• US taper talk yet again dominated over the past week, as a US budget deal and more strong economic data was seen as boosting the probability of a tapering in the week ahead. This saw US bond yields rise and global share markets remain under pressure. Australian shares have particularly been under pressure thanks to a combination of tapering fears weighing on high yield shares like banks, the ongoing drain from capital raisings, several profit warnings, foreign investors selling or staying away until the $A stabilises and news that Holden will end local production after 2017 not helping sentiment.
• Our assessment is that it’s still 50/50 as to whether the Fed will announce tapering in the week ahead. The case for a December taper is that US labour market looks stronger and fiscal risks have diminished with the budget deal. Against this though inflation remains very low, Bernanke and Yellen may prefer to see a bit more certainty that recent strength will be sustained and the Fed may prefer to start to tapering when financial market liquidity is stronger rather than just before Christmas. I kind of think they should just bite the bullet and start the process to put an end to the “will they taper or not” soap opera!
• However, whether it’s in the week ahead or early next year, I remain of the view that Fed tapering is not a major threat for investors, apart from a bit of short term volatility. First, it will only occur because the Fed is more confident the US recovery is sustainable. In other words it should be reason for celebration. Second, tapering is not tightening as it will just mean a gradual reduction in the amount of asset purchases (maybe from $US85bn a month to $US75bn a month initially). Third, the Fed will likely couple the start of tapering with a move to further push out expectations for the first rate hike. Finally, when it happens it will be well and truly factored into most markets. As such it could turn out to be a case of “sell on the rumour, buy on the fact”.
• The bipartisan US budget deal is very positive. Not only does it signal a small fiscal easing next year, but it means no risk of shutdowns for almost the next two years and improved Congressional cooperation signals reduced political uncertainty, including around the debt ceiling that needs to be increased again early next year.
• In Australia, news that Holden will cease car production after 2017 is terrible for auto industry workers and sad for people like me who like to own and drive Holden cars. From a broader economic perspective there is a real risk that, given the iconic status of Holden, the announcement will dampen confidence. In this sense the timing is not good. However, the impact on the overall economy of Holden’s demise should not be exaggerated. First the impact will be spread over time. Second, direct job losses of 2900 and total losses of maybe 15,000 are tiny compared to total Australian employment of 11.6 million people (just 0.1%). Third, this impact is likely to be reduced by government assistance programs and if other producers take over some of Holden’s plants. Fourthly, while Holden’s demise adds to the manufacturing sector’s woes, it should be noted that manufacturing has been in decline for 50 year or so. Back in 1960 manufacturing employed 26% of the workforce and now it’s just 8%. And yet the economy has performed well despite this. Finally, we need to accept that government assistance of the auto industry was not a good use of taxpayers’ money. It can now be re-directed to well-targeted infrastructure spending which is what the economy really needs.
• The past week marked the 30^th anniversary of the $A float. Its swings over the last 30 years have been a great shock absorber for the economy and a catalyst for economic reforms. Right now its direction is down. To help the economy adjust as the commodity boom slows, RBA Governor Steven’s wants to see the $A at $US0.85, I would prefer $US0.80 but it’s all in the same direction, ie down. More broadly Steven’s comments in an interview indicate a degree of comfort with current rate settings as the focus remains on getting the $A down.

Major global economic events and implications

• US data continues to point to improving growth. Retail sales rose strongly in November indicating a good start to holiday sales, job vacancies rose to a five year high and rising wealth will help add to spending.
• Eurozone economic data disappointed with industrial production falling more than expected in October.
• Japanese data provided more evidence that Abenomics is working with improved confidence readings, the Manpower employment outlook survey at a five year high and M2 money supply growth at its fastest since 1999.
• Chinese data for November was benign with industrial production and investment slowing a notch but retail sales accelerating and all remaining solid consistent with 7.5% or so GDP growth. Meanwhile lending growth was a bit stronger than expected but with non-food inflation at just 1.6% there is little pressure on the central bank to tighten aggressively. Uncertainty over policy tightening to slow the shadow banking system may linger though.
• Indian data was poor with falling industrial production and rising inflation. Strong gains for the opposition BJP in state elections provided a bit of support to the Indian share market though on the grounds that it augured well for the BJP in next year’s national elections which in turn could usher in economic reforms.

Australian economic events and implications

• Australian economic data was messy. Consumer sentiment fell but remained in a rising trend. The NAB’s business survey showed a slight improvement in conditions but a marginal fall in confidence – but at least both well up from their lows. The November jobs report was confusing with a stronger than expected jobs gain but rising unemployment and falling hours worked highlighting that the jobs market remains weak. Against this, housing finance continued to surge higher in October both for owner occupiers and investors and also for construction indicating the housing recovery continues. This is a positive sign for broader economic growth.

Major market moves

• It was another messy weak for share markets with tapering fears dominating globally and Australian shares hit again by the combination of global weakness, capital raisings, the falling $A which acts to keep foreign investors away and the announcement that Holden will cease production not helping confidence.
• The $A continued to slide on the combination of taper talk, more jawboning from RBA Governor Stevens and Holden’s production demise providing another reminder it is still too high.
• Bond yields rose in the US and China but were flat to down elsewhere

What to watch over the next week?

• Globally, the week ahead will see all eyes on the US Federal Reserve (Wednesday) to see whether it starts slowing its quantitative easing program. We would not be at all surprised to see the Fed start tapering in the week ahead as it’s now a 50/50 call.
• Apart from the taper decision in the US, expect the flash Market PMI (Monday) along with various regional manufacturing surveys to remain solid, CPI inflation (Tuesday) to have remained benign, the NAHB homebuilders conditions index (Tuesday) to show a slight gain and housing starts (Wednesday) to be strong.
• In the Eurozone, expect flash PMIs (Monday) to remain consistent with a gradual recovery.
• In Japan, the Tankan business survey (Monday) is expected to show further signs of improved growth.
• China’s flash HSBC PMI (Monday) is expected to remain consistent with growth remaining around 7.5%.  
• In Australia, the Federal Government will release its mid-year budget review on Tuesday which will likely show a further blowout in the budget deficit for this financial year to around $50bn as a result of the RBA recapitalisation and more revenue slippage. Minutes from the RBA’s last rate setting meeting (also Tuesday) are likely to reiterate that it retains an easing bias but that it is not close to acting on it given recent signs of improvement in economic data. Parliamentary testimony by Governor Stevens will likely reiterate the same message and provide another opportunity for more $A jawboning.

Outlook for markets

• Fed taper talk and still high short term sentiment readings regarding US and global shares suggest that the share market correction could have a bit further to run. Capital raisings and the falling $A are not helping Australian shares right now. However, we remain of the view that this is just a pause ahead of the resumption of the rising trend as share market valuations are reasonable, monetary conditions are set to remain very easy despite Fed tapering, profits will improve next year as global & Australian growth picks up and there is still a lot of money sitting in cash and bond funds. Australian banks are now back to offering grossed up yields around 8% and so are starting to look pretty attractive again given that term deposit rates of around 3.5 to 4% are continuing to slide. Note that the first half of December is often flattish for shares with the Santa rally usually starting around Christmas and we expect the same to occur this time around. Next year the combination of stronger profits and low interest rates are likely to see the Australian ASX 200 push up to around 5800.
• Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering eventually occurs. Low yields and an unwinding of years of massive inflows point to poor sovereign bond returns ahead. However, dovish forward guidance from central banks is likely to help ensure the rising trend in yields remains gradual.
• Expect the $A to be buffeted in the short term between signs Australian rates have bottomed but talk of Fed tapering and RBA jawboning. It’s ultimately on its way down to around $US0.80.

By Dr Shane Oliver, Head of Investment Strategy & Chief Economist

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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) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties 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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It’s not that investors and the markets have their heads in the sand but rather that the ratings downgrades and the news from the World Bank and IMF have already been factored in and tell us nothing new. In the meantime Euro-zone bond auctions have gone reasonably well and global economic data releases have been reasonably favourable.

• The ratings downgrades have been well flagged since early December, the downwards revisions to the World Bank’s growth forecasts just sees them catch up to private sector growth expectations and its been well known over the last few months that the IMF was looking at increasing its emergency lending capacity.
• On the World Bank’s comments about the risk of a deeper downturn than that of the GFC there is no doubt that the risk is there, but it was most intense three months ago. Since then moves by the ECB and other central banks to provide cheap access to funding for banks have reduced the tail risk of a meltdown in global financial markets. So while their comments provide a reminder that Europe is still a big risk, they are a bit dated.
• It’s doubtful the IMF will get the full amount of its extra funding, with both the UK & US looking unlikely contributors – they think the ECB should do more – so more pressure is likely on emerging countries to chip in.

Major global economic releases and implications

• US data releases over the last week remained positive. Manufacturing conditions indicators for the New York and Philadelphia regions showed further improvement in January and industrial production rose solidly in December. Evidence of a stabilisation and possible improvement in the housing sector continues to build with housing starts and permits continuing to trace out a sideways to slightly up trend and good gains in home builder conditions, home sales and mortgage applications. Initial jobless claims fell to their lowest level since June 2008 indicating that the jobs market is continuing to improve. Finally, inflation remained benign in December. The pick up in the US appears to be continuing into the New Year. Is the US undergoing a renaissance with GM the world’s number 1 car seller again and Honda choosing to build a “supercar” plant in Ohio rather than in Japan?
• US December quarter earnings results have been off to a mixed start, but have improved. So far 60% of results have come in better than expected which compares to 70% or more at the same point in the past 10 reporting periods. However, the 60% compares to just 47% a few days ago so the trend appears to be improving with good results from tech stocks (albeit Google missed). Consensus expectations are for 10% earnings growth.
• Similarly in Europe, economic data was generally better than expected with a solid rise in a ZEW measure of economic sentiment, a rise in construction activity and a smaller than expected rise in inflation in December.
• Chinese economic data was also encouraging with GDP growth for the year to the December quarter slowing to 8.9%, which is stronger than expected. Growth in industrial production and retail sales also came in stronger than expected and the HSBC flash manufacturing conditions index improved marginally in January. There is still no sign of a hard landing in China and with economic growth, inflation and the property market cooling down there is likely to be further policy easing in the months ahead.
• In Japan, consumer confidence and machine orders recorded better than expected gains. 

Australian economic releases and implications
Australian economic data was mostly disappointing. While housing finance rose in November, maintaining a slight uptrend over the last year, it is yet to show much evidence of a solid recovery from the falls of 2010. Moreover, consumer confidence failed to recover much from a sharp fall in December, motor vehicle sales fell in December and the December labour market report highlighted very soft employment conditions. In fact, through 2011 there was no jobs growth. The only reason unemployment hasn’t increased more sharply is because labour force participation has declined.

To be fair part of the softness in employment in 2011 is payback for the record 366,000 new jobs of 2010. But it also reflects much softer economic conditions and with further falls in job ads and more talk of job layoffs, particularly in the finance sector, a further rise in unemployment is likely in the months ahead, possibly pushing the unemployment rate up to around 6% by year end. Finally, the terms of trade fell in the December quarter as export prices fell and a weaker $A boosted import prices. All of this combined with the TD Securities Inflation Gauge suggesting that inflation remains benign, supports the case for more rate cuts from the RBA, with the next cut likely to occur at next month’s meeting.

Major market moves

• Global share markets continued to push higher over the last week helped by favourable economic data, solid earnings results in the US and solid debt auctions in Europe. Australian shares followed suit but lagged somewhat due to weaker than expected Australian economic data.
• Commodity prices rose on improving confidence regarding global growth. Improving investor confidence also pushed up the euro and the Australian dollar. 
• Bond yields rose in the US, UK and Germany on improved investor sentiment, but Italian and Spanish yields fell. 

What to watch over the week ahead?

• In the US, the Federal Reserve is expected to make no changes to monetary policy when it meets on Wednesday but it will start to publish its view on appropriate levels for the Fed Funds rate out to 2014. These are expected to show no change in the Fed Funds rate for the next two years which may have the effect of keeping long term bond yields down in the US. The post meeting press conference will also be watched closely to judge how likely another round of quantitative easing is in the US. On the data front, durable goods orders for December (due Thursday) are likely to show solid growth, new home sales (also Thursday) are expected to show modest growth and December quarter GDP due Friday is expected to show solid annualised growth of 3%. Data for house prices and consumer sentiment will also be released. President Obama’s State of the Union address on Tuesday is unlikely to contain anything substantive but a risk is that it may see more populist proposals for a tax on large financial institutions.
• In Europe, a finance minister’s summit on January 23rd and a leaders’ summit on January 29th will be watched for progress towards the fiscal compact that was agreed back in December. January manufacturing conditions indicators (PMIs) (Monday) are expected to improve slightly from bleak December readings.
• In Asia, Korean December quarter GDP data (Thursday) is expected to show a 0.5% gain and Japanese inflation data (Friday) is likely to show ongoing deflation.
• In Australia, the main focus will be on December quarter inflation data due Wednesday. We expect headline inflation of 0.3% in the quarter or 3.4% year on year, but underlying inflation of just 2.4% year on year. This should prove to be no barrier to another interest rate cut next month. The risk is on the downside for headline inflation thanks to a plunge in banana prices.

Outlook for markets

• After strong gains so far this year shares are getting a bit overbought and vulnerable to a correction. What’s more Europe is likely to remain a source of volatility, with, for example, ongoing issues regarding Greece’s debt restructuring. However, the broader picture for shares is looking more favourable: valuations are attractive particularly against very low bond yields, the risk of a meltdown in Europe has receded, the global recovery looks like it will continue (albeit at a slower pace than seen in 2010 and 2011), monetary conditions are easing and there is lots of cash on the sidelines. We expect a good year for shares overall.
• The last two years have seen the Australian share market lag global shares due to a combination of worries about Chinese policy tightening, relatively tight monetary conditions in Australia and the strong $A. Going forward we expect to see relief in terms of the first two which should see the relative performance of Australian shares start to improve. We continue to see the ASX 200 pushing up to 4800 by year end.
• Global bond yields are very low in core countries suggesting low returns unless Europe’s debt crisis intensifies. Australian government bonds are relatively more appealing with higher yields. Australian corporate debt is an even better investment proposition if one needs income or is worried about shares.
• The $A is likely to see its usual large price swings this year but generally remain solid. Australia is one of the very few countries with a stable AAA rating and so is partly perceived as a “safe haven”.

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Europe’s government bond markets had an improving tone for the week with moderately successful funding issuance by Italy and Spain. Both countries secured reasonable volume of funds at lower interest rates than were prevailing a month ago. This has had a positive impact on bond yields with Italian 10 year government yields declining by 0.44% to 6.58% and Spain’s 10 year bond yield falling by 0.5% to 5.06 % over the week.

Global shares have benefited from this stabilisation in European government bond markets. American shares have risen by +1.4 % for the week (US S&P 500) while German DAX share index has risen by 2 % .  Australian shares had a solid week with the ASX 200 up + 2 %. 

Major global economic releases and implications

• However Europe’s largest economy is now struggling given the financial market turmoil and debt troubles of its European colleagues. Preliminary estimates from Germany’s Federal Statistics Office indicate that Germany’s economy expanded by 3% for 2011. This compares to the previous year’s 2010 growth of +3.7%. However given a robust first half of 2011, this 3% year average result implies that the final quarter of 2011 Germany’s economy contract by approximately – 0.3 % qoq.
• American nominal retail sales disappointed in December with a marginal rise (+ 0.1% mom) after November +0.4% mom rise.  While there was strength in US car sales in December (+1.5% mom), this was offset by weak electronic sales (-3.9% mom) and general merchandise spending (-0.8% mom). Yet US consumer spending has been solid over the past year despite weak asset prices and a sluggish labour market. For the past year, nominal US retail sales have risen by +6.5% yoy. So December’s US sales are a disappointment but not a turning point.
• China released economic activity this week which signalled that the economy‘s growth momentum is progressively cooling while inflation pressures are moderating. China’s annual export growth slowed further to +13.4 % yoy. China’s CPI for December shows annual inflation at 4.1%, a continued improvement considering that China’s inflation was running at 6.5% in mid 2011. Given these moderating export growth and price data, China now has considerable scope to lower interest rates in 2012 to mitigate any adverse developments from Europe’s turmoil and weak export prospects.

Australian economic releases and implications

• Australia’s nominal retail spending recorded a flat result (0.0% mom) in November after October’s subdued +0.2%. Retail spending is also sluggish on an annual basis, having risen only +3.1% compared to average of 6% per annum from 2002 – 2007. There were no signs of any strength in November, with softness particularly evident in clothing sales and department stores while there was a surprisingly weak result recorded for Victoria on a state basis. Australian consumers remain cautious generally about spending, casting a wary eye on Europe’s debt crisis, global market turmoil and a more sedate Australian labour market. 
• While Australian home building approvals did rebound in November (+ 8.4 % mom), the overall trend has been negative with approvals down -18.9% over the past year.  Commercial construction outside of mining also remains weak, with “non residential” building approvals down by -2.4% for November and -18.8% for the past year. Clearly lower mortgage and corporate borrowing rates with the RBA’s recent interest rate cuts should be progressively beneficial for construction in 2012.

Major market moves

• Commodities have also benefitted from the improved risk appetites, with copper up + 6 % for the week while Gold is +1.3% to US$ 1639 per ounce.        

What to watch over the week ahead?

• Generally this should be a quiet week for economic data with the focus more on financial markets. 
• America’s sees the release of December data on housing starts, industrial production and inflation.
• Europe will sees a measure of German business confidence (ZEW) and the central bank‘s monthly bulletin.
• China is set to release critical economic activity data during the week with Real GDP for the December quarter as well as industrial production & retail sales for December. The key focus is whether China’s economy continues to slow given tighter monetary policy in 2010-11 and recent weaker global demand for its exports (particularly in Europe). 
• Australia’s sees labour market data for December. Employment growth should improve to +10,000 jobs compared to a disappointing November result of -6,300 and the unemployment rate to hold steady at 5.3%.

Outlook for markets in 2012

• Global shares are very cheap compared to corporate profits as well as government bond yields. Yet Global shares have to battle the current prevailing headwinds of Europe’s banking and debt crisis, doubts on the US recovery as well as concerns that Asia’s growth is slowing sharply. While Global Shares are likely to tread water in the short term given the prevailing caution, 2012 should ultimately prove a better year than last year. Global share have factored in a significant amount of stress as indicated by forward price to earnings multiples which are now 10.2 times for Global shares compared to 12.4 times a year ago. For Australian shares, the forward PE is now 10.6 times compared to 13 times a year ago. The Australian ASX 200 to expected to rise towards 4800 by the end 2012.
• Global Bond yields are very low in the core countries of America, Germany, Britain and Japan. This suggests low returns unless Europe’s debt crisis intensifies further and a global recession transpires. Australian government bonds are relatively more appealing with higher yields than these global bonds. Yet Australian corporate debt is an even better investment proposition if one needs income or is worried about shares.
• Cash & term deposits should become less attractive in 2012 with the RBA likely to lower Australia’s official cash rates by a further 0.25% to 4.0 % in February 2012.
• Commercial property returns are likely to be solid in 2012 reflecting yields around 7%. This suggests that only modest capital growth can generate a decent annual return.
• The $A is likely to have some large price swings in 2012 but generally remain solid. Australia as one of the very few countries with a stable AAA rating is perceived as a “safe haven” with Europe’s sovereign debt woes.

The post Weekly market & economic update appeared first on AdviserVoice.

While new coalition governments in Italy and Greece look set to approve new austerity measures the risks in Europe remain high. Forward indicators point to a slide into recession ahead, fiscal austerity will only worsen the economic and public debt situation, elections early next year in both Italy and Greece will only prolong the uncertainty and increasing talk of countries leaving the euro is adding to fears of defaults.

The slide into the abyss by Italy since July is particularly concerning. While Italy’s level of public debt (120% of GDP) and budget deficit (4% of GDP) are far better than Greece’s, investors are starting to fear that it is heading down the same path ultimately requiring a debt write down. And these fears are in danger of becoming self fulfilling. Italian bond yields at 6.42% – having fallen from a mid week peak of over 7% – are well above sustainable levels (which is probably around 4% or less) and risk turning a liquidity crisis into a solvency crisis.

Italian bond yield spreads to Germany remain around levels that ultimately forced Ireland and Portugal to seek a bailout. The trouble is that Italy accounts for 17% of Euro-zone GDP and 23% of its public debt, and European banks have a near $US800bn exposure to it (nearly six times their exposure to Greece). The enhanced European bailout fund is unlikely to be big enough to deal with Italy as well as other countries and in any case it’s not yet up and running.

While European Central Bank purchases of Italian bonds helped push Italian bond yields back down late last week, on its current approach this is likely to be temporary and insufficient to make a lasting impact. The ECB should be committing to unlimited purchases of Italian bonds in order to ward off speculators and push yields back down to sustainable levels of around 4%. Unfortunately it remains reluctant to do this. In short the news out of Europe is likely to remain poor, albeit interspersed by brief bouts of relief and optimism.

However, it’s not all bleak globally. The US is continuing to grow despite numerous headwinds, China looks to be on track for a soft landing and various countries are continuing to ease monetary conditions, with the latest being Indonesia.

Major global economic releases and implications
US economic data was mostly positive over the last week with a rise in consumer sentiment, slight rise in small business confidence, a further fall in weekly jobless claims, a rise in weekly mortgage applications and a narrower than expected trade deficit. What’s more the September quarter profit reporting season is now largely complete with profit growth coming in at a much stronger than expected 18% year on year. The only negative was that a Fed survey pointed to fewer banks easing lending standards and signs that credit demand is weakening. Overall the picture remains of continuing growth in the US, albeit around a sub par 2-2.5% pace.

European economic data was soft with a fall in euro-zone retail sales, sharp falls in German, French and Italian industrial production and flat industrial production in the UK. Business conditions indicators point to further shape falls in European industrial production ahead.

Chinese economic data for October confirmed the picture of moderating growth and cooling inflation. While industrial production, export growth, money supply growth and the property market continue to slow, retail sales, fixed asset investment and imports remain strong. Overall, there remains no sign of a hard landing in China.  What’s more inflation is continuing to cool, falling to 5.5% in October from a cyclical peak of 6.5% in July. While food inflation is coming off the boil, non-food inflation is also slowing and falling producer price inflation and slowing growth all point to a further fall in inflation ahead. The moderation in growth and inflation is likely clearing the way for monetary easing in the next few months.

While the general picture across Asia remains one of moderating growth and slowing exports, there was some strong news out of Indonesia with GDP growth holding up at 6.5% over the year to the September quarter. However, with global uncertainty on the rise and inflation cooling, Indonesia cut interest rates again by another 0.5% taking them to 6%. Further interest rate cuts are likely across Asia in the months ahead.
Australian economic releases and implications

Australian economic data continued the somewhat more positive tone seen over the last month with gains in consumer and business confidence, housing finance and employment and another solid trade surplus for September. That said, it’s worth noting that this doesn’t mean the economy is suddenly booming. Both business and consumer confidence have just bounced back to average levels and housing finance remains low. While employment growth remains positive it is worth noting that trend monthly employment growth is now running around 6000 jobs a month compared to 30000 jobs a month a year ago. What’s more job ads and various business surveys and anecdotes point to labour market softness ahead.  This combined with the intensifying risks coming out of Europe means that the outlook for interest rates is still skewed to the downside.

Major market moves
Share markets had another volatile week with markets falling sharply mid week on the blowout in Italian bond yields and fears that Italy will knock Europe into an even deeper recession before staging a rebound later in the week as the political situation in Greece and Italy improved. Share markets were up in the US, Europe and Australia, but closed down in Asia.

Commodity prices also had a volatile week and ended mixed with oil and gold up, but metal prices down. Mixed commodity prices and the uncertainty over Europe also weighed on the Australian dollar.

Bond yields were generally mixed. A concern remains that despite an improvement later in the week, French and Italian bond yield spreads to German yields remain wide. 

What to watch in the week ahead?
In the US, October retail sales (due Tuesday) are likely to show modest growth, manufacturing conditions surveys (Tuesday and Thursday) are expected to show an improvement, inflation (Wednesday) is expected to be benign and housing starts & permits are expected to continue the basing action seen over the last year. Data for industrial production and consumer sentiment will also be released.

In Europe, September quarter GDP growth (Tuesday) is expected to come in around 0.2%, the same as in the June quarter.

In Japan, GDP data (Monday) is expected to have recorded a solid 1.5% rebound in the September quarter following three quarters of contraction partly due to the earthquake.

In Australia, the minutes from the RBA’s last Board meeting and a speech by RBA Governor Stevens will be watched closely for clues as to whether there will be another interest rate cut next month. Of particular interest will be any guidance as to how seriously the RBA views the European crisis. Wages data due for release on Wednesday is expected to remain benign with a gain of 0.8% in the September quarter and 3.7% year on year.

Outlook for markets
The mess in Europe continues to cloud the short term outlook for shares. Long term value is good for shares, the US and China are looking okay, global monetary easing is positive, we are entering a seasonally stronger period of the year and investors generally are short shares, but the event risk around Italy and Greece and the slide into recession in Europe generally are likely to keep the ride volatile in the short term.

The $A, like all risky assets, is likely to remain vulnerable in the short term to the ongoing European debt debacle. However, the medium-term trend is likely to remain up as the $US remains under long-term downward pressure, not helped by its debt woes and the prospect of more quantitative easing, Chinese commodity demand remains strong over the long-term and Australian interest rates will remain well above US rates even if the RBA cuts rates by more.

Government bonds in major global countries are a good diversifier and with short term interest rates likely to remain low indefinitely it’s hard to see much sustained upwards pressure on bond yields for the foreseeable future. However, yields are extremely low so expect modest medium-term returns.

The post AMP Capital weekly economic and market update appeared first on AdviserVoice.

The ACPF is a diversified fund-of-funds that invests in listed and unlisted property funds that are predominantly managed by AMP Capital Investors (AMPCI). 

The ACPF provides investors with access to three of AMPCI’s well-diversified wholesale unlisted property funds—the AMP Capital Shopping Centre Fund, the AMP Capital Wholesale Office Fund, and the AMP Capital Hedged Global Direct Property Fund—which are managed AMPCI. These funds invest in quality real estate portfolios, primarily holding office and retail properties located in Australia and overseas. 

The ACPF also invests in AMPCI’s Global Property Securities Fund and the BlackRock Property Securities Index Fund, which are both rated four stars by S&P. 

“AMPCI’s real estate investment capability is considered to be a core competency, and this underpins S&P’s conviction,” said S&P Fund Services analyst Peter Ward. “In particular, we believe that the underlying unlisted property funds are well positioned to take advantage of opportunities, and to weather challenging conditions,” said Mr Ward.

The post S&P affirms rating on AMP Core Property Fund as Five Stars appeared first on AdviserVoice.

Where to from here? Is the upswing from $US0.48 in 2001 now over?

The $A moves with other growth trades
In recent years short term swings in the Australian dollar have become highly correlated to other growth oriented risky assets like shares. This is clear in the chart below which shows the Australian dollar against the US share market.While the longer term trends in each differ (up for the $A, down for US shares) each time shares have taken a decent hit so too has the $A – falling 39% during the GFC, 13% during last year’s double dip worries and 14% recently. 

There are three key reasons for this sensitivity. First, because 70% of Australia’s exports are commodities the $A is seen as a commodity currency. Whenever there are concerns about global growth and shares take a hit, commodity prices also take a hit and so too does the $A.

Second, in times of economic uncertainty investors unwind so called ‘carry trades’. These involve borrowing in Yen or $US at near zero interest rates and parking the money in higher yielding currencies like the $A. When they are reversed during times of uncertainty, it pushes the $A down.

Third, the $US is seen as a safe haven currency (perversely given America’s debt problems). Since a big chunk of global trade and lending are conducted in US dollars, demand for them goes up in times of uncertainty. The $US strength in times of stress also pushes commodity prices down as most are priced in US dollars which in turn weakens the $A.

If anything this correlation with shares for the $A may intensify as more investors cotton on to the importance of macro economic issues in driving global investment markets and so see investing in terms of ‘risk on’ (buy shares, commodities and commodity currencies in good times) and ‘risk off’ (do the opposite).

Europe getting worse
It’s likely the $A’s vulnerability will remain high for some time. Europe looks terrible, with any relief provided by the EU’s latest policy response now being blown apart by political instability in Greece and Italy. While the EU’s latest response to its debt problems – of implemented – may help head off a worst case financial blow up it does nothing to break the vicious spiral of fiscal austerity, economic contraction, budget blowouts, market panic, more fiscal austerity, etc.

Current indications are that Europe is on track for recession. But it’s also driving social and political dislocation on an immense scale, as seen recently in Greece and Italy. Italy’s slide into the abyss since July is particularly worrying as it accounts for 17% of Euro-zone GDP and 23% of its public debt, and European banks have a near $US800bn exposure to it (as opposed to a $US130bn exposure to Greece). Italian elections will only lead to more uncertainty and delay. Italian bond yields have now reached levels that if sustained will turn its problems into a solvency crisis just like Greece. They have now surged past the levels that forced Ireland and Portugal to seek assistance.

The crisis is creeping further and further into the core of Europe with France also coming under pressure. The best way out of this would be for the ECB to commit to unlimited bond buying and significant monetary easing, but it is still not prepared to do this. What’s more there is increasing talk of a break up of the euro. All of which means continuing volatility out of Europe for some time to come, with an obvious threat to global growth, commodity prices and the $A.

From the short to the medium term
Pulling back from the myopic focus on the tragic soap opera unfolding in Europe and the short term vulnerability this implies for the $A, the medium term outlook for the Australian dollar remains strong. This reflects two key forces – long term commodity demand out of the emerging world and ultra easy monetary policy in the US, Europe and Japan.

Commodity story remains alive and well
While commodity prices have fallen sharply over the last few months the longer term trend remains up. Rising supply is likely to slow the uptrend in real commodity prices in the years ahead, but, abstracting from cyclical fluctuations, demand is likely to be strong, driven by rapid industrialisation in emerging countries.

Emerging countries are now passing through the $US3000-10,000 per capita income range that normally sees a sharp spike higher in demand for consumption goods. Last year, 50% of the population in emerging countries fell in this range.

Related to this, over the next few years around half a billion people in emerging countries will enter the middle class, adding to demand for consumer goods.

The potential raw material demand is highlighted in China. Despite massive investment, China still has a long way to catch up in terms of infrastructure and consumer goods. The following table compares China to the US.

On a per capita basis, roads, railways, phone lines, living space and cars are well below US levels. Indian levels are a fraction of China’s. This implies a huge catch up still ahead which is likely to continue to be driven by urbanisation, strong productivity growth and surging consumer demand – mainly in China, but increasingly in India.

As the catch up occurs it will result in increasing demand for commodities. The following table compares annual commodity consumption per person in China and India with that in Korea, Taiwan and the US.

 On a per capita basis, roads, railways, phone lines, living space and cars are well below US levels. Indian levels are a fraction of China’s. This implies a huge catch up still ahead which is likely to continue to be driven by urbanisation, strong productivity growth and surging consumer demand – mainly in China, but increasingly in India.

As the catch up occurs it will result in increasing demand for commodities. The following table compares annual commodity consumption per person in China and India with that in Korea, Taiwan and the US.

The historical experience suggests commodity consumption normally peaks once per capita income (adjusted for purchasing power parity) of $US25,000 is reached. However, China and India are well below this.  So as per capita income in these countries continues to grow, it implies a further significant increase in global commodity demand, particularly so given their 2.5bn population. India is running around 10 years behind China in terms of commodity demand but it has a similar demand potential in the decades ahead.

This all implies that, while Australia’s terms of trade may have peaked for this cycle following the recent fall in commodity prices, it is likely to remain at very high levels on a longer term basis, which in turn is likely to see the Australian dollar remain strong. In fact, even if the terms of trade just averages around current levels it implies the potential for more upside in the $A over the medium term.

 
Interest rates and monetary policy
While the RBA may be easing and may indeed ease further, other countries are also easing and likely by more. The public debt problems in Europe, the US and Japan – and resultant budget cutbacks and tax hikes – are likely to constrain growth in these countries for years to come.

This is likely to see interest rates stay near zero for at least the next two or three years. It is also likely to see further quantitative easing (ie using printed money to buy up government and other debt in order to boost the money supply). The UK started another round last month, Japan is continuing on a modest scale, the US is likely to follow in the months ahead and while the ECB professes it won’t, it probably will have to as Europe slides deeper into recession. The net outworking of all this will be to put ongoing downwards pressure on the value of the $US, Yen, Euro and British pound against other currencies. On the flipside, monetary easing in Australia is likely to be limited, reflecting the relatively stronger Australian economy. The end result will be that Australian interest rates will remain well above those available in traditional advanced countries (providing an inducement to park funds in Australia) and the supply of US dollars, Yen, euros and pounds will rise relative to Australian dollars – all of which will result in long term upwards pressure on the $A.

Conclusion
While the Australian dollar remains vulnerable to further weakness in the short term on worries about global growth, particularly on the back of Europe’s debt problems, on a medium term basis it is likely to remain strong on the back of emerging world commodity demand and relatively high interest rates and tight monetary conditions in Australia.

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The new fund – Irish Infrastructure Trust – will target investment in Irish assets including those designated for disposal by the Irish Government and Irish commercial State enterprises and also in new infrastructure projects in Ireland. It will seek up to €1 billion from global and Irish institutional investors and has already received investment commitments of €300 million from institutional funds including €250 million from the National Pensions Reserve Fund (NPRF).

AMP Capital will invest and manage the portfolio of infrastructure assets with full responsibility for all investment decisions. AMP Capital Head of Infrastructure Europe Boe Pahari said: “We are very pleased to be appointed as infrastructure manager for this Irish infrastructure fund which will provide institutional investors globally with a unique opportunity to invest in the Irish infrastructure sector.

“We have over 20 years’ experience in owning and managing infrastructure assets and are well positioned to effectively manage and add value to the fund’s investments. With the first close of the fund we are progressing an active deal pipeline consistent with our strategy of investing in quality Irish infrastructure assets across a range of sectors.”

Irish Life Investment Managers Chief Executive Gerry Keenan said: “We expect considerable investment opportunities to emerge in the coming years with infrastructure assets which have traditionally been closed off from outside investment. This fund aims to provide long term investors with a stable income yield as well as the potential for capital growth from a substantial portfolio of assets which underpin the Irish economy.”

National Pensions Reserve Fund Chairman Paul Carty said: “This commitment by the NPRF is a significant building block in the establishment of a Strategic Investment Portfolio that is focused on investments in Ireland. It has the added benefit of allowing the NPRF to fulfil its goal of investing on commercial terms and alongside other investors in Irish infrastructure.”

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AMP Capital Brookfield is committed to a centralised portfolio-management model in Chicago and at this time has opted not to fill Mr. Ward’s role. Instead, his portfolio and team management responsibilities will be shared between global portfolio managers Jason Baine and Bernhard Krieg. Both are experienced investors in European markets and the strategy is operated under a collegial decision-making approach ensuring familiarity across regions. 

“We view Brett Ward’s departure as significant since he was a long-serving and key member of the business. He’s an experienced global investor and provided important cultural leadership for the broader team. He established the European research team and made an important contribution toward integrating the global research capability,” said S&P Fund Services analyst Kelly Napier. 

Despite Mr Ward’s departure, the investment team is still one of the largest and most impressive in the rated peer group and the global property capability is a high quality offering with an established track record. The strategy benefits from a centrally coordinated top-down and regionally implemented bottom-up investment process and a strong and experienced team.

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After some delay, Europe has finally announced a range of measures. Unfortunately much of the details are yet to be worked out so it looks more like a work in progress than the final solution. This is the third attempt by Europe to get its debt problems under control. Will it work and what does it all mean for investment markets?

Debt response 3
The key elements of the latest package are as follows:

• A 50% haircut for private investors in Greek bonds.
• A program to recapitalise banks thought to require around 110bn euros, with banks given till mid 2012 to get core capital ratios up to 9% (after writing sovereign bond holdings down to market levels), after which they have to rely on their governments or lastly the EFSF for funding.
• A scaling up in the firepower of the remaining funds in the EFSF (around 200bn euros) to around 1 trillion euros, probably by using it to provide first loss insurance on sovereign bonds and associating it with a special purpose investment vehicle which would buy bonds issued by struggling countries such as Spain and Italy, with funding hopefully coming from non-European sovereign wealth funds, the IMF and private investors.

Will it work?
The latest set of measures go further than those before and should help to head off a near term meltdown. Europe has accepted the reality that Greece is insolvent (with its debt to GDP ratio projected to grow to 180% of GDP next year) and so it has moved to further reduce Greece’s debt burden and protect banks and other countries in the process.

However, announcing a plan is one thing, but implementing it is another. Europe hasn’t done too well on this front over the last 18 months. More broadly, it’s doubtful this is the end of the European debt crisis.

First, while the Institute of International Finance has apparently agreed to the “voluntary” 50% write down of Greek debt, actually achieving acceptance from individual banks and financial companies won’t be easy. It took two months to reach 90% acceptance to the 21% haircut announced on July 21. Also, one wonders what’s the point of having so-called credit default swap insurance on Greek debt if it won’t pay out on a 50% loss. Investors might start wondering whether CDS insurance on other investments is equally as useless. Furthermore, the proposed hair cut is probably not enough because once allowance is made for debt holders who won’t participate in the haircut (such as the IMF) it will only amount to a 25% write down to Greek debt.

Second, it’s doubtful the recapitalisation of European banks thought to cost 110bn euros will be enough, with most estimates suggesting the figure should be 200bn.  Allowing banks until mid next year to recapitalise on their own will only allow uncertainty to linger. More importantly, and despite regulatory oversight, many European banks would rather boost their capital ratios by shrinking their balance sheets (ie by cutting lending) than accept government funds. Asset reduction plans already announced add up to around 1 trillion euros. If banks follow through with this, the impact from such a lending cutback on growth will be significant. The forced recapitalisation approach used by the US Government in late 2008 was arguably more effective in making sure banks maintained lending levels.

Third, numerous uncertainties remain around the enhancement to the firepower of the EFSF:

• Confirming IMF and non-European sovereign involvement likely means waiting for the G20 Summit next week and probably beyond. The US already seems to be sceptical of greater IMF involvement, participating in such a fund would go beyond anything the IMF has ever done before, and sovereign wealth funds are likely to be sceptical after the bad experience of helping to recapitalise US banks three years ago. In fact its hard to see anything beyond token involvement from China.
• The involvement of sovereign wealth funds would probably entail a cumbersome governance arrangement.
• Getting private sector involvement may be difficult, without attractive terms.
• It’s doubtful the proposed firepower of 1 trillion euros will be enough. This would only cover Spain and Italy’s gross financing needs over the next two years. To cover Belgium and France will require 1.7 trillion euros.
• Whose bonds would be bought? Obviously Spain and Italy are prime candidates, but what about France and Belgium? And if it’s not the latter, why won’t speculators attack those markets? This already appears to be happening, with a sharp rise in the relative borrowing costs between France and Germany since July.
• If the EFSF is to take first loss on bonds then it entails more risk for countries that guarantee it, because they will potentially take a loss with no chance of recovery. This naturally adds to concerns France will lose its AAA credit rating, which partly explains the recent blow out in French bond yields. And if more countries lose their AAA credit rating this will threaten the EFSF itself.
• While the scheme has the approval of the German Parliament it may still be subject to legal challenges.

The limited and restricted buying power of the enhanced EFSF contradicts the first rule of successful market interventions, ie that buying power be unlimited and unpredictable. What Europe needs is an unlimited buyer of bonds in troubled countries to ward off speculators. Gearing up the EFSF using money from the ECB would have achieved this with less threat to credit ratings. Unfortunately both the ECB & Germany have ruled this out.

Finally, none of this changes the underlying reality that fiscal austerity is causing a vicious cycle where austerity depresses growth, making deficit reduction unachievable, causing more ratings downgrades, more bouts of panic and more fiscal austerity, and even weaker growth. Business conditions indicators already point to a recession for the EU. Clearly a circuit breaker is needed. This normally comes from monetary easing and exchange rate depreciation, but the ECB is still missing in action on this front.

This all suggests it’s doubtful the response put up by Europe will end the European debt crisis, nor will it prevent Europe falling into recession. However, it probably will help head off a worst case financial meltdown scenario and therefore a much deeper recession in Europe. As such, it adds confidence to our view that the global economy won’t fall into recession over the year ahead.

What about the world and share markets?
A month ago I set out a list of five measures that would help keep the global recovery going and provide confidence to investors. So where do we stand on this list?

• Coordinated global monetary easing – well it’s not quite coordinated but we are seeing global monetary easing with rate cuts in Brazil, Russia, Israel, Turkey, Indonesia, quantitative easing in Switzerland and the UK and China starting to ease at the margin. Obviously there is more to go, with Europe and Australia likely to ease soon.
• An increase in the firepower of the European bailout fund – on the way but not as aggressively as hoped.
• Aggressive and unlimited buying of European peripheral country bonds by the ECB/expanded EFSF – still further to go on this front.
• Recapitalisation of European banks – this is set to occur although not optimally.  
• The passage of President Obama’s stimulus plan – this is yet to occur and looks debatable given the polarised political machinations in the US.

While we are yet to see everything on this list, we are at least moving in the right direction. Furthermore, US economic data has picked up some pace recently, consistent with growth of around 2-2.5%. This is not great, but is also not the recession feared a month ago.
Overall, we have become more confident that the global recovery will continue with around 3% global growth next year, with 1% in advanced countries and 5% in the emerging world. This is sub-par but not recession.

Since early October share markets are up by around 10 to 12%. A further bout of short term weakness cannot be ruled out and the ride is likely to remain volatile. But against this:

• Value is good. This is particularly evident in Australian shares, with grossed up for franking credits dividend yields still high at 6.7%. For financials and blue chip stocks, dividend yields are even higher than this. This is well above bank term deposit rates and means share values only need to rise by 3% pa or so to provide pretty attractive returns for long term investors.
• US economic data has improved with solid September quarter profit results.
• Europe is far from out of the woods, but is moving to substantially reduce the risk of a GFC rerun.
• After the September quarter normally being the weakest quarter of the year, October often marks an important turning point ahead of strength into year end and there is a good chance the same is underway this year.

All of this suggests there is a good chance that we will see further gains in share markets into year end.

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With fears Europe and the US are on the brink of a return to recession and the European debt crisis still out of control and threatening to trigger a re-run of the 2008-09 GFC it’s natural to wonder how the emerging world, particularly Asia, would fare in the event of another recession in advanced countries. This is particularly important because the emerging world is now more than 50% of world economic activity. It’s also critically important for Australia given our key export markets in Asia.

Lessons from 2008-09
During first half 2008 there was much talk that the emerging world could decouple from the deteriorating economic environment in advanced countries. This helped push commodity prices to record highs into mid-2008. Ultimately the blow to confidence and trade following Lehman’s demise saw the emerging world pulled into recession along with advanced countries, commodity prices fall 60% and emerging market shares fall more than advanced country shares through the associated bear market (with a 59% fall in emerging market shares and a 61% fall for Asian, ex Japan, shares versus 56% for developed market shares). So those looking for decoupling were disappointed.

Or were they? While there is no doubt those who thought the emerging world could just sail on through despite the problems in advanced countries were wrong, emerging countries did do much better than advanced countries through the downturn and in the subsequent recovery. And their share markets rebounded by much more – up 118% from their GFC low to this year’s highs versus a gain of 82% in developed country global shares. The key lesson seems to be that emerging countries remain coupled to the global economic cycle, but can continue to outperform over time.

Similarities to 2008
There are a number of similarities to the situation in 2007-08 before the GFC for the emerging world. Now like then emerging countries have been battling an inflation problem, which in large part reflects higher food prices but also a rise in underlying inflation. This has resulted in rising interest rates and, as was occurring before the GFC, a slowing in growth, with leading indicators suggesting a further slowdown ahead.

What’s more, budget deficits are worse than was the case in 2007, suggesting less scope to respond with stimulus. In 2007 emerging countries had a budget surplus equal to 0.1% of GDP on average, whereas now they have a budget deficit equal to around 2% of GDP on average. This is highlighted by the problems Chinese local governments now face with much higher debt following their participation in the Chinese stimulus programs of 2008-09.

And emerging countries don’t appear to have significantly reduced their export exposure to developed countries since the GFC. So far, so bad. This all suggests that if advanced countries slide into a recession, the emerging world is vulnerable.

But it’s not that simple – the emerging world is in much better shape
However, a number of considerations are different this time around, or at least suggest the emerging world will continue to perform much better than advanced countries.

First, emerging countries are structurally sounder. Budget deficits of around 2% of GDP in emerging countries compare to average budget deficits of around 8% of GDP in developed countries. Public debt levels are low at around 35% of GDP on average, compared to around 100% of GDP in developed countries. Households are not under pressure to reduce debt in the emerging world. While the scope to provide further fiscal stimulus is reduced compared to 2008-09, it is nevertheless much stronger than is the case in developed countries. This also applies to China – while its higher level of public debt today (gross public debt is around 50% of GDP) means it is more constrained than in 2008, it still has scope to provide fiscal stimulus if need be as its public debt is low by global standards and in any case it would simply be borrowing from itself. (China is the world’s biggest creditor nation & its net public debt is zero.)

Second, just as inflation subsided in Asia and other emerging countries in 2008, clearing the way for monetary easing, the same is likely to occur this time around as weaker economic activity takes the pressure off food and oil prices and underlying inflation. Once inflation starts to fade in response to slower growth, monetary policy is likely to swing from tightening to easing. Brazil seems to have led on this front, but China and India are likely to follow suit in the next 6-9 months.

Third, the transmission to emerging countries of the 2008-09 recession was made worse by the GFC which resulted in a drying up of trade finance. While the risks of a GFC re-run emerging out of Europe is high, right now we are a long way from a drying up in trade finance.
Fourth, leverage and credit growth was rising in the run up to the GFC in Asia and other emerging countries. Over the last year credit cycles have been much more subdued.

Fourth, leverage and credit growth was rising in the run up to the GFC in Asia and other emerging countries. Over the last year credit cycles have been much more subdued.

Finally, Asian and emerging markets shares are trading at similar valuations to global shares compared to a premium in 2007. This all suggests that if the advanced economies roll over again, Asia and other emerging countries are vulnerable. But if a dry up in trade finance is avoided then the economic fall out is likely to be far milder than 2008-09. Either way, Asia and other emerging countries are likely to come through in better shape than advanced countries. Our base case is for growth of around 1% over the year ahead in advanced countries (comprising recession in Europe, but the US managing to narrowly avoid it) and around 5% growth in the emerging world, resulting in global growth of around 3%.

Who is most vulerable in the emerging world?
The experience of the GFC indicates the countries most vulnerable are small countries with big export sectors in relation to their economy. In the case of Asia this means Singapore (which may already be one quarter into a technical recession), Thailand, Malaysia and Taiwan, as opposed to China, Indonesia and India where the export sector is far less important.

Concluding comments
The next chart compares share market indices for emerging markets and developed world shares over the last twenty years. The clear message is while emerging market shares are not immune to the swings in advanced country shares the trend has been up over the last decade even though it’s been flat in traditional global share markets. The same has been apparent in Asian shares. There is little reason to see this changing.

While emerging market shares are vulnerable in the event of a return to recession in advanced countries, the longer term trend is likely to remain up on much stronger growth potential, driven by rapid industrialisation and urbanisation. At the same time, emerging countries generally lack the macro economic risks that come with the excessive levels of debt in advanced countries.

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