Weekly market & economic update 10 September 2010

Headline developments of the past week

• US President Obama announced plans for another round of fiscal stimulus including increased infrastructure spending, accelerated tax write-offs for new investment that would allow companies to write off all new investment undertaken before the end of 2011 and an extension of the Bush tax cuts for those earning less than $US250,000. However, while the plan would provide a modest economic boost it is questionable whether it will pass through Congress.
• Meanwhile, Japan announced details of an $US11bn package designed to boost the economy by 0.3% and indicated that it will intervene to cap the Yen if needed. While the stimulus is modest it adds confidence to our view that Japan will avoid a swing back into recession.
• Worries about European banks and highly indebted countries returned, although these settled a bit with a successful Portuguese bond auction.
• In Australia, the Labor party gained enough support from independents to form government, but with only a 76 to 74 seat majority in the lower house. The national broadband network, the mining tax, a tax summit, action on climate change, increased spending in regional areas and a return to budget surplus by 2012-13 look to be the key policy outcomes. The requirement for ongoing support from regional independents should act as a counterweight to the possibly less business friendly influence of the Greens. The first test will be whether the new Government sticks to its scaled down mining tax or reverts to something more onerous as the Greens might prefer, although this may take some time to play out. A concern is that with a wafer thin majority and the need to bring along a diverse range of people the new minority Government will be timid when it comes to undertaking reforms to boost the supply side potential of the economy.
• There were no surprises from the Reserve Bank of Australia which decided to leave the cash rate unchanged for the third month in a row at 4.5%. However, the addition of the phrase “for the time being” in describing monetary policy as being appropriate suggests the RBA has a mild tightening bias which is consistent with its concerns about capacity constraints and expectations for underlying inflation to start rising again in the second half of next year. The RBA’s tightening bias is likely to have strengthened further following the August labour market report which showed another solid gain in employment and a fall in unemployment, such that a rate hike next month is looking increasingly likely assuming that the global growth outlook doesn’t deteriorate any further.

Major global economic releases and implications

• US economic news had a slightly positive tone. While the Fed’s Beige book of anecdotal reports confirmed signs of a slowdown in the pace of economic growth, weekly unemployment claims fell more than expected, weekly mortgage applications to purchase a home are continuing a very modest recovery and the trade balance improved sharply in July suggesting that it won’t be the big detractor from September quarter growth that it was in the June quarter.
• German economic data was disappointing with falls in factory orders and industrial production in July.
• Chinese property data is presenting a confusing picture with some private sector data suggesting that property sales and prices rebounded strongly in August but official data showing that annual growth in property prices in 70 major cities slipped to 9.3% in August from 10.3% in July and that prices were actually flat in the month. The property collapse many feared a few months ago just hasn’t happened but it’s unclear as to whether the market has taken off again. Given the confusing picture from August data and a likely increase in the supply of apartments hitting the market this month and next it would seem premature for the authorities to further tighten property measures. While growth in Chinese exports slowed slightly in August, growth in imports picked up which is normally a sign of strength in domestic demand.
• Japanese economic data was mixed with a solid rise in machine orders and a fall in bankruptcies but falls in bank lending and economic confidence. June quarter GDP growth was revised up to 0.4% quarter on quarter from a previously reported 0.1%, which should go some way to allaying double dip fears.

Australian economic releases and implications

• Economic data releases in Australia continue to reveal solid growth momentum. Employment surprised again on the upside in August pushing the unemployment rate down to 5.1% and with the ANZ job ads series still rising, further labour market improvement is in prospect. Expect unemployment to fall below 5% by year end. Housing finance commitments were essentially flat in July and appear to have stabilized after earlier falls in response to rising interest rates. On the inflation front the TD Securities/Melbourne Institute inflation gauge was pretty benign in August.

Major market moves

• After a poor start, global share markets climbed higher on better economic news. Australian shares were little affected by news that a Labor/Green independent alliance would form government and rose in line with global shares.
• Despite softer commodity prices the Australian dollar rose above $US0.92 on the back of the stronger than expected employment report in Australia.

What to watch in the week ahead?

• In the US, all eyes will likely be on the New York and Philadelphia regional manufacturing surveys which gave such a bad lead to the national ISM manufacturing survey last month. Data for retail sales and industrial production are likely to show signs of the slowdown in US economic growth. August inflation data is likely to remain benign.
• Chinese economic data for August is likely to confirm that while the economy has slowed from the blistering pace earlier this year, it remains robust and certainly hasn’t collapsed. Inflation data is likely to rise slightly to 3.5% year on year, but this is due to a weather related boost to food prices with underlying inflation remaining much lower.
• In Australia, the NAB business conditions and confidence survey is likely to show a rise after recent weakness and consumer confidence is expected to strengthen further on the back of another month of interest rates staying on hold and more good news on the labour market. Dwelling commencements for the June quarter are likely to rise by 5% in response to the earlier strength seen in building approvals. A speech by RBA Assistant Governor Lowe will be watched closely for any indications as to how the RBA has interpreted recent strong economic data for Australia.

Outlook for markets

• Shares are likely to remain on a bit of a roller coaster ride over the next month or so reflecting the ongoing uncertainty as to whether there will be a double dip back into recession in the US and other industrialised countries and normal cyclical weakness at this time of year. However, beyond the near term uncertainties we remain of the view that shares will see strong gains into year end and then through 2011. Shares are very cheap relative to government bonds, investors are still very bearish which is positive from a contrarian perspective and once it becomes clear that the US/global recovery is continuing (albeit slowly) there is likely to be a big reversal of investment flows – out of government bonds and back into equities.
• The $A is likely to remain volatile in the short term, but should rise on a six to 12 month horizon as it becomes clear that the global recovery is continuing, commodity prices are remaining strong and that Australian interest rates are remaining well above global rates.
• Double dip and deflation worries may keep bond yields low in the short term, but medium term returns are likely to be poor reflecting low yields and excessive public debt levels in many developed countries.