4 February 2015

Weekly Market Update – 30 January 2015

weekly market
Investment markets and key developments over the past week

Share markets have had a mixed week with messy US earnings, soft US gross domestic product (GDP) data and worries about the US Federal Reserve (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 at around US$45 a barrel for now. Heightened talk of a Reserve Bank of Australia (RBA) rate cut pushed the Australian dollar below US$0.78 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 European Central Bank (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 (the International Monetary Fund, the European Union and the 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 Australian dollar it will have to join the easing party lest the Australian dollar 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.


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