THE SHERWOOD OVERNIGHT UPDATE REPORT 18th November 2014 A dovish Draghi offsets the impact of another Japanese recession and sends markets higher. Summary • Data yesterday revealed that Japan fell into its fourth recession in six years in the September quarter, which sparked notable losses in Asia and set the scene for a tough night in northern hemisphere markets. Although this recession highlighted the limitation of monetary policy in preventing economic downturns in a highly indebted economy, an ultra dovish speech from ECB chief Draghi in which he said that the ECBs QE program could include government debt if inflation failed to lift as expected, sparked gains in regional bond and equity markets and offset weaker than expected manufacturing data in the US. With around 45 minutes left to trade in the US session, the MSCI World Index is higher (+0.2%) with a loss in Asia (-0.9%) outweighed by gains in the US (+0.1%) and Europe (+0.7%). • In other financial markets, 10-year government bond yields all rose marginally despite broad weakness in economic data and the increased likelihood of central bank QE (US Treasuries up to 2.34%, UK gilts higher at 2.12% and Japanese bonds closed at 0.471%), high beta currencies were weaker against a stronger Greenback (AUD -0.4% to 87.12 and the Euro -0.6% to 124.65) and commodities were mostly lower: • gold -0.2% to USD1,183.10 per troy ounce. • Dr copper -0.1% at USC304.35 per pound. • oil -0.4% to USD75.52 per barrel. • iron ore -1.1% to USD73.96 per metric tonne in US futures markets (a fresh five year low. • base metals were universally lower. • The SPI suggests that the Australian market will open +11 points higher (+0.2%) at 10am AEST. Market news • Asia - Asian markets closed broadly lower as Japans fourth recession in six years weighed on regional sentiment and inserted downward pressure on regional bourses. The growth number was way below expectation and its composition was very disappointing with broad weakness in investment and consumption and little growth in exports, which sent the Yen lower, but this failed to spark any interest from regional investors. Meanwhile, the hype surrounding the launch of the Hong Kong-Shanghai stock market connect was muted with both indices closing lower - perhaps a case of buy on the rumour and sell on the fact. The launch overshadowed some weakness in Chinese credit growth data late on Friday, and the FTA signed between China and Australia yesterday, which seems a very good deal for the latter. By the regional close in Mumbai, the MSCI Asia Index was lower (-0.9%) with losses in Japan (-2.5%), Hong Kong (-1.2%), Taiwan (-1.1%), Singapore (-0.8%), Australia (-0.7%), China (-0.2%) and Korea (-0.1%), whereas India (+0.5%) was the sole advancer. In the local market the S&P/ASX 300 Index was -40 points lower (-0.7% to 5,341) with all ten sectors closing lower led by healthcare (-1.5%), IT (-1.1%) and financials (-1.0%). • Europe - The European sharemarket ignored the negative lead from Asia and closed higher as the absence of macro news and corporate updates kept markets focused on a speech from ECB chief Draghi. In his prepared words, the President stated that an expanded purchase program could include government bonds, which sparked sharp gains in regional indices as investors went on a yield hunt with periphery markets particularly strong, although not all plays here were among the regions top performers. By the regional close, the EuroStoxx Index was higher (+0.7%) with advances in telcos (+1.1%), consumer discretionary (+0.8%) and IT (+0.7%) offsetting some relative softness in industrials (+0.2%) and healthcare (+0.4%). In the major markets, gains were led by Germany (+0.6%) and France (+0.6%), whereas the UK (+0.2%) recorded a more sedate rise. In the periphery markets performance was more upbeat but mixed with gains in Spain (+1.6%), Italy (+1.3%), Ireland (+0.7%) and Portugal (+0.4%), with Greece (-1.0%) one of the few regional markets to decline as Budget problems persist. • US - on Wall Street, US equities are flat with around 45 minutes left to trade after coming off early lows following Japans surprising negative GDP reading for the September quarter. Macro data was in light supply but detailed a moderation in industrial activity in October which was well below market consensus (-0.1% m/m relative to +0.3% m/m), but sentiment was stabilised by ECB President Draghis dovish comments and some large M&A deals in the pharmaceutical sector. Within the last hour of trading, the Dow Jones Industrial Average is up +18 points (+0.1% to 17,6453) with the S&P 500 (+0.1% to 2,041) and the NASDAQ (-0.3% to 4,672) posting mixed results with five sectors currently in positive territory led by utilities (+1.6%), healthcare (+0.6%) and consumer staples (+0.4%), whereas IT (-0.2%) and telcos (-0.2%) are the only noteworthy decliners. Mondays economic news • Australia/Asia - no major domestic releases, but the Japanese economy entered technical recession after contracting -0.4% q/q in the September quarter 2014, which followed a -1.8% q/q growth reduction in the June quarter. The result was considerably worse than consensus forecast (+0.5% q/q) and represents Japan’s fourth recession in the past six years with three primary areas of weakness; inventories (-0.6% q/q), personal consumption (+0.4 q/q) and business investment (-0.2% q/q). Even excluding inventories which are notoriously hard to forecast, the private sector recovery is extremely anaemic in aggregate which indicates that April’s consumption tax rise continued to take its toll on the Japanese economy. Meanwhile, exports remains sluggish which demonstrates that trade is not impacted as much by your currency as it is by demand growth in your trading partners, and this remains soft in most regions. More importantly, while the government has previously stated that it would wait for the second estimate of Q3 GDP before making any decision on whether to proceed with a further rise in its consumption tax, this growth result will kill that debate off in the Cabinet Office. • Europe - The European trade balance improved to €17.7 billion in September, which was above market consensus (€16.0 billion) and a downgraded August result (€15.4 billion). Meanwhile, there were dovish comments from both the ECB (where President Draghi stated that a stimulus measures could include purchase of sovereign bonds in regional inflation fails to rise as expected) and the BoE (where governor Carney noted that large disinflationary forces are coming from trade partners, which is likely to delay any tightening cycle), both of which were seen as constructive for risk assets. • US - The pulse of activity in the US industrial sector slowed in October with activity down -0.1% m/m after a strong rise in September (which was downgraded from +1.0% m/m to +0.8% m/m). The result was weaker than consensus forecasts (+0.2% m/m) as the output of motor vehicles and paper products cut into overall output. Surprisingly, energy goods failed to respond positively to lower oil prices, but production of business equipment and technology was up strongly (+0.6% m/m) in a positive sign for US business investment in the December quarter. Major data releases Australia/Asia • Economics - no major releases. • Equities - Ruralco is expected to post full year results, Thorn Group is due to release half year results and Patties Foods has its annual general meeting in Melbourne. Europe/US • Europe - November Germany ZEW survey (Oct: +3.2) and October UK CPI (Sep: +0.0%). • US - no major releases. What is the key investment message overnight? This is a dangerous time for Japan as the Abe Government needs to increase and broaden revenue sources to reduce its huge debt load, which is the highest for any advanced nation. It has to accomplish this as the population progressively ages and contracts in the next three decades and the consumption tax rise was by far the most efficient way of achieving this. The key problem for Japan at present is the lack of worker wages growth, which is an issue that is evident in all advanced economies, irrespective of their growth and debt levels. The large depreciation of the Yen in response to a massive expansion in the Japanese monetary base (or the Bank of Japan’s QE program) has increased profit margins and corporate earnings, which has sparked a near doubling of Japanese share prices over the past two years. However, this stimulus has come at a cost as the lower Yen has increased the price of imports and this acts like a tax on Japanese discretionary spending. Despite higher margins, Japanese corporations have not passed on any of their profit surge to workers, and wages growth (and inflation) remains very sluggish and well below the target of the BoJ. Households have adjusted to higher import prices by lowering their savings rate to zero, but it can’t go lower. Therefore unless wages growth starts to accelerate, Japanese GDP will be anchored to extremely low growth rates, at best, for the decade ahead. However, more worryingly the near-certain delay in the consumption tax hike leaves Japan’s biggest problem, namely how to stop and finance its ballooning debt, completely unresolved and markets will not want to live in ignorance for too much longer on this issue, one would assume. Regards, Matt Sherwood Head of Investment Markets Research
Posted on: Mon, 17 Nov 2014 23:10:01 +0000
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