Investor Signposts: Week Beginning October 31 2010

From

The big picture

  • Here’s a scary thought – 2010 is almost over, with just over two months to go to the end of the year. So it is opportune to see where Australia stands in the global rankings of shares, currencies and interest rates.
  • One of the interesting findings is that the Australian sharemarket is amongst the laggards, not the leaders. Of the 72 global sharemarkets monitored, the Australian sharemarket is in 57th place, with the All Ordinaries just over three per cent down from the start of the year.
  • The best performer is Sri Lanka, with shares up 94 per cent, followed by Estonia (up 59 per cent) and Lithuania (up 46 per cent). Asian sharemarkets have done well with both Indonesia and the Philippines up over 40 per cent and Thailand up 34 per cent. And of the major markets, the German Dax is up 10 per cent, the US Dow Jones is up almost seven per cent and Hong Kong has gained six per cent.
  • At the other end of the scale the Greek sharemarket has slumped 28 per cent, followed by Cyprus and Slovakia. But it’s also worth noting that the Japanese sharemarket is down 11 per cent with China down 8.5 per cent.
  • The relative weakness of our sharemarket will surprise some, especially as it has occurred at a time of a stronger Aussie dollar. Of 120 currencies monitored, the Australian dollar is the 8th strongest this year against the greenback. The Aussie dollar is currently up almost eight per cent against the US dollar, after being up by over 11 per cent at one point.
  • The strongest currency is the Japanese yen, up almost 12 per cent in 2010 followed by the Thai baht, Mongolian tugrik and Icelandic krona (all up around 10 per cent). The other end of the list is dominated by African nations – Ethiopia, Uganda and Tanzania, but the Euro has also fallen against the US dollar over the year, down by around four per cent. Over 2010 the US dollar index is largely unchanged – a result that will surprise many given the perception that the greenback has been weak. Rather it has risen and retreated over the year.
  • In terms of interest rates, Australia will end 2010 with the highest rates of any industrialised economy. The Economist magazine has data on 58 countries across the globe and Australia’s 3-month rate of 4.78 per cent is the 14th highest in the world, just behind Iceland and Hungary. Still, if the IMF’s listing of “advanced nations” is chosen instead, then Australia’s interest rates are the second highest, behind Iceland. Whichever way you cut it, Australia’s interest rates have more in common with those of developing nations.

The week ahead

  • Will Murphy’s Law rule in the coming week? In October economists tipped a rate hike and it didn’t happen. For November, most have gone cold on a rate hike, so does that mean the Reserve Bank will spring a surprise?
  • If the Reserve Bank does lift rates it will be a very big surprise. No matter how you cut the inflation data, there are no price pressures to be found. Rather, retailers are coping with deflation – falling prices. Add in the contraction in manufacturing and services sectors, the fact that no one is borrowing and the high Aussie dollar and there is no reason why the Reserve Bank would have to lift rates – even if it used its best pair of binoculars to gauge the future.
  • In terms of the economic data, the Bureau of Statistics releases its house price index on Monday together with the Performance of Manufacturing index and October’s monthly inflation gauge. On Wednesday the Performance of Services index and building approvals are issued. Retail trade and international trade data are released on Thursday with the Reserve Bank’s Statement on Monetary Policy slated for Friday.
  • It’s worth pointing out that the TD Securities/Melbourne Institute monthly inflation gauge has had a good track record. Not only was it ‘spot on’ with its forecast of the September quarter consumer price index, but past predictions have also been accurate. So the October data is worth watching closely.
  • Of the other data, building approvals probably only partially rebounded by 2 per cent during September after the 4.7 per cent slump in August. And we expect that consumers are starting to spend a bit more, although it’s clear from the data that they are very selective. Retail trade probably rose 0.7 per cent in September after a 0.3 per cent lift in August with poor weather restraining seasonal purchases.
  • The Statement on Monetary Policy will clearly be pivotal for the direction of interest rates. If the Reserve Bank trims its inflation forecast then rate hikes will be off the agenda until 2011.
  • In the US, there will be three events that dominate attention over the week. The first is the midterm elections on Tuesday. Then the focus will turn to the Federal Reserve meeting to be held over Tuesday and Wednesday. And the third focal point will be Friday’s employment (non-farm payrolls) data.
  • In terms of the mid-term elections, pundits expect the Democrats to lose seats – it just depends on how many and whether the Democrats also lose control of the Senate. Some investors believe that if control of the presidency and Congress is in different hands this would actually be a positive result – it may lead to fewer changes over the next two years and thus more investor certainty.
  • Turning to the Federal Reserve meeting, the Fed would like to cut rates, but unfortunately the zero limit has been reached. (No matter how many times you say it, it’s still a remarkable situation.) So to give the economy a boost, the Federal Reserve is planning another batch of quantitative easing – in effect printing money. Arguably cutting payroll taxes would be more effective, but that gets us back to the political inertia.
  • And then there is the employment data. At this early point economists expect private sector payrolls to rise by 80,000, a small improvement on the 64,000 lift in jobs in September. Job gains are still insufficient to trim the jobless queue, but that is largely because businesses are not confident enough to hire.
  • Other data to watch over the week includes personal income, construction spending and the ISM manufacturing index on Monday. On Wednesday the ADP employment index and ISM services index are due together with factory orders and car sales.

Sharemarket

  • We haven’t changed our end-year forecast for the Aussie sharemarket for around three months. For most of that period it has been more likely that we would have to trim our projection, but just in the past few weeks, our fabled 4,800 point target has moved into sight. We are actually still quite comfortable with our view, but it’s worth pointing out that the sharemarket rally can be traced back to August 27 when Federal Reserve chief Ben Bernanke vowed to do what it takes to restore economic growth. Bernanke said: “The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.”
  • Global sharemarkets will be on edge in the coming week when investors put Ben Bernanke’s words to the test. The speculation is that the Federal Reserve won’t undertake ‘shock and awe’ stimulus measures, rather it will opt for modest purchases of bonds. But it is the statement that many will be watching. Businesses don’t have the confidence to use their hoards of cash to invest and employ staff. Economists may debate whether another round of quantitative easing is necessary, but it is the words and confidence effects that are generated rather than the action itself that are now important.

Interest rates, currencies & commodities

  • Ahead of the last Reserve Bank Board meeting, financial markets reckoned there was a 74 per cent chance of the Reserve Bank lifting rates. In the end it didn’t happen. Current market pricing suggests a 20 per cent chance of a rate hike. It’s clear that investors have gone cold on the idea of a rate hike, just like the majority of economists.

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