A month ago, Chinese economic data was showing signs of bottoming, but this vanished with official data for April showing a further sharp slowing in industrial production, retail sales, fixed asset investment, imports, exports and bank lending.
While this contrasts with business conditions indicators pointing to a stabilisation in growth it nevertheless suggests that growth could dip to 7% in the current quarter.
Fortunately with inflation and the property market having cooled there is plenty of scope for further policy easing in China, which we expect over the next few months. China doesn’t have the debt constraints that the US and Europe have and so growth should stabilise over the second half.
Until about a month ago US economic data was universally surprisingly on the upside, but recently it has been a bit mixed with notably soft readings on employment. However, current indications are that the US is growing around 2% to 2.5%.
The real concern for the US is an impending fiscal tightening that will follow the end of the Bush era tax cuts and various stimulus measures at the end of this year. The fiscal cutback, commonly referred to as a “fiscal cliff”, will amount to around 3.5% of GDP next year. While this is likely to be reduced to 2% of GDP, it is hard to see Congress and the President agreeing to do this until after the presidential election in November and naturally uncertainty regarding it may intensify into year-end.
While the risks are significant, it is worth noting there are several positives compared to 2010 and 2011, when shares fell roughly 15% from their April high in 2010 and 20% from their April/May high in 2011.
First, business conditions indicators, notably the US ISM index, have improved after last year’s falls but haven’t yet reached the cyclical highs they got to a year ago. In other words, having not increased that much, there is not as much downside. Right now they are at levels consistent with modest global growth.
Source: Bloomberg, AMP Capital
Second, the US economy is looking better in three key areas: the housing sector looks like it is bottoming; manufacturing is experiencing a renaissance and US oil production is surging thanks to shale oil.
Third, the global economy hasn’t been hit by the supply chain disruptions that flowed from the Japanese earthquake in March last year. This time a year ago the US economy was already slowing partly due to this.
Similarly, the rise in oil prices this year hasn’t been as great as occurred early last year in response to the “Arab Spring”. Consequently the blow to household income hasn’t been as great.
Global monetary policy has been easing, whereas a year ago it was being tightened. This was notable in the emerging world where inflation in China was on its way to a high of 6.5%, but also evident in Europe and, in Australia, the RBA was still threatening to raise interest rates. Now monetary policy has been easing, notably in most emerging countries and in Australia.
At their April highs this year, shares were cheaper than at their early 2010 and 2011 peaks in terms of the earnings yield pick up they provide over government bonds. This can be seen in the next chart.
Source: Thomson Reuters, AMP Capital
Finally, it seems everyone is fearful of a re-run of the last two years where shares fell 15 to 20% after highs in April or May. When everyone expects something, sometimes it doesn’t happen.
On balance, while the tenuous situation in Europe, along with normal seasonal weakness from May into the third quarter, points to the likelihood of further weakness ahead, there are some positives suggesting the downside in markets won’t be as great as the 15 to 20% falls seen in 2010 and 2011.
There are several implications in this for Australia.
First, while recent domestic data for retail sales, building approvals and employment suggest that the chance of a further June rate cut has fallen, the uncertainty regarding the global growth outlook and weakness in China, which has pushed down commodity prices suggest that further interest rate cuts are likely to be justified. We continue to see the cash rate falling to 3 to 3.25% over the next six months.
To the extent that global shares remain vulnerable over the next few months, Australian shares will as well. However, the combination of monetary easing (in contrast to the higher rates and threat of further tightening a year ago) and a weaker Aussie dollar provide some buffer. We continue to see share markets higher by year-end, notwithstanding the risk of further downside over the next few months.
The growth sensitive Australian dollar, like share markets, is vulnerable to further weakness in the short term, possibly taking it down to last year’s low of around $US0.95. By year-end it is likely to be back above parity, though as it becomes clear that global growth is continuing, possibly helped along by more quantitative easing in the US (QE3) and Europe, which will reduce the value of the $US and euro.
Renewed uncertainty regarding the global growth outlook, particularly fears around a Greek exit from the euro and worries about Spanish banks, mean that further downside is possible for share markets over the next few months.
However, key differences compared to the last two years, including a stronger US economy, global monetary easing and cheaper share markets, hopefully should help limit the downside in shares and help result in a better year-end.
Dr Shane Oliver is the Head of Investment Strategy and Chief Economist at AMP Capital Investors.
Andrew Sadauskas is a former journalist at SmartCompany and a former editor of TechCompany.
