• American consumer spending has been reasonably solid considering the recent political turmoil over budget tightening (“fiscal cliff”) as well as Hurricane Sandy. Further spending gains are expected. The strong positive for the US economy has been the housing recovery in 2012, so strength in housing construction would also be welcome.
• China’s see the release of critical economic activity results for the end of 2012. China’s Real GDP result for the December quarter should show that economic growth stabilised at a 7.5% pace. This comes after a slowdown in the preceding quarters from the +9% growth pace set in 2011. Industrial production & Retail Sales should show solid results for December consistent with China’s economy becoming more focused on domestic demand rather than exports.
• Australia’s labour force data for December is the key focus. Given subdued sentiment in the “Non – Mining” economy as well as significant job loss announcement in both the private & public sectors in 2012, a soft result is expected for employment for the end of 2012.  Job losses of circa -10,000 are anticipated for December while the unemployment rate is expected to rise sharply from 5.2 % to 5.4 %.  

Outlook for markets

• Global shares appear to be now entering a consolidation phase after a sharp rally with the “fiscal cliff” vote in the opening week of 2013.  America’s fiscal problems are yet to be fully resolved with further political turmoil likely over government spending and the debt ceiling. Caution will also likely prevail as   the US corporate earning reporting season for the December quarter has just started.  Europe faces significant political challenges with an Italian general election in February while Spain’s is struggling with a weak banking system and an alarming +26% unemployment rate. Hence Global Shares seem set to drift sideways over coming weeks.
• Yet 2013 should ultimately be another good year for Global Shares. Global growth should slowly improve in 2013 as America employment and housing recovery gathers speed while Europe’s economy gradually stabilises. This will create a solid corporate profit environment favourable for Global Shares. Given Global Shares are undervalued on historic measures and with investors likely to be tempted to switch from overvalued and low yielding Government Bonds, this year should be another rewarding one for share investors.
• Global Sovereign bonds are vulnerable to a rising trend in yields as global economic growth improves. American, German, Japanese and Australian Government bonds provide extraordinarily low yields currently. This would suggest low returns for the medium term. Corporate bonds are thus a better proposition for those seeking income but who are cautious about investing in shares presently.

Headline developments of the past week

• Australia’s nominal retail sales disappointed in November with a marginal -0.1% fall. Considering that the RBA had cut interest rates by 0.25% in the previous month, this is a very soft result. Over the past year, Australian nominal retail sales have recorded only modest growth of +2.9%.  For the RBA, this soft November retail sales result would suggest further interest rate cuts may be required in 2013 to revive retail spending.
• Europe’s labour markets continue to weaken given the recession conditions prevailing. November saw Europe’s unemployment rate climb to 11.8%. Within Europe, there is a dramatic divergence in jobless rates. Greece’s unemployment rate of 26.8% and Spain at 26.6% contrast sharply with Germany’s 5.4% unemployment rate. Even Italy (11.1%) and France (10.5%) are also struggling with elevated unemployment rates in November.
• In more encouraging news, China’s trade performance improved with a sharp pickup in exports. China’s export growth rose at a +14% annual pace in December which is a dramatic revival compared to November’s muted +3% pace. A pick-up in China’s export volumes would typically signal a revival in global growth. For Australia the news is considered beneficial as China’s import growth revived to a +6% annual pace signalling that demand for Australia’s commodities is gaining speed. This is particularly apparent in the sharp revival in the spot Iron Ore price from US$ 87 in August 2012 to now US$ 158 per ton.
• Japan’s new Government announced a fiscal stimulus package of Yen 10 billion (A$ 109 billion) to revive Japan’s weak economy. This stimulus should enable Japan slowly emerge from its current recession in 2013 although the government debt burden is set to surge beyond the recent estimates of 237 % of Nominal GDP.

Major global economic releases and implications

• Europe’s economic activity data released this week was also disappointing. The European Commission’s surveys of business & consumer sentiment were weak and suggest that a mild recession continues in Europe.
• However the European Central Bank (ECB) kept their key policy interest rate on hold at 0.75%. The ECB President Dr Draghi conceded that the risks “remain on the downside” for Europe given “balance sheet adjustments” and “persistent uncertainty”. Dr Draghi expected that “later in 2013, economic activity should gradually recover”.
• America’s economic releases were mixed last week. The NFIB small business survey shows soft confidence readings in December. Yet consumer credit demand is slowly reviving judging by November’s annual +6% rise. Housing mortgage applications and refinancing were strong in the opening week of this year.  
• China’s annual inflation showed a mild pickup to 2.5% in December given the recent cold weather adversely impacting vegetable prices. However price pressures seem generally well contained and below the central bank’s 4 % inflation target. So there is still scope for China to gradually relax monetary policy in 2013.                     

Australian economic releases and implications

• Job vacancies fell sharply in November 2012 by 7%. This signals that labour demand is clearly softening with the “non mining economy” struggling (sectors such as manufacturing, retail, transport and tourism are very subdued). 
• Australia’s trade performance deteriorated in November with an increased deficit of A$ 2.6 billion. This is the fourth largest monthly deficit on record. Strong capital import demand given the Mining investment boom and solid consumer good imports taking advantage of a high Australian Dollar were the key factors for the larger deficit.
• Building approvals did improve by +2.9% in November indicating that housing construction is slowly responding to lower interest rates.  

Major market moves

• Global shares were generally flat for the past week. American shares (S&P 500) rose marginally by +0.4 % given caution with the start of the corporate earnings season for the December quarter. There were also minimal changes in Europe. Australia’s ASX 200 marginally fell by -0.3% for the week. 
• US earnings reporting season commenced with Alcoa the first major company to report. Alcoa provided signs of optimism, expecting growth in aluminium demand to reach 8% in 2013. A mild US earnings season is expected with annual profit growth of circa +2% anticipated.

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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• 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. 

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