Once again last month, central banks were the star of the show, and our own Reserve Bank was right in the thick of things. A steady stream of easing activity in different parts of the world has lit a fire under risky assets like shares and property. To think that over the last two months the European and Australian markets have risen as much as they would in an average year is testament to the momentum created by increased liquidity. But it also makes you stop and wonder what’s behind it all…
Beggar thy neighbour?
The RBA kicked off the month by cutting Australian cash rates to a record low of 2.25%, which was not widely expected and was in fact somewhat controversial. On the one hand the unemployment rate hit a 10 year high of 6.4%, but on the other the number of jobs lost and created has jumped around a lot in the last few months and job ads have actually risen eight months in a row to be up 10% year on year. Also, property prices have rocketed in the last few years taking household indebtedness with them and the A$ has fallen 30% to be within cooee of the bank’s U.S.$0.75 target.
But the bank’s board justified the cut on the grounds that households aren’t spending as much as the RBA thought they would and companies aren’t investing as much as expected to offset the end of the mining boom. Consequently the bank feels economic growth is going to take longer to get back to what they call ‘trend’ levels of 3-3.25% and the risk in the meantime is unemployment might rise.
The upshot has been the ASX200 jumped 6.1% over the month, including a record run of 12 consecutive up days, led particularly by the higher yielding stocks. Much the same has happened in the EU and Japan (+6% in February) where the central banks, unable to cut rates any further, have resorted to quantitative easing as an alternative form of monetary stimulus. Investors are piling into assets that either pay some kind of yield above the extremely low interest rates on offer or are seen to benefit from increased liquidity.
But there is a very good argument that all this central bank activity is not really about injecting liquidity, rather it’s about beggar-thy-neighbour currency policies. In a world where growth is scarce, countries have to make sure their exports stay competitive and if Japan thinks it’s going to lose business to German companies because the ECB is aggressively lowering the euro, there is a strong incentive for them to make sure the yen stays low too. This is no better illustrated than Israel lowering its base interest rates by 0.15% to 0.1%, despite reporting staggering 4Q GDP growth of 7.2% annualised. Likewise, for South Korea, whose exports to the EU fell a whopping 31% from a year ago and to China by 8%, or Australia, where we still rely on being competitive for our commodities exports, a weaker currency becomes an economic imperative.
A$ vs. Yen, U.S.$, Euro and Yuan
Last week we attended a seminar where all 18 presenters forecast the U.S.$ will continue to strengthen over 2015. Consensus forecasts like that should automatically make you suspicious: last year it was a similar consensus that bond yields would fall over 2014 – wrong! Because the market is expecting the Fed to start raising rates some time this year, the U.S.$ has strengthened for an unprecedented eight months in a row and that’s going to hurt their exports. All it will take is for the Fed to change its tune based on the currency being uncomfortably high and a big spanner will be hurled into the works.
To Grexit or not to Grexit
The other ongoing saga is whether the new Greek government is going to win its staring contest with the EU. Having been elected on a platform of telling the EU to go jump, the reality of not having the whip hand in the negotiations is tempering the Greek’s bolshiness. Greece has dispatched its Finance Minister, Yanis Varoufakis (left), who as well as being a published author with seven books on game theory is now assuming movie star status, being likened to Bruce Willis.
The austerity program imposed on Greece by the EU as a condition of its previous bailout has been a disaster: the Greek economy has shrunk more than 30% since its imposition, unemployment remains above 25% and its loans are no more repayable now than ever before. For now the EU has done what it does best: kicked the can down the road by giving Greece a four month extension on its bailout terms. So without some kind of miracle in the meantime we can look forward to the same wringing of hands and gnashing of teeth in the middle of the year.
Working this problem out would have tested Solomon. On the one hand if the EU lets Greece walk away from its debts, it can rest assured Portugal and Spain will be expecting the same lenience. That would surely test the patience of German taxpayers, who have effectively underwritten the EU and would question why they should remain in it, which would spell the end of the euro. On the other hand, Greece will never be able to repay its loans as they currently stand and may as well just default and leave the EU, which could cause irreparable damage to the euro. For now, the strategy appears to be to avoid making a decision.
Can we rely on the U.S. or China?
In a world that celebrates even a whiff of growth, the U.S. is now regularly called the best horse in the glue factory or the cleanest dirty shirt in the laundry. A lot of global hopes are pinned to its ongoing recovery, but given a downwardly revised GDP for 4Q 2014 of 2.2% is still celebrated, it puts things into perspective. The U.S. unemployment rate continues to tick down (see the chart below) and, just as importantly, wages growth is ticking up.
Source: U.S. Bureau of Labour Statistics
An interesting reflection on the state of the U.S. labour market came this month when Walmart, the biggest private employer in the country, announced as of April they will pay a minimum of $9 per hour, meaning their more than 500,000 affected workers will no longer be on the minimum wage of $7.25 (which hasn’t changed for six years). In fact, the company announced the pay rate will rise to $10 by next February. When a notoriously tight company like Walmart makes an announcement like that you can rest assured it’s unlikely because they suddenly found a heart. Instead it’s quite possibly a good reflection of how they see the labour market is changing.
The U.S. December quarterly reporting season saw annual profits rise by 3.9% from a year ago, almost three times what companies had guided to in the usual smoke and mirrors pre-reporting season shenanigans. The chart below gives good insight into one of the reasons the U.S. share market has been as strong as it has: there’s money flowing into the market but a lot fewer shares to buy. U.S. companies argue share buybacks are as good as dividends, their problem is the long-term track record shows companies are poor at judging what is a good price to buy their shares. A cynic would think the fact CEO’s tend to be remunerated based on rising EPS may have something to do with it.
Source: ICL Haver, Deutsche Bank
All eyes remain on the Fed, and as usual Janet Yellen’s testimony was pulled apart and analysed for every conceivable nuance. The focus now seems to be on the word ‘patient’: when the Fed no longer talks about being patient, watch out, it’s interest rate rising time. Unless, of course, they come up with another watch word.
After last month reporting the weakest annualised growth rate in a quarter of a century, China continued to disappoint those who hope its apparently unstoppable growth will underwrite a global recovery. Imports dropped 20% in January from the year before, reflecting a weak enough economy to prompt the Bank of China to join the monetary easing party and lower the capital reserves banks are required to carry, meaning more money is available to lend out. A bit surprisingly, that easing was followed up only three weeks later by a cut in the rates banks can lend out at and what they can pay to depositors.
The dreaded deflation provided another reason to ease, with Chinese producer prices continuing their three year decline in January( see the chart below) and the CPI hitting multi-year lows of 0.8% year on year ( see the chart below). Market bulls are on tenterhooks waiting for the government to announce another big round of spending programs.
Annual change in Chinese Produce Prices (PPI)
Source: National Bureau of Statistics, China
Annual change in the Chinese CPI
Source: National Bureau of Statistics, China
The Australian interim reporting season
The interim reporting season has seen its usual share of positive and negative surprises. Overall, analysts appear to have concluded it was neither extraordinarily good nor bad. About half the companies beat consensus forecasts and 41% of companies saw earnings upgrades. Quite clearly we can conclude the ASX200’s stellar performance has more to do with reserve bank largesse, and the possibility there’s more where that came from.
The good stuff
Researchers at the Salk Institute have developed a pill, called fexaramine, that fools the body into thinking it’s had a filling meal, causing it instead to burn fat. Because the pill doesn’t dissolve into the blood but remains in the intestines, there are very few side effects. The researchers are trying to set up human trials and are hopeful it will be available in a few years.