October was a bad month for share markets with global shares losing 6.8% in local currency terms which was their worst month since August 2011 and Australian shares losing 6.1% which was their worst month since August 2015. The good news though is that markets have had a good bounce from their lows of around 3%. Shares had become technically oversold and were due for a bounce. It’s possible that following top to bottom falls of 10% for global shares, 11% for Australian shares and 21% in emerging markets we have now seen the low but with risks remaining around US interest rates, the US/China conflict, tech stocks, emerging countries, the Italian budget and the US midterm elections in the week ahead it's impossible to be definitive so there could still be another leg down.

 

However, while it’s impossible to say for sure whether we have seen the bottom in share markets there are reasons to be optimistic beyond the near-term uncertainty.

 

• First, investor sentiment has hit very bearish extremes which is positive from a contrarian view.

• Second valuations have improved with many markets now in cheap territory, including Australian shares which have seen their forward PE fall from around 16 times to 14 times.

• Third, US shares tend to rally once the midterm elections (to be held Tuesday) are out of the way and global shares would follow.

• Finally, we remain of the view that what we have seen or may still see is a correction or a mild bear market at worst (like 2015-16’s circa 20% fall that was quickly reversed) rather than a deep bear market like the GFC as the conditions for a US recession that invariably drive major bear markets are not in place: US monetary policy is not tight and the sort of excesses that normally precede recessions in terms of inflation, spending and debt are not present.

 

There were some limited signs of progress in Sino-American trade relations, while a weaker oil price and US dollar also helped improve sentiment regarding the outlook for global demand. However there were some more mixed signals late in the week, as Apple Inc.’s earnings guidance disappointed expectations, while strong US payroll data saw bond yields snap up as the focus returned to the pathway for US interest rates. US 10-year Treasuries were yielding 3.21% by the week’s end.

 

This week sees the US midterm Congressional elections. The outcome, while difficult to predict, will be important in dictating the tone of President Trump’s subsequent trade negotiations with China. It could also feed through to further market volatility.

 

US economic data remains strong with solid growth in September personal spending, an 18 year high in consumer confidence, still strong business conditions surveys (albeit the ISM manufacturing index fell back from its very high September reading) and continuing strong jobs data. The October jobs report was particularly strong with payrolls up by 250,000, unemployment remaining very low at 3.7% as participation rose and wages growth (as measured by average hourly earnings) moving up to 3.1% year on year, its highest since 2009, as a decline in wages last October dropped out of the annual calculation. Despite very low unemployment the rise in wages growth remains gradual and we are a long way from the 4% plus growth rate that preceded the last three recessions.

 

Yet again the US September quarter earnings reporting season is proving to be strong. With roughly 75% of results now in 83% have beaten on earnings, 61% have beaten on revenue and earnings growth expectations for the quarter have now moved up to 26% (up from 20% a month ago). All of which is seeing earnings match their June quarter high. Of course, the uncertain environment has seen investors latch on to those companies who have disappointed resulting in outsized share price declines relative to those who have exceeded expectations.

 

 

Source: Bloomberg, AMP Capital

 

Australian data released over the last week highlighted the cross currents currently impacting. On the negative side the trend remains down in building approvals, credit growth remains soft, retail sales were weaker than expected in September and rose just 0.2% in real terms in the September quarter and home prices continued to slide in October posing an ongoing threat to consumer spending. Meanwhile underlying inflation as measured by the trimmed mean and weighted median fell to 1.7%yoy in the September quarter and is just 1.3%yoy using a US core inflation measure.

 

On the positive side the trade surplus came in far stronger than expected in September with upwards revisions to previous months. While this was mainly driven by higher prices net exports look like providing a positive contribution to September quarter GDP growth and another rise in the terms of trade in the June quarter will provide a boost to national income. All of which indicates that trade along with an approaching end to the mining investment slump, rising non-mining investment and surging infrastructure spending will help offset the drag on growth from the declining housing cycle.

 

On balance our assessment remains that Australian economic growth will fall back into a 2.5-3% range, inflation will remain lower for longer than the RBA is allowing for and so an RBA rate hike is unlikely until late 2020 at the earliest.

 

 

Important note: While every care has been taken in the preparation of this document, Farrow Hughes Mulcahy make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.