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Shane Oliver
Financial markets
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Shane Oliver is head of investment strategy at chief economist at AMP Capital.

Is this 1997-98 all over again?

Monday, August 24, 2015

By Shane Oliver

Investment markets and key developments over the past week

The global share market correction continued over the last week as worries intensified regarding emerging countries, their currency rout and the impact on global growth along with the ongoing fall in commodity prices.

Even Greece and tensions between North and South Korea got a look in. Messy profit results also didn’t help Australian shares. For the week US shares fell 5.8%, Eurozone shares lost 6.7%, Japanese shares fell 5.3%, Australian shares fell 2.7% and Chinese shares lost 11.5%. Reflecting investor nervousness, oil and metal prices remained under pressure and bonds benefitted from safe haven demand. Emerging market currencies fell further and weak Chinese economic data put renewed pressure on the $A.

From their highs earlier this year US shares have now lost 7.5%, Japanese shares are down 7%, Australian shares are down 13%, Eurozone shares are down 14%, Asian shares have lost 20% and Chinese shares are down 32%. With US shares only having just broken down technically they likely have more short term catch up ahead.

Is this 1997-98 all over again?

The past week has seen a further intensification of concerns regarding the emerging world with a range of general and country specific factors coming together, including the ongoing plunge in commodity prices, more falls in emerging market currencies (with Vietnam devaluing and Kazakhstan abandoning its currency fix) as China's 3% devaluation continues to reverberate, the bombing in Thailand, a reference by the Fed to global weakness presumably mainly in emerging countries and worries about China with the explosion in Tianjin not helping.

Fears of a re-run of the 1997-98 Asian-emerging market crisis are building again. Such fears are of course not new - we saw similar worries early last year with talk of the fragile five - and emerging market (EM) currencies have been plunging since 2011 (now down 36% on average) and their share markets underperforming over the same period.

The EM world is arguably much stronger than it was is 1997-98 with stronger current account balances, higher foreign exchange reserves and mostly floating as opposed to fixed exchange rates (which mean they don't have to be defended from speculative attacks).
However, some of the emerging world is suffering from a return to populist policies and a reversal of economic reforms so the EM crisis could go on for a while yet. What may be needed to end the negative feedback feeding through global currency and share markets at the moment though is a policy easing.

This came in 1998 with Fed monetary easing. While it’s now looking unlikely the Fed will tighten in September, a circuit breaker policy easing this time around ideally needs to come from China – so keep an eye out for further Chinese stimulus measures. Expect China to cut its benchmark interest rate below 4% from 4.85% currently and step up fiscal stimulus.

Reporting season
The Australian June half profit reporting season is now almost two thirds done and overall the results have been a little disappointing - 43% of results have beaten expectations and 60% have seen their profits rise from a year ago which is okay, but it’s well down on what we have been seeing in the last few reporting seasons.

Resources companies have remained under pressure, industrial profit margins have been weaker than expected and the banks have been mixed and guidance for the current financial year has been a bit downbeat.

As a result profits now look to have fallen by around 2% over the last financial year and expectations for the current financial year have been downgraded to around 2%.

However, it’s not all doom and gloom. Profits are still growing outside the resources sector by around 7% with companies exposed to housing and NSW and Victoria generally doing well, the lower $A should provide and dividends are continuing to rise solidly. So there is a bit of light at the end of the tunnel.

What to watch over the next week?

US economic data releases over the week ahead are expected to be positive. Expect to see further gains in home prices (Monday), a bounce back in both new home sales (Tuesday) and pending home sales (Thursday), a stronger reading for August consumer confidence (Tuesday), a further modest trend gain in underlying durable goods orders (Wednesday) and an upwards revision to June quarter GDP growth to around 3% annualised. Meanwhile, the core consumption deflator for July (Friday) is expected to show that inflation remains low at 1.3% year on year.

In the Eurozone, economic confidence indexes (Friday) will be watched to see if the solid levels of July have been sustained.

Japanese economic data for July (Friday) is expected to show continued strength in the labour market and an improvement in household spending but inflation remaining too low.

In Australia the focus will be on business investment. June quarter construction data (Wednesday) is likely to show a 2% decline with a rise in residential building being offset by the ongoing downturn in mining construction. June quarter capex (Thursday) is also likely to show a 2% decline with plans for the current financial year likely to show ongoing softness. All of which is likely to reinforce the case for a further interest rate cut and decline in the value of the $A.

The June half Australian profit reporting season will wrap up with around 80 major companies reporting including Lend Lease, BHP, Worley Parsons, Origin and Woolworths.

Outlook for markets


Share markets are likely to see a further correction in the next few months. We are still in a seasonally weak period of the year for shares, uncertainties regarding China and the emerging world are likely to intensify in the short term posing risks for global growth and the US share market has only really just joined in the correction. Worries regarding a Fed rate hike in the run up to its September meeting are certainly not helping.

But beyond the near term, the cyclical bull market in shares is likely to resume. Valuations against bonds are good and are now getting even better as bond yields fall and share market earnings yields rise; monetary conditions are set to remain easy with the latest global growth scare likely to drive further global monetary easing and see the Fed delay raising rates yet again; this in turn should help see the global economic recovery continue; and finally investor sentiment is deteriorating rapidly into the sort of pessimism that provides great buying opportunities.

As such, despite the current significant set-back share markets are likely to remain in a broad rising trend. Given this I am reluctant to ditch my year-end target of 6000 for the ASX 200.

Low - and getting even lower - bond yields point to soft medium term returns from bonds.

The broad trend in the $A remains down as the Fed is still likely to raise rates sometime in the next six months despite ongoing delays, whereas there is a good chance the RBA will cut rates again and the trend in commodity prices remains down. Our view remains that it is heading into the $US0.60s.

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Reporting season so far

Monday, August 17, 2015

By Shane Oliver

Reporting season

It’s early days in the Australian June half profit-reporting season, but so far the results have been rather mixed. 51% of results have beaten expectations and 61% have seen their profits rise from a year ago which is good, but good results often come out early on and at the same point in the February reporting season these numbers were 60% and 76%.

Despite this, dividends are continuing to surge with 68% of companies so far raising their dividends and only 8% cutting them. Other key themes are ongoing weakness amongst resources and mining services companies, slowing profit growth for the banks at the same time they are raising more capital and ongoing cost control.


What to watch over the next week?

In the US, the minutes from the Fed’s last meeting (Wednesday) are expected to confirm that it remains on track for a rate hike later this year. On the data front, expect to see continued strength in home builders’ conditions (Monday) and housing starts (Tuesday) but a slight fall in existing home sales (Thursday). Core CPI inflation (Wednesday) is expected to remain low at 1.8% year on year. New York and Philadelphia regional Fed manufacturing surveys will also be released and the Markit manufacturing PMI (Friday) for August is likely to remain solid at around 53.8.

Japanese June quarter GDP (Monday) is expected to show a decline after two quarters of growth.

In Australia, the minutes from the last RBA Board meeting (Tuesday) are likely to confirm that the RBA is happily on hold for now. Data for car sales, the Westpac leading index and skilled vacancies will also be released.

The June half Australian profit-reporting season will really ramp up with around 80 major companies reporting results, including QBE, Qantas, Wesfarmers, Stockland and AMP. Profit growth for 2014-15 is likely to be around -1% as resource sector profits slump 28% thanks to the hit from lower commodity prices, but with the rest of the market seeing profit growth of around 9% as industrials ex financials benefit from low interest rates, the lower $A and cost cutting.

Outlook for markets

Share markets are at risk of a further correction in the next few months as we are still in a seasonally weak period of the year for shares, uncertainties remain regarding Chinese economic growth and a likely Fed interest rate hike lies ahead. In fact, the declining breadth of gains in the US share market, with just two sectors, health care and retail, keeping the market up point to a rising risk of a correction in US shares.

But beyond the near term, the cyclical bull market in shares likely has further to go:  valuations against bonds are good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to remain in a broad rising trend. My year-end target for the ASX 200 remains 6000.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity.

Notwithstanding the risk of a short term bounce from oversold levels, the broad trend in the $A remains down as the Fed is likely to raise rates later this year whereas there is a good chance the RBA will cut again and the trend in commodity prices remains down. Our view remains that it is heading into the $US0.60s.

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Cost cutting focus of earnings reports

Monday, August 10, 2015

By Shane Oliver

June half profits

While the June half earnings reporting season is underway, too few companies have reported so it’s far too early to draw any general conclusions, but it’s interesting that while Rio's profits were down sharply they were stronger than expected and it continues to ramp up dividends which is appropriate as its hardly the time for miners to be ramping up investment, whereas ANZ's capital raising and earnings update highlight the environment has become tougher for the banks.

What to watch

In the US, expect to see a rebound in July retail sales growth (Thursday) after June weakness and solid growth in industrial production, a rise in consumer confidence and low producer price inflation (all due Friday). The NFIB small business optimism survey and data on job openings and hirings will also be released.

Eurozone June quarter GDP data (Friday) is likely to show a further slight pick-up in GDP growth to 0.5% quarter on quarter or 1.5% year on year, with Spanish growth out in front.

In China, expect July activity data to show a slight further slowing in growth in industrial production to 6.6% year on year, but stable growth in retail sales of around 10.6% and fixed asset investment of around 11.5% (all due Wednesday).

Growth in money supply, bank lending and credit is likely to slow from June levels but remain accommodative.

In Australia, expect the July NAB business survey (Tuesday) to show a slight pull back in confidence and conditions reflecting the negative news around Greece and China at the time but the August consumer sentiment survey (Wednesday) to show a rise as the negative news abated. June quarter wages growth is expected to remain weak at around 0.5% quarter on quarter taking the annual growth rate to a new record low of 2.2% year on year.

Speeches by RBA officials Lowe and Kent will be watched closely for any additional clues on the outlook for interest rates.

The June half profit reporting season for Australian listed companies will start to ramp up with around 40 major companies reporting results, including JB HiFi, Cochlear, CBA, News Corp and Telstra.

Profit growth for 2014-15 is likely to be around -1% as resource sector profits slump 28% thanks to the hit from lower commodity prices, but with the rest of the market seeing profit growth of around 9% as industrials ex financials benefit from low interest rates, the lower $A and cost cutting. Key themes are likely to be: weak revenue growth, ongoing cost cutting, competitive pressures amongst consumer staples but tailwinds for building material companies and continued strength in dividend growth.

Outlook for markets

Share markets are likely to remain volatile in the next few months as we are still going through a seasonally weak period of the year for shares, uncertainties remain regarding Chinese economic growth and a likely Fed interest rate hike lies ahead for later this year.

But beyond the near term, the cyclical bull market in shares likely has further to go: valuations against bonds are good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to remain in a broad rising trend.

My year-end target for the ASX 200 remains 6000.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving & spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

Notwithstanding the risk of a short term bounce from oversold levels, the broad trend in the $A remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance the RBA will cut again and the trend in commodity prices remains down. Our view remains that it is heading into the $US0.60s.

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The week in review and what's ahead

Monday, August 03, 2015

Investment markets and key developments over the past week

Share markets had a mixed ride over the last week not helped by renewed weakness in Chinese shares early in the week, but this was offset to a greater or lesser degree depending on the market by good US earnings results, a benign Fed and good data in Europe.

While Chinese shares fell 10% over the week, Eurozone shares only lost 0.1% and Japanese rose 0.2%, US shares rose 1.2% and Australian shares gained 2.4%. In fact the Australian share market rose 4.4% in July, which was its best monthly gain since February, albeit this followed a bad June.

Bond yields fell, spurred along by weak US wages data. Commodity prices were weak, but currencies were little changed with the $A remaining just below $US0.73.

Chinese shares had a bad week with their biggest one-day fall in eight years, largely in response to a rumour that the China Securities Finance Corp was no longer committed to stabilising the share market. While this was subsequently denied volatility remained high.

After very sharp share market falls like the 1987 share crash or through the tech wrecks and GFC it’s quite normal to see a volatile period of base building around the bottom. So the same is likely to apply in relation to China. That said further policy stimulus is still needed in China.

Fed on track to hike, but September is looking less likely thanks to very weak June quarter wages growth. While the Fed sounded reasonably upbeat, its description of the risks to the US economy being “nearly balanced” as opposed to “balanced” suggests it’s not itching to hike just yet. A further improvement in growth and confidence that inflation will rise is needed.

On the inflation front, falling commodity prices and a very weak rise in June quarter employment costs which saw annual growth fall back to just 2% suggests that a September hike is now looking less likely with the timing being pushed back to December. The weakness in wages growth suggests that the level of unemployment at which wage growth picks up in the US (ie. the so-called NAIRU) is actually lower than the Fed has been allowing for.

By the time the Fed does eventually hike it will be the most anticipated rate hike ever, which should mean it will hardly be a shock to financial markets.

Are Australian companies really paying out too much in dividends? With the August profit reporting season the focus will no doubt return again to the high dividend payout ratios of Australian companies in response to yield hungry shareholders.

Some allege that this is robbing future growth potential and risks a ‘doom loop’ turning Australia into a backwater’. But is it really? First let’s put it in perspective. The dividend payout ratio of Australian companies at around 75% is not out of line with its long-term range. See the next chart.

Source: AMP Capital

Yes it’s increased since 2012 but this has been driven by higher payouts for resources stocks and there is a good reason for this. After their huge investment in new mining capacity it makes sense to use excess cash flow now to return to investors via dividends. For the rest of the market the payout ratio has been going sideways!

Second, it’s far healthier for companies to pay strong dividends (provided they are not being paid using debt) because it signals sustainable cash flows, confidence in future earnings and helps prevent corporate hubris leading to wasteful investment.

Finally, capex in Australia is now too low and needs to rise – but the reason its low has nothing to do with investors' desire for dividends. Miners would be crazy to ramp up in investment now and the reason industrial companies are reluctant to invest owes to the beating they got through the mining boom years and a lack of corporate confidence post the GFC, which is a global phenomenon.

Major global economic events and implications

US economic data was a bit disappointing. June quarter GDP growth bounced back, but only to a 2.3% annualised pace, the March quarter was revised up less than expected and previous years’ growth was revised down. On top of this durable goods orders, consumer confidence, home prices and pending home sales disappointed. Against this, the Markit services conditions index rose to a solid 55.2 and a surge in household formation to around 1.6 million a year suggests demand for housing will remain solid.

Overall the US economy is continuing to grow but it’s a long way from booming. With the June quarter Employment Cost Index rising just 0.2% and falling back to 2% year on year, it’s hardly an environment where the Fed needs to rush into raising interest rates.

The US June quarter earnings reporting season continues to better expectations. We are now 70% done and 74% of companies have beat on earnings, 50% have beat on sales and earnings growth expectations for the 12 months to the June quarter have improved from -5.3% at the start of July to -0.1%.

Eurozone economic confidence rose in July to a four year high, despite the noise around Greece, and is running around levels consistent with decent growth. On top of this bank lending is continuing to improve and the Spanish economy grew 1% in the June quarter with annual growth at its fastest since before the GFC. Clearly Spain is not a Greece! Meanwhile, although Eurozone core inflation rose in July to 1% YOY it remains well below target and is likely to fall as lower commodity prices feed through so ECB QE is set to continue.

Japanese economic data was mixed with household spending down and unemployment up, but against this the jobs to applicants ratio held at its highest since 1992, industrial production rose more than expected in June with an improvement in the July PMI pointing to further gains and core inflation at least rose to 0.6% year on year in June.

China’s economic data was better than feared with the official July manufacturing PMI down but only fractionally, the non-manufacturing conditions PMI up slightly, consumer confidence up despite the share market turmoil and average city property prices continuing to rise and property inventory levels falling. Further policy easing is likely still needed though.

Finally, the messy picture in the emerging world is continuing with Brazil hiking rates for the 16th time since April 2013 as consumer confidence there continues to crash. Continue to be selective when investing in the emerging world. Asia – from India to China – looks best.

Australian economic events and implications

Australian data was weak with a sharper than expected fall in building approvals and another sharp decline in export prices in the June quarter. While the fall in building approvals is not really a concern being driven by normally volatile apartment approvals and with the trend remaining very strong, the continuing slump in export prices indicates a continuing fall in the terms of trade and national income.

Credit growth also moderated with all components soft except lending to investors which at 10.7% YOY is well above APRA’s target. But with APRA now biting hard this is likely to be a last gasp for lending to property investors.

What to watch over the next week?

In the US the focus will be on the July ISM manufacturing conditions PMI (Monday), which is expected to remain solid at 53.5, and July jobs data (Friday), which is likely to show continued strong jobs growth of 220,000 but unemployment remaining unchanged at 5.3%. Monthly wage earnings data will be watched closely for an acceleration.

The Bank of Japan (Friday) is unlikely to change monetary policy, although more QE remains on the cards at some point.

In China, expect a slowing in export and import growth for July and inflation data (Sunday) is likely to show a pork price driven rise but with non-food inflation remaining very low.

In Australia, the RBA will probably leave interest rates on hold (Tuesday), but it’s a very close call and I think on balance that they should be cutting again. Recent commentary from Governor Stevens suggests the RBA is not in a hurry to cut rates again and stronger than expected jobs data in recent months, the fall in the $A and a desire to confirm that APRA’s efforts to slow property investment are working all suggest the RBA will leave rates on hold on Tuesday.

However, there is a strong case for the RBA to cut again and as such the odds are strongly skewed in favour of another cut, if not Tuesday then in the months ahead, thanks to the bleak outlook for investment, continued sub-par economic growth, the $A still being too high, inflation remaining benign and increasing signs that APRA’s efforts to rein in property investment are starting to really bite.

And it’s worth noting that the hikes in interest rates to property investors amount to a de facto monetary tightening which ideally needs to be offset by a cut in rates for all owner occupiers. The RBA’s August Statement on Monetary Policy (Friday) will likely confirm that the RBA retains an easing bias.

We'll also see the usual Australian data avalanche that occurs at the start of each month. Expect to see a moderation in Core Logic-RP Data home price growth (Monday), a slight improvement in the trade balance and a modest 0.3% gain in June retail sales (both Tuesday), a 5000 gain in July employment and unemployment rising to 6.1% (Thursday) and a 4% bounce back in housing finance (Friday).

Finally, the June half profit reporting season for Australian shares will start albeit with only seven major companies reporting results with one being Rio. Profit growth for 2014-15 is likely to be around -1% as resource sector profits slump 28% thanks to the hit from lower commodity prices, but with the rest of the market seeing profit growth of around 9% as banks and financials continue to perform well and industrials ex financials benefitting from low interest rates, the lower $A and cost cutting.

Key themes are likely to be: weak revenue growth, ongoing cost cutting, competitive pressures amongst consumer staples but tailwinds for building material companies and continued strength in dividend growth.

Outlook for markets

Share markets are likely to remain volatile as we are still going through a seasonally weak period of the year for shares, uncertainties remain regarding Chinese economic growth and a likely Fed interest rate hike lies ahead for later this year.

But beyond the near term, the cyclical bull market in shares likely has further to go: valuations against bonds are good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to remain in a broad rising trend. My year-end target for the ASX 200 remains 6000.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving & spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the $A remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance the RBA will cut again and the trend in commodity prices remains down. Our view remains that it is heading into the $US0.60s, and this could now come before year end.

While Eurozone shares rose 0.5% on Friday, the US S&P 500 fell 0.2% on disappointing earnings results from energy shares. Reflecting the weak US lead along with falling energy and metal prices ASX 200 futures fell 12 points, or 0.2%, on Friday night pointing to a soft opening for the Australian share market on Monday morning.

A fall in the official Chinese manufacturing PMI for July released on Saturday may also impact but the fall was only marginal and was offset by news of a slight rise in the non-manufacturing conditions PMI and further gains in Chinese property prices.

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Global focus returns to the US

Monday, July 27, 2015

By Shane Oliver

What to watch over the next week?

Globally the focus will likely return to the US, with the Fed meeting on Wednesday. The Fed won’t make any changes to monetary policy, but is likely to express confidence in the US growth outlook and reiterate that an interest rate hike remains on track for later this year but that it is dependent on a further improvement in growth and that future hikes will be gradual. At this stage its 50/50 as to whether the first hike will come in September or December, whereas the US money market appears to be attaching a 25% chance to a September move.

On the data front in the US, expect to see a further gain in durable goods orders (Monday), another rise in home prices, a continued solid reading for the Markit services PMI but a slight fall in consumer confidence (all Tuesday) and another solid gain in pending home sales (Wednesday). The June quarter employment cost index (Friday) will be watched for a further rise in wages growth, but monthly wages data suggest it may track sideways. GDP data (Thursday) is also likely to see June quarter growth bounce back to 3% annualised, but watch for a seasonal re-analysis of March quarter GDP growth which is likely to see it revised up from -0.2% annualised to maybe +1%. Also 172 S&P 500 companies will report June quarter profit results.

In the Eurozone economic confidence indicators (Thursday) will give a further guide to how the Greek crisis affected confidence – I suspect that the impact will be minor. Meanwhile expect to see a further improvement in money supply and bank lending growth (Monday), a slight fall in unemployment to 11% (Friday) and continued low inflation (also Friday) in June with core inflation remaining around 0.8%yoy.

Japanese data for industrial production (Thursday) along with data for jobs and household spending (Friday) are expected to point to a continuation of the economic recovery but with inflation (also Friday) remaining too low at just above zero.

China’s official PMI for July (Saturday) will be watched to see whether it moves lower in line with the flash Markit PMI.

In Australia, expect to see building approvals remain strong (Thursday), a further decline in export prices relative to import prices (Thursday), a benign June quarter reading for producer price inflation and continued modest growth in credit (both Friday). A speech by RBA Governor Stevens (Thursday) will be watched closely for any clues on the interest rate outlook.

Outlook for markets

Share markets are likely to remain volatile as we are still going through a seasonally weak period of the year for shares, uncertainties remain regarding Chinese economic growth and a likely Fed interest rate hike lies ahead for later this year.
But looking beyond the near term, the cyclical bull market in shares likely has further to go:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to remain reasonable, despite current uncertainties. My year-end target for the ASX 200 remains 6000.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the $A remains down as the Fed is likely to raise rates later this year, whereas there is a 50/50 chance the RBA will cut again and the trend in commodity prices remains down. Our view remains that it is heading into the $US0.60s, but this could now come before yearend.

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Is the short-term correction over?

Monday, July 20, 2015

By Shane Oliver

What to watch over the next week?

Greece will remain in the spotlight with progress towards a new three-year bailout likely to be watched closely with a few fireworks along the way likely to be inevitable. But I suspect that Greece is on the way to becoming just background noise – at least for a while anyway.

On the data front, the release of global business conditions PMIs for July (Friday) will give a guide as to how global growth is progressing. The readings for June indicated that global growth remains uneven and slightly below trend, albeit this is not necessarily a bad thing as it means that inflation and interest rate pressures remain very low. The Chinese manufacturing PMI will be watched for a further slight gain after that seen in June and the US manufacturing PMI is likely to remain around 53.6, but the main focus will be on the Eurozone PMIs to see if they held at the previous month’s reasonable levels despite all the turmoil around Greece.

In the US, expect to see a further gain in home prices and existing home sales (Wednesday) but a slight pull back in new home sales (Friday). The June quarter profit reporting season will also start to ramp up. The market consensus is for a 5.3% year on year fall in profits but as with last quarter this is likely to be too negative.

In Australia, headline inflation for the June quarter (Wednesday) is likely to show a rebound to 0.8% quarter on quarter or 1.7% year on year thanks to a roughly 12% spike in petrol prices and some flow through of higher import prices due to the lower Australian dollar. Underlying inflation is likely to remain around 0.6% quarter on quarter or 2.3% year on year, but with the combination of significant spare capacity, record low wages growth and weak pricing power according to business surveys suggesting downwards pressure on inflation. While I see a 50/50 chance of another rate cut in the months ahead, June quarter inflation data is unlikely to be low enough to justify on its own an immediate RBA rate cut.

On the interest rate front, the minutes from the last RBA Board meeting (Tuesday) probably won’t tell us anything new but a speech by RBA Governor Glenn Stevens on Wednesday will be watched for any clues.

Outlook for markets

Most share markets have already seen the short-term correction that I had been a bit wary off. From their highs earlier this year to recent lows Chinese shares fell 32%, Asian shares 14%, Eurozone shares 13% and Australian shares 9%, providing opportunities to increase exposure to such markets.

Some volatility is likely to remain though as we are still going through a seasonally weak period of the year for shares and a likely Fed interest rate hike lies ahead for later this year.

But looking beyond the near term, the cyclical bull market in shares likely has further to go:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to remain reasonable, despite current uncertainties. My year-end target for the ASX 200 remains 6000.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.
The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year, whereas there is a 50/50 chance that the RBA will cut again and the long term trend in commodity prices remains down. We expect a fall to $US0.70 by yearend, and a probable overshoot into the $US0.60s in the years ahead.

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Uncertain times

Monday, June 29, 2015

By Shane Oliver

The week ahead will involve significant uncertainty. A missed payment to the IMF on June 30 could be handled by the IMF allowing Greece to be in "arrears" until the outcome of the referendum is known.

The situation for Greek banks is rapidly worsening. So ideally the referendum needs to be held with the support of Greece's creditors – but so far this is unclear with Eurozone finance ministers telling Greece that its bailout program will expire on June 30. It’s also not quite clear what the Greeks will be voting on as the creditor offer will lapse. The continuing uncertainly will likely weigh heavily on Eurozone shares (which may give up their 4% gain of the last week and then some), the Euro and global shares generally.

Putting aside the risks around the week ahead, having a referendum is probably a good way forward for Greece as it will indicate whether the Greeks want to stay in the Euro or not. If the referendum is passed it will send a clear signal to the Greek Government to engage constructively with the rest of Europe to provide funding and then work with the creditors to put Greece's debt burden on a more sustainable footing. The latter was getting close last year but the election of Syriza threw a spanner in the works. However, a Yes vote would not provide immediate resolution though as it may mean that a new Government would have to be formed. A No vote would put Greece on the messy path to an exit from the Euro (or Grexit).

Finally, while uncertainties around Greece remain intense, leaving financial markets vulnerable, it’s worth reiterating the rest of Europe is in far better shape now to withstand a Grexit than was the case through the 2010-12 Eurozone crisis, so the fall out in financial markets should be limited. If Grexit is the way it goes, at some point it will provide a big relief rally for Eurozone shares as it will mean that the whole silly, nearly six year long debacle with Greece is finally over.

What to watch over the next week?

In the US, the main focus will be on June manufacturing and jobs data. Expect to see a 1% gain existing home sales (Monday), further gains in home prices and consumer confidence (Tuesday), a slight gain in the ISM manufacturing conditions index (Wednesday) to 53, another solid 225,000 gain in June payrolls and a fall in unemployment to 5.4% (both Friday). Perhaps the main focus will be on whether the average hourly earnings data shows another uptick in wages growth.

In the Eurozone, uncertainty will be intense regarding Greece ahead of its referendum. On the data front expect to see modest gains in economic confidence (Monday) consistent with gains already reported in business conditions PMIs for June. June data for inflation (Wednesday) and retail sales (Friday) will also be released.

In Japan, expect a slight fall back in May industrial production (Monday) and the Tankan business survey (Wednesday) to show a further improvement.

China’s manufacturing conditions PMI for June (Wednesday) will likely show a modest gain reflecting support from the monetary easing.

In Australia, expect to see further strength in new home sales and continued modest growth in credit (Tuesday), a rebound in home prices in June after a weak May and a 1% gain in building approvals (both Wednesday), a sharp improvement in the May trade deficit (Thursday) after the partly weather related blowout seen in April and a slight rise in May retail sales (Friday). On the credit front the main interest will be in whether the growth in lending to property investors slows below APRA’s 10% target.

Outlook for markets

Much depends on Greece in the short term with a Yes vote and an eventual deal likely to see a bounce in shares, but a No vote leading to more near term weakness.

Beyond this though the combination of seasonal weakness and uncertainties around bond yields and the Fed are likely to make for continued volatility in the short term.

But looking beyond near term risks, the conditions for an end to the cyclical bull market in shares are still not in place:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to see another year of reasonable returns, despite current uncertainties.

It’s worth noting that we have seen similar bouts of uncertainty at some stage through most of the last few years, so in a big picture sense it’s nothing new.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance that the RBA will cut again and the long-term trend in commodity prices remains down. We expect a fall to $US0.70 by year end, and a probable overshoot into the $US0.60s in the years ahead.

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Volatility to continue, but bull market not over yet

Monday, June 22, 2015

By Shane Oliver

Chinese shares

Chinese shares have had another sharp pull back with the Shanghai composite having had a 13% fall from its June 12 high.  After rising 140% over 12 months and around 50% year to date, such volatility is to be expected as it has risen a bit too far too fast.

The easy gains are probably over and a period of correction would be healthy. However, it’s worth reiterating that the Shanghai composite index on an historic PE of 21 times is still below its long term average and should benefit as further monetary easing comes through.



Note that chart shows monthly data. Source: Thomson Reuters, AMP Capital

 

In fact with Chinese authorities wanting the share market to be strong but not manic, the latest share market correction means that it wouldn’t be surprising to see another PBOC rate cut or required reserve ratio reduction soon. 

The US

The Fed remains on track to hike later this year, but it’s looking more gradual. The message from the Fed’s latest meeting was relatively benign with growth and the jobs market looking stronger and a rate hike on track for later this year, but the hike remaining dependent on a further improvement in employment and confidence that inflation has bottomed. The Fed has also revised down its interest rate expectations (the so-called dot plot) reinforcing that rate hikes will be gradual. My base case remains that the first hike will be in September – but the risks are that a combination of slower growth, Greek related turmoil or a stronger US dollar could push this out to December. So far it feels like the experience with the taper in 2013, with investor nervousness ahead of the taper, but by the time it started it was already factored in.

What to watch over the next week?

In the US, expect to see a decent gain in existing home sales (Monday) but a fall in new home sales, a further gain in home prices, a continued trend improvement in durable goods orders and the Markit manufacturing conditions PMI remaining reasonable at around 54 (all due Tuesday) and continued benign core inflation according to the personal consumption deflator (Thursday). March quarter GDP growth (Wednesday) is also likely to be revised up to -0.3% annualised from -0.7%.

In Europe the focus will remain on whether there is a resolution on Greece. Meanwhile, expect the noise around Greece to have weighed on the Markit manufacturing and services conditions PMIs (Tuesday) but money supply and bank lending growth (Friday) are expected to show further improvement.

In Japan, the Markit manufacturing conditions PMI (Tuesday) and a range of economic data to be released Friday will be watched for confirmation that the Japanese economic recovery is on track. In terms of the latter, expect to see jobs data remaining strong and a rebound in household spending growth. Core inflation is expected to have remained only just above zero though highlighting why the Bank of Japan is still likely to be forced to undertake more monetary easing.

In China, the Markit manufacturing PMI (Tuesday) is expected to show a slight improvement from 49.2 to 49.4 for June consistent with other indicators.

In Australia, expect ABS data to show a solid 2.5% gain in March quarter home prices (Tuesday), driven largely by Sydney and Melbourne, consistent with private sector estimates that have already been released. Data for job vacancies and population will also be released.

Outlook for markets

The combination of seasonal weakness and uncertainties around bond yields, Greece and the Fed mean that the volatility/correction we are now seeing in share markets could have further to go in the short term. However, notwithstanding near term risks, the conditions for an end to the cyclical bull market in shares are still not in place:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to see another year of reasonable returns, despite current uncertainties.

It’s worth noting that we have seen similar bouts of uncertainties at some stage through most of the last few years, so in a big picture sense its nothing new.

Australian shares ran too hard earlier this year and this set the market up for a correction that has been triggered by a combination of softer global markets, the back-up in bond yields weighing on high dividend payers and uncertainty around the Australian growth outlook. So far the market has had a correction of 8.5% and the resultant improvement in valuations and continued low rates and an eventual improvement in the growth outlook should set the scene for a renewed run up later this year, probably back up to around the 6000 level.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance that the RBA will cut again and the long-term trend in commodity prices remains down. We expect a fall to $US0.70 by year end, and a probable overshoot into the $US0.60s in the years ahead.

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The RBA's clear easing bias is back

Monday, June 15, 2015

By Shane Oliver

If there was any doubt that the RBA retains an easing bias it was laid to rest last week by Governor Glenn Steven's comment that "we remain open to the possibility of further easing" and that "the economy could do with some more demand growth". 

Of course there were numerous qualifications around this - in particular the risks around low interest rates - but the clear message is that another rate cut is under serious consideration. I think it’s now more about narrowing the interest rate gap between us and the zero rates in the US, Europe and Japan to make sure the Aussie dollar continues to come down, helping globally exposed sectors like tourism, higher education, manufacturing and agriculture combine with home construction and consumer spending to help fill the gap left by the end of the mining boom.  The Australian dollar probably needs to fall into the $US0.60s.

Whether there is another cut or not, Stevens pointed out that "it will be quite some time before we can think about interest rates going back up" so get used to low rates for a long time yet. (Sorry Mum!)

On Greece

While there have been some positive signs of progress with Angela Merkel saying “where there’s a will there’s a way”, with the IMF leaving Brussels and indicating there are still major differences, and EU leaders issuing ultimatums to Greece, the ball is now clearly in Greece’s court to accept what is on offer or face the consequences. 

To avoid defaulting at end June a deal needs to be agreed soon so it can pass various country parliaments (which will be another source of uncertainty) in time. The June 18 Eurozone finance ministers’ meeting is the next deadline to watch. 

The pressure on Greece is now immense as recent turmoil has helped plunge it back into recession, which has hit tax revenue and likely eliminated its primary (ie ex-interest payments) budget surplus. So even if it were to repudiate all its debts it will still have to undertake aggressive austerity. The problem for PM Alexis Tsipras is trying to get support for an agreement, which is acceptable to both Greece’s creditors and to the rest of Syriza. Our base case remains that a deal will be agreed but the risks are high. So Greece is likely to remain a source of volatility. 

But even if Greece does end up leaving the Euro, the threat of contagion to other peripheral countries is low compared to the 2010-12 period as they are now in better shape and the ECB is now providing stronger support.

What to watch over the next week?

In the US, the Fed will be the big focus in the week ahead. The recent improvement in US economic indicators have come too late, and the labour market improvement is not yet strong enough, to bring on a rate hike at Wednesday's Fed meeting, but the Fed is likely to signal that it remains on track to hike rates later this year, providing economic data continues to improve, giving confidence that inflation will rise back to target. 

On the data front, expect modest gains in industrial production and the NAHB home builders’ conditions index (both Monday) and a slight fall back in May housing starts and permits (Tuesday) after very strong gains in April. May CPI inflation data (Thursday) is expected to show a 0.5% monthly gain in headline inflation on the back of higher gasoline prices, but the annual rate is likely to remain at zero. Core inflation is likely to show a 0.2% monthly gain with the annual rate falling back to 1.7%.

In Europe the focus will remain on Greece, ahead of Thursday’s finance ministers’ meeting.

The minutes from the RBA's last Board meeting (Tuesday) will be looked at closely for guidance as to the extent of the RBA’s easing bias. Speeches by RBA officials Christopher Kent (Monday) and Guy Debelle (Tuesday) will also be watched for any clues regarding the outlook for interest rates. 

The Bank of Japan (Friday) is unlikely to make any additions to its quantitative easing program, although it may still need to do so in the months ahead in order to ensure it eventually meets its inflation target.

Outlook for markets

The combination of seasonal weakness and uncertainties around bond yields, Greece and the Fed mean that the next few months could remain volatile for shares. 

However, notwithstanding near term risks, the conditions for an end to the cyclical bull market in shares are still not in place:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. 

My year-end target for the Australian ASX 200 index remains 6000. Australian shares ran too hard earlier this year and this set the market up for a correction that has been triggered by a combination of softer global markets, the back-up in bond yields weighing on high dividend payers and uncertainty around the Australian growth outlook. So far the market has had a correction of 8.5% and the resultant improvement in valuations and continued low rates, and an eventual improvement in the growth outlook should set the scene for a renewed run up later this year.

The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance that the RBA will cut again and the long term trend in commodity prices remains down. We expect a fall to $US0.70 by year end, and a probable overshoot into the $US0.60s in the years ahead. 

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Greek negotiations drag on

Tuesday, June 09, 2015

By Shane Oliver

Greek developments

Negotiations on a “reform for funding” deal for Greece are continuing to drag on with Greece rejecting an offer from its creditors and choosing to bundle up its June 5 IMF payment to be made with other IMF payments at the end of the month.

So the deadline has yet again been pushed out. Fortunately, negotiations look to be ongoing. Our base case remains that some sort of deal will be reached in time, but given the stresses within the Greek Government, and the need for any deal to be passed by various parliaments, it is a close call. So a missed payment later this month remains a high risk. Such a Graccident doesn't necessarily mean that a Grexit is inevitable but Greece will likely continue to be a source of volatility through June.

Whichever way it goes though, the threat of contagion to other peripheral countries is low compared to the 2010-12 period as they are in far better shape now and the ECB is buying bonds across Europe as part of its QE program.

Australian economic events and implications

Australian economic data last week was messy. The good news was that March quarter GDP growth was a stronger than expected 0.9% quarter on quarter. Against this though, annual economic growth is just 2.3%, domestic demand remains very weak and data for April looks to be off to a soft start with flat retail sales, a blow out in the trade deficit and a fall in building approvals.

The trade deficit blowout may be partly related to bad weather and a slump in the iron ore price to around $US45/tonne, whereas it’s now back over $US60/tonne and the fall in building approvals looks like normal volatility.

But Australian economic growth looks like remaining sub-par for a while yet as the investment outlook remains weak and the loss of national income due to lower commodity prices continues to impact. There is no reason to get too gloomy as the combination of low interest rates and a lower $A help rebalance the economy, but more help is likely to be required in the form of an even lower $A and possibly another interest rate cut.

While the RBA left interest rates on hold as expected and appears to retain a mild easing bias, it was disappointing to see that it did not reinstate a more explicit easing bias. Doing so may have helped push the $A lower. Given the still messy economic outlook another RBA rate cut is a 50/50 proposition, with the August RBA meeting the one to watch.

Finally, there is nothing new in the latest house price data from CoreLogic RP Data. While prices fell in May this looks like a regular seasonal pattern. More fundamentally, while Sydney remains strong, annual price gains are averaging around just 2% in the other capital cities. As such, Sydney should not be seen as limiting any further monetary easing if it’s deemed necessary for the rest of the Australian economy.
What to watch over the next week?

In the US, expect May retail sales (Thursday) to show a decent 1% bounce, a slight rise in consumer sentiment (Friday) and producer price inflation (also Friday) to show a gasoline driven bounce but remain benign on a core basis.
In Europe the main focus will remain on Greece and April industrial production (Friday) is expected to show a bounce.

In China, official economic data for May is expected to show signs of stabilisation in growth. Growth in exports and imports (Monday) is expected to improve slightly but remain negative, retail sales and industrial production are expected to pick up a bit, but investment may slow a bit further (all due Thursday) and credit and money supply growth should show a further improvement on the back of recent monetary easing.

In Australia, the NAB survey (Tuesday) will be watched to see whether the Budget had a positive impact on business confidence and it will be interesting to see whether consumer confidence (Wednesday) hangs on to its Budget related boost from last month. Meanwhile, April housing finance data (Tuesday) is likely to fall back a bit and jobs data (Thursday) is expected to be flat leaving unemployment stuck at 6.2%.

Outlook for markets

Given the combination of seasonal weakness and uncertainties around bond yields, Greece and the Fed the next few months could remain volatile for shares. However, notwithstanding near term risks, the conditions for an end to the cyclical bull market in shares are still not in place:  valuations against bonds remain good; economic growth is continuing at a not too cold but not too hot pace; and monetary conditions are set to remain easy. As such, share markets are likely to see another year of reasonable returns.

My year-end target for the Australian ASX 200 index remains 6000. The problem is that Australian shares ran too hard earlier this year and this set the market up for a correction that has been triggered by a combination of softer global markets, the back-up in bond yields weighing on high dividend payers and uncertainty around the Australian growth outlook. The correction will see value restored and this, plus continued low rates and an eventual improvement in the growth outlook, should set the scene for a renewed run up later this year.

Still low bond yields point to soft medium term returns from bonds, but it’s hard to get too bearish on bonds in a world of too much saving and spare capacity. Central banks won’t ratify a bond crash like in 1994, by raising interest rates aggressively.

The broad trend in the Australian dollar remains down as the Fed is likely to raise rates later this year whereas there is a 50/50 chance that the RBA will cut again and the long-term trend in commodity prices remains down. We expect a fall to $US0.70 by year end, and a probable overshoot into the $US0.60s in the years ahead.

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