Gottliebsen’s Week: US rates, Traders take over, Oil, Dividend debate, Profit season

Last Night

Dow Jones, up 2.4%
S&P 500, up 2.4%
Nasdaq, up 2.4%
Aust dollar, US70.7c

US rates

Last night's big rise on Wall Street signals that the market is now confident interest rate rises in 2016 and 2017 will be more restrained. And that's good for equities. In many ways the sharemarket is catching up with the US bond market, which has seen rates fall in the last few weeks, in recognition of the same forces.

That means the doomsday scenario, which saw higher US interest rates causing havoc in emerging economies and sending the US dollar through the roof, is much less likely to take place.

Traders take over

But there are still many respected market operators who are worried about the state of equity markets. You will remember two weeks ago, when I wrote my first 2016 commentary, I pointed out that a number of major funds, led by the UK-based Nevsky Capital Group, had either lowered their equity proportions or left the equity market. This week we saw the Future Fund has reduced its equity holdings and lifted its cash allocation to 20 per cent of its portfolio. It must be said, it’s not a one-way street -- Australian Foundation Investment Company (AFIC) is taking precisely the reverse course.

One of the issues making people nervous about our markets is they have been taken over by traders who are focused on making quick gains rather than the fundamentals. Longer term, our stock exchange is going to have to tackle this issue because it is leading to incredible volatility in a whole range of securities. Nothing illustrates what is taking place better than the US equity markets and the oil market.

On the equity front, Wall Street is dominated by the traders. Last year, when Federal Reserve chair Janet Yellen set out a scenario whereby US interest rates would rise over 2016-17, the traders moved in and shorted US shares. They also took money out of emerging economies and brought it back to the US, sending the US 10-year bond rate lower at a time when the Fed was predicting higher interest rates.

The decline in the US equity market was compounded by declining growth in China and very sharp falls in the price of oil (more of that later).

Then this week, Yellen showed she is clearly being influenced by what the traders are doing in the markets. She is no longer as definitive about predictions of higher interest rates, despite nothing really changing in the base US economy.

Yellen essentially gave in to the traders. Initially she was not rewarded. Wall Street fell following the release of the FOMC statement, in part because traders have long positions in the US dollar and got nervous. On Thursday, Wall Street steadied and overnight made further big gains.

In going long the US dollar, the traders had gambled that the Fed was going to increase interest rates and the US dollar would rise. With interest rates moderating, the long positions in the US dollar have so far been vindicated, helped by weakness in Japan, the eurozone and other countries. But longer term there is a clear risk in the US dollar.

What we are seeing is US monetary policy being set by the whims of the traders rather than the fundamentals of the American economy. And, of course, running monetary policy in such a chaotic way makes people nervous.

Oil

If you think the US stockmarkets are highly volatile then spare a thought for those who are producing oil.

We are now learning that the hedge funds and investment banks have taken a monumental short position on oil. They reason that with China slowing and Iran sending oil to the market we are in for more falls and surprise, surprise, Goldman Sachs, along with one or two of its Wall Street mates, announced there was a good chance of oil falling to close to $US20 a barrel. As expected, before the latest rally, that statement pushed the price of black gold even lower.

Those with long memories will remember when Goldman Sachs last hit the big headlines with an oil prediction. In 2008 oil was trading around $US147 a barrel and Goldman boldly announced that it was likely to go to $US200 a barrel. Legend has it Goldman made a fortune from trading oil at the time. Whether that is true or not, the whole affair got mixed up with Lehman Brothers and nobody came out of it well.

The point is, with most of the investment houses having major positions in oil, you really can’t believe them. Indeed, many believe that Goldman’s statements signalled the top of the oil market in 2008 and the bottom last year. Meanwhile, most of the oil producers are getting heartily sick of Wall Street’s antics and how they govern their profits.

Not surprisingly, Russia is establishing an oil marketplace, aiming to attract more and more oil contracts in roubles rather than US dollars. China is looking to do the same thing in its currency.

Russia is unlikely to have huge sway in the short term unless President Vladimir Putin pulls off his ambitious plan to set up a new oil cartel which will involve Russia, Iran, Saudi Arabia and Iraq, although a news report overnight suggested Iran will not participate in a deal.

As I have previously described, the Putin plan is a longer-term play that is linked to the settlement of the Syrian situation. Putin wants to link any Syrian settlement to the trade embargos in the Ukraine. To now he has not been anxious to push the plan too hard, preferring to bide his time and be in a stronger position in Syria, but an oil price below $US30 a barrel forced his hand. There are now preliminary discussions taking place among the four players.

One of the reasons oil has fallen so low is that the Saudis’ plan to knock out US production quickly has failed. The Saudis believed that if they kept producing at high levels and the oil price fell, US high-cost producers would go out of business relatively quickly.

What the Saudis didn’t know was that the US had sold half of their oil forward at the high prices. So the Americans continued to get strong revenue even though the price was falling. Most of those US oil producer hedge contracts will end in the current quarter and there is likely to be a big fall in oil production and a rise in bankruptcies.

With victory close at hand Saudi Arabia is reluctant to try and restore the price through production cuts but it is a very delicate balance, as the pain level for itself and its allies is now very severe.

And of course, sitting on the sidelines is this massive short position on oil. Some of the shorters are now becoming twitchy as they see talks taking place and are starting to cover their positions. This has caused the oil price to rise in recent days. The lift in the oil price could see more shorters begin buying back, resulting in further price rises. But once again it is trader-driven.

On the fundamental side there are substantial stocks of oil but production and consumption are not that far out of balance. If there are substantial production cuts, they will bring the oil price back quite sharply. Meanwhile ordinary investors are sideline observers in this situation.

Dividend debate

The biggest debate in the looming profit season is whether Australian banks should lower their dividend rates.

For some time the market has been anticipating that the big four banks will lower rates by pricing the shares to give very high yields. As I have written many times in Eureka Report, bank dividends are at levels which I believe are dangerous for the businesses and way out of line with world practice. All banks are engaged in a high-technology fast-moving game and so they must invest in their business to keep pace. Paying out such large dividends means necessary investment has been put on the back burner.

Bad board decisions and silly institutional pressure saw bank shares pushed higher via unsustainable dividend rates. And those decisions were made worse by the recent need for banks to raise capital to comply with the new regulations – there are more shares to service.

All the banks are trying to assess how far their shares will fall if they lower dividends. It would make it easier for all of them if Commonwealth Bank made the first move. Then they could all follow and damage would be contained.

I am not going into the short-term tipping business but our market will be healthier for longer-term investors if bank dividend rates are trimmed. ANZ Bank, which has the most urgent need for technology investment, has heralded publicly it is thinking about such a move. Of course, I know for those depending on bank dividend yield that lower dividends will not be a popular view, but the trimming of bank dividends is not reason enough to make fundamental portfolio adjustments.

Profit season

In the coming half-yearly profit season, watch the performance of your companies. Look to see if they are vulnerable to disruptive technologies and, if so, see what the directors are doing about it.

If your company is a good one but has a disappointing profit caused by factors that have been addressed and the stock is trashed don’t sell out at the low point. If you are really certain, you can buy more stock at the low point but that requires a clear degree of confidence. We so often see share traders get very cross when a stock does not meet their expectations and they are inclined to sell their funds out without too much regard to the price.

If, of course, there is a terminal problem with the company then take the lower price. That is where you have to make a judgement.

Readings & Viewings

Ambrose Evans-Pritchard: Hysteria over China has become ridiculous.

The global economy’s marshmallow test.

Enda Curran’s useful piece on what China might do about money pouring out of the country…some of it into our property market.

China’s bumpy new normal.

Oliver Marc Hartwich: A mess of Merkel’s own making.

Facebook is doing some amazing numbers just now, especially on mobile advertisements.

Why you’re more valuable to Facebook than ever.

US election: Trumped by ‘The Donald’.

World heritage forests burn as global tragedy unfolds in Tasmania.

The Zika virus is spreading explosively, says WHO.

Zika virus: no vaccine, no cure.

The late Paul Ramsay of Ramsay Healthcare created Australia’s largest private charity foundation … here’s how the folks left with the task of managing it are approaching the challenge.

After the ABC Four Corners piece on abuse in the greyhound industry won a Gold Walkley last year you might have expected very different results to what this Roy Morgan survey found about younger people just loving to bet on the ‘dishlickers’.

Are computers to blame for market jitters?

Activists target Yahoo over links to ivory trade.

Can Japan afford to increase sales tax?

How two guys built the ultimate GIF search engine.

Chart of the Week

Japanese 10-year bond yield fell to a record low after the Bank of Japan’s negative interest rate move.

Last Week

By Shane Oliver, AMP Capital

The past week has been rather messy. On the one hand global growth fears remain with US and Eurozone shares falling back, Chinese shares still seeing significant selling pressure and bond yields continuing to fall. On the other hand a more dovish Fed has taken pressure off the US dollar, the Chinese renminbi has remained relatively stable, commodity prices including oil have seen further gains and shares in Japan and Australia rose. The Australian dollar also rose.

The March towards more dovish central banks continued over the last week. Quite clearly they are concerned that the latest bout of global growth worries and commodity price falls will further delay the return of inflation to their targeted levels. This renewed dovish tilt started with the ECB which is now expected to ease at its March meeting and became clear from the Fed following its January meeting where it was less positive on the growth outlook and indicated it was monitoring recent economic and financial developments. The probability of a March Fed hike is now just 14 per cent and rather than four Fed rate hikes this year as the Fed has been projecting in its “dot plot” I see only one or none. This should further help reduce the upwards pressure on the US dollar which in turn should help oil and other commodity prices. The Reserve Bank of NZ has also turned more dovish and I expect the RBA to do the same next week. An upbeat RBA and a dovish Fed would not be a good combination in terms of getting (and keeping) the Australian dollar down.

January has seen a terrible start to the year in share markets with the US S&P 500 down 7.4 per cent and the Australian share market down 6.4 per cent (at the time of writing). It’s not the worst ever – ie we have seen it all before. But for US shares it has been the worst January since January 2009 (when shares lost 8.6 per cent) and for Australian shares it’s the worst January decline since January 2008 (when shares lost 11.3 per cent). Obviously this will lead many to fear the old saying “as goes January so goes the year”, ie the so-called January barometer. But it’s worth noting that the track record of the January barometer is very mixed. For US shares the track record of a negative January going on to a negative year has been 43 per cent since 1980. Similarly for Australian shares the track record of a negative January going on to a negative year has been 33 per cent since 1980.

Interestingly Australian shares have been a relative outperformer so far this year falling 6.4 per cent in local currency terms versus the US -7.4 per cent, Eurozone shares -8.5 per cent and Japanese shares -10.5 per cent. This could just be noise. Then again given the usual tendency of Australian shares to underperform when there are global growth worries, falling commodity prices and when the Australian dollar is falling it may be telling us something…perhaps that the Australian economy is in relatively better shape? and/or that a lot of bad news has already been factored in?

Our high level view remains that if there is to be a US/global recession then share markets have much further to fall (eg another 20 per cent plus), but if recession is avoided and global growth continues to muddle along around 3 per cent pa then further downside in markets is likely to be limited and they are likely to stage a decent recovery by year end. We see a recession as being unlikely because we have not seen the normal excesses – massive debt growth, over investment or inflation – along with aggressive monetary tightening that invariably precede them

Major global economic events and implications

US economic data over the past week was mixed with solid gains in home prices, a sharp rise in new home sales, an unexpected rise in consumer confidence and a fall in jobless claims but against this the Markit services sector PMI fell in January albeit it remains reasonably solid at 53.7 and December durable goods orders were much weaker than expected. The fall in durable goods orders is a bit concerning as it was broad based and may be warning of weaker business investment generally. It could just reflect month to month volatility but its work keeping an eye on. So far the US December quarter earnings reporting season is about 28 per cent complete. While 79 per cent of results have beat on earnings, its only 49 per cent for sales and earnings are still down 7 per cent year on year.

Eurozone confidence readings slipped in January, presumably on the back of all the news around global growth worries and share market turbulence, but remain at levels consistent with okay growth.

The Japanese labour market remained strong in December but household spending and industrial production were very weak and core inflation fell slightly to 0.8 per cent year on year. It all adds up to ongoing pressure on the Bank of Japan to do more.

Chinese industrial profits fell over the year to December, but consumer confidence rose in January.

Australian economic events and implications

Australian December quarter inflation data indicate that pricing power and inflationary pressures remain very weak, but probably not weak enough to trigger another RBA rate cut just yet. But with underlying inflation running at the bottom of the 2-3 per cent inflation target it leaves plenty of room for another rate cut and helps reinforce the RBA’s easing bias. Meanwhile another sharp slump in December quarter export prices means that the hit to national income is continuing, but that net export volumes will have continued to help real GDP growth. The NAB business survey indicated that business conditions and confidence slipped in December, but remain above average, albeit this was before the intensification of global growth worries seen so far this year. Finally, credit data for December shows continued moderate growth overall with an ongoing slowing in lending to property investors relative to owner occupiers – no doubt APRA will be happy!

Next Week

By Savanth Sebastian, CommSec

Reserve Bank in focus

The start of a new month ushers in a barrage of economic data. In Australia, no less than six indicators are set for release, but most investors and analysts are focused just in direction: the Reserve Bank.

The first board meeting for 2016 is held while the Statement on Monetary Policy is released. In the US, a raft of indicators is released including those covering manufacturing, trade and the all-important employment figures.

The Reserve Bank board meets on Tuesday and much has changed in the past two months. Volatility has certainly lifted, oil prices have continued to slide; and the Aussie dollar has also weakened; and the European Central Bank has discussed the likelihood of further stimulus measures to boost growth.

While we can’t totally rule out a rate cut from the Reserve Bank, it is almost certain it will keep rates on hold and maintain its quasi-easing bias, suggesting rates could fall in coming months. Interestingly if the Reserve Bank were to cut rates, it would be able to flesh out its reasoning in the Statement on Monetary Policy. In the Reserve Bank’s interest rate decision, investors will be particularly interested in the policymaker’s views on the Aussie dollar and also the outlook for China.

As mentioned above, the spotlight on the Reserve Bank doesn’t stop with the Board meeting — the quarterly Statement on Monetary Policy is slated for release on Friday. Not only does this report assess economic developments over the past quarter, it includes the latest economic growth and inflation forecasts.

In terms of economic data, the CoreLogic RP Data home value index is released on Monday alongside the monthly inflation gauge and Performance of Manufacturing index.

On Tuesday, weekly consumer sentiment data is released.

On Wednesday data on international trade is issued with the monthly building approvals publication, the Performance of Services index and new car sales figures for January.

And on Friday the December retail trade figures are released. Not only will the report cover the Christmas and Boxing Day clearance sales period but it will also contain quarterly estimates of real or price-adjusted sales for the December quarter.

Raft of US economic indicators due for release

The ‘star’ of the US monthly economic data calendar is the non-farm payrolls (employment) figures. And those jobs figures are released in the coming week on Friday.

Economists expect that the good run of results continued in January with 210,000 jobs created. Apart from the jobless rate, the other indicator in the report that will be scrutinised will be the measure of wages. If wages are starting to lift, the Federal Reserve will feel more comfortable continuing the process of “normalising” interest rates.

In terms of the other indicators, the procession starts on Monday with data on personal income and spending, construction spending and the ISM manufacturing index.

On Tuesday, the regional ISM New York survey is released alongside auto sales. Sales of new vehicles may have lifted from 17.2 million to 17.5 million in January.

On Wednesday, the ADP survey of private sector jobs is released together with the ISM services index. Aside from the non-farm payrolls, international trade figures and consumer credit data are slated for release on Friday. A trade deficit of $43 billion is expected while consumer credit should have lifted from $14bn to $15bn.

In China, the focus is on the various activity measures covering the manufacturing and services sectors. The official statistician — the National Bureau of Statistics — and the private sector Caixin, both have purchasing manager surveys for the two key sectors of the economy. The manufacturing purchasing manager surveys are released on Monday while the services sector measures are issued on Wednesday.

Sharemarkets, interest rates, exchange rates and commodities

Financial market pricing suggests that there is a one in four chance that the Reserve Bank will cut rates on Tuesday, but participants are more certain about a potential rate cut in future months.

The overnight index swap market has priced in a 24 per cent chance that the Reserve Bank will cut rates on Tuesday. Financial market participants believe that a quarter per cent rate cut in five months’ time is virtually certain (119 per cent chance) while the cash rate is projected at 1.58 per cent in nine months’ time.

The US profit-reporting season continues in the coming week while at the same time the Australian earnings season also kicks off. The ‘confessional’ period has resulted in no clear trend, with a mix of earnings downgrades and upgrades.

On Monday, earnings results are expected from Argo Investments, while News Corp is among those to report on Tuesday. On Thursday, earnings include those from Downer EDI, and Tabcorp, while Macquarie Group is set to issue a trading update. And on Friday, earnings are expected from REA Group and Whitehaven Coal.

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