Weekly Market Update – 3rd October 2014

• Global shares appear to be in the midst of a significant correction which is likely to last until the current ‘event risks’ dissipate. America’s Ebola scare, Iraq’s deteriorating security situation, Hong Kong’s extended pro-democracy protests and Ukraine’s stalemate with Russia is seeing investors prefer the sidelines rather than the main game. Add to this volatile mix the prospect of the American central bank ending the quantitative easing program and European bank stress test results that are due later in October, and it’s understandable that  global investors are feeling cautious. As October is still a seasonally weak period, global shares are vulnerable to further modest falls before turning back up.

• Australian shares have been particularly disappointing in recent weeks as concerns over tighter housing lending standards for banks, weaker commodity prices and a falling Australian dollar has seen global investors selling. However, this appears more a healthy correction than the start of a bear market given that Australian valuations are reasonable, interest rates remain low and credit still appears readily available.

• Similarly global shares are not overvalued and global financial conditions should remain very easy until mid-2015. So this global share correction is viewed as likely to prove a buying opportunity provided the event risks listed above do not intensify.

• Low Government bond yields presently are likely to give subdued returns from bonds over the next year. Given the prospect that the US central bank will start a gradual interest rate tightening cycle in the next six to nine months, rising global bond yields are likely to be a key issue and feature in 2015.

• America’s payroll employment report for September provided a positive surprise. There were strong job gains of +248,000 and the US unemployment rate fell to 5.9% which is a six-year low. Given these encouraging job gains, the US central bank is likely end their quantitative easing program at the end of October. There are also increased prospects that the US central bank will raise interest rates in the next six to nine months.

• Australia’s economic data provided mixed news. Nominal retail trade disappointed in August with only a marginal +0.1% rise but the annual result remains at a healthy +5% pace. Residential housing approvals rose solidly by +3% in August which suggests strong prospects for housing construction for the remainder of 2014.

• There were further warnings to Australian housing buyers and investors from the Reserve Bank of Australia (RBA). The RBA is concerned about “excessive speculative activity” in the housing market. Both the Australian Prudential Regulation Authority and the RBA are discussing “steps that might be taken to reinforce sound lending practices, particularly for investor finance”. This suggests “targeted” measures that include tougher bank loan serviceability tests and higher capital risk weightings for investor housing loans particularly for Sydney and Melbourne by the end of 2014.

• America’s ISM manufacturing survey moderated in September but is still consistent with the US economy posting +3% Real GDP growth for the September quarter (annualised). The ISM survey edged down -2.4 points to 56.6 in September. Given that August’s ISM reading of 59.0 was the highest in 3½ years, September’s ISM pullback is modest. The survey highlighted comments such as “outlook is very good” and “demand seems to be growing.”

• The European Central Bank (ECB) kept the key interest rate at the historic low of 0.05% and maintained the commitment to provide Europe’s banks with extra liquidity and make asset purchases over the next two years. The ECB President Dr Mario Draghi conceded that Europe still faced “downside risk” with the “recent weakening in the Euro area growth momentum alongside heightened geopolitical risk”. Europe’s recovery “is likely to be dampened by high unemployment, sizable unused capacity, continued negative bank loan growth to the private sector and necessary balance sheet adjustments”. Europe’s unemployment rate remained high in August at 11.5% while price pressures are minimal with August’s CPI annual inflation rate only at 0.3%.

• China’s official Purchasing Managers’ Index (PMI) measure shows a steady manufacturing sector in September. The NBS PMI held at 51.1 in September and remains above the recent low of 50.2 recorded in February 2014. This is in marked contrast to the sharp slowing in China’ s industrial production (August’s +6.9% gain year-on-year was the weakest since 2009).

• Japan still appears in a gradual recovery after April’s consumption tax hike negatively impacted activity. Japan’s Markit PMI manufacturing survey eased back -0.5 points to 51.7 but is still well above the low of 49.4 set in April 2014. Japan’s labour market also softened after the April sale tax hike but has since improved. Japan’s unemployment rate has fallen from 3.8% in July to stand at 3.5% in August. The jobs-to-applicants ratio stands at a healthy 1.1 in August (highest in 22 years) for the third consecutive month, indicating solid labour demand.

• Nominal retail sales disappointed in August with only a marginal gain of +0.1%. This follows July’ s +0.4% rise. While there were healthy results for other sales (+1.6% rise for media and pharmaceutical) and clothing (+0.3% month-on-month) in August, these were countered by sharp falls in department stores (-2.9% mom) and household goods (-0.8%). Over the past year, nominal retail sales have increased by +5.1%. This remains a welcome improvement over the 2010 – 2012 experience with +2.8% annual growth in retail sales.

• Residential housing approvals rose solidly in August with a 3% monthly gain. This suggests strong prospects for housing construction for the remainder of 2014.

• Australia labour force data for September should provide an important gauge of economic activity. However the problem is that August’ s data was distorted by an extraordinary +121,000 gain in jobs. So the Australian Bureau of Statistics is having major problems measuring the labour markets performance. Focus will centre on the unemployment rate as the most credible and realistic measure. Australia’s unemployment rate is expected to drift higher from 6.1% to 6.2% in September reflecting the recent run of modest economic activity results (for example, retail sales) as well as business and consumer sentiment measures recently.

• China’s monetary aggregates for September are due next week. This data will provide a timely measure of credit growth. Financial markets will be trying to decipher the importance of the current property market downturn on financial conditions and the “shadow banking system” performance. Modest credit results will provide the Chinese central bank with flexibility to relax policy if needed to support economic growth.

• The US Federal Reserve will release the September meeting minutes. These will be examined for any guidance on when the US central bank is likely to start raising interest rates in 2015.

• Global shares generally had a generally negative week. European shares were particularly negative with Germany’s DAX (-3.3% fall for the week), Britain’s FTSE (-1.8%) and Italy’s share index (-2.7%) recording significant falls. Japan’s Nikkei also struggled with a -3.2% decline for the week. America’s shares – as measured by the S&P 500 – also fell by -0.8% but the decline was moderated by a Friday rally. By contrast there was more resilience with Australia’s ASX 200 being flat for the week.

Source: AMP CAPITAL ‘Weekly Market Update’

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