• Economic data is generally coming in better than feared, German Chancellor Merkel has backed ECB President Draghi’s commitment to do whatever is necessary to maintain the common currency, Spain looks likely to soon receive funds to recapitalise its banks, Chinese Premier Wen Jiabao acknowledged the Chinese economy was under pressure and noted that falling inflation provides room to provide stimulus and Brazil announced plans to boost infrastructure investment.
• In China, we expect two more rate cuts and two more bank reserve ratio cuts in the months ahead.
• It’s good to see the Australian Treasury logically putting the case against RBA intervention to lower the Australian dollar on the grounds that it is not clear that its overvalued, likely to be futile and that a better alternative would be to cut interest rates if the $A is judged to be too high and harming the economy. I completely agree on all counts. Intervention to lower the $A is unlikely to have any lasting impact, likely to be
  very costly and would take us back to the failed macro economic policy approaches that prevailed prior to the $A float in 1983.

Major global economic releases and implications

• US data releases were mixed suggesting the soft patch in growth continues but with no sign of recession. The good news was that retail sales rebounded in July, consumer sentiment rose, industrial production is continuing to rise solidly, unemployment claims are trending down and home builders are still seeing a pick up in demand for housing and this is flowing through to a rising trend in starts and permits to build new homes. Against this though manufacturing conditions in the New York and Philadelphia regions are weak and small business optimism is slipping. Meanwhile, inflation remains benign suggesting plenty of room for the Fed to ease further if needed.
• The US earnings reporting season is now largely done with 68% of results better than expected which
  makes it a reasonable set of results.
• In terms of US budget deficit and debt problems, Republican Presidential candidate Mitt Romney’s choice of conservative Paul Ryan as his running mate increases the likelihood the November election will result in a mandate to produce a long term agreement to reduce the budget deficit as a Republican victory will commit Romney and it will likely force Obama into presenting his own plan which would then have a mandate if he wins.
• The Euro-zone economy contracted by an as expected 0.2% in the June quarter, highlighting that the recession continues but that it is relatively mild. Of course this masks deep contractions in southern Europe balanced by modest growth in core countries. Further weakness is likely and we remain of the view the Eurozone will contract 1% this year, worse than consensus but better than the GFC re-run many investors fear.
• Japan’s economy grew a less than expected 0.3% in the June quarter, but this was partly offset by an upwards revision to March quarter growth resulting in annual growth of 3.5%. With the recovery from the earthquake behind it and exports slowing, growth is likely to slow to a 1% pace going forward.
• Across Asia, India saw some better inflation numbers but its unlikely to be enough to speed up the Reserve Bank of India’s easing process as inflation is still very high and won’t be helped by a poor monsoon. The news out of Malaysia though is particularly good with 5.4% GDP growth over the year to the June quarter and inflation of just 1.4% over the year to July – a beautiful set of numbers.

Australian economic releases and implications

• Australian economic releases provided a mixed picture. The NAB survey for July reported a fall in business conditions presumably as the boost to retailers from the carbon tax compensation payments to households washed out, but an improvement in confidence, with both remaining at subdued levels. Consumer confidence surprisingly fell in August despite a run of better economic news since the July survey and leaves confidence below where it was when the RBA started easing last year. This would suggest that interest rates still need to fall further for consumers to become confident. Meanwhile annual wages growth perked up to 3.7% in the June quarter, but this was primarily due to strength in the mining sector and WA.
• The Australian June half profit reporting season is now one third complete and the results have become much better than was the case a week ago. So far 27% of results have come in better than expected which is still well down on the norm of 43%, but at least its up from just 22% a week ago and the proportion coming in worse than expected has fallen to 24% from 35% a week ago. Reflecting the improvement, 53% of companies have seen their share prices outperform the market on release day. So far 67% of companies have seen profit gains on a year ago and perhaps the biggest surprise is that outlook statements are mildly positive on balance (bottom right chart). Despite this, bottom up consensus estimates for 2012-13 profit growth has fallen by around 1% since the reporting season started but this is mainly due to analysts using the cover of the reporting season to revise down unrealistically high expectations for around 10% profit growth.
• The main themes have been pretty much as expected with expensive defensives underperforming if they deliver ok to sub-par results, but sold down cyclicals getting heavily rewarded with share price gains if they are better than feared (notably Bradken, JB HiFi, Downer EDI, Hills, AMP, Wesfarmers). The resources sector is seeing sharp falls in profits on lower commodity prices, capex spend and cost pressures, but the banks and nonfinancial industrials are seeing very modest growth. So far only 29% of companies have cut dividends with 71% raising them, highlighting the determination of companies to maintain and raise dividends despite weaker profits.

Major market moves

• Share markets mostly rose over the past week on better than feared economic and profit news and positive news from global policy makers. Indications that market leadership is at last starting to switch to cyclicals and away from defensive stocks is a positive sign although volumes and breadth are still low. US shares are close to a new post GFC high and Australian shares rose to their highest since early May.
• Commodity prices mostly rose, but the $A slipped as the Australian Treasury argued that it would be better
  to ease monetary policy than intervene in the foreign exchange market if it is judged the $A is too high.
• The improvement in investor confidence has seen a continued back up in bond yields in major countries with US 10 year bond yields up 0.4% and Australian 10 year bond yields up 0.6% from their July lows at the
  same time that Spanish and Italian bond yields have continued to fall.

What to watch over the week ahead?

• In the US, expect gains in existing home sales (Wednesday), new home sales and house prices (Thursday) and durable goods orders (Friday). The preliminary Markit PMI manufacturing conditions index (Thursday) will likely remain softish. The minutes from the Fed’s last meeting will be released Wednesday.
• Thursday will also see the release of preliminary August readings for Euro-zone PMIs which are expected
  to remain consistent with a mild recession in Europe.
• In China, the HSBC flash PMI for August (Thursday) is likely to remain around 49.
• In Australia, the minutes from the RBA’s last board meeting to be released Tuesday and Governor Stevens’ parliamentary testimony on Friday are likely to confirm that the Bank is reasonably comfortable with current interest rate settings, but will be watched closely for an indication as to how concerned the RBA is about the level of the $A and whether it is about to do anything about it.
• The Australian profit reporting season will move into its busiest week with 87 major companies reporting
  including Bluescope, Amcor, Oil Search, AGL, BHP, Coca-Cola, CSL, Woodside, Fortescue, IAG & Woolworths.

Outlook for markets

• After a period of strong gains, shares are a bit overbought and vulnerable to a short term setback maybe on implementation delays for the ECB’s plan and worries about poor economic data in Europe, the US and China as we approach the seasonally weak month of September. However, with the ECB on the brink of a major game changer, the Fed providing a win/win for the US sharemarket in that either the economy improves or it eases, further easing likely in China and shares cheap we remain of the view that shares will be higher by year end. As such any weakness over the next month or so will likely provide a good buying opportunity as the broader trend from June remains up.
• While sovereign bonds in safe countries are a good diversifier, bond yields in major countries remain very low and point to 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.
• Apart from normal volatility, the $A is likely to remain strong as global central banks undertake further
  monetary easing, commodity prices hold up and as central bank reserve diversification continues.

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