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AMP Capital Investors Limited ABN 59 001 777 591,AFSL 232497

Investment Strategy & Economics


Weekly market & economic
update

By Dr Shane Oliver, Head of Investment
Strategy & Chief Economist
17 OCTOBER 2014
MARCH 2012



Data/Event Units Movement Trend
LATEST PREVIOUS
US Retail sales, September mom -0.3% +0.6%

US Industrial production, September mom +1.0% -0.1%

China Consumer price index, September mom +1.6% +2.0%
Australia - Westpac consumer confidence, October index +0.9% -4.6%

Financial markets
Indicator
Friday
17 October
2014
Friday
10 October
2014
Weekly
change
17 October
2013
12-month
change
S&P/ASX 200 Index 5,272 5,188 +1.6% 5,283 -0.2%
S&P/ASX 200 Property Trusts 1,088 1,087 +0.1% 1,038 +4.8%
US S&P 500 1,887 1,906 -1.0% 1,733 +8.9%
Dow Jones Eurostoxx 297 300 -0.8% 303 -2.0%
UK FTSE 100 6,310 6,340 -0.5% 6,576 -4.0%
Japan Nikkei 1,177 1,243 -5.3% 1,206 -2.4%
China - CSI 300 2,442 2,467 -1.0% 2,413 +1.2%
MSCI (ex-Aust/in LC) 1,183 1,197 -1.2% 1,131 +4.6%
Australian 90-day bank bill yield 2.72% 2.72% 0 bps 2.58% 14 bps
Australian 10-year bond yield 3.23% 3.33% -11 bps 4.13% -91 bps
US 10-year bond yield 2.19% 2.28% -9 bps 2.59% -40 bps
Oil West Texas Crude 82.75 85.82 -3.6% 100.67 -17.8%
A$ in US cents 0.8744 0.8686 0.0067 0.9636 -9.3%
A$ trade-weighted index (TWI) 68.50 68.90 -0.01 72.60 -5.6%
Major upcoming global economic releases and events
Date Data/Event Units Previous Forecast
21 October China - GDP yoy +7.5% +7.2%
22 October US CPI September mom -0.2% +0.1%
22 October Australia - CPI yoy +3.0% +2.3%
23 October Eurozone - Markit PMI Composite index 52.0 51.7
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Investment markets and key developments over the past week
> Global shares had another rough week on worries about global growth and as the Ebola scare continued to build.
Despite a rally in US and European shares on Friday most share markets fell with US shares down 1% for the week,
European shares down 0.8%, Japanese shares down 6.1% and Chinese shares down 1.4%. However, Australian shares
having led on the way down, managed to rise over the last week as investors started to look for bargains. 8% yields on
Australian banks are hard to resist. Global shares are now down 7.4% from their September high and Australian shares are
down 6.8%, although this has been pared from an 8.9% decline to the low on Monday. Bond yields continued to slide on
global growth fears and on the back of safe haven buying. Commodity prices remained under selling pressure but the
Australian dollar rose slightly as the $US pulled back a bit on talk that the Fed may delay the end of QE and/or rate hikes.
> While doom and gloom is now rife, there are some signs that shares may be at or close to a low: the 8.4% (September
top to recent low) correction in global shares is around the size of the average correction seen since the current bull market
began in 2011; in fact US and Australian shares have had a healthy correction of nearly 10% top to bottom using intraday
data; markets that led on the way down like Australian shares and US small caps have been clawing back in the last few
days; the last few sessions have seen US and Australian shares rebound from intraday lows suggesting that bulls may be
starting to get the upper hand; investor sentiment is now so bad that its good with our composite measure of investor
sentiment in the US having fallen to levels often associated with share market lows (see chart below at left); and the month of
October is known for seeing shares start to turn back up after seasonal weakness ahead of a rally into year-end (chart at
right). From a fundamental perspective the fall in share markets has seen shares move well into cheap territory (with the
forward PE on Australian shares at around 13.7 times, being well below its long term average) and lower bond yields also
adding to the relative cheapness of shares.

Source: Bloomberg, AMP Capital

Source: Bloomberg, AMP Capital
> The Fed may delay ending QE and rate hikes. Various Fed officials have added to the message that the Fed will allow for
the impact of softer global growth and the stronger $US and that it may result in a delay to rate hikes. I suspect that they
might now get pushed into the September quarter next year. Two Fed officials even referred to possibility of more quantitative
easing or a delay to the end of the current program if needed to head off falling inflation expectations. Fed President Bullards
comments regarding extending QE are particularly significant because he often provides a lead on where the Fed is heading.
The key is that the Fed is not on a pre-set path towards monetary tightening and there is now a good chance that QE will not
end this month.
> In Australia, RBA Assistant Governor Guy Debelle reiterated the view that the $A is still too high and the RBAs
concerns about the potential for financial market volatility and in particular warning of a potential violent sell off in
fixed income markets if the outlook for low interest rates changes. Of course, the latter was taken out of context by the
media in referring to financial markets generally - as they say bad news sells! At this stage though there is no sign of any end
to the low interest rate environment. Yes we are getting the volatility, but bonds are rallying as global growth is yet again
disappointing, pushing out any eventual global monetary tightening/higher interest rates. More broadly, central banks and the
IMF need to be very careful in what they wish for here. In providing monetary stimulus a key aim was that investors take on
more risk thereby spreading easier monetary conditions through the economy and facilitating economic recovery. Warnings to
the effect that we are now seeing unsustainable bubbles (I dont see many), frothy markets and the risk of violent sell -offs, to
the extent it adds to investor panic, risks undoing all they have sought to achieve over the last few years.
> The risk around Ebola is clearly continuing to increase with more cases in the US after botched medical protocols.
Our base case remains that it should be easier to control its spread in the US and in other western countries, given modern
medical facilities and higher hygiene standards, and as such it will remain largely contained to Africa but with short term bouts
of share market volatility around Ebola scares. However recent events in the US suggest that the risks have gone up. As we
saw in Hong Kong and Singapore with SARS, the main threat is to consumer confidence and hence to spending. So far US
consumer confidence appears to have been little affected but its worth keeping an eye on.



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0
500
1000
1500
2000
08 09 10 11 12 13 14
S&P 500 (LHS)
Extreme Optimism (Bearish)
Extreme Pessimism (Bullish)
0.97
0.98
0.99
1.00
1.01
1.02
1.03
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
The seasonal pattern in US and Australian shares
Seasonal share price indexes, 1985 - 2013
Australia
US
US investor sentiment at levels associated with lows
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Major global economic events and implications
> US economic data was mixed with retail sales falling more than expected in September, albeit after a strong August,
manufacturing conditions deteriorating in the New York region, small business confidence down slightly and home builder
conditions falling. However, against this, jobless claims fell, industrial production rose strongly, manufacturing conditions in
the Philadelphia region remained strong, housing starts and permits rose and consumer confidence rose despite share
market falls and Ebola fears. Weak producer price inflation highlighted the risk that US inflation will continue to undershoot the
Feds 2% inflation objective. There was some very good news with the budget deficit in fiscal 2014 falling to 2.8% of GDP
(lower than Australias budget deficit!) which is well down from its 10% peak in 2009. Its also noteworthy that falling mortgage
rates and gasoline prices are set to provide a boost to household finances.
> Its still early days in the US reporting season for September quarter profits but so far so good. Of the 82 S&P 500
companies to have reported so far, 77% have beaten earnings expectations (against a norm of 63%) and 58% have beaten
on sales. Profit growth for the quarter is likely to come in at 10% year on year, roughly double current market expectations.
> Eurozone data was mostly soft with industrial production down in August and the ZEW survey of investment analyst
confidence falling sharply in October. German unemployment fell to 6% though providing some positive news along with a
rise in car sales in September.
> Chinese credit growth continued to slow, albeit remaining solid, but money supply growth picked up marginally and
trade data provided positive news with much stronger than expected growth in exports and imports for September.
Inflation data was also weaker than expected with CPI inflation at its lowest in more than four years and the annual rate of
decline in producer prices accelerating. Quite clearly China is operating well below its potential, adding to global deflationary
risks and theres significant potential for rate cuts.
> India also saw good news on the inflation front with both consumer and whole sale price inflation falling sharply suggesting
the next move by the Reserve Bank of India will be a rate cut. That global interest rates are still going down, not up was
highlighted by a cut in Koreas policy rate to 2% from 2.25%.
Australian economic events and implications
> Australian economic data was somewhat subdued with a fall back in business conditions and confidence to below
average levels (albeit at least up on last years lows) and only a modest rise in consumer confidence in October leaving it
below average levels too. Dwelling commencements also fell in the June quarter but after two very strong quarters and with
building approvals pointing to a rebound in the September quarter. Dwelling starts are running around 180,000 pa which is in
line with underlying demand after many years of shortfalls.
What to watch over the next week?
> In the US, September inflation data (Wednesday) is likely to remain benign with inflation falling to 1.6% year on year
adding to the lack of pressure on the Fed to eventually raise interest rates. Meanwhile existing home sales (Tuesday)
and house prices (Thursday) are expected to show modest gains, but expect new home sales (Friday) to reverse some of the
18% gain seen in August. Markits manufacturing conditions PMI (Thursday) is expected to have remained strong, albeit
falling slightly from 57.5. The flow of September quarter earnings results will ramp up.
> In the Eurozone, Markits business conditions PMIs are expected to remain down on the highs seen in July
continuing to raise concerns about a loss of momentum in growth. The main focus though will likely be on the start of
ECB quantitative easing and the October 26
th
release of the ECBs much anticipated bank Asset Quality Review and Stress
Tests. This will assess the adequacy of 130 Eurozone banks capital levels against both baseline and adverse scenarios and
those that fail will be given 6 to 9 months to boost their capital ratios. Some failures are possible but mainly for unlisted and
mutual banks, but not many of the major listed banks are likely to fail given pre-emptive capital raisings (75bn since 2013)
and conservative lending practices in the lead up to this review. In fact, just as occurred with the Feds stress test of US banks
in 2009, it could prove to be a watershed event that helps restore confidence in Eurozone banks and clears the way for more
bank lending.
> Chinese activity data for September (Tuesday) is expected to show a bounce in industrial production to 7.5% year on
year growth from 6.9%, but a further slight loss of momentum for retail sales and fixed asset investment. Stronger
exports are likely to have helped support GDP growth but not enough to prevent a further slight slowing to around 7.2% year
on year. The HSBC flash manufacturing PMI for October (Thursday) is likely to have remained around the 50 mark suggesting
relatively stable growth.
> In Australia, the focus will be on September quarter inflation data (Wednesday) and a speech by RBA Governor
Stevens (Thursday). September quarter inflation is likely to be benign, helped by lower petrol and fruit & vegetable prices
and the removal of the carbon tax. Expect headline inflation of 0.4% quarter on quarter and 2.2% year on year and underlying
inflation of 0.5% quarter on quarter and 2.6% year on year. RBA Governor Stevens speech will be watched for any updated
comments on the outlook for interest rates but he is likely to retain the on hold with a dovish tone approach evident in the
RBAs last post meeting statement. The minutes from the last meeting (Tuesday) and speeches by RBA officials Kent and
Lowe will also be watched closely but are all unlikely to signal any deviation from the RBAs period of stability stance on
interest rates.
Outlook for markets
> Our assessment remains that recent falls in shares represent a correction and not the start of a new bear market.
Share valuations have now pushed well into cheap territory (the forward PE on Australian shares has fallen from 14.8 times to
13.7 times), the global growth outlook remains for okay growth (not too hot, but not too cold), monetary conditions globall y
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and in Australia look like they will remain very easy with Europe and Japan filling the quantitative easing gap that will be left
by the US, and US rate hikes looking even further away. Investor sentiment is now very bearish again which is positive from a
contrarian perspective. The lower Australian dollar will also help boost growth in Australia and eventually profits. So for these
reasons the correction should be seen as providing a buying opportunity. October is often a month where market falls come to
an end ahead of a Santa Claus rally into year end and I expect to see the same happen this year. Seeing the ECBs bank
stress test results and the ECB start up its QE program (both of which will occur in the next week) are likely to help in thi s
regard.
> Low bond yields will likely mean soft medium term returns from government bonds. That said, in a world of too much
saving, spare capacity and low inflation its hard to get too bearish on bonds.
> In the short term the Australian dollar has fallen too far too fast (just as the $US has risen too far to fast), so a short
covering bounce could well emerge. That said the broad trend in the $A is likely to remain down, reflecting soft commodity
prices, the likelihood the Fed hikes interest rates before the RBA and the relatively high cost base in Australia. Expect to see it
fall to around $US0.80 in the next year or so.





































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