Global Review & Outlook
- The dominant global theme over the past week has been the increase in rhetoric from central banks – other than the US Federal Reserve – suggesting the day is nearing when emergency policy stimulus will need to be unwound. Global bond yields rose, while the $US and stock prices weakened. The weaker $US, meanwhile, provided some support to commodity prices, with oil up 2.9% for the week.
- Most significantly, über-dove Mario Draghi suggested that “deflationary forces [in Europe] have been replaced by reflationary ones”. Although ECB official sought to play down Draghi’s remarks a day later, it was enough to push up the Euro and European bond yields over the week. Not to be outdone, the Bank of England and the Bank of Canada also hinted at policy tightening. To my mind, a broadening in monetary policy normalisation across the world would be a very healthy development, as despite persistent low inflation, the steady decline in unemployment rates in Europe, the United States and Japan suggest “emergency” policy settings are clearly no longer needed. Despite low inflation, “re-loading the canon” so to speak is important to reduce the risks of financial bubbles developing, and leave central banks better equipped to deal with the next cyclical downturn.
- Of course, the challenge will be to pull off the band aid slowly and in a well-telegraphed way so as to not cause too much financial market consternation. The US Federal Reserve’s early efforts suggest this is possible. Another notable development was the release of updated stress tests on US banks, which suggested they now have improved balance sheet capacity to boost dividends and buy back shares – a boon for shareholders. Together with the growing prospect of higher bonds yields – which helps global bank profitability – this suggests the global banks as an investment theme (such as through the BNKS ETF) could come back into favour.
- The key development this week will be US payrolls on Friday, in which another solid employment gain (around 180k) is expected. As always, an important indicator to watch will be average hourly earnings – the Fed is patiently waiting and expecting a decent upturn in wage growth which so far has failed to materialise despite the sharp drop in unemployment.
Australian Review & Outlook
- Locally, the key development last week was the sharp rebound in iron ore prices (+14.6%) apparently due to Chinese official comments emphasising the still important need to reduce China’s large overcapacity in steel and coal. That said, the speed of the rebound also has the look of a short-covering rally, driven by China’s notoriously speculative Dalian futures market. With China’s demand nonetheless slowing, and supply growing, it’s still very hard to see a sustained strong rebound in this well-supplied resource! Despite the rebound in iron ore prices – which helped resource stocks – the local share market ended the week flat as fears of global policy tightening eventually took their toll on Friday.
- This week we’ll get a range of good monthly indicators – from building approvals, ANZ job ads to retail trade – and the RBA meets on Tuesday. No surprises will come from Martin Place, with the RBA likely now hoping growing talk of policy tightening elsewhere can help push down the $A (finally!) to more competitive levels. With local growth lagging global peers in the wake of the mining downturn, we’re should be in no hurry to follow others in raising rates.
- The fact more central banks are talking about the need to tighten policy is another hurdle for global equity markets, but not an insurmountable one. Importantly, with inflation likely to remain low, central banks will back away from tightening at the first signs of economic weakness.
- Against this backdrop, it’s hard to be super negative on equity markets – suggesting the current period of consolidation will prove only temporary – even though outright price-earnings valuations are at above-average levels and earnings growth is still a little patchy. In turn, such an environment favours the tech-heavy Nasdaq especially, and some catch-up performance in Europe and Japan. Meanwhile, sectors that stand to most benefit from rising bond yields – such as global banks – may be coming back into favour.
- Closer to home, recent upbeat economic indicators suggest the real economy is travelling reasonably well, even though this is not as yet translating into decent listed company earnings performance due to intense competition and weak nominal incomes growth. In such an earnings challenged environment, yield, rather than growth, investment themes are likely to remain favoured locally – which will tend to favour financials (over say, bond proxies like listed property) if longer-term bond yields do eventually start to rise.
Have a great week!