Themes for September

2 September 2014

Geopolitics
In the Middle East Iraq’s parliament approved a new government headed by Haider al-Abadi as prime minister, increasing the prospects for a more unified front to combat the growing power of Islamic State. In Afghanistan the two rival presidential candidates agreed on Sunday to share power in a unity government, ending a three-month crisis over disputed election results, and opening the way for President Hamid Karzai to stand down after 13 years in the country’s first democratic transition.

In Europe a solid majority of Scottish voters rejected a proposal to pull out of the U.K. The tally was just over 55% to preserve the union with England, Wales and Northern Ireland. In the final days before the vote, leaders of the three major unionist parties promised to give new powers over taxation and public spending to the Scottish government in Edinburgh. Markets were relieved by a victory for the “no” camp in Scotland’s independence vote. Victory for the “yes” camp was forecast to leave the rate on 10-year gilts between 2.75% and 3% within a month, up from 2.54% before the vote. Meanwhile in Ukraine Poroschenko said most Russian forces have now left Ukraine after a ceasefire was agreed.

Protests in Hong Kong demanding that Beijing fulfil its promise of democracy led to a police baton charge, and barrage of teargas in the government district. The government’s tactic of subsequently waiting the protestors out seems to have worked, for now.

Macroeconomic news
In Australia job ads rose 1.5% in August and were up 8% YoY, according to ANZ. Leading data has been surprisingly good given the backdrop of restructuring. Meanwhile the volatility in official employment data from the ABS continued with employment in August reported to have risen by 121,000, a likely statistical error.

The value of Australian mortgage lending to property investors jumped 6.8% in July MoM, lifting the gain to 30% during the past 12 months. What’s more, mortgage lending to investors accounted for 49.7% of all housing loans, the highest share of the monthly total on record. With the rise in house prices first-time buyers are at a record low. This is likely to keep a lid on rents (as has been the case so far), and does not speak of a healthy “ecosystem”. Eventually, if these trends continue, it will not only be an issue for the RBA, but will also be a political issue.

The Chinese property market continues to wane – prices fell in 68 of 70 cities surveyed, compared to 64 cities in July. Average new home prices fell 1.1% in August, following drops of 0.89% in July and 0.47% in June. Exports in China rose 9.4% in August YoY, imports sagged 2.4%, indicating that the crucial factor of domestic demand continues to challenge the economy and policymakers. The trade surplus hit a record of $49.8 bn. Meanwhile industrial production rose 6.9% in August, down from 9% growth in July, and missing expectations of 8.8% growth. On the other hand Premier Li said China created almost 10 million jobs in the first eight months of 2014, close to the full-year goal. This number, along with real wage gains, is more important to the longevity of the government than GDP growth.

In the US producer prices registered no increase in August. Inflation expectations continue to creep lower. The five-year U.S. Treasury bond market is pricing the gap between bonds and inflation-protected securities at 1.7%, below the Federal Reserve’s 2% inflation target. Along with the somewhat softer data this month the Fed is gaining a little breathing space, though I still believe the improving employment market will start feeding in to inflation in the coming months

The figure for U.S. second-quarter growth was revised to 4.6% from 4.2%, equal to the best quarterly performance since the end of the last recession. Separately, the consumer sentiment index was confirmed at 84.6 this month, the highest level in 14 months. And initial jobless claims rose less than expected, remaining below 300,000. On the negative side durable good ordered dropped 18.2% in August, though this was driven by volatile aircraft orders. The data from the US remains positive overall.

Australian Equities
The macro data seems to be exceptionally noisy at the moment but I think the hard numbers show that corporate Australia doesn’t see the growth opportunity. Total private capital spending will fall 10% to $145.16bn this FY according to the government. That is the fastest pace of declines since 1992. Excluding mining Australia’s private sector spent A$68 billion on capital in the year to June, the lowest since 2007, even as the economy has grown 20% since then. Meanwhile it looks likely that listed companies will spend more on paying out dividends than capital investment for the first time in history.

TLS is considering competing with NBN Co offering fibre with comparable speeds to high density areas following the ACCC’s approval of TPGs plan to connect 500,000 urban apartments in a fibre to the basement (FTTB) network. This may complicate future renegotiation. Myer dropped 20% over two days after net profits fell 22.6% as margins were squeezed by rising labour, depreciation and refurbishment costs. It also said it would not budge from plans to invest as much as $160m this year to prepare for a newly invigorated David Jones challenge. Myer cut its final div to 5.5c from 8c, making the full year payout 14.5c or 86% of profits. At the time of writing around 13% of Myer’s registry was short sold.

International Equities
In the U.S. Apple unveiled the Apple Watch and the iPhone 6. The watch is Apple’s first new product category since the introduction of the iPad in 2010. It also released details of Apple Pay, which is designed to make iPhones into a digital wallet. McDonald’s Corp. posted the worst same-store sales decline in more than a decade, hurt by sluggish demand in the U.S. and a health scare involving a Chinese supplier.

Alibaba Group, China’s largest e-commerce company, conducted the largest IPO in history. At the close price on the day of listing it was valued at 35X forecast next year’s earnings, with a market value of $231 bn.

Rates / FX / Commodities
Europe’s banks borrowed €82.6bn through the first of the ECB’s Targeted Longer-Term Refinancing Operations, or TLTROs, out of a possible €400bn, much less than analysts had forecast. That dealt a blow to Mr Draghi’s ambitions to expand the ECB’s balance sheet by up to €1tn, in order to boost lending to smaller businesses in the region and counter low inflation. The issue in Europe remains a lack of demand, moderate monetary expansion will likely not help.

Federal funds futures expiring in Dec 2015 traded at 0.74%, compared with Fed officials’ median projection of 1.375% for the end of that year in forecasts issued Sept. 17. The divergence was even wider for the end of 2016, when futures traders saw a federal funds rate of 1.8%, while Fed estimates call for an increase to 2.875%.

The percentage of new junk-rated loans with minimal investor protections has increased to about 61%, higher than the 25% in 2007, Morgan Stanley says. And companies are embarking on share repurchases at the fastest rate since the financial crisis, a tactic that is generally viewed as negative for bondholders, because it means companies have less cash on hand to pay back debt. However firms still have large cash stockpiles: Cash and short-term investments for nonfinancial companies in the S&P 500 were up about 7% YoY at the end of the second. Default rates remain low, with 1.85% of U.S. junk-rated companies defaulting in the 12 months ended Aug. 31, according to Moody’s Investors Service. The rate was 14.1% at the end of 2009. We still appear to be in the expansion phase of the credit cycle. The key remains how fast the Fed will raise rates (or is expected to raise rates), not when they will start. This speed will determine the turning of the cycle in to a downturn phase where earnings slow and companies are not able to refinance or pay down debts.

The iron ore price fell below $80 a tonne for the first time since Sept 2009.