Global markets continue to take their lead from Wall Street and this seems to have laid waste to the markets’ latest correction attempt. The ASX200 lost just 7.2% from October 23 to a near term low of 4508 earlier this month. The Dow shed just 3.6% and the FTSE 4.6% over a similar timeframe.
Friday’s US unemployment data was the major development on the US economic front since our last update. The stronger than expected third quarter GDP number (3.5% annualised) had seemingly reduced the risk of a downside surprise for unemployment. This wasn’t to be, with 190,000 US workers losing their jobs last month compared to expectations for 175,000 job losses.
US unemployment now sits at 10.2% and there is little doubt that the Fed will maintain their loose monetary policy setting well into next year.
Here in Australia, ANZ’s job advertisement series revealed that the demand for labour remains at a low level. Both the Treasury and the Reserve Bank of Australia have however recently revised down their expectations for unemployment. Both now expect the peak to be less than previously anticipated.
The phenomenal stock market rally from the March lows was initially driven by a correction from deeply oversold levels. This is a natural function of the policy makers’ decisive action, which prevented last year’s credit freeze degenerating into wholesale failure of the financial and therefore wider economic system.
The corrective phase of the rally has since given way to expectations of the recovery process translating into a return to corporate earnings growth, fuelling the latter stages. It is certainly our view that next year’s earnings seasons will prove considerably more positive than 2008/09, both here and in the US.
We cannot however ignore the risk that the rally could extend itself beyond the medium term fundamentals, leaving next year’s earnings falling short of expectations. We will of course guard against this through measuring individual stocks against our view of their valuation and acting accordingly.
In terms of the broader market though, loose monetary policy and stimulus efforts have played a significant role in driving equity markets higher. Looking at the Fed specifically, their 0-0.25% interest rate policy has seen the greenback replace the yen as a preferred source of cheap capital.
The yen carry trade saw investors borrow cheaply in Japan, sell yen and buy higher yielding assets overseas. Just as this drove the yen down, the same process is now a significant factor in the US dollar’s protracted weakness. Conversely, it is also a cause of commodity and equity price strength.
The prospect of the Fed turning off the taps through higher interest rates is as a result a very likely catalyst for some form of reversal in asset valuations against a US dollar recovery.
While the possibility of this increased somewhat following the US GDP data, the unemployment numbers firmly pushed a potential rate hike to the back burner. The prospect of premature tightening was also taken out of play anytime soon by the G20, with finance ministers pledging to maintain stimulus efforts until the recovery is certain.
The prospect of continued loose monetary and fiscal policy, particularly in the US, has added support to the current upward trend in equities.
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