial impact from the recent sales tax hike. This is likely to show up as a fall in household spending and industrial production (both of which were boosted prior to the hike) and a spike in inflation to around 3%. Labour market data is unlikely to be much affected.

• In Australia, March quarter construction data (Wednesday) is likely to remain weak as a rebound in residential investment only partly offsets the ongoing slump in mining investment and March quarter capital spending (Thursday) is expected to show a further decline. Of greater interest will be capital spending intentions data which will show further weakness in mining investment but will be watched for signs that the outlook for non-mining investment is starting to improve. Credit data (Friday) is likely to show a further modest lift in momentum.

Outlook for markets

• Shares remain vulnerable to a mid-year correction, consistent with weak seasonal influences that kick in around May and continue into the September quarter. However, with shares having been in a bit of a stealth correction all year, any pullback may well be mild and in any case the broad trend in shares is expected to remain up. 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. 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 continue to offer poor returns.

• With Australian dollar short positions now largely unwound, it’s likely that the broad downtrend in the Australian dollar is resuming. Commodity prices remain relatively soft, interest rate hikes are getting pushed out and the Australian dollar is likely to revert to levels that offset Australia’s relatively high cost base.

Source: AMP CAPITAL ‘Weekly Market Update’

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