Investor Signposts: Week Beginning September 26 2010

The big picture

• Finally one of the great myths has been debunked. The Reserve Bank has finally acknowledged that housing affordability is not a major problem in Australia. Neither is it worsening dramatically, or alternatively going through the floor. Actually it has been going sideways for the last 5-6 years.
• The Reserve Bank has come to the view (actually a view CommSec has held for some time, and which we reiterated a fortnight ago) by assessing more complete figures on home prices. In the past economists had compared capital city home prices to incomes. But clearly a more accurate measure is to compare home prices in every town and region of Australia with incomes across the country. That analysis is made possible by figures from RP Data and Rismark and reveals that affordability has been flat since 2004.
• Some investors will say ‘so what?’ – what is the importance of the findings? Well, foreigners have been particularly concerned by the potential for a ‘housing bubble’ in Australia. That risk has now been defused so foreign investors will have less concern about parking their funds in Australia. So the effects may show up in a firmer sharemarket, but also it may take away another factor restraining our dollar from going higher.
• That, in turn, raises another issue for investors: what can stop the Aussie dollar? The greenback is on the nose and foreign investors are embracing currencies such as the Euro, Aussie dollar and other commodity currencies. But here in Australia, arguably the fundamentals are far stronger than in other parts of the globe. Our government debt is amongst the lowest of advanced nations; the economy continues to grow, buoyed by the Chinese and Indian economies; and speculation has again turned to the prospect of higher interest rates.
• But why the speculation about rate hikes? Certainly any balanced assessment of the latest data suggests that a rate hike should be the furthest thing on RBA policymaker minds. It all boils down to a fear of the economy again bumping up against capacity limits, causing a re-run of the inflation spike that was witnessed in 2008.
• Australia has never been able to get this one right. When we are perceived to be reaching our productive capacity – and note that this is basically a guess – we always opt to constrain demand rather than increase supply. If we need more workers, migration needs to rise. And if we need more capital, the Government and RBA should be identifying where the problems are with the Government providing greater incentives to businesses.

The week ahead

• After a quiet start to the week, more than half a dozen important statistics will be released from Wednesday together with the Reserve Bank’s half-yearly assessment of the health of the financial system.
• On Wednesday the latest data on population growth is released. Meanwhile on Thursday, job vacancies, building approvals, new home sales, private sector credit (lending) and the RP Data/Rismark home price index are all slated for release. The Reserve Bank also issues the Financial Stability Review on Thursday. And on Friday the Performance of Manufacturing index is issued.
• Population growth had been running at the fastest pace in 40 years, but it is eased in the December quarter and likely eased further in the March quarter based on the latest long-term arrivals data. Still population growth near 2 per cent is both historically high as well as being close to the fastest rate for any developed economy. Here’s hoping the new government recognises the importance of maintaining the current population growth pace.
• Of the other data CommSec expects that job vacancies lifted in the three months to August but home prices, building approvals and home sales remained soft in August. And the high Aussie dollar probably ensured that the Performance of Manufacturing index was only modestly above the 50 line that separates expansion from contraction in September.
• Building approvals probably rose by around 3 per cent in August, after only posting the first gain in four months in July. With new home sales already at 19-month lows, it is clear that the short-term outlook for the new home construction market is decidedly weak. Further home prices may have lifted by 0.4 per cent in August, suggesting that annual growth eased further to more ‘normal’ level of 8.7 per cent from 9.7 per cent in July. And credit growth probably rose 0.2 per cent in August keeping the annual rate historically low near 2.9 per cent.
• The Reserve Bank is clearly contemplating an interest rate hike In October, but another batch of weak housing and credit market indicators may give it second thoughts.
• In the US, again the coming week gets off to a slow start before picking up pace as the week progresses. On Tuesday consumer confidence and the Case-Shiller home price index are issued. And the Chicago purchasing managers index and final June quarter GDP figures are released on Thursday. Meanwhile on ‘Fabulous Friday’, at least four key indicators are released – the ISM manufacturing index, auto sales, construction spending and personal income & spending.
• Economists tip only a modest improvement in consumer confidence In September, from 53.5 to 54.0. But an increase is still an increase and it should ease some doubts on the global economy. And GDP growth should be confirmed at a 1.6 per cent annual pace in the June quarter – no surprises there.
• There will probably be more mixed signals from Friday’s data. Economists tip a modest easing in the manufacturing index and construction spending. But auto sales, personal income and spending are expected to have advanced in the latest readings. Overall it is clear that the US expansion is still intact but the jury is unlikely to be convinced that recession may not return.
• It is also worth pointing out that most of the global purchasing manager indexes are released on Friday, and that together, they provide a good guide to global economic growth. Especially keep a watch on the PMI for China.
• Sharemarket
• In a fortnight’s time, Alcoa will kick off yet another profit-reporting season in the US. Alcoa’s earnings are due on October 7 and will be followed by the likes of Intel, JP Morgan, Google and General Electric in the following week.
• The good news is that earnings guidance has been favourable to date. Over the past 30 days more than 120 companies have issued earnings guidance with 47 per cent expecting earnings in line with previous guidance while 34 per cent have upgraded estimates and only 19 per cent believe that earnings will miss forecasts.

Interest rates, currencies & commodities

• Strangely, views about a rate hike in October have dramatically shifted. A week ago no economic group tipped an October rate hike but now all and sundry believe it will occur. So what data has provoked the change? Actually recent domestic figures have been decidedly soft. In the US the Federal Reserve is still debating whether it needs to provide additional stimulus. The only area of strength has been the latest batch of Chinese economic data.

• Certainly the Reserve Bank Governor delivered a speech this week and minutes of the last Reserve Bank Board meeting were released. No surprises in either – the Reserve Bank has never made a secret of the fact that it believes further rate hikes are necessary. There has been one other factor though – a prominent financial journalist has signalled that a rate hike in October is now likely. Given his impeccable track record, market economists believe there is little alternative but to flag the risk of an October move. CommSec doesn’t believe that the RBA should be lifting interest rates, but flags the risk of the RBA lifting rates anyway.

• Our currency strategists have markedly changed their forecasts for the Aussie dollar. They now believe that the Aussie dollar will end the year at US97 cents and that parity with the greenback is possible in the first quarter of 2011. However the Aussie is expected to ease to US94 cents in late 2011 as the US economy lifts.