Weekly market & economic update 17 December 2010


Headline developments of the past week

  • Sovereign debt issues in Europe raised their ugly head again over the last week. While the Irish austerity package was passed by its Parliament, investors were kept on edge by Moody’s putting Spain and Greece on credit watch, Standard and Poors doing the same for Belgium and bickering amongst euro-zone politicians about whether to increase the size of its bailout fund and about a longer term crisis resolution mechanism. This issue is likely to keep flaring up periodically for years, until public debt levels are clearly heading back towards more sustainable levels. In the meantime, the European Central Bank will continue to have to play a big role in keeping investor panic at bay by buying the bonds of troubled countries and ensuring that liquidity conditions remain easy. In this regard it is helpful that the ECB will receive an extra 5 billion euro of capital.
  • Global bond yields continued to push higher as investors revised up their global growth expectations, with an unwinding of the record inflows of recent years into bond funds likely exaggerating the size and the speed of the sell off in bonds. Australian bond yields were little changed though and as they are well above global yields and are already around long term sustainable levels and so therefore are at much less at risk of a sharp sell-off.

Major global economic releases and implications

  • Signs continue to build that the US economic recovery is gathering momentum with retail sales up strongly in November resulting in a gain of 7.7% over the last 12 months – so much for the US consumer being wiped out! On top of this industrial production rose solidly in November, business conditions in the New York and Philadelphia regions were solid, small business optimism rose to its highest level since December 2007 and unemployment claims continued to fall. Housing indicators remained softish though with a modest rise in housing starts but a further fall in permits to build new homes, demand conditions remaining poor according to home builders and new mortgage applications falling over the last week. At least housing seems to have found a floor though. Inflation remains down and out with the core CPI up 0.1% in November resulting in an annual gain of just 0.8%. While the Fed sounded a little more optimistic on the economy, it signalled that it remains in no rush to raise interest rates and will continue with quantitative easing as growth remains insufficient to bring down unemployment and inflation remains below levels that it is comfortable with.
  • European data was generally favourable with another improvement in manufacturing conditions in November, led by Germany. While conditions in the services sector fell in November they remain levels consistent with reasonable growth. Euro-zone inflation remained benign at 1.9% year on year, or just 1.1% on a core basis.
  • Japanese data was mixed with a softening in the Tankan business survey but a rise in a tertiary activity index.
  • China reportedly raised its 2011 inflation target to 4%, from 3% for 2010, suggesting that it will allow time for inflation to fall back. This along with the likely maintenance of a reasonably high target for new loan growth in 2011 adds to confidence that China is not willing to crunch its economy in the face of higher food prices. While China maintained its growth target at 8%, this should be seen as more of a floor to growth rather than an actual objective.

Australian economic releases and implications

  • Australian economic data was mixed over the last week. While dwelling starts fell sharply in the September quarter reflecting the earlier fall in building approvals and skilled vacancies fell in December, consumer sentiment edged up slightly and remains well above long term average levels, and new vehicle sales rose slightly in November. While the NAB business survey showed that business confidence fell in November reflecting last month’s rate hike, business conditions actually improved slightly and both remain at levels consistent with reasonable economic growth.

Major market moves

  • Share markets continued to rally on the back of good global economic and corporate news.
  • Commodity prices were mixed with gold down possibly on investor concerns that with the global outlook improving again the liquidity backdrop might become tighter and demand for a safe haven might recede, whereas base metal prices continued to benefit from improving confidence in the economic growth outlook.
  • The Australian dollar rose modestly helped by the news that China left interest rates on hold despite fears last week that it would raise them.
    What to watch in the week ahead?
  • In the US, data for existing home sales for November (due Wednesday) are likely to show a strong rise reflecting a 10% gain in pending home sales in October. New home sales (Thursday) are also likely to rise solidly. September quarter GDP growth (Tuesday) is likely to be revised up to 2.8% annualised and durable goods orders for November (Thursday) are likely to rise after a sharp fall in October.
  • In Australia, the minutes from the Reserve Bank’s last rate setting meeting (due Tuesday) are expected to simply reinforce the message that interest rates are likely to remain on hold for several months.  We remain of the view that the RBA won’t start to tighten monetary policy until April next year at the earliest.

Outlook for markets

  • Share markets are likely to benefit from seasonal strength over the next few weeks. The period from mid December into early January is normally positive for shares reflecting new year optimism, the absence of new capital raising and the investment of year end bonuses. Over the last 15 years, over this period the US share market has risen 11 times and the Australian share market 14 times.
  • While GFC aftershocks will continue to cause volatility and shares may become vulnerable to a correction in January/February after several months of very strong gains, shares are likely to put in good gains through 2011 as a whole.  Shares are cheap, the run of better than expected global economic data is continuing suggesting that the global economic recovery remains on track which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very low interest rates in key countries and quantitative easing in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends.
  • Notwithstanding inevitable volatility, the $A is likely to head higher as the $US and the euro remain under downwards pressure, interest rates in Australia remain relatively high and high commodity prices keep the terms of trade near early 1950s highs. By end 2011 the $A is likely to have reached $US1.10.
  • While low inflation, central bank government bond purchases and the absence of any near term monetary tightening should help keep bond yields in key advanced countries reasonably low in the short term, the risk of a sharp back up in bond yields at some point is very high. Bond yields in key advanced countries are still well below longer term sustainable levels and sooner or later the record inflows into bond funds seen in recent years are at risk of becoming record outflows. The back up in bond yields over the last few weeks may be a warning sign of things to come.
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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