Weekly Market Update – 25th April 2014

Investment markets and key developments over the past week

• The past week saw Australian shares gain +1.4% helped by news of low inflation, but US and Eurozone shares fell on Friday on the back of renewed worries about tech stocks leaving them both down -0.1% for the week. Chinese shares fell -2.9% on concerns about new share offerings and Japanese shares fell -0.6%. Increasing tensions in Ukraine are also weighing on investor confidence. Bond yields mostly fell with 10 year yields in Italy and Spain pushing down to near 3%. Oil prices fell but gold and metal prices edged higher. While the yen and euro were little changed, weaker than expected inflation saw the Australian dollar fall.

• US earnings reports for the March quarter are providing strong support for shares, after expectations were pushed too low following poor winter weather. So far 239 S&P 500 companies have reported, with 75% beating earnings expectations, including Boeing, Apple and Caterpillar, by an average 5.8%, and 53% beating sales expectations.

• Despite hopes for a diplomatic solution before Easter the crisis in Ukraine is dragging on, with a renewed risk that conflict with pro-Russian activists in eastern regions will form the pretext for a Russian intervention. While the April 17 Geneva deal that would see a move towards a Federal structure for Ukraine could still work out, the risks of an escalation causing short term volatility in investment markets has increased again. We remain of the view though that Ukraine is unlikely to derail the global economic recovery or bull market in shares as the US and Europe are unlikely to get too heavily involved.

• In Australia, benign March quarter inflation data has added to confidence that the Reserve Bank of Australia (RBA) will keep interest rates on hold for a while yet.

• A softening up prior to budgets is normal in Australia – every year we seem to hear it will be a tough budget – but Treasurer Joe Hockey looks to be pretty serious this time around with numerous speeches and comments providing a pretty consistent picture. The bottom line is that Australia’s budget outlook is unsustainable, relying on stronger growth won’t solve the problem and the focus has to be on slowing long term growth in areas of the budget that are growing well above average, notably health, welfare and pensions and that this will involve more limited access to such services. Measures such as raising the pension age, greater means testing and co-payments for government services to kick in in the years ahead are looking inevitable. While this will be tough, it’s necessary if Australia is to get its long term finances back under control, ensure that government benefits and services like the pension remain strong for those who need them and at the same time is preferable to a short term slash and burn budget that would threaten economic growth only to make it harder to get back to surplus.

Major global economic events and implications

• The US economy continues to emerge from its winter slumber. While new home sales were much weaker than expected, durable goods orders rose strongly and augur well for an acceleration in capital spending. Consumer confidence increased, existing home sales beat expectations, home prices continue to rise, the leading index rose strongly in March and the preliminary Markit manufacturing Purchasing Managers’ Index (PMI) remained strong at 55.4 but not so strong that it will invite talk of earlier US Federal Reserve (Fed) rate hikes.

• The Eurozone economy is continuing to mend. Not only have bond yields plunged in troubled peripheral countries, but business conditions PMIs are continuing to trend higher with April readings at levels consistent with annualised growth running around +2% and consumer confidence is continuing to improve.

• China’ s growth may be stabilising with policy fine tuning providing support. While the flash HSBC manufacturing conditions PMI rose fractionally in April suggesting growth may be stabilising, the authorities have continued to announce policy fine tuning measures, with the latest being reduced reserve ratio requirements for regional banks coming on top of tax cuts for small firms, spending on railways and shantytown rebuilding along with easier interbank liquidity and the lower renminbi. There won’t be any large stimulus program, but these measures are adding up and will help support growth around the +7.5% level for this year.

• Korean Gross Domestic Product (GDP) growth accelerated to +3.9% year-on-year in the March quarter from a low of +2.1% 12 months ago, helped by the pick-up in global growth and Korean policy stimulus.

Australian economic events and implications

• Inflation is benign. March quarter inflation of just +0.6% quarter-on-quarter with similarly low underlying readings highlights that the higher than expected inflation readings seen in the second half of last year were an aberration and that inflation remains under control. This was also evident in the components with an excise increase driving higher tobacco prices and seasonal increases in health and education costs but with offsetting weakness in prices for clothing, household equipment and travel. While private sector inflation remains benign at around +2% year-on-year, there remain concerns about the ongoing strength in government-related prices which were up around +5.8% year-on-year. This calls for more deregulation and less government involvement in the economy.

• While the March quarter inflation outcome was not low enough to see a return of the RBA’ s easing bias, it does mean that there is no pressure for any early rate hike. We remain of the view that the RBA will leave interest rates on hold for the next four or five months ahead of the first rate hike around September/October.

What to watch over the next week?

• In the US, the Fed (Wednesday) is expected to continue the process of tapering by reducing its bond buying program by another $US10 billion taking it to $US45 billion a month, and is likely to express confidence that growth is picking up in line with its expectations after a soft patch through winter. On the data front expect to see a modest rise in April pending home sales (Monday), continued strength in home prices and a slight rise in consumer confidence (both Tuesday), March quarter GDP growth of just +1.5% annualised (Wednesday) thanks to the winter freeze, a slight gain in the manufacturing ISM index to 54 (Thursday) and a solid +210,000 gain in April payrolls and a fall in unemployment to 6.6% (Friday). March quarter earnings results will also continue to flow.

• Eurozone confidence measures (Tuesday) are expected to show further improvement, but inflation (Wednesday) is likely to have remained very low maintaining the pressure on the European Central Bank for further easing.

• It’s too early to expect further easing from the Bank of Japan (Wednesday) as not enough data has been seen post the sales tax hike, but it is likely to signal that it stands ready to act if needed. Further action is unlikely until around June though. Japanese industrial production (Wednesday), household spending and employment data (Friday) for March will be a bit dated given the tax hike.

• The official Chinese manufacturing conditions PMI for April (Wednesday) is likely to have increased slightly after the soft patch seen last quarter.

• In Australia, the Government’s Commission of Audit will be released Thursday and as already foreshadowed by the Treasurer will paint a bleak picture of Government finances and provide 86 recommendations to bring the budget back under control and improve public sector efficiency. On the data front expect a continued gradual improvement in credit growth (Wednesday) driven by housing credit and a slight rise in the AIG’s manufacturing conditions index for April (Thursday). Producer price inflation data (Friday) is likely to have remained benign. Data for house prices (Thursday) and new home sales (Friday) will also be released.

Outlook for markets

• While investors should allow for more volatility in share markets, including the likelihood of a significant correction around mid-year, the broad trend in shares is likely to remain up. Share market fundamentals remain favourable with reasonable valuations, improving earnings on the back of rising economic growth and easy monetary conditions helping entice investors to switch out of cash and into shares. 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 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.

• With Australian dollar short positions now largely unwound, it’s likely that the short covering rally in the Australian dollar, that saw it rise from a low of $US0.8660 in January to a high of $US0.9461 recently, is now largely over and that the broad downtrend is likely to resume. Commodity prices remain relatively soft and the Australian dollar is likely to revert to levels that offset Australia’s relatively high cost base. Renewed RBA jawboning in the months ahead is also likely to weigh on the Australian dollar. Our medium term view remains that the Australian dollar will fall to around $US0.80.

Source: AMP CAPITAL ‘Weekly Market Update’

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