1. Art and Diseño

30 January 2015
Investment markets and key developments over the
past week
Share markets have had a mixed week with messy US
earnings, soft US GDP data and worries about the Fed and
Greece weighing on US shares (-2.8%) and Eurozone
shares (-0.6%), Chinese stocks continuing to go through a
bit of a correction (with a 3.9% fall) but Japanese shares
(+0.9%) and Australian shares (+1.6%) seeing gains. Bond
yields mostly fell. Oil had a bounce from oversold levels
suggesting a base may have been formed around $US45 a
barrel for now. Heightened talk of an RBA rate cut pushed the
$A below $US0.78 for the first time since 2009.
January saw last year’s share market winners, namely the
US (-3.1% in January) and China (-0.8% in January), give up
some of their gains with investors rotating into Europe
(+7.1%), Japan (+1.3%) and Australia (+3.3%). China aside,
there is clearly a bit of investor rotation at play here along with
central bank action, notably the ECB and the Bank of Japan in
easing mode and hopefully the RBA too, but the Fed edging
towards tightening.
Is the negative January in US shares (-3.1% for the S&P
500) a bad sign for the year as a whole? While the January
barometer, "as goes January, so goes the year", has sent a bad
signal, it’s not that reliable when it comes to negative January's
going on to negative years. In fact, since 1980 the hit rate of a
negative January going on to a negative year has only been
38% in the US. The most recent failure on this front was last
year when US shares fell 3.6% in January but rose 11.4% in
2014 as a whole. So a negative January doesn't mean much for
the rest of the year as a whole. It’s not an issue for Australian
shares of course which have had a positive January (up 3.3%),
and where since 1980 positive Januarys have seen positive
gains for the year as a whole 75% of the time.
In Europe, its early days in terms of the new Greek
Government and the Troika (of the IMF, EU and ECB)
reaching an agreement on the Greek austerity and reform
program. While the rest of Europe looks prepared to grant
Greece a bit of relief it’s unlikely at this stage to include another
debt write down, except in maybe extending the term or further
lowering the interest rate. Rather most of the pressure will be
on the Syriza led Greek Government to back down. Faced with
the economic chaos that would result from no deal – as Troika
funding would immediately end and ECB funding for Greek
banks would end leading to an immediate banking crisis, capital
flight and a return to depression – the Greek Government is
likely to back down. However, there is so far no sign of this and
the process could take months and there is likely to be several
hair-raising moments along the way. The better state of other
Eurozone peripheral countries and the ECB’s quantitative
easing program should help prevent much contagion to the rest
of Europe during the negotiation period and beyond if Greece
does end up on a path to exit the Euro.
In the US the Fed continues to indicate that it can be
patient in raising rates. However, while it has clearly become
a bit more sensitive to international developments it also
upgraded its assessment of the US economy to “solid” and
sees the fall in inflation as largely transitory leaving the overall
impression that it sees itself on track to raise interest rate
around June. Markets – which are factoring in a later tightening
– were clearly hoping for something more dovish. For what’s it’s
worth, our view remains for a June first tightening by the Fed,
but the risks are that a further fall in core inflation towards 1%
year on year in the US will see this delayed and the Fed’s
reference to monitoring international developments have given
it an off ramp if it decides to delay.
Outside the US the predominant trend globally is still
towards easing and this is putting massive pressure on the
RBA to do the same. Singapore is the latest country to ease in
the face of massive quantitative easing programs in Europe and
Japan that are forcing other smaller countries to ease unless
they want to see their currencies go higher. This should really
be characterised as “easing wars” as opposed to “currency
wars” and to the extent it is forcing monetary easing around the
world it adds to confidence that sustained deflation can be
avoided. Australia is not immune. If the RBA wants to see a
continued broad based decline in the value of the $A it will
have to join the easing party lest the $A rebounds again on
the back of our still relatively high interest rates.
December quarter inflation data in Australia was not low
enough to provide a smoking gun to justify an RBA rate
cut. However, it was benign enough to provide plenty of
scope for the RBA to cut in order to provide a boost to the
economy. Headline inflation has fallen below the 2-3% target
and is likely to fall to just 0.9% year on year in the current
quarter, underlying inflation is low at 2.2% year on year and
there are plenty of signs of price discounting in areas like
clothing, furniture, household equipment and motor vehicles.
Major global economic events and implications
Timely US data was mostly strong with consumer
confidence at a seven year high, jobless claims down sharply
and strong readings for new home sales, home prices and the
Markit services PMI. However, December quarter GDP growth
at 2.6% annualised was weaker than expected and durable
goods orders were disappointingly soft for the fourth month in a
row. Falling energy company capex may be weighing here, but
it highlights that while the US economy is strong it’s not taking
off. Employment costs rose modestly in the December quarter,
with no sign of further acceleration.
US December quarter earnings are a bit messy. So far 78%
of companies have beaten on earnings and 55% have beaten
on sales, but there have been some high profile misses
indicating that the strong $A is impacting and earnings growth
for the year to the December quarter is running at just 2.7%.
In the Eurozone there was some good news, with economic
sentiment up, credit growth improving, German unemployment
down and Spain growing for a sixth consecutive quarter. Price
deflation continued to intensify in December though.
Japanese data for December was mixed with a fall in
unemployment, a rise in job vacancies to applicants, stronger
industrial production but by less than expected and falling
household spending. Core inflation remains weak once the
impact of the sales tax hike is removed.
Australian economic events and implications
Apart from the December quarter inflation data, other
Australian data over the past week was mostly soft with a
slight fall in business conditions and business confidence
remaining subdued according to the December NAB survey,
skilled vacancies falling for the third month in a row in
December and the terms of trading falling further although by
less than expected. Private credit growth remained around the
same modest 6% annualised pace seen through most of last
year, with investor housing credit still growing around 10% pa,
personal credit remaining weak and business credit perking up
a bit. It’s too early to expect APRA’s macro prudential measures
aimed a capping investor housing credit at 10% growth to have
much impact. Producer price inflation also remains weak.
What to watch over the next week?
In the US, expect to see a slight fall in the ISM
manufacturing conditions index (Monday) but leaving it at a
still strong reading of 55, continued strength in the nonmanufacturing ISM (Wednesday) and another strong jobs report
(Friday). January payrolls are expected to rise by a strong
235,000 with unemployment remaining at 5.6%. However, the
focus in the jobs report is likely to be on wage earnings which
were surprisingly weak in December but are likely to have
bounced back in January. The annual growth rate in wage
earnings is still likely to be just below 2% though. Productivity
and trade data will also be released. US December quarter
earnings results will continue to flow.
In the Eurozone, final January business conditions PMIs
(Monday and Wednesday are likely to confirm the slight
improvements already reported in preliminary estimates.
In Australia, the RBA should cut interest rates by 0.25% on
Tuesday. Growth is too low, confidence is subdued, prices for
key commodities like iron ore and energy have collapsed
resulting in a much bigger hit to national income than expected
a year ago, the $A remains too high on a trade weighted basis
and is set to bounce if the RBA fails to cut soon and benign
inflation provides plenty of flexibility for the RBA to move. It’s
not that I am bearish on the Australian economy. But rather it
makes sense for the RBA to take out some insurance to make
sure growth improves. However, it’s a close call as to whether
the Reserve will actually cut on Tuesday or wait till March as it
may prefer to prepare the way for a cut by dropping the
reference in its post meeting Statement to a “period of stability
in interest rates” being prudent and by lowering its inflation
forecasts in its Statement of Monetary Policy to be released
Friday. Ultimately it doesn’t matter a lot whether it’s in
February or March, but the key is that interest rates need to
come down and I expect they will either on Tuesday or if
not then in March. But it would be easier to get the first cut
out of the way now and hence avoid a short term bounce
back up in the $A. Beyond the first cut there is a 50/50
chance of another cut taking the cash rate to 2% around
May.
Meanwhile, expect the TD Securities/MI Inflation Gauge
(Monday) to show a further fall in inflation in January on further
fuel price declines, a 3% pull back in building approvals
(Tuesday) after November’s surge and a modest rise in
December retail sales (Thursday) but good quarterly growth in
real terms. Data for home prices (Monday), business conditions
PMIs and the trade balance (Tuesday) will also be released.
Outlook for markets
Uncertainties associated with the impact on energy producers
from the plunge in oil prices, negotiations with Greece and the
Fed’s move towards a rate hike could result in a volatile first
half in share markets with the risk of a 10-15% correction at
some point along the way.
However, the broad trend in shares is likely to remain up
as: valuations, particularly against bonds, are good; economic
growth is continuing; and monetary policy is set to remain easy
with further easing in Europe, Japan, China and Australia and
only a gradual tightening in the US. As such share markets
are likely to see another year of reasonable returns.
The Australian share market is likely to do better than in
2014 as growth continues to rebalance away from resources
helped by low interest rates and the fall in the $A. However, it
will probably continue to lag global shares as commodity prices
remain in a long term downtrend. Expect the ASX 200 to rise to
around 5700 by end 2015.
Commodity prices may see a bounce from very oversold
conditions, but excess supply for many commodities is
expected to see them remain in a long term downtrend.
Low bond yields point to soft medium term returns from
sovereign bonds, but it’s hard to get too bearish in a world of
too much saving, spare capacity and deflation risk.
The downtrend in the $A is likely to continue as the $US
trends up and reflecting the long term downtrend in commodity
prices and Australia’s relatively high cost base. Expect a fall to
around $US0.75, with the risk of an overshoot. However, the $A
is likely to be little changed against the Yen and Euro.
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