By Shane Oliver

Shares were mostly flat to down over the last week. While Chinese shares gained 2.2%, US shares were flat, Eurozone shares lost 2% reversing some of the gains of the previous week, Japanese shares fell 2.2% and Australian shares dipped 0.1%. Except in Australia, bond yields rose as some Fed officials indicated a September Fed rate hike was “possible” but the $US fell back to near where it was prior to the Brexit vote, which in turn, saw commodity prices rise, with oil helped by optimism of a supply cutback. The $A fell slightly.

The Olympics, US elections and shares in August

Its well-known that August is a seasonally tough month for US shares, with an average decline of -0.6% in the S&P 500 for all Augusts since 1985. Interestingly though, in US presidential election years/Olympic years (they are the same) since 1985, US shares have seen an average 0.7% gain in August. Maybe the feel-good feeling of the Olympics offsets the uncertainty around the election. For Australian shares, average August gains have been 0.4% over the same period for all Augusts and for Augusts in US election/Olympic years.

A big positive this year has been the fall back in the $US after several years of strong gains. From its high late last year, it has now fallen nearly 6%. This has taken pressure off US manufacturers and multinationals, helped commodity prices to stabilise and pick up (as they are priced in US dollars), reduced the downwards pressure on the Chinese Renminbi and the risk of capital flight out of China, and alleviated fears about a dollar funding crisis in the emerging world – all of which has been positive for global growth prospects and hence, risk assets. Of course, the downside has been for Japan and Australia which would prefer a lower Yen and $A respectively, but this is a minor issue in a global context.

Rethinking monetary policy, or just back to the past?

For the last two decades, central banks have been focussed on price stability (using inflation targets) and have played the first line of defence in stabilising the economic cycle, whereas fiscal policy has played back up, focussing more on fairness and efficiency for much of the time. But we are starting to see increasing discussion about whether a new approach is needed to manage macro-economic stability in a world of slower trend growth. Key aspects of this debate are about inflation targeting – that is, whether inflation targets need to be set higher or turned into price level or nominal GDP targets – and whether fiscal policy should play a greater role.

The debate is arguably not as big an issue for countries like the US and Australia, but it is a big one for countries where deflation is or risks becoming entrenched, such as Japan and maybe Europe. Ideally, Japan needs to combine monetary stimulus and fiscal stimulus – via some form of helicopter money - to have a greater chance of meeting its inflation and growth targets without further blowing out its already huge public debt to GDP ratio. The week ahead is likely to see a heightened focus on some of these issues, as the title of the US Federal Reserve’s annual economic policy symposium in Jackson Hole, Wyoming over Thursday to Saturday is “Designing Resilient Monetary Policy Frameworks for the Future.”

The Australian June-half earnings results improved in tone over the last week. While there was no real surprise from BHP’s profit slump, there have been some excellent results from stocks like JB Hi-Fi and Treasury Wine Estates. Key themes are: improving conditions for resources companies following a stabilisation in commodity prices; constrained revenue growth for industrials; ongoing cost cutting; continuing headwinds for the banks; and an ongoing focus on dividends. So far, 51% of companies have reported, with 46% exceeding expectations which is around the norm of 45%. 68% have seen their earnings rise on a year ago, 56% have seen their share price outperform the market the day results were released and 92% have either maintained or increased their dividends. While overall profits look to have fallen 8% in 2015-16 thanks to the slump in resource profits, they are on track for a return to growth in 2016-17 as the slump in resources profits reverses and non-resource stocks see growth.

Source: AMP Capital

Major global economic events and implications

US economic data was mostly good, with solid home builder conditions and another unexpected rise in housing starts, strong leading indicators and a fall in jobless claims but mixed readings from the New York and Philadelphia regional manufacturing conditions indexes. Meanwhile, there were a few gyrations around expectations for when the Fed will next raise interest rates, with the minutes from the July Fed meeting presenting a relatively dovish picture, but regional Fed President’s Williams and Dudley pushing back against market expectations that look to be too dovish. While I don’t see a Fed hike in September, I think it’s possible if we see another really good jobs report for August, and I remain of the view that the Fed will hike in December. Against this backdrop, the US money market’s probabilities of just a 22% chance of a hike in September and 51% in December, albeit up from a week ago, are still too low.

UK real retail sales surged 1.4% in July or 5.9% year-on-year, far stronger than expected. What happened to post-Brexit gloom? I can understand Brexiteers feeling happy, but they were only 37% of those of voting age!

Chinese home prices rose again in July, but with slower growth for Tier-1 cities, and to confuse the China bears, electricity consumption rose 9.6% year-on-year in July, the fastest in 3 years.

The Japanese economy barely grew in the March quarter, as poor net exports and capex offset consumer spending and housing construction. Poor growth, core inflation sliding back towards deflation and the Yen having risen 20% from last year’s low point are piling pressure on the BoJ and PM Abe to do something. With the US dollar around the 100 Yen “line in the sand” a point of action could be getting near.

Australian economic events and implications

While jobs growth was much better than expected in July, and unemployment fell back to 5.7%, the quality of jobs growth remains poor with another surge in part time jobs at the expense of weak full time jobs. And this, in turn, is keeping the combination of unemployment and underemployment very high at over 14% and driving wages growth (including bonuses) to a record low of just 2% year-on-year in the June quarter. Given this, and the ongoing downside risks it implies for inflation, we remain of the view that the RBA will cut the cash rate again in November to 1.25%. In this regard, the minutes from the RBA’s last Board meeting offered nothing really new.

Speaking of interest rates, the Sydney and Melbourne housing markets are looking to be a bit more of a challenge. The perk up in finance commitments to investors, HIA new home sales and weekly auction clearance rates in Sydney and Melbourne (see chart) despite mixed readings on what home prices are doing suggest that the Sydney and Melbourne property markets may be getting a bit too hot again (at least in parts - I hear that western Sydney isn't so strong). Returning to rapid house price gains at a time when the supply of apartments is starting to surge would not be a good thing. But interest rates need to be set on the basis of what is right for the average of Australia - not just house prices in two cities - so the RBA has been right to cut as the average of Australia needed it. However, pressure is likely shifting back to APRA to further tighten lending standards.

Source: Australian Property Monitors/Domain, AMP Capital

What to watch over the next week?

In the US, the focus is likely to be on Fed Chair Janet Yellen’s address to the Jackson Hole symposium for any clues on the interest rate outlook if she even decides to discuss current monetary policy. The likelihood is that if she does, she will reiterate that the process of raising interest rates to more normal levels is likely to remain cautious and gradual, but leave the impression that the Fed is on track to raise interest rates again this year. On the data front in the US, expect the manufacturing conditions PMI (Tuesday) to remain around 52.9, a fall back in new home sales (Tuesday) and in existing home sales (Wednesday), a further rise in home prices (Wednesday), a rise in core durable goods orders (Thursday) and a slight further downgrade to June quarter GDP growth (Friday) to 1% annualised from 1.2%.

In the Eurozone, business conditions PMIs will be released (Tuesday) but are expected to remain around an okay 53.

Japanese consumer price data (Friday) is expected to show continued deflation of around -0.4% year-on-year at a headline level and core inflation of just 0.4% year-on-year.

In Australia, expect June quarter construction data (Wednesday) to show continued weakness in mining related investment but strength in dwelling construction. Skilled vacancy data for July will also be released.

The Australian June quarter earnings reporting season will see its biggest week, with 87 major companies due to report in the week ahead including Fortescue, Oil Search, Westfield and Woolworths.

Outlook for markets

After a period of strong gains, shares are due to take a breather and weak seasonals for the next couple of months along with risks around Italian banks, the Italian Senate referendum, the Fed and global growth generally could be the drivers. However, after a 1-2 month correction or consolidation, we anticipate shares to trend higher over the next 12 months, helped by okay valuations, very easy global monetary conditions and continuing moderate global economic growth.

Ultra-low bond yields point to a soft medium-term return potential from them, but it’s hard to get too bearish in a world of fragile growth, spare capacity, low inflation and ongoing shocks. That said, the recent bond rally has taken yields to pathetic levels, leaving them at risk of a snapback.

Commercial property and infrastructure are likely to continue, benefitting from the ongoing search for yield by investors.

Dwelling price gains are expected to slow to around 3% over the year ahead, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment prices get hit by oversupply.

Cash and bank deposits offer poor returns.

With the Fed continuing to delay rate hikes, a break of April’s high of $US0.78 and a push up to $US0.80 is likely for the $A. Beyond the short term though, we see the longer term downtrend in the $A ultimately resuming as the interest rate differential in favour of Australia narrows as the RBA continues cutting and the Fed eventually resumes hiking, the risk of a sovereign ratings downgrade continues to increase, commodity prices remain in a secular downswing and the $A sees its usual undershoot of fair value.

Eurozone shares fell 0.8% on Friday as worries about Italian banks, the upcoming Italian Senate referendum and the risk of another Spanish election weighed and the US S&P 500 fell 0.1%. Reflecting the soft global lead ASX 200 futures fell 6 points or 0.1% on Friday night pointing to a soft start to trade for the Australian share market on Monday.