Alex Vynokur

A growing number of investors are looking to capitalise on a potential further decline in the Australian dollar with trading data from BetaShares, a leading exchange traded fund (ETF) provider, showing significant inflows into its US Dollar ETF in September.

With the Australian dollar hitting seven month lows against the US dollar, BetaShares has seen approximately $30 million of net inflows into the BetaShares US Dollar ETF (ASX code “USD”) since the start of September. The fund is designed to provide exposure to the performance of the US dollar relative to the Australian dollar, meaning the value of the fund will go up as the US dollar appreciates, and vice versa. The fund now has over $200 million in assets under management.

BetaShares’ Managing Director, Alex Vynokur, said the rise in inflows into the USD ETF indicates that many investors expect the Australian dollar to continue its recent decline.

“We are currently seeing a sharp increase in the level of interest in the USD ETF, both in terms of incoming enquiries and net inflows, which seems to reveal an undercurrent of pessimism regarding the Australian dollar,” said Mr Vynokur. “With growing expectations around a potential US interest rate rise, as well as Reserve Bank modelling indicating the AUD is overvalued, investors are taking the opportunity to position themselves to capitalise on a potential long-term decline in the local currency.”

Commenting on the broader take up of exchange traded products in Australia, Mr Vynokur concluded: “As the ETF landscape continues to mature in Australia, there has been significant growth in the number of investors using exchange traded funds to execute tactical positions across asset classes as diverse as currency, commodities and international equities. It’s encouraging to see investors start to fully utilise the low-cost, transparent access that ETFs can provide.”

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• 

  The unemployment rate rose in August.

  Hiring again: Job advertisements rose by 1.5 per cent in August to a 17-month high.

• Bigger Chinese trade surplus: The Chinese trade surplus rose from US$47.3 billion to a record high of US$49.8 billion in August. Exports were 9.4 per cent higher over the year.

What does it all mean?

• The continued lift in hiring intentions by employers casts further doubt on recent data showing a jump in the jobless rate. In July, the unemployment rate rose from 6.0 per cent to 6.4 per cent, but in the background job ads continue to rise, now hitting the highest levels in 17 months. Job ads are a forward-looking indicator of the job market as opposed to the employment and unemployment data which reflect decisions made by employers up to six months earlier.
• The lift in job ads is clearly good news for consumer-facing businesses.
• The continued lift in Chinese exports is encouraging for Australian producers. Essentially the data tells us that demand in the US, other parts of Asia and selected countries in Europe and South America are rising. For a commodity producer such as Australia, that is good news – especially for the coal and iron ore sector that are facing falling prices at present.
• Of course the most favourable situation would be where Chinese exports and imports are both growing healthy annual rates. The softness in the Chinese property sector is keeping a lid on domestic economic conditions.

What do the figures show?

Job Advertisements

• Job advertisements rose by 1.5 per cent in August to a 17-month high after a 0.5 per cent gain in July. Newspaper advertisements rose by 1.8 per cent in the month and internet ads rose by 1.4 per cent. Job ads were up 7.7 per cent on a year ago. In trend terms, ads rose by 0.3 per cent, the 10th straight gain.

China trade data

• The Chinese trade surplus rose from US$47.3 billion to a record high of US$49.8 billion in August. Economists had forecast a US$40 billion surplus. Exports were up 9.4 per cent on a year ago (forecast +8.0 per cent) while imports fell 2.4 per cent (forecast +1.7 per cent). In July, exports were up 14.5 per cent on a year earlier with imports down 1.6 per cent.
• The monthly Job Advertisements release is a leading employment indicator. Employers only seek additional staff if business activity is strong, and more importantly, if they expect that conditions will remain favourable in coming months. It takes around 5-6 months for the new staff to be added to the payrolls. But a fall in job advertisements would have a more immediate impact on monthly employment estimates.
• China’s National Bureau of Statistics releases its monthly economic statistics around mid-month. Quarterly GDP data is released around the 16th of January, April, July and October. China’s Customs Office releases trade data, and the People’s Bank of China releases financial statistics, around the 10^th of each month. China is Australia’s largest trading partner and changes in the Chinese economic have major implications for the Aussie economy.
• The lift in the number of jobs being advertised will translate into higher employment over the next 5-6 months and hopefully lower unemployment. The lift in hiring intentions provides confidence to those in jobs. And the lift in job numbers will support higher spending. Overall the data is positive for retailers.
• The Aussie dollar was unmoved near US93.65 cents after the Chinese trade data.

What is the importance of the economic data?

• The monthly Job Advertisements release is a leading employment indicator. Employers only seek additional staff if business activity is strong, and more importantly, if they expect that conditions will remain favourable in coming months. It takes around 5-6 months for the new staff to be added to the payrolls. But a fall in job advertisements would have a more immediate impact on monthly employment estimates.
• China’s National Bureau of Statistics releases its monthly economic statistics around mid-month. Quarterly GDP data is released around the 16th of January, April, July and October. China’s Customs Office releases trade data, and the People’s Bank of China releases financial statistics, around the 10^th of each month. China is Australia’s largest trading partner and changes in the Chinese economic have major implications for the Aussie economy.

What are the implications for interest rates and investors?

• The lift in the number of jobs being advertised will translate into higher employment over the next 5-6 months and hopefully lower unemployment. The lift in hiring intentions provides confidence to those in jobs. And the lift in job numbers will support higher spending. Overall the data is positive for retailers.
• The Aussie dollar was unmoved near US93.65 cents after the Chinese trade data.

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Mining: How deep is the hole?

Chart 1 shows that mining as a percentage of GDP is at record highs, although it has started to drop off. The rise in mining has resulted not only in mining capex rising as a percentage of GDP spending, but also that total capital spending has been boosted. We know that a sizeable decline in mining investment is approaching, with capex falling. However, the end of the investment phase of the mining boom is going to be partially offset by the increase in net exports as capital imports fall and exports grow, helping to support GDP growth as the production phase begins.

Nevertheless, the transition will entail jobs losses as fewer workers are required for the production phase. In addition, there will be an income shock for those transitioning away from mining since wages will be lower as non-mining jobs tend to pay less.

Exchange rate and interest rate sensitive sectors which have been hurt by the high Australian dollar and relatively high interest rates (such as housing, overseas education, and tourism) need to recover to help offset the drop in mining investment and they must grow to keep unemployment down. Low interest rates are currently helping housing and consumption but we also need a lower Australian dollar for tourism and education.

How does iron ore factor into the story?

The supply of iron ore has lagged the surge in demand for steelmaking in China, which has led to a quadrupling of its price over the past decade. While supply from India and Brazil has continued to lag, seaborne supply from Australia has increased due to production increases by BHP Billiton, Rio Tinto and, more recently, by Fortescue Metals.

Over the past five years, a lack of overseas iron ore supply to Chinese steel mills has meant that steel producers supplemented it with high cost, low quality domestic iron ore. This pushed up the iron ore price, which in turn gave strength to the AUD.

At the start of 2014, the market expected iron ore prices to fall, as has recently been seen, due to the removal of a large portion of this Chinese domestic supply. In addition, the iron ore market should transition from being in a deficit position to a mild surplus due to increased supply, largely from the lower cost producers in Australia, which will also help to subdue prices.

If iron ore prices drop, isn’t it bad news for the AUD?

Not necessarily. Although prices may fall slightly, the increase in volumes that Australia supplies to China should help to prop up the AUD, which in the past had been driven to some extent by the iron ore price (see chart 2). However, we can also note from the chart that the iron price started falling in September 2011 but this had little effect on the AUD.

Will iron ore exports help Australia’s current account position?

Australia has historically experienced current account deficits as the norm. Moving the budget from a deficit to a current account surplus will require, among other things, a shift to a trade surplus. There should be a significant rise in resource export volumes as the mining boom transitions from the investment to the production stage.

Despite the drop in iron ore prices, export values are increasing due to these greater volumes.  This is expected to continue since Australian iron ore is a low cost, high quality product and is replacing current production of high cost, low quality products in other major export markets. As a result, iron ore now represents nearly 30% of Australian total exports measured by value (see chart 3).

This added around 0.5% to December quarter 2013 GDP growth as the balance of trade went from a deficit to a surplus. The trade account has been largely in surplus from 2008-2012 due to the impact of higher terms of trade. Although the terms of trade remain high, they have fallen from the peak reached in 2012. However, the trade account has not returned to a deficit, like it did in 2009, because capital imports have fallen and volumes of iron ore exports have increased.

Will a current account surplus be positive for the AUD?

The trade account is likely to remain in surplus as the volume of iron ore exports accelerates. Additionally, this increase is currently offsetting the fall in the iron ore price so we should see the AUD more stable going forward. This impact from iron ore should be compounded as the liquid natural gas (LNG) projects are completed and proceed to the production phase, which should further underpin the currency.

What does this mean for the Australian bonds and the cash rate?

Australian government bonds are currently experiencing sustained low yields due in part to the current economic environment and offshore buying. 10-year bond yields are now sitting at around what we view as the new neutral rate of 4.00%, but 3-year yields remain much lower. In our view, we should expect lower rates for longer, which may keep a lid on yield rises. With the recent budget announcement of a reduction in bond issuance, there may also be a small positive effect on our bond market due to reduced supply.

In our view, the Reserve Bank of Australia (RBA)  is at the end of its easing cycle and our base case is that the RBA will keep rates on hold at 2.50% for some time to allow historically low rates to help the economy rebalance and that the next move in rates will be upwards.

However, the timing of rate hikes will not be as early as in previous easing cycles over the past two decades as the present shock to the economy, with the mining boom shifting from the investment to the production stage, requires low interest rates to help smooth the economy’s transition.

The drag on growth this year and next year from the budget is unlikely to be that great due to the government’s back loading of cuts, but it won’t help a fragile economy that is in the process of transitioning from the mining boom. Infrastructure spending will take a few years to come through and announced job cuts won’t help the unemployment rate.

If the budget measures negatively affect consumer sentiment for a prolonged period, then this could also be a drag on economic growth, as could any strength that it gives to the AUD.  All this is likely to keep the RBA on hold for at least this year and perhaps now for longer than previously expected.

Tyndall has launched Bonding with Income – an information kit which aims to help advisers educate their clients about investing in the asset class. Aimed at financial advisers, the guide explains how bonds work and how fund managers choose which bonds to buy, as well as outlining the risks and rewards of adding an active fixed income manager to an investor’s portfolio. Advisers can earn 3 CPD points towards their professional standards by taking the accompanying online quiz. Visit the Tyndall site to access the Bonding with Income guide and do the CPD quiz.

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Disclaimer: This document was prepared and issued by Tyndall Investment Management Limited ABN 99 003 376 252 AFSL No: 237563 (“Tyndall AM”). Tyndall AM is part of the Nikko AM group. The information contained in this document is of a general nature only and does not constitute personal advice. Nor does it constitute an offer of any financial product. It is for the use of researchers, licensed financial advisers and their authorised representatives. It does not take into account the objectives, financial situation or needs of any individual.  The information in this document has been prepared from what is considered to be reliable information but the accuracy and integrity of the information is not guaranteed by the Company. Figures, charts and other data, including statistics, in these materials are current as of the date of publication unless stated otherwise. In addition, opinions expressed in these materials are as of the date of publication unless stated otherwise. The graphs, figures, etc., contained in these materials contain either past or backdated data, and make no promise of future investment returns etc. Past performance is not a reliable indicator of future performance.

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Weekly Petrol Prices

• 

  Petrol prices drop

  Petrol prices drop: According to the Australian Institute of Petroleum, the national average Australian price of petrol fell by 1.8 cents per litre to 149.9 cents a litre in the week to June 15. The petrol price has broadly trended sideways over 2014.

• Wholesale prices: Wholesale petrol prices are still falling in Australia, hitting a 21-day low of 141.85 cents a litre today.
• World prices: The Singapore gasoline price rose by US$3.15 or 2.6 per cent last week. But in Australian dollar terms, gasoline rose by a smaller $2.17 a barrel or 1.7 per cent, courtesy of a stronger Aussie dollar.

What does it all mean?

The post Higher Aussie dollar to cap petrol price appeared first on AdviserVoice.

• The rising tide in favour of the $A has well and truly reversed with further downside likely in the years ahead, particularly against the $US and Euro.
• The commodity price boom has faded in response to a moderation in Chinese growth as commodity supply increases, the US is slowing its quantitative easing program and rate cuts have reduced the attractiveness of the $A all at a time that it remains above levels that offset relatively high costs and prices in Australia. Expect it to fall to around $US0.80 in the next few years.
• For Australian investors, this means less need to hedge global exposures back to Australian dollars.

Introduction

Over the last year the $A has fallen from around $US1.05 to around $US0.89 – a fall of 15%. In fact the $A is down nearly 20% from its 2011 high. The drivers of the slump have been a combination of lower commodity prices; increasing evidence that Australia is not competitive internationally; a deterioration in Australia’s relative growth outlook; falling Australian interest rates; and more recently the Fed’s move to slow down its monetary stimulus. RBA “jawboning” has also helped. Despite periodic bounces, like that in the last few days, our assessment is that more downside lies ahead.

The big secular picture

The big swings in the value of the Australian dollar line up well with key long term swings globally:

• In the 1980s and 1990s the $A fell as commodity prices softened on stronger supply, global investor sentiment shifted in favour of the US and Australia was seen as “old economy”. As a result the $A fell to $US0.48 in 2001.
• In the 2000s the $A surged as commodity prices rose (driven by China and the emerging world and weak commodity supply), the US and Europe hit hard times, Australia was seen as being in good shape and the $US generally fell. The $A peaked in 2011 at $US1.10.
• Now the secular picture is turning again: the US, Europe and Japan seem to be tracing out a renaissance of sorts at a time when parts of the emerging world seems to be running difficulties; slower growth in the emerging world led by China at a time of increased commodity supply is weighing on commodity prices; as a result the $A is trending down as the $US trends back up.

Central to these long term swings as far as the $A is concerned is the commodity super cycle. This is because 70% or so of Australia’s exports are commodity related. Raw material prices over the past century have seen a roughly 10 year secular or long term upswing followed by a 10 to 20 year secular bear market. This can be seen in the next chart.

The upswings are usually driven by a surge in global demand for commodities after a period of mining underinvestment. The downswings come when the pace of demand slows but the supply of commodities picks up in lagged response to the previous price upswing. The last commodity super cycle that got underway around 2000 looks to have run its course. Growth in China remains strong but it has slowed from 10% plus to 7 to 8% at a time when the supply of commodities is surging after record levels of mining investment globally. And a basing in the $US is also not helping as commodities tend to be priced in US dollars.

Just as the upswing in the $A lasted a decade the downswing could last as long. But how far will the $A fall?

Purchasing power parity & hamburgers

A good place to start is with what economists call purchasing power parity, according to which exchange rates should equilibrate the price of a basket of goods and services across countries. A rough guide to this is shown below which shows the $A/$US rate against where it would be if the rate had moved to equilibrate relative consumer price levels between the US and Australia over the last 110 years or so.

Purchasing power parity doesn’t work for extended periods. In fact the commodity super cycle and the key long term global swings noted earlier play a big role in the long term swings in the $A around the level suggested by purchasing power parity, ie rising above it during 1970s, falling below in the 1980s & 1990s before rising back above it into 2011.

However, it does provide a guide to where exchange rates are headed over very long periods of time. A popularised version of purchasing power parity is The Economist magazine’s Big Mac index, which works on the principle that exchange rates should adjust until the Big Mac costs the same in any two countries. Such measures can give different results depending on the estimation period and the types of prices used. Right now after the sharp fall of the past year the Big Mac index suggests the $A is fair value. By contrast the relative consumer price measure used in the chart above suggest the $A is still 15% overvalued, with fair value around $US0.75-0.80. The broader approach also lines up with anecdotes of high prices and labour costs in Australia compared to many other countries. This suggests the $A could at last fall to $US0.80 in the years ahead.

Other drivers

But the last chart above also suggests there is a good chance of an overshoot. Several other factors also point lower for the $A. The major factors on this front are commodity prices, relative monetary policies and changing perceptions of Australia. First, as already noted commodity prices are in a secular downswing.  The chart below shows an index of industrial metal prices against the $A, showing they have gone from a positive influence to a negative.

Second, monetary policies are now working against the $A with the RBA cutting interest rates since late 2011 which has reduced the interest rate differential favouring the $A when the US Fed is slowing its quantitative easing program.

Finally, perceptions of global investors about the $A appear to be changing. Over much of the last decade it was positive reflecting Australia’s favourable fundamentals tied to growth in the emerging world and more latterly as a AAA rated safe haven against turbulence in the US and Europe. Now there is a bit more wariness as emerging markets have gone out of favour and Australia’s budget deficit has deteriorated.

While the RBA appears to have relaxed its efforts at jawboning the $A lower this may simply reflect the extent of the fall that has already occurred. Coming at time when short positions in the $A are extreme the change in the RBA’s stance could see a further short term bounce in the $A as short positions are unwound. However, it doesn’t change our broader assessment that the trend in the $A will be down.

Implications for investors

Changes in the value of the $A can have a big impact on the return Australian based investors receive from international investments. This can be seen in relation to international equity returns in the next table. The first column shows the return from global shares in local currency terms, the second shows the return in Australian dollars (if foreign currency exposures are not hedged back to Australian dollars), the third column shows the difference which is the change in the $A on a weighted basis and the final column shows the return to global shares if hedged back to Australian dollars.

In years when the $A falls like last year it boosts investors’ returns from global shares. But when the $A rises as was the case for much of the 2002 to 2011 period it reduces returns from international shares. As can be seen in the last column the return from global shares when hedged back to Australian dollars is usually a bit higher than the local currency return because investors also receive the difference between Australian and foreign interest rates.

Over the 2001 to 2010 period unhedged international shares lost an average 3% pa whereas hedged international shares returned 5.5% pa. The difference largely reflects the rise in the $A (+6% pa), but also the interest rate differential between Australia and the rest of the world (+2.5% pa).

Most global investments offered by fund managers come with a choice of being unhedged, ie exposed to fluctuations in the value of foreign currencies, or hedged, where the value of the investment is locked back into Australian dollars.

There are essentially three key drivers of the decision to hedge or not when investing offshore:

• The outlook for the $A. When it is rising it is best to be hedged, but best to be unhedged when it is falling.
• Whether an investor is “paid” to hedge or not – this is determined by relative interest rates. Most of the time Australian interest rates are above average global rates so investors are paid to hedge into Australian dollars.
• The diversification benefits of foreign currencies. Having an exposure to foreign currency means not keeping all your “currency eggs” in one basket. At times the $A can be pro-cyclical, rising in good times and falling in bad, so it can smooth out swings in global shares.

Right now the broad trend in the $A remains down and investors are getting “paid” less to hedge as the RBA has cut interest rates (2% pa compared to around 3.5% pa 3 years ago). As a result it makes sense to take advantage of the diversification benefits of other currencies by having a greater unhedged exposure than a decade or so ago.

The one major currency where this may not apply is the Yen where further weakness against the $US is likely.

by Dr Shane Oliver, AMP Capital

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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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RBA Board minutes

• Reserve Bank Board minutes: Minutes of the November Board meeting confirm that the Reserve Bank is assessing developments before deciding the next move in interest rates. “it was prudent to hold the cash rate steady while continuing to gauge the effects, but not to close off the possibility of reducing it further should that be appropriate to support sustainable growth in economic activity, consistent with the inflation target.”
• Rate cuts at work: “There was mounting evidence that monetary policy was supporting activity in interest-sensitive sectors and asset values, and given the lags with which monetary policy operates, the stimulatory effects would likely continue coming through for some time.”
• Board members discuss uncomfortably high Aussie dollar: “The Australian dollar, while below its level earlier in the year, remained uncomfortably high. Members noted that a lower level of the exchange rate would likely be needed to achieve balanced growth in the economy”.

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• The past week saw US shares pushed lower by increasing fears that the Fed will start to taper its quantitative easing program in December. This weighed on most global share markets and Australian shares, pushed the US dollar slightly higher and commodity prices lower. Bond yields were little affected though.
• While the “when to taper” debate continues to rage in the US, it’s looking increasingly likely that when it does commence it will be accompanied by a reduction in the unemployment threshold (currently 6.5%) below which the Fed would consider raising interest rates. Two papers prepared by Fed staffers appear to lay the groundwork for such a move effectively arguing that demand growth needs to be boosted to avoid further damage to the supply potential of the economy and that one way to do this is to lower the unemployment rate threshold. Cutting the threshold to 6% or 5.5% would suggest that the Fed Funds rate will remain near zero out to 2016 or maybe 2017. It’s highly likely these papers are consistent with the thinking of Bernanke and Yellen. As a result when the Fed starts to taper either next month or early next year, it will be paired with a reduction in the unemployment threshold. By doing this the Fed will be able to limit any upwards pressure on bond yields.
• The timing of such a move remains uncertain though with tapering still conditional on seeing stronger data. I attach a 30% probability of tapering next month, 20% chance in January, 40% chance in March and 10% for later. Most Fed officials who spoke over the last week don’t appear convinced of a December taper just yet.
• In China, Premier Li reiterated that 7 to 7.5% growth was the minimum necessary to keep unemployment down, suggesting that 7.5% may again be the growth target for next year, but he also highlighted that there is limited room for fiscal or monetary stimulus with the focus being on structural reforms to unleash growth.
• There were no surprises from the RBA which left interest rates on hold, but its quarterly Statement on Monetary Policy was a bit more dovish than expected. While the Bank acknowledged that rate cuts are helping the economy it has restated an explicit easing bias and backed this up by downwards revisions to its GDP growth forecasts,  which now see growth stuck around 2.5% out to end next year, and a slight downwards revision to its 2015 inflation forecast. The key concerns the RBA has are a faster slowing in mining investment, fiscal cutbacks and the still strong $A. These are real risks but just as the RBA was arguably too optimistic at the ‘top’ in 2011, there is now a risk that it is getting too pessimistic at the “bottom”. Our view remains that the RBA will leave the cash rate on hold ahead of eventual rate hikes starting around September/October but the near term risks are still on the downside, particularly if the $A stays high.
• On the $A, clearly the Reserve Bank is stepping up its efforts to jawbone it lower, noting that it’s “uncomfortably high” and will likely need to fall. More efforts from the RBA to try and talk the $A down are likely, but with it clearly more concerned about it than surging house prices, if talk fails it may resort to another rate cut.
• The new Australian Government’s decision not to proceed with various taxes will add to the blow out in the budget deficit. The decision to recapitalise of the RBA along with softer revenue assumptions has probably pushed the 2013-14 deficit to around $45bn. All of which is likely setting the scene for significant spending cuts.

Major global economic events and implications

• US economic data was mostly positive with the ISM non-manufacturing conditions index up in October, a leading index continuing to rise, September quarter GDP growth rising a stronger than expected at 2.8% annual rate and a Fed survey pointing to a further easing in bank lending standards. However, there were some soft areas with continued weakness in mortgage applications and the pre-shutdown downtrend in jobless claims looking like it has stalled. And the upside surprise in GDP growth was all due to a 0.8% contribution to growth from inventories. So it’s still not clear that growth is strong enough to justify monetary tapering in December.
• In Europe, the ECB rightly responded to the recent plunge in inflation by cutting its key interest rate to 0.25%. Actually they should have done this years ago, but better late than never and President Draghi’s forward guidance of low or even lower interest rates for an extended time should help keep bond yields down adding to the monetary stimulation. Economic data was positive with the final services sector October PMI revised up slightly. German industrial production fell in September but rising factory orders point to gains ahead.

Australian economic events and implications

• Australian jobs data remains very weak with trend employment now falling at 4,000 a month. While unemployment looks to have flattened out at 5.7% this is only due to a falling participation rate as discouraged job seekers give up and baby boomers are starting to retire.
• However, while the employment data is weak it’s worth bearing in mind that the labour market is a lagging indicator. This is particularly relevant now with a range of economic indicators on the improve. This was certainly evident over the past week with gains in retail sales for the fifth month in a row, a 1.9% increase in house prices in the September quarter leaving them up 7.6% year on year, gains in the AIG’s performance indicators for the services and construction sectors with the latter actually looking quite strong and indications that the ANZ job ads index is starting to stabilise after earlier falls. With forward looking indicators improving, jobs growth is likely to improve next year with the unemployment rate likely to peak around 6% before mid-year.

Major market moves

• Share markets mostly fell in response to rising expectations that the Fed will start to taper in December. US, Asian and Australian shares fell, but Eurozone shares were up very slightly.
• Taper talk also saw the $US pushed slightly higher and this weighed on commodity prices & the $A, with the latter not helped by more RBA jawboning designed to push it lower and a weaker than expected jobs report.
• Bond yields were mixed: down slightly in the US, but up in parts of Europe and Australia.

What to watch over the next week?

• In the US, a speech by Fed Chairman Ben Bernanke (Wednesday) will be watched closely for any clues as to whether it will start to taper its quantitative easing program next month and whether it will cut the unemployment threshold for raising interest rates from 6.5% to 5.5% or 6%. On the data front the shutdown is expected to have constrained October industrial production (Friday) to only a 0.1% gain, but a post shutdown bounce back in small business optimism (Tuesday) and the New York manufacturing conditions survey (Friday), are likely to point to stronger demand growth ahead. Data for the trade balance will also be released.
• Eurozone GDP for the September quarter (Friday) is likely to show growth of around 0.2% quarter on quarter as the modest recovery that commenced in the June quarter continues.
• Japanese September quarter GDP growth (Thursday) is expected to have slowed to 0.4% quarter on quarter after a couple of quarters around 1%. Leading indicators point to a rebound in the current quarter though.
• In China, the focus will be on the reaction to October economic data released over the weekend and the Third Plenum of the Chinese Communist Party which wraps up Tuesday. The Plenum occurs every 5 years but this being the first under the new leadership is widely expected to announce an aggressive reform agenda possibly covering the role of the state – with more privatisation, the financial system with a faster move to opening up the capital account and deregulating interest rates and the exchange rate, fiscal reform, land reform and the Hukou household registration rules. The new Chinese President is regarded as politically conservative and an economic liberal and appears to have a lot of support. However, only a broad outline is likely so the lack of specifics may disappoint some. Particularly so given the hype that seem to be surrounding this plenum.
• In Australia, the NAB’s business survey (Tuesday) and Westpac’s consumer sentiment survey (Wednesday) will be watched to see whether the recovery in confidence evident over the last few months is sustained. Given more upbeat news flow and the rising share market and house prices it’s likely that it will be. Housing finance data (Monday) is expected to show a bounce back after a fall in August and September quarter wages growth (Wednesday) is expected to remain soft at 2.9% year on year.

Outlook for markets

• After solid gains from early October lows and with technical and sentiment indicators a bit stretched a short term correction or consolidation in shares would not be surprising. More Fed taper talk may well be the trigger. However, the trend in shares is likely to remain up as valuations remain reasonable, monetary conditions are set to remain easy and profits are likely to improve next year as global and Australian growth picks up. Australian shares remain on track to hit 5500 or even higher by year end, with a little help from a Santa rally.
• Government bond yields are likely in a gradual upwards trend as the global economy continues to pick up momentum and as Fed tapering comes back into focus either later this year or early next. 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 ensure the rising trend in yields remains very gradual.
• Expect the $A to be buffeted in the short term between signs Australian interest rates have bottomed and stable growth in China but talk of Fed tapering and RBA jawboning. The medium term trend in the $A is likely to remain down.

By Dr Shane Oliver, Head of Investment, AMP Capital

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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 FundsManagement 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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US debt ceiling still impacting markets and currencies.

Thankfully politicians in the US can at least agree on one thing – that America defaulting on its obligations would be a “bad thing”.

And so it was recently at the eleventh hour that an agreement was struck to simultaneously suspend the debt ceiling and reopen the US government. All it took was a sixteen day circus and a glimpse over the abyss but all was finally resolved, at least until early 2014.

While the news has since put the bulls back in charge, the outcome is far from optimal and a long way from a sustainable fiscal solution. But not to worry. Part of the arrangement that helped solve the impasse was the formation of yet another budgetary committee tasked with doing what hasn’t been possible so far, agreement on a long term budget deal.

Perhaps the opposing sides could learn from opinion polls and share the bipartisan call for co-operation but if history is any guide this seems unlikely.  Either way, we’ll find out in mid-December if there is any common ground. Otherwise it’s another shutdown in January and another debt ceiling debacle set for February 2014.

The situation is all the more frustrating as the US economy seemed poised to accelerate and while the extent of the damage has yet to be quantified there’s little doubt the shenanigans have undermined business and consumer confidence.

Taper your expectations

Like the general public the Fed too has been similarly unimpressed. Rather than dialling down QE the Fed is still going full throttle on asset purchases with taper possibly off the table until 2014.  Of course the ripple effects are not confined to the US either.

While the ongoing liquidity is supportive for asset markets, there has also been a sting in the tail on the Australian economy. Coupled with a mildly better China, the Australian Dollar has surged on the belief that QE will be around for a little while yet.

A higher Aussie Dollar makes it harder to rebalance “the growth sources of the economy”. The RBA is surely gnashing its teeth.

Drive your dollar further

From a longer-term perspective, the Australian Dollar remains near historical highs and still provides attractive purchasing power so it is a little surprising that many local investors shy away from global shares. For those worried about the transition taking place in the domestic economy, investors could look offshore to companies benefitting from long term change such as the digital disruption.

We were recently reminded of the dominance of Google in search, advertising and content. With strong growth in mobile, the company delivered results ahead of expectations and put a rocket under the share price moving it past $1,000 for the first time. Not a bad outcome for anyone who bought at the IPO in 2004 for just $85. With audiences continuing to shift to tablets and smartphones, advertisers will be compelled to go with them placing Google in an enviable position.

Indeed some 40% of traffic to YouTube now comes via mobile. A perfect way to stay in touch on the debt ceiling and other dysfunctional debates on Capitol Hill over the coming months.

By Pat Noble, Senior Investment Specialist, Zurich Financial Services Australia Limited

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This general information is dated 23 October 2013, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It does not take into account the personal investment objectives, financial situation or needs of any person. Investors should consider seeking advice from their licensed financial adviser. Past performance is not a reliable indicator of future performance. Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511, 5 Blue Street North Sydney NSW 2060 (Zurich Investments). No part of this document may be reproduced without prior written permission from Zurich Investments.

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Petrol prices; Lending Finance; Credit & debit card lending

• 

  Petrol prices falling.

  Petrol prices: According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol fell by 2.3 cents a litre to 151.2 c/l in the week to August 11. CommSec expects fuel prices to fall by a further 2-3 cents a litre in the next fortnight.

• Lending lifts to five-year high. Total lending finance rose by 6.9 per cent in June – marking the strongest increase in 15 months. Lending is up by 12.2 per cent on a year ago.
• Record fall in credit card debt. The average credit card balance fell by 3.7 per cent in the year to June, the biggest drop in 19 years of records. Average use of credit and debit cards is at record highs.

What does it all mean?

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Weaker Australian dollar creating opportunity in many sectors.

The weaker $A will benefit tourism, education, agricultural and even the mining industry, a leading fund manager says.

Pengana Capital’s Australian equities fund manager Rhett Kessler says ‘a lower $A represents lower global purchasing power for us as consumers. However, we expect several important domestic industries to benefit materially from the currency shift’.

‘These include the tourism, education, agricultural and even, dare we say it, mining industry. Many companies have been forced to streamline their operations to cope with the high $A.’

Although we have been biased towards a weakening $A for some time, the speed of its decline has been surprising.

Kessler is pessimistic about the short- to medium-term outlook for discretionary spending and employment levels, despite the falling $A possibly translating into very high profits for some companies.

‘Having said this, we expect most domestically orientated companies to report muted trading activities (at best) while also being cautious in their outlook statements.

‘The recent unusual political activity continues to impact negatively on consumers and corporates alike while the unseasonably warm winter has severely dented discretionary fashion retail sales.’

Commenting on the US Fed ‘frightening’ investors during May and June with several ‘tapering’ of fiscal stimulus statements, Kessler says the Fed highlighted its flexible approach to ensure a sustained US economic recovery.

This saw a widespread relief rally with most equity markets – S&P500 (+4.9 per cent), FTSE 100 (+6.5 per cent) and the Euro Stoxx 50 (+6.4 per cent), closing significantly higher.

The Australian market followed with resources (+10 per cent), materials (+9 per cent) and energy (+6 per cent) leading the charge.

Conversely the weaker sectors were REITS (-1 per cent), information technology (0 per cent) and consumer staples (+1 per cent).

The Australian dollar continued its slide against the US dollar falling another 2 per cent (to print) to below 90c for the first time since August 2010.

‘It appears that the combination of political uncertainty, a deteriorating fiscal position, weakening mining sector and persistent concerns regarding the outlook for the Chinese Economy continues to weigh on the domestic economy (read lower interest rates) and consumer confidence,’ he says.

The long list of companies issuing profit warnings during the lead-up to the 2013 financial year reporting season has highlighted the impact these issues are having on trading conditions.

Mining services companies have been hit particularly hard due to the triple whammy of:
a) a difficult comparison with a robust prior period
b) the sharp slowdown in mining activity generally
c) the effect of the larger mining houses laser-like focus on cost-cutting

While this may provide some relief for financial and industrial companies due to less competition for scarce resources (labour and capital in particular), the transition is expected to take some time and be the source of some pain, says Kessler.

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