“We’re on a road to nowhere, Come on inside, Taking that ride to nowhere…we’ll take that ride” – Road to Nowhere, Talking Heads
- Spain’s Federal Government continues on the “Road to Nowhere” with another round of budget tightening. The Rajoy Government announced austerity measures that include a wage freeze, a -8.9% cut to public spending and a consumption tax increase (VAT). A sign of desperation is that “lottery wins” over Euro €2,500” will be taxed at 20%. These austerity measures aim to move Spain’s budget deficit from circa 6% GDP in 2012 towards 4.5% GDP for 2013. So considerable pain for marginal gain. Spain’s central bank has ominously warned this week that Spain’s economy keeps “falling at a significant rate”. This “road to nowhere” of European budget tightening in the midst of a recession is the main downside risk to the Global economy.
- European economic data this week was also disappointing and frustrating. The European Commission’s surveys of business & consumer sentiment were weak and suggestive of a mild recession. The EC industrial sentiment fell to its lowest level in the past 33 months. The EC consumer sentiment result was at a 3 year low. The European Central Bank (ECB) measure of private sector credit shows that European banks remain reluctant to lend. Private sector loans have fallen by -0.6% over the year to August.
- In more encouraging news, American house prices show signs of a sustainable recovery. The S&P Case Shiller “10 Major Cities” measure rose by +0.4% in July. Over the past year, American house prices have risen +0.6%. American consumer confidence is now running at a warmer temperature after a chilly period mid year. The Conference Board‘s consumer confidence survey rose to a 7 month high in September.
Australian economic releases and implications
- Australia’s central bank indicates that Australian banks have limited direct asset exposure to troubled European nations. The RBA’s Financial Stability Review (FSR) highlights that most of the Australian bank’s asset exposures are to France, Germany and The Netherlands for A$ 38.9 billion while the troubled nations (Spain, Portugal, Greece Ireland and Italy) are only A$ 4.7 billion. However there is an impact through “swings in global financial market sentiment” and Europeans banks cutting their lending to Australian commercial property.
- The RBA’s assessment is that Australian households appear to be “coping well with its debt levels”. Australian “household borrowing has also slowed in recent years”. The RBA notes that “many households are choosing to repay their existing debt more quickly than required”. Around 50% of “borrowers are repaying their mortgages ahead of schedule and are thereby building up buffers”. These “buffers” are “estimated to be equivalent to around 1½ years of scheduled repayments (principal plus interest).”
Major market moves
- Global shares recorded mild falls during the week but considerable volatility with European concerns. American shares declined by circa 1%. There were sharper falls in Europe with Spain recording with a -2 % fall.
- Australian shares were more resilient with a marginal fall of circa 0.5%. The prospect of the RBA cutting interest rates appears to be contributing to the resilience.
- American and Australian bond yields fell with the intensification of Spain and Greece’s woes. The scene of public protests in Madrid & Athens has generated some “safe haven” buying in 10 year bond yields.
What to watch over the week ahead?
- The Reserve Bank should cut the Australian cash rate by another 0.25% to 3.25% on October 2nd. Given subdued business & corporate sentiment, slowing jobs growth, sluggish retail spending and a high Australian Dollar that is weighing “more heavily” on the economy, there is a strong case to cut interest rates next week.
- The European Central Bank’s Governing Council meets on October 4th and should also cut interest rates by another 0.25%. Given that the European banking system is reluctant to lend, that European Governments are committed to severe budget tightening and the broader European economy is in recession, there is a robust case for the interest rate to fall to a record low of 0.5%.
- America sees the release of key September data on employment and business surveys. Sedate jobs growth and a stubbornly high unemployment rate have been the major concern for America’s central bank as well as the Presidential contenders. A marginal improvement in September is expected after Augusts’ disappointing +96,000 job gains and unemployment rate at 8.1%. The ISM business surveys for manufacturing should also modestly improve for September after the subdued results over the last 3 months.
- China’s financial markets are essentially closed next week for holidays.
Outlook for markets
- Allowing for Europe’s budget tightening obsession and recession woes, the rest of the Global economy is in a modest slowdown phase. Global growth momentum should stabilise by the end of this year given the extraordinarily low interest rates and assertive commitment by the American & European Central Banks’ to purchase assets. China’s economic activity is cooling at a steady pace while inflation pressures have dissipated, thereby allowing further policy stimulus after the leadership transition in October.
- For Australia, the RBA is likely to lower interest rates over coming months given the softer Global growth profile, the strong Australian Dollar and mild inflation pressures. These interest rate cuts should provide strong support for Australian Shares over coming months as well as supportive of the struggling “Non-Mining” economy.
- Global Shares are now in a consolidation phase after a strong rally in the September quarter. While the last week saw a disappointing pullback in Global Shares, this comes after robust gains for the quarter. Yet the medium term prospects for Global Shares is still favourable.
- Global Shares are cheap on comparisons to corporate earnings as well as relative to Government Bonds. Any significant pullback over coming weeks should be seen as a great buying opportunity for Global Shares for the medium term. Global Shares should end 2012 on a strong note.
- American and Australian Government bonds provide extraordinarily low yields currently. This would suggest low returns for the medium term. Corporate bonds are a better proposition for those seeking income but who are cautious about investing in shares presently.