Investment markets and key developments over the past week
- The past week was mixed for share markets. US shares gained +1%, European shares rose +0.9% and Japanese shares rose +0.4%. Share prices were lifted by good economic and profit news. However, worries about Ukraine acted as a constraint, particularly as the week wore on. Chinese shares fell 0.5% and this weighed on some Asian markets. Australian shares also fell, down 1.3% with mining stocks slipping on the back of the falling iron ore price. In addition, talk of a tax hike pushed retailing stocks down by 2%. Bond yields fell, commodity prices were mixed and the A$ was little changed. The value of the A$ was resilient in the face of talk of tax hikes which would dampen the outlook for Australia interest rates.
- US earnings reports for the March quarter provided strong support for shares. So far 375 of the S&P 500 companies have reported and 75% beat earnings expectations by an average 6%. In addition 52% of companies beat sales expectations after earnings growth expectations for the quarter were slashed from +7% year-on-year (yoy) in January to -1% a month ago on the back of bad weather. This has now bounced back to +5%.
- While the much stronger than expected +288,000 gain in US payroll employment in April may have been boosted by the late timing of Easter, it nevertheless adds to confidence that the US economy is picking up pace. However, other US jobs data was a bit more mixed. While unemployment fell to 6.3%, this was due to a decline in labour force participation with a fall in participation among 25-44 year olds looking more like noise than a signal. Hourly earnings were unchanged leaving wages growth weak. Given this the April jobs report is unlikely to see the US Federal Reserve (Fed) bring forward the timing for eventual interest rate hikes.
- The situation in Ukraine is deteriorating with pro-Russian activists taking over more cities and Ukraine forces moving in to try and clear them out. The risk of civil war and Russian intervention is high. Ukraine continues to pose a risk for investment markets to the extent worries might rise about the impact on Europe. Beyond the potential for a short-term impact on markets, we remain of the view that the 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, the National Audit Commission has helped build the case for measures to bring long-term spending growth under control. Reflecting this, the budget is likely to introduce or flag measures to restrict access to pensions and welfare (eg, a tougher means tests and raising the retirement age to 70 by 2035), copayments for Medicare services, reductions in the number of government bodies and more privatisation.
- While there has been much talk of a four year tax hike to help reduce the budget deficit this would be a serious mistake and is hopefully just pre-election kite flying. An increase in the top two marginal tax rates would seriously dent household spending and threaten the economic outlook, further reduce incentive to work and participate in the labour force at a time when we need to boost productivity and participation and is not the right remedy for a long-term spending growth problem.
- Australia is a long way from the sort of budget crisis that Europe and the US face and near-term nominal growth is likely to be higher than assumed in the mid-year fiscal outlook which should result in a slightly faster decline in the budget deficit than currently projected for this year and next. So right now the key is to put policies in place that bring long-term spending growth under control, as opposed to adopting too much austerity in the short term which could threaten the economy and make the deficit reduction task even harder.
Major global economic events and implications
- In the US there were no surprises from the Fed which sounded more confident about a growth pick-up after winter weakness and continued to taper its quantitative easing program. The March quarter saw the US economy virtually stall with just +0.1% annualised growth. However, this was driven by a combination of poor business investment that will improve after being weather affected and negative contributions from inventories and trade which will reverse. Growth in the current quarter is likely to bounce back strongly. Certainly, this is the message from a rebound in the Institute for Supply Management (ISM) index and stronger jobs growth and improved household spending in March.
- Eurozone economic confidence slipped slightly in April with worries about Ukraine, but remains consistent with strengthening growth. While credit growth remained poor, a European Central Bank (ECB) survey of banks pointed to stronger loan demand which is a positive sign. Meanwhile, inflation came in at just +0.7% year-on-year (yoy) in April, and is not low enough to trigger quantitative easing by the ECB.
- Japanese economic data is messy and was distorted by the April sales tax hike. March household spending was strong and is likely to have fallen back in April, with small business confidence and the manufacturing purchasing manager index (PMI) falling sharply in April after the sales tax hike. A positive sign is that the jobs-to-applicants ratio rose in March suggesting employers have a degree of confidence regarding the post tax-hike environment. It is too early for the Bank of Japan (BoJ) to be able to assess the impact of the tax hike and so it left policy unchanged as expected. Conditions are stronger now than they were the last time the sales tax rate was hiked in 1997. Conditions are different now. With the inclusion of quantitative easing, fiscal stimulus, rising property prices, bank lending and consumer confidence, Japan is unlikely to be knocked back into recession this time. If the BoJ does ease further it is unlikely to take action until around July.
- China’ s manufacturing PMI rose slightly in April providing some confidence that growth may have stabilised. More broadly levels remain in the same range it has been in since late 2011, which is consistent with growth running around +7.5%. Meanwhile house price gains slowed further in April confirming that the housing slowdown continues and this provides scope for more easing in restraints on home buyers.
Australian economic events and implications
- Australian economic data was mixed. Credit growth continued to trend modestly stronger in March led by housing investors. While the terms of trade rose in the March quarter this looked temporary given the fall in the iron ore prices. According to RP Data Australia, house price growth slowed in April to just +0.3% month-on-month (mom) but this followed a +2.3% rise in March so could just be noise as opposed to a real slowing. Meanwhile, new home sales remained strong in March. Finally, the AIG’s manufacturing PMI fell again in April to 44.8 highlighting that economic improvement remains patchy and certainly vulnerable to any mis-step by the Government on taxes.
What to watch over the next week?
- In the US, expect a modest increase in the non-manufacturing ISM index (Monday) and a decline in the March trade balance (Tuesday). Fed Chair Yellen will deliver a Congressional testimony on Wednesday.
- The ECB (Thursday) may unveil further monetary easing in response to weak bank lending, deflation risks and the still strong euro. However, this is more likely to take the form of more interest rate adjustments rather than quantitative easing as the ECB does not appear to be ready for easing just yet.
- Chinese export growth (Thursday) is expected to return to positive territory after the weakness of recent months but imports are expected to remain subdued. Inflation data (Friday) are expected to show a fall back in the consumer price index (CPI) inflation levels to +2.1% accompanied by a decline in producer prices.
- In Australia, the Reserve Bank of Australia (RBA) is expected to leave interest rates on hold for the eighth month in a row (Tuesday). While confidence surrounding an increase in non-mining activity has increased uncertainty remains surrounding how this will take over from mining investment as a driver of growth, and how smooth the transition will be given talk of budget tax-hikes adding to the uncertainty. As a result, the RBA is expected to reiterate that a period of stability in interest rates is appropriate. The RBA’s quarterly Statement on Monetary Policy (Friday) is likely to reiterate the same message.
- On the data front in Australia, expect to see a +2% rise in building approvals (Monday), another solid trade surplus (Tuesday), a slight rise in retail sales (Wednesday), a slight fall in employment (Thursday) after three months of good gains and a bounce back in unemployment. Data for ANZ job ads and the Term Deposit Securities Inflation Gauge 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 all helping to entice investors to switch out of cash and into shares. Any dip should be seen as a buying opportunity. For Australian shares much is riding in the short-term on how aggressive the coming budget is with respect to austerity for the next financial year. Tax hikes and aggressive short term austerity, if announced in the budget, would clearly be significant headwinds for the Australian share market.
- 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 A$ short positions now largely unwound, it is likely that the short covering rally in the A$ that saw it rise from a low of US$0.8660 in January to a high of US$0.9461 recently is now over and that the broad downtrend is likely to resume. Commodity prices remain relatively soft and the A$ is likely to revert to levels that offset Australia’s relatively high cost base. Tax hikes if implemented would likely also weigh on the A$. Our medium-term view remains that the A$ will fall to around US$0.80