Dow Jones, down 0.32%
S&P 500, down 0.14%
Nasdaq, up 0.18%
Aust dollar, US76.2c
The US economy added 280,000 jobs in May according to this morning’s employment report, well above what the market had been expecting (225,000) and the most since December.
It wasn’t enough to reduce the unemployment rate, which ticked up from 5.4 to 5.5 per cent because 397,000 more people entered the labour force, which is actually good news, of course.
In any case, on a trend basis jobs growth is greater than the growth in the participation rate and as a result full employment shouldn’t be too far off. Over the past 12 months the labour force has grown by about 150,000 per month and employment has expanded by 250,000 per month.
If that continues for the rest of this year, unemployment will reach 5.1 per cent by December (see chart), which means that the Federal Reserve will have reached the “full employment” part of its dual mandate – which is 5-5.2 per cent unemployment.
That means that unless the Fed changes its mind about what full employment means for inflation, interest rates in the US will have increased by December.
I have been arguing for a while now that the so-called NAIRU (non-accelerating inflation rate of unemployment) may have been altered by the fourth (or is it third?) industrial revolution putting downward pressure on costs and prices.
That may have run its course by the end of this year, or the Fed might think it has, in which case it will think that the inflation side of its mandate will require higher interest rates once unemployment reaches 5.1 per cent.
Anyway, that’s what the market thinks now, which is why Wall Street indexes were pale and wan this morning – the Dow off slightly as I write and the S&P 500 flat – even though the employment report was unambiguously good news for the economy.
One of the main good things about the report was that wages growth (average hourly earnings) has moved up to 2.3 per cent and the three month annualised growth rate has moved up to 2.9 per cent, the strongest since 2009.
Some economists are reporting that wages growth has reached a tipping point and will start accelerating meaningfully from here, which supports the prediction of a rate hike by September.
One of the mysteries about the US economy has been the discrepancy between strong employment and weak consumption. It’s beginning to look like that will be resolved by rising consumption rather than weaker employment.
Nevertheless, GDP won’t snap back like a rubber band after the first quarter contraction of 0.7 per cent, and is likely to be still pretty subdued in the second quarter, which should keep the Fed on the sidelines in June/July.
The US economy in general is on track for a decent bounce-back in the second half of this year, which should see at least one rate rise and, more importantly for us, solid gains in the value of the US dollar.
With any luck, we’ll see an Australian dollar in the 60s before Christmas.
All else being equal, that should be good for the sharemarket. Between June 1996 and June 2001, the currency devalued by 40 per cent, from US80c to US50c and the ASX 200 accumulation index rose 92 per cent in a straight line over the same period, or 14 per cent compound per annum.
Of course all else is not equal. Those five years saw the big recovery of the bank share prices from the recession in 1992 – so the banks tripled in price (CBA went from $10 to $34). Also the cash rate was cut from 7 to 5 per cent.
Those things are not going to happen this time.
But having said that, the recovery in the US economy that is obviously underway is unambiguously good for Australians, as both employees and investors.
It was telling that 24 hours after the national accounts were released showing GDP growth of 0.9 per cent in the March quarter as a result of strong net exports and inventories, we learned that in April there was a record trade deficit and flat retail sales.
Ridin’ high in March, shot down in April, to misquote Frank Sinatra. But anyway, it gave Joe Hockey a chance to grandstand briefly and to call the gloom-mongers “clowns”. But the economic outlook remains as clouded as it did a week ago: exports can fluctuate, as we saw in April, and in any case they depend on other countries, mainly China. And inventories are not any kind of basis for sustained output growth.
As I have been setting out in detail recently, the problem is the failure of non-mining businesses to invest, so far. But look, it’s not all bad and in fact inside the bad trade data for April was some good news. Paul Bloxham of HSBC says the blow out in the trade deficit in April was due to a “perfect storm” of mostly temporary factors: "Exports fell by a whopping -6 per cent in April, largely driven by a fall in coal exports as severe weather temporarily closed ports. At the same time, imports lifted strongly ( 4 per cent month-on-month), largely driven by capital goods, which is a positive story for business investment.”
And Shane Oliver put out a piece this week listing “seven reasons not to be gloomy”. They’re worth reproducing:
1. Borrowing rates are at generational lows. Interest payments on a $350,000 mortgage are now around $730 a month below what they were four years ago. While those relying on bank deposits have lost income, Australians owe the banks $1.2 trillion more in debt than the banks owe them via deposits, so the household sector is a net beneficiary of low rates. Some of this freed-up income is being spent.
2. Rising wealth levels are benefiting spending. Over the year to May average capital city home prices are up 9 per cent (although skewed to Sydney), the Australian share market has returned 10 per cent and average balanced growth superannuation funds have returned around 14 per cent.
3. While petrol prices have bounced back from the lows seen earlier this year, they remain well down on the highs seen over the last few years, providing savings to businesses and households.
4. The household savings rate remains relatively high at 8.3 per cent and has scope to drift down further, supporting spending.
5. The lower Australian dollar is a big positive for manufacturing, tourism, education, services, farming and mining. The boost is evident in education and tourism exports which took a hit when the Australian dollar went above parity, but are now at record levels. It’s also worth recalling the comment from BlueScope CEO Paul O’Malley from earlier this year: “As the Australian dollar gets into the 70s we get competitive, and with a year or two of that…you start to get the confidence to invest.” The point is that it takes a while for this to feed through so we shouldn’t be too depressed as non-mining companies take their time to get more confident on this front.
6. Export volumes are continuing to rise strongly ( 8.1 per cent year on year) on the back of completed resource projects and as the lower Australian dollar makes exports more competitive. Reflecting this, the current account deficit as a share of GDP is around its lowest in the last 30 years, despite plunging prices for resources exports.
7. Australia has arguably managed the boom a bit better than it has in the past when booms led to inflation or trade deficit blow-outs or both and all sectors of the economy boomed together and so went bust together. This time there was no major build-up of imbalances in the economy and sectors suppressed by the mining boom have the potential to bounce back and are starting to.
One of the negatives for Australia at the moment is the state of politics. It’s really bad.
I happened to be listening to Question Time on the radio when the following exchange took place:
Mr Shorten (Maribyrnong – Leader of the Opposition) (14:44): My question is to the Prime Minister. Yesterday the government's top economic adviser warned Australians that there is a housing bubble in Sydney and parts of Melbourne. Does the Prime Minister agree with his top economic adviser that there is a housing bubble in Sydney and parts of Melbourne?
Mr Abbott (Warringah – Prime Minister) (14:44): Millions of Australians have borrowed money to buy a house – millions of Australians have mortgages – and the last thing they want to see is a decline in the value of their most important asset. That is the thing. Why should members opposite be talking down our economy? Why should members opposite be saying that somehow people's houses are worth too much? That is what the Leader of the Opposition is saying. He is saying that people's houses are worth too much. This is someone who wants to be the Prime Minister of Australia, and he wants your house to be worth less. The Leader of the Opposition wants your house to be worth less. This bloke has wrecked a lot of things, but what I do not want him to do is to wreck the housing market of Australia. Do not trust this man with your house price, do not trust this man with your superannuation, do not trust this man with your future and do not trust this man with the government of Australia. What he wants is for your house to be worth less. Just imagine how you would go paying back your mortgage when your house is worth less.
This is truly crazy stuff.
In her column in the Australian Financial Review yesterday, Laura Tingle likened what’s going on to Malcolm Fraser’s effort at a scare campaign in 1983, when he warned that "under Labor (your savings) would be safer under your bed than it would be in the banks. They would be robbing the savings of the people to pay for their mad and extravagant promises.” It was spectacularly deflated when Bob Hawke said: “They can’t put them under the bed because that’s where the commies are.”
It’s not just Tony Abbott who’s responsible for the poor state of politics. Niki Savva wrote in The Australian the other day: "Thanks to their individual flaws, shortcomings and eccentricities Abbott and Shorten keep each other afloat. If Labor had a better leader Abbott would be political dead meat by now. The reverse is also true... Neither leader has been able to gain complete ascendancy over the other, leaving people almost deadlocked on who is better. Or, rather, who is worse.”
Metcash’s $640 million writedown and 18 per cent share price dive on Thursday need to be put into the context of broader trends, in supermarkets and business in general.
The big trend is that the middle is being hollowed out, in everything, and marketing no longer works like it used to. Consumption is dividing into discount and premium, canny and aspirational. I think it has come as a result of the internet handing consumers more power: they are no longer sheep to be herded by the power of brands but are breaking out of the brand environment and making decisions based on their own wants and needs. People are using Uber and Airbnb. They are using the internet and apps to compare prices and services, and are becoming much more demanding. It has been a gradual process, and you can see it everywhere – in clothing, cars, beer … and groceries.
Metcash is in strife because of Aldi, which is starting to carve a real hole into the market shares of the three incumbent supermarkets – Coles, Woolworths and the IGA network. Those incumbents are essentially collections of brands – FMCG (fast moving consumer goods) brands that have been created and sustained by heavy marketing investments over many years. But with the fragmentation of the media and time-shifted TV viewing using iQ boxes and PVRs, marketing is losing its power.
Aldi is a non-brand operation with prices that are devastatingly low, thanks to own low costs and margins, and also the way it deals with suppliers. The suppliers get one transparent price and are always paid on time. The other supermarkets charge suppliers shelf space rents, plus a range of other fees, so the price they get is complicated and not what it seems, and they often get mucked about on terms. As a result Aldi is able to negotiate very low prices from suppliers. Also, the brands are all owned by Aldi, so none of the suppliers can build brand marketing expenses into their prices.
The result is the following table from a Choice supermarket survey published this week:
IGA (Metcash) was not included but they would be at the top end.
Those price differences are shocking – 100 per cent premium to buy “leading brands” in Coles and Woolworths? Forget it. The traditional brands that are owned by Proctor and Gamble, Unilever etc are losing their power as marketing itself loses the ability to influence.
Except perhaps at the top end. I interviewed the local boss of Maserati this week for my Qantas radio show and he told me they have just had their best year ever – selling more cars in 2014 than in the previous three years combined. Another interview was with a young bloke who started a premium beer business called Endeavour Vintage Beer which is also doing very well indeed.
The problem is that the products and environments at Coles, Woolworths and IGA do not qualify as premium. Their brands and the stores themselves are mid-range and that part of most consumer markets is being shaken out. That process has only just begun and has a long way to go.
I can see a big shake-out coming in the grocery business, with many of the prime sites currently owned by the IGAs, and possibly Woolworths and Coles, eventually being re-named Aldi.
The implications for investors are obvious: you need to be on the winning side of this, and avoid the losing side.
This morning’s email is a bit shorter than usual because I have been spending a lot of time at my father’s bedside this week, including most of yesterday. The cancer went to his liver a few weeks ago and the end is now close. I’m trying to spend as much time with him as possible (which is why I haven’t been on the ABC much this week either).
Dying is hard, I can see that. He doesn’t want to let go, but none of us has a choice – either in the time or the manner of going. Dad’s 89 and had a full and happy life; he’s dying painlessly surrounded by his family, who all love him. That’s what I want when it’s my turn.
This week's CEO interview is Phillipa Blakey of Pulse Health, but I’m afraid I can’t tell you much about it because James Kirby did it in my absence (see above). The business is an interesting combination of private hospitals, day surgeries, community care and corporate health. You can view and read the interview here.
You might remember I talked last week about some big changes we’re making to Eureka Report on July 1. One of these changes is the introduction of a stream of live and interactive events that we’re calling "Eureka Interactive". James Kirby, our managing editor, talks a bit more about Eureka Interactive and how it works here.
Readings & Viewings
Stephen Colbert shaves off his beard, or not.
It’s the 800th anniversary of the Magna Carta.
How capitalism is killing war.
FIFA has applied to become a global bank.
Pliny the younger on FIFA: the jury is still out.
Five takeaways on the Blatter resignation.
The inevitability of journalism written by robots. (Sometimes it is already, I reckon.)
Why Greece might still choose to leave the euro.
Five myths of investing - e.g. The market returns 10 per cent over the long term (it doesn’t) and you can beat the index (you can’t).
Another five things … five things to know about the Yangtze River.
The financial planning industry is getting over the shock of Trowbridge recommendations against life insurance commissions.
Power no longer lies in confining physical bodies, but in controlling flows of data.
The inflation puzzle, by Martin Feldstein. (Why isn’t there inflation, despite all the money printing?)
It’s not a puzzle at all.
In fact it was obvious from the beginning that there would not be inflation.
Oh whoops – Google apologises after India’s PM appears in the search result for “Top 10 Criminals”
How all banks could become slaves to Google, Facebook, Apple and Amazon.
The great digital banking debate.
Here’s a new startup that uses as a kind of crystal ball.
Ninety-one per cent of Wikipedia’s editors are men. It shows.
The dividends of a business are based on reality. The stock price is based on emotion.
Bikram Choudhury: yoga guy, and absolute dick.
Happy Birthday Steve Vai, guitarist extraordinaire. Here he is playing I’m The Hell Outta Here at the Eric Clapton Crossroads festival in 2004.
Happy Birthday Liam Neeson. Here he is in the phone call scene from Taken.
By Shane Oliver, AMP
Investment markets and key developments over the past week
Shares had a rough week as Greek worries continued to weigh, the back-up in global bond yields resumed, and uncertainty about the US economy and the Fed continued. Australian were hit particularly hard by the weak global lead, messy Australian economic data and the RBA’s failure to reinstate an explicit easing bias. While global shares are down less than 2 per cent from their recent high, Australian shares have come down by around 8 per cent since their April high. Commodity prices generally fell and the Australian dollar rose slightly.
The bond sell off has clearly resumed again led by Europe on the back of stronger than expected Eurozone inflation prompting a further unwind of deflation fears. Comments by ECB President Draghi to get used to periods of higher volatility in bonds didn’t help. Our assessment remains that the bond sell off is unlikely to go too far as global growth remains below trend, inflation is weak, the ECB will continue to be a big buyer of bonds and other countries may still have to cut interest rates again. That said the rise in Eurozone bond yields may be a sign of success as US 10 year bond yields rose through each of quantitative easing mark 1 (by 200 basis points), QE2 (by 130 basis points) and QE3 (by 140 basis points).
The 140 per cent surge over 12 months and recent gyrations in Chinese shares have naturally led some to question whether it’s another bubble that may be close to ending. For example, the cover story in The Economist referred to a “mania” in China’s “overvalued” stock markets. There’s no doubt the Chinese share market has risen a bit too far too fast and parts of it, like ChiNext, do look overvalued. The easy gains are probably over and a period of correction would be healthy. However, the Shanghai composite index on an historic PE of 21 times is still below its long term average and should benefit as further monetary easing comes through. See the next chart.
In fact, The Economist’s cover story on “Flying too high – China’s overvalued stock markets” reminded me of the “Magazine Cover Indicator” which got its start from Business Week’s August 1979 cover on “The Death of Equities” which proved to be a great buying opportunity in shares. Since The Economist cover in October last year relating Europe to Monty Python’s dead parrot Eurozone shares are up 22 per cent.
Source: Thomson Reuters, AMP Capital
Negotiations on a “reform for funding” deal for Greece are continuing to drag on with Greece rejecting an offer from its creditors and choosing to bundle up its June 5 IMF payment to be made with other IMF payments at the end of the month. So the deadline has yet again been pushed out. Fortunately, negotiations still look to be ongoing. Our base case remains that some sort of deal will be reached in time, but given the stresses within the Greek Government and the need for any deal to be passed by various parliaments it is a close call. So a missed payment later this month remains a high risk. Such a Graccident doesn't necessarily mean that a Grexit is inevitable but Greece will likely continue to be a source of volatility through June. Whichever way it goes though, the threat of contagion to other peripheral countries is low compared to the 2010-12 period as they are in far better shape now and the ECB is buying bonds across Europe as part of its QE program.
Major global economic events and implications
US economic data was mostly good. Personal spending in April was clearly on the weak side, but against this the ISM manufacturing conditions index rose solidly, non-manufacturing conditions indexes were a bit weaker than expected but remained at solid levels, construction activity rose strongly in April, auto sales rose to their fastest pace since 2005, the trade deficit narrowed sharply in May and labour market indicators are strong. The run of stronger data is adding to confidence that growth is rebounding in the current quarter. However, so far it’s not doing so as quickly as occurred last year and in contrast to the CPI, the core private consumption deflator - which is the Fed's preferred measure of inflation - fell to 1.2 per cent yoy, from 1.3 per cent. So there’s still no reason for the Fed to hurry in raising interest rates. To this end it’s interesting to note that the IMF has effectively endorsed the position of the doves at the Fed in arguing rate hikes should be delayed until next year, not that this means the Fed will necessarily listen to the IMF.
The Eurozone also saw some good economic data, with the composite business conditions PMI revised up for May such that it remains at a reasonable level, retail sales up more than expected in April and unemployment falling more than expected. While the latter is still high at 11.1 per cent the key is that it’s going in the right direction. On top of this inflation rose to 0.3 per cent yoy in May and core inflation rose to 0.9 per cent indicating that the risk of deflation is continuing to recede. However, Europe still has a long way to go to get growth and inflation back to decent levels and so it was not surprising to see ECB President Draghi reiterate the commitment to implement its quantitative easing plans in full (ie buying bonds out to September 2016).
In Japan there was a welcome rise in wages growth. However, at 0.9 per cent yoy it still has a fair way to go before the BoJ can be confident its broken the back of deflation.
China's official manufacturing conditions PMI rose marginally in May, albeit it’s still at the low end of the range it’s been in for the last few years. However, the slight improvement combined with a gain in average city property prices in May does add a bit to confidence that growth may be stabilising if not picking up. More policy easing is likely required though to be confident.
In India, the Reserve Bank cut interest rates again consistent with inflation being below target and growth in activity slowing in the March quarter. Further rate cuts are still likely. By contrast Brazil is continuing to hike interest rates with the policy rate reaching 13.75 per cent reflecting high and accelerating inflation.
Australian economic events and implications
Australian economic data was messy. The good news was that March quarter GDP growth was a stronger than expected 0.9 per cent quarter on quarter. Against this though, annual economic growth is just 2.3 per cent, domestic demand remains very weak and data for April looks to be off to a soft start with flat retail sales, a blow out in the trade deficit and a fall in building approvals. The trade deficit blowout may be partly related to bad weather and a slump in the iron ore price to around $US45/tonne whereas it’s now back over $US60/tonne and the fall in building approvals looks like normal volatility. But Australian economic growth looks like remaining sub-par for a while yet as the investment outlook remains weak and the loss of national income due to lower commodity prices continues to impact. There is no reason to get too gloomy as the combination of low interest rates and a lower Australian dollar help rebalance the economy, but more help is likely to be required in the form of an even lower Australian dollar and possibly another interest rate cut.
While the RBA left interest rate on hold as expected and appears to retain a mild easing bias it was disappointing to see that it did not reinstate a more explicit easing bias. Doing so may have helped push the Australian dollar lower. Given the still messy economic outlook another RBA rate cut is a 50/50 proposition, with the August RBA meeting the one to watch.
Finally, there is nothing new in the latest house price data from CoreLogic RP Data. While prices fell in May this looks like a regular seasonal pattern. More fundamentally, while Sydney remains strong, annual price gains are averaging around just 2 per cent in the other capital cities. As such, Sydney should not be seen as limiting any further monetary easing if it’s deemed necessary for the rest of the Australian economy.
By Craig James, Commsec
Employment and business confidence in focus
In Australia, there is a solid schedule of economic events over the week, with the labour market in focus, alongside business and consumer sentiment surveys. In China, the economic data fest starts on Monday with trade data, followed by economic activity indicators like retail sales. And in the United States the key data releases take place late in the week.
In Australia, the economic data kicks off on Tuesday after a Monday holiday (all states except Western Australia). On Tuesday housing finance data is released together with the NAB business survey and job advertisements. Based on Bankers Association data we tip a 3 per cent fall in the number of loans to owner-occupiers with the value of all loans lifting 1 per cent.
In terms of the NAB business survey we anticipate that the tame federal budget and resulting favourable policy for small and medium businesses should lift business confidence and conditions. Businesses have been holding back from embracing super-low interest rates, however the federal government’s $5.5 billion small business package (which includes the $20,000 asset write-offs as well as a 1.5 per cent tax cut) may lift investment plans.
On Wednesday the Westpac/Melbourne Institute consumer confidence survey is released. No doubt the weekly Roy Morgan consumer sentiment figures will continue to steal some of the former’s thunder, being released on Tuesday – the first sentiment gauge to assess the recent Reserve Bank interest rate decision. Expect a flat reading given that stability on rates is balanced against a weaker Aussie dollar and sharemarket. However of interest in the Westpac survey will be the survey respondents’ views on the wisest place to put new savings. Also on Wednesday, the Reserve Bank Governor Glenn Stevens delivers a speech in Brisbane to the Queensland chapter of the Economic Society of Australia. No subject has been set for the speech at this stage but investors would be hoping that it provides more clarity on future rate movements.
On Thursday the Bureau of Statistics issues the May employment figures. The employment figures have been rather upbeat in recent months. And we expect that hiring rose further in May with jobs up by 20,000 and the unemployment rate holding around 6.2 per cent. Given the recent improvements in the labour market, more focus will be paid on hours worked – which at present is rising as the fastest pace in four years.
On Friday the Reserve Bank releases monthly data on credit and debit card lending. Consumers are still spending, but most prefer to use their own money to make purchases rather than using credit. In fact Commonwealth Bank credit card statistics show that around 57 per cent of our credit card customers currently pay no interest on their credit card, paying off the full amount outstanding on every statement.
Lending finance data is also out on Friday, covering housing, personal, commercial and lease finance. The ongoing lift in total lending finance commitments is certainly encouraging, particularly given that lending is been driven by the commercial and residential space. The only area of weakness is personal borrowings. Keep in mind the May rate cut has shifted consumer sentiment and may result in a lift in household activity.
China data will dominate investor attention
The US will play second fiddle to the “top shelf” Chinese data releases over the early part of the week.
China kicks of proceedings on Monday with the release of import and export data on Monday. Exports and imports have continued to decline in recent months, highlighting the slowdown in the Chinese economy. A trade surplus of around $30 billion is expected.
On Tuesday Chinese inflation data is released. There are no signs of inflationary pressure at present. In fact businesses are experiencing a deflationary environment. In essence inflation is not going to be a stumbling block for further rounds of targeted stimulus.
In the US, wholesale sales and inventories are issued on Tuesday.
On Wednesday the usual weekly data on housing finance activity is released alongside the monthly estimates of the Federal Budget. A budget deficit of around $100 billion is expected.
On Thursday the weekly data on jobless claims is issued together with retail sales, import and export prices and business inventories. Economists expect that retail sales lifted by 0.8 per cent in May, or up 0.7 per cent if sales of automobiles are excluded.
And on Friday in the US, the producer price index (PPI) is issued alongside consumer sentiment figures. Economists expect that business inflation was contained with a small 0.4 per cent lift in the PPI. Core inflation (ex food and energy) is anticipated to lift by just 0.1 per cent in May. And the preliminary reading on consumer confidence is expected to show a lift from 90.7 to 91.5 in June.
Sharemarket, interest rates, currencies & commodities
In Australia the end of the financial year is around the corner. In other economies, the focus is on the end of the month and the end of the quarter. But the one common feature will be the likelihood of “window dressing” over the next few weeks. This is the practice where ordinary fund managers and hedge funds attempt to buy and sell securities with the aim of improving their performance figures before books get ruled off. So expect to see a lift in volatility.
With just over three weeks to go, the ASX 200 has managed to eke out a 3.5 per cent gain for the financial year. In the US the Dow Jones has gained 7.4 per cent so far. And the technology-heavy Nasdaq has been the outperformer, lifting by 15.7 per cent. However the real winners have been the Japanese Nikkei, which has lifted by 35 per cent, and the German Dax, up by 16.1 per cent. No doubt the European Central Bank and Bank of Japan stimulatory measures, and resulting currency devaluation, have been big drivers of the gains.