• This resulted in a mixed performance for shares over the week as a whole – with Australian shares up 2.9%, US shares up 0.4% and Euro-zone shares down 0.3%.
• The news out of Europe was poor, with renewed concerns about Spain going down the same path as Greece.
• Germany’s Bundestag approved support for the Spanish bank bailout and Spain had a successful bond auction. But the German constitutional court announced it will not rule on the constitutionality of Germany’s participation in the ESM bailout fund for another two months meaning its start date will be delayed, the Spanish region of Valencia announced it was seeking rescue funds and the Spanish Government announced its recession will extend into 2013 (which is hardly a surprise, but didn’t go down well). Renewed worries about Spain and a loss of momentum in terms of the policy response post the EU leaders summit has seen an intensification of fears that Spain will not be able to service its debts and so its ten year bond yield has surged back above 7% to a new crisis high. Italian bond yields also pushed higher. Quite clearly Europe still has a long way to go before it can be said that its debt crisis is under control and the threat to the global economy has subsided.
• Congressional testimony by Fed Chairman Ben Bernanke didn’t indicate that QE3 was imminent as some had hoped. However, Bernanke rarely pre-empts Fed meetings so no surprise on that front.  However, the fact that he appeared more concerned about the US economy and indicated again that the Fed remains prepared to take action and was looking at a range of options suggest that more action is likely unless the economy picks up quickly. Such action is likely to include extending the commitment to keep rates down into 2015, more asset purchases, ie QE3, including the purchase of mortgage backed securities and measures to encourage banks to lend more such as the Bank of England is doing with its “funding for lending” scheme.
• The surge in global prices for wheat and corn on the back of the US drought is a concern. It will add directly to headline inflation, but with weak global economic conditions it’s more likely to act as a tax on growth rather than resulting in a boost to underlying measures of inflation. As such we don’t see it standing in the way of more monetary easing. This is particularly the case in Asia where rice prices have not been affected.

Major global economic releases and implications

• After April’s upgrade to its global growth forecasts, the International Monetary Fund downgraded its global growth forecasts to 3.5% for 2012 and 3.9% for 2013. Lately the IMF’s forecasts have just seem to be moving up and down in lagged response to share markets so perhaps should just be seen as a contrarian indicator.
• US economic data was mixed. Retail sales were much weaker than expected and add to evidence that GDP
  growth in the June quarter slowed to around 1 to 1.5%. Consistent with this unemployment claims reversed the previous two weeks falls, although this was largely due to a seasonal distortion, the Conference Board’s leading index fell in May and the Fed’s Beige Book of anecdotal evidence described the economy as growing at a “moderate to modest” pace. Against this though manufacturing conditions improved slightly in the New York and Philadelphia regions, industrial production rose solidly in June and gains in a homebuilders conditions and housing starts add to confidence the US housing sector is recovering. Inflation readings in the US were benign, suggesting plenty of room for further monetary easing.
• US June quarter profit results have continued to come in better than feared, with 67% of the 119 S&P 500 companies to have reported so far having come in better than expected, including for most major banks,
  Microsoft, Intel, IBM, GE, Coca-Cola and Intel.
• In China, property indicators show no sign of the much feared property crash many fear. Residential property sales appear to be improving and only 30% of cities saw falls in house prices in June, compared to 74% back in December. This adds to confidence that the Chinese economy is on track for a soft landing, but also means that China won’t be easing its property restrictions any time soon.

Australian economic releases and implications

• The minutes from the RBA’s last rate setting meeting imply a neutral bias, with the Reserve uncertain about the global backdrop but a bit more upbeat about the domestic economy. Overall it appears pretty relaxed about current interest rate settings. I still see more rate cuts over the next six months, but unless the June quarter inflation figures in the week ahead are very low or there’s some sort of imminent global crisis a rate cut at the August 7 meeting is looking increasingly less likely.
• On the data front, export and import prices point to another slight fall in the terms of trade, the NAB’s quarterly business survey confirmed the softness evident in its monthly survey, vehicle sales fell slightly, Westpac’s leading indicator continues to point to sub trend growth ahead and job layoff announcements continue.

Major market moves

• Share markets rose over most of the past week on better profit news and hopes for more policy easing from the US Federal Reserve, but European and US shares suffered from a Friday sell-off on heightened concerns regarding Spain and concerns that China won’t be relaxing its property controls. This resulted in a mixed performance from share markets with Euro-zone shares down 0.3%, US shares up 0.4% and Australian shares up 2.9%. Australian shares broke out to their highest level since mid May on the back of strong gains in energy, consumer staple and bank shares.
• Soft economic data and renewed worries about Spain saw bond yields fall in the US, UK, Germany and Australia but rise in Spain and Italy.
• While the US drought has continued to boost agricultural prices, oil prices have also increased. The US oil price is up 18% from its June low and the Asian Tapis oil price is up 16%. Since the rise in the oil price has been only partly offset by a stronger $A, motorists are likely to see a 5 cent a litre or so rise in petrol prices over the next few weeks if oil prices stay around these levels.
• While the euro fell, the $A benefitted from ongoing talk of QE3 from the Fed and indications central banks are continuing to diversify their foreign exchange reserves into the $A, the latest being the Bundesbank.

What to watch over the week ahead?

• In the US, the Markit manufacturing conditions index (to be released Tuesday) will be watched to see whether it confirms the fall in the ISM index below 50, new home sales (Wednesday) and pending home sales (Thursday) are expected to confirm the recovery getting underway in the housing sector and durable goods orders  Thursday) are expected to rise modestly. June quarter GDP growth (Friday) is expected to come in around 1.5% annualised confirming some loss of momentum in the US economy on the back of softer consumer spending, but consumer sentiment is expected to have risen slightly in July.
• US June quarter profit results will continue to flow with around 150 S&P 500 companies due to report. So far June quarter profits results have been better than feared, but the best results are normally released in the first two weeks of the reporting season so a concern is the results over the next few weeks may not be so good.
• In Europe, the focus will be on the release of preliminary business conditions PMIs for July (Tuesday) which are expected to remain around levels consistent with a mild recession.
• In China, HSBC’s flash PMI (Tuesday) will be watched for signs of improvement after softness in recent months.
• In Australia, June quarter CPI data is expected to confirm that inflation remains benign on the back of continuing soft demand. We expect the CPI to increase by 0.6% quarter on quarter or 1.3% year on year and
  underlying measures to increase by around 0.5% quarter on quarter or 1.9% year on year. Benign inflation won’t necessarily bring on a rate cut next month, but it will help set the scene for further cuts over the next six months. A speech by RBA Governor Stevens on Tuesday will be watched for any clues on interest rates.

Outlook for markets

• Shares remain somewhat vulnerable in the short term. The September quarter is often difficult for share markets and the European debt crisis, US slowdown and lingering worries about China remain ongoing sources of weakness. However, relative to profits and relative to alternatives such as bonds and bank deposits, shares are very cheap and as such should benefit by year end as policy makers add further to the plentiful monetary stimulus already in place and as the global economic recovery continues.
• While sovereign bonds in safe countries are a good diversifier should the global economy worsen, bond yields in major countries around record lows suggest very low medium term bond returns. Corporate debt is a better proposition for those after income but not willing to accept the volatility that comes with shares.
• The Australian dollar remains vulnerable in the short term, reflecting worries about the global growth outlook and China specifically. However, it is likely to move higher by year end as global central banks undertake further monetary easing, commodity prices hold up and central bank reserve diversification continues.

23 July 2012

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