17 December 2014

Weekly Market Update ~ week ending 5 December 2014

global economic
Investment markets and key developments over the past week
  • Share markets rose over the past week helped by good US economic data, signs the European Central Bank (ECB) is likely to broaden its quantitative easing program, a stabilisation in energy shares after their plunge the week before and growing investor interest in Chinese shares. US shares rose 0.4%, European shares gained 1.1%, Japanese shares rose 2.6%, Australian shares gained 0.4% and Chinese shares surged 9.5%. Bond yields mostly rose after the previous week’s oil-driven plunge. The oil price fell only slightly after its plunge the week before and other commodity prices saw gains. However, the Australian dollar continued to drift lower against the US dollar as the latter continued its broad upwards trend and as expectations for another interest rate cut in Australia intensified.
  • Chinese shares spring back to life, but there is more to go. After a four-year bear market that started in August 2009 and took them down 44%, Chinese shares have sprung back to life big time since July and are now up 39% year-to-date, making them one of the world’s strongest markets this year. The upturn looks to have caught many by surprise but it’s typical of the way the Chinese share market – which remains very retail-driven and speculative – works. Recent gains are now leading to a surge in new share market account openings in China as investors swing back from property to shares. Inevitably it will go too far but right now we are a long way from that as the forward price-to-earnings ratio is just 10 times and the historic price-to-earnings ratio around 12 times which are both low against their own history and globally. So we remain overweight Chinese mainland shares.
  • While the Reserve Bank of Australia (RBA) left interest rates on hold again, it’s increasingly clear that the balance of risks have shifted in favour of the next move in rates being a cut. Commodity prices have fallen much faster than expected, the Australian dollar has not fallen enough on a trade weighted basis to compensate thanks to significant monetary easing in Europe and Japan, the non-mining sectors of the economy are improving but not fast enough and are at risk of stalling in the face of a national mode of pessimism. As a result it’s become increasingly clear that more monetary easing is required in the form of a further significant fall in the Australian dollar and lower interest rates. Without the latter the Australian dollar may not fall enough. Fortunately, low inflation and a loss of momentum in house prices provide the RBA with plenty of flexibility. As a result, I now expect a 0.25% cut in the March quarter and see a 50% chance of another cut in the June quarter.
  • There are a few big events ahead on the policy front in Australia. First up will be the reaction to the Murray Financial System Inquiry, particularly in relation to its recommendations regarding bank capital requirements and superannuation, although the final decision will be made by the Government. Second, the Government’s discussion paper on the tax system will soon be released and will likely highlight the excessive reliance in Australia on income tax as opposed to indirect tax and the negative impact of this on incentive as average workers are pushed into ever higher tax brackets. Finally, the Mid-Year Economic and Fiscal Outlook (mid-December) is expected to reveal another A$5-10 billion per annum deterioration in the budget deficit over the next four years (or A$30 billion in total) reflecting an estimate of savings that will remain blocked by the Senate and the impact of slower economic growth and the slump in commodity prices, delaying the return to surplus to around early next decade. Fortunately, the Treasurer has implied that savings to make up the gap won’t be announced straight away but action is likely to be taken in the May budget. The government has also most recently announced that it will restructure its paid parental leave scheme in an effort to secure Senate support in 2015.

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