There are winds ahead for global equity markets which have enjoyed strong growth but are now faced with weak economic data.
Shane Oliver (AMP Capital)
A correction is underway. Shares went sky-high into July on the back of better news on inflation, increasing optimism about lower interest rates ahead and optimism about IT and AI related earnings. Our view remains that lower interest rates will boost shares on a 6 to 12 month view, assuming recession is avoided.
However, in the next few months global and Australian shares look vulnerable to further falls suggesting that it’s too early to buy the dip as: valuations are stretched; investment sentiment looks too optimistic; recession risk is now very high in the US and Australia; and geopolitical risk is high particularly around the US election but also around the Middle East with increasing risks of escalation in the Israel war to include Hezbollah and Iran with risks to oil supplies.
So, as we enter the seasonally weak period of August and September a further correction in share prices looks likely. As a result, while the Australian share market briefly made it above our year-end target of 8,100 in the last week, we are reluctant to revise it up, particularly with the June half reporting season now upon us. There is a high risk that it may be the high for a while.
Shares got a boost mid-week from firming expectations for Fed rate cuts, but this gave way again to renewed concerns about weaker economic growth after weak US jobs data and concerns that we have seen the best for tech stocks as tech earnings results have been mixed.
For the week US shares fell 2.1%, Eurozone shares fell 4.2%, Japanese shares fell 4.7% not helped by a hawkish Bank of Japan and Chinese shares fell 0.7% on the back of uncertainty about the Chinese growth outlook and a lack of decisive policy stimulus. The ASX 200 surged above 8,100 mid-week helped by lower than feared inflation and a boost from rising Fed easing prospects but the gains were reversed on Friday as global growth worries impacted leaving the market up just 0.3% for the week.
Bond yields plunged on expectations for lower interest rates along with safe haven demand. Despite escalating tensions around Israel and Iran again oil prices fell reflecting worries about oil demand as did metal and iron ore prices. And consistent with the risk off tone the $A fell, despite a fall in the $US.
Australian inflation softer than feared
Three months of increases in a row in the ABS Monthly CPI Indicator had led many to fear a sharply higher June quarter inflation rate that would trigger more rate hikes. In the event, the Monthly CPI Indicator (yet again) gave a bad steer and June quarter inflation rose but only in line with RBA expectations and not enough to justify another rate hike. In fact, while much is made of Australian inflation being higher than in other countries this just appears to reflect the fact that it lagged other countries on the way up and so is just lagging on the way down, ie it’s nothing to get too alarmed about.
And as we have been pointing out for the last few months – just as the US and other countries have seen setbacks in the process of getting inflation down, these countries have seen disinflation resume and the same is likely in Australia. This will be particularly evident this quarter as government cost of living measures could cut up to 0.7 percentage points off September quarter inflation potentially pushing it down to around 2.9%yoy. Of course, the focus will be on underlying inflation but even here falling cost and price pressures evident in the NAB business survey point to a down trend in trimmed mean inflation.
The ABS should ditch the Monthly CPI Indicator
From the get-go I have been sceptical about the value of a monthly CPI in Australia. It would just create more noise in investment markets, won’t result in better RBA decisions, will just use up ABS funding that could be better deployed elsewhere and the only beneficiaries will be traders and economists who think more data is always better than less and financial journalists who will have more to talk about. My scepticism has grown. From the chart below it looks roughly right – but as it does not include many key items in any one month it may not be of value until the final month in each quarter but that only comes out on the day of the quarterly release. And even then, its questionable. The October and November 2022 releases provided a poor guide to the December quarter 2022 CPI surge to nearly 7.8%yoy, the low readings in January and February this year exaggerated the fall in March quarter inflation and the rise in April and May this year led to exaggerated fears of a surge in June quarter inflation. (This likely exaggeration was one reason I thought the RBA would not be hiking again.) This led to excessive optimism about rate cuts early this year then endless talk of rate hikes more recently resulting in big swings in money market expectations from cuts to hikes and now back to cuts and endless noise in the media resulting in unnecessary angst for mortgage holders. The ABS should ditch it at least until it can get it right.
Australian economic events and implications
Australian economic data over last week was mostly soft. Retail sales rose solidly in June but as in May this was due to a stronger than normal boost from cash strapped consumers taking advantage of end of financial year sales, suggesting a pull back in July. Meanwhile, retail sales volumes fell another 0.3% in the June quarter and have now fallen in 7 of the last 8 quarter. Real retail spending per person is now well down from the post pandemic reopening highs and is barely above 2018 levels. The only things keeping nominal retail sales trending up over the last two years have been price rises and population growth.
Australian economic data over last week was mostly soft. Retail sales rose solidly in June but as in May this was due to a stronger than normal boost from cash strapped consumers taking advantage of end of financial year sales, suggesting a pull back in July. Meanwhile, retail sales volumes fell another 0.3% in the June quarter and have now fallen in 7 of the last 8 quarter. Real retail spending per person is now well down from the post pandemic reopening highs and is barely above 2018 levels. The only things keeping nominal retail sales trending up over the last two years have been price rises and population growth.
The weakness in consumer spending is also evident in the ABS Monthly Household Spending Indicator – albeit its been dramatically revised since the May release (which initially showed 0.1%yoy growth and now shows 4.9%yoy growth). Over the 12 months to June household spending is up 3.1%yoy which is ok but that’s in nominal terms and translates to a roughly 1% fall after inflation and a roughly 3% fall in real per capita terms.
Home building approvals for June fell 6.5% month on month, due to a sharp fall in volatile unit approvals. Approvals are running around an annual pace of 160,000 pa which is way below current underlying demand for around 250,000 dwellings a year.
Home price growth slowing – with CoreLogic home price data showing more moderate growth of 0.5% month on month in July. We expect price growth to slow further as poor affordability, high interest rates for longer and rising unemployment impact.
Bank of Japan getting more hawkish: how does that impact things?
The BoJ announced that it will cut its bond buying in half by early 2026 and raised it policy rate from the range of 0-0.1% to 0.25%. This reflects increased confidence in the outlook for activity and inflation and points to further gradual hikes ahead, possibly taking the cash rate to 0.5% or slightly higher by year end.
An obvious concern is whether this will drive a big reversal of the Yen carry trade (where money was borrowed cheaply in Yen and put into global assets), which would weigh on assets like US and Australian bonds and indirectly shares as the BoJ hikes and other central banks cut. I suspect the impact will be relatively minor though as Japanese rates will still be well below rates in other countries for some time to come.
