• Global share markets had a messy week as good economic data, earnings reports and reduced concerns regarding Banco Espirito Santo helped markets only to see them hit by worries about Ukraine, after a Malaysian Airlines flight was downed, and the Middle East, as Israel launched a ground offensive in Gaza. The geopolitical tensions saw bonds rally, oil rise and the $A fall. Australian shares proved relatively resilient though.
• Our thoughts are with those affected by the downing of MH17. I also feel very sorry for Malaysian Airlines and Malaysia generally which has lost two planes this year for reasons that look to be beyond its control.
• It is the time of year for share market corrections (with the September quarter often being soft for shares), but the fall in US and European shares in response to the news regarding Ukraine and the Middle East looks like an overreaction. The downing of the MAS plane won’t necessarily increase the risks around Ukraine, if it has been shot down its likely to have been in error anyway, airlines will simply no longer fly through eastern Ukraine with little impact on international travel and the Israeli/Palestinian crisis has been flaring up for years with no broader consequences. In some ways it is just a continuation of what we have seen all year with occasional geopolitical flare ups which simply constrain markets, but without having a major impact.
• While Fed Chair Janet Yellen’s comments about stretched share valuations in some sectors caused nervousness it’s noteworthy that she also said that in general “price equity ratios and other measures are not outside of historical norms”. Nasdaq stocks remain the main focus of valuation concerns with a PE of 35 times, but this is one third of tech boom levels. Moreover, the forward PE for the broad US share market at 15.5 times is around its long term average and remains well down on its tech boom high of 24.5.
• Should new entrants to the Australian housing market buy or rent? An RBA paper which, after allowing for the costs of owning a house versus renting, concluded that “if house price growth were to be slower than the historical average…then the average home buyer would be financially better off renting” has understandably created much discussion. After nearly two decades of above trend house price growth which has taken Australian housing from being relatively cheap to relatively expensive my assessment has for some time been that we are in for an extended period of range trading around a broadly flat trend for real house prices, which on the RBA’s analysis would point to renting as the way to go. However, I think it’s more complicated than this. First, the RBA’s analysis ignores the forced saving implicit in buying a house which will likely mean that even if house price growth turns out to be sub trend home buyers will likely end up building more wealth than renters over the long term. Second, there is more to buying a house than just a financial decision. I would much rather own than rent. Finally, there is a risk to my sub trend view of house prices if we don’t solve the housing supply shortage.
• Carbon tax no more. It’s a pity that an attempt to put a price on carbon that made sense from an environmental and economic perspective turned into such a political mess. Moving straight to an emissions trading scheme, which would have seen the price of carbon fall by two thirds, would have made more sense. But back to the here and now – just as the introduction of the carbon tax had little macro-economic impact I can’t see its demise having much impact either. It will cause a temporary fall in inflation of around 0.75 percentage points but the RBA will look through this just as it did the temporary boost to inflation in 2012-13. More broadly the sooner the Senate returns to reality – and starts finding savings to replace the Budget cuts it is threatening to reject the better.
• Dividend imputation is not a distortion. The past week saw the interim report of the Financial System Inquiry question whether dividend imputation was creating a bias to invest in domestic equities and adversely affecting the development of the corporate bond market. The trouble is that dividend imputation actually corrects a bias by removing the double taxation of earnings – once in the hands of companies and again in the hands of investors. It also encourages corporates to give decent dividends to shareholders as opposed to irrationally hoarding earnings. Interest on corporate debt never suffered from double taxation as it is paid out of pre-tax corporate earnings. The removal of dividend imputation would not only reintroduce a bias against equities but substantially cut into the retirement savings of Australian investors and lead to lower returns from Australian shares.

Major global economic events and implications

• US data provided more evidence that the pace of growth has picked up with strong underlying retail sales, strong readings for regional manufacturing conditions, okay growth in industrial production and a fall in jobless claims to their lowest since June 2007. Housing starts fell, but the decline was narrowly based and a gain in the NAHB home builders’ index points up. Meanwhile, Janet Yellen’s Congressional testimony maintained a dovish tone, still seeing plenty of slack in the economy, but she does acknowledge the upside risk to interest rates if the economy improves faster than anticipated. Our assessment remains that the first US rate hike is still a while away, but the reality is that the Fed is now in data dependent mode and as growth continues to pick up speculation about rate hikes is likely to cause volatility just as last year’s taper talk did.
• US earnings are coming in better than expected again. We are only 15% through the June quarter earnings reporting season but so far so good with 75% of results beating on earnings and 70% beating on sales.
• Chinese data confirmed that the growth slowdown seen earlier this year is over and suggests mini-stimulus efforts are working. June quarter GDP growth bounced back to 2% quarter on quarter after 1.4% in the March quarter, June growth in industrial production and fixed assets investment accelerated, retail sales growth remained strong at 12.4% and money supply and credit growth picked up. Overall, Chinese growth looks to be on track to come in “around” 7.5% this year. Over the last few years China has had a hard landing scare once a year, but it seems the latest fears regarding a hard landing will also come to nothing.

Australian economic events and implications

• In Australia, an 8.7% surge in dwelling commencements in the March quarter to a record high confirms that a home construction boom is on the way. Meanwhile, the minutes from the RBA’s last Board meeting offered little that was new. While it repeated that a period of stability is the most prudent course, its comments about the mining investment slowdown, fiscal tightening and the high $A suggest it has a slight easing bias.

What to watch over the next week?

• In the US, expect to see an elevated rise in June headline inflation (Tuesday) due to higher energy costs but core inflation remaining around 2% year on year, a modest increase in existing home sales (Tuesday) but a fall in new home sales (Thursday) after an 18.6% gain in May, continued strength in the Markit PMI for July (Thursday) and an ongoing rising trend in durable goods orders (Friday). June quarter earnings results will continue to flow with close to 100 major companies reporting.
• Eurozone business conditions PMIs for July (Thursday) are likely to be consistent with ongoing gradual recovery.
• Japan’s manufacturing PMI (Thursday) will likely show a continued recovery after the fall associated with its sales tax hike. Inflation data will also be released Friday.
• China’s HSBC manufacturing PMI (Thursday) for July is likely to show a further modest improvement to 50.8.
• In Australia, June quarter inflation data is likely to be benign leaving plenty of scope for the RBA to keep the cash rate low at 2.5%. We expect headline inflation of 0.5% quarter on quarter or 3% year on year, with underlying inflation of 0.6% quarter on quarter or 2.6% year on year. Key drivers are likely to be the ongoing increase in tobacco excise and seasonal price increases for health, offset by falls in prices for petrol and food and ongoing weak pricing power on the back of soft final demand. The RBA is unlikely to be fussed by the headline inflation rate being at the top end of the target range as it reflects the inflation surprise of the last half of last year, underlying inflation has been benign over the last six months and wage cost growth remains weak.

Outlook for markets

• Could shares have a correction? Yes. After all we are in the seasonally weak September quarter and there is no shortage of possible triggers – Ukraine is back in the headlines, the Israeli Palestinian dispute is hotting up again, civil war is continuing in Iraq and there is the potential for a Fed rates scare as the US economy continues to hot up. Are we at a major share market top? No. Valuations are not stretched, particularly if low interest rates are allowed for, global earnings are continuing to improve on the back of gradually improving economic growth, monetary conditions are set to remain easy for some time and there is no sign of the euphoria that comes with major share market tops. In terms of the latter if anything there is still a lot of scepticism – about the global recovery and about financial markets – which is a long way from the sort of confidence that is normally seen when bull markets end. Given all, this any short term dip in shares should be seen as a buying opportunity.
• Bond yields are likely to resume their gradual rising trend led by increasing evidence that US growth is picking up pace. This combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.
• Although the continuing carry trade from ultra easy money in the US, Europe and Japan risks pushing the $A higher, the combination of soft commodity prices, an increasing likelihood that the Fed will start raising interest rates ahead of the RBA and relatively high costs in Australia are expected to see the broad trend in the $A remain down. RBA jawboning is already making a bit of a comeback.

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.

The post Weekly market & economic update – week ending 18 July, 2014 appeared first on AdviserVoice.

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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National accounts

• 

  Australian economy continues to gather pace.

  Another quarter of growth: The record-breaking economic expansion is in its 23^rd year. The Australian economy grew by 0.8 per cent in the December quarter after a 0.6 per cent increase in the September quarter (forecasts centred on a 0.7-0.8 per cent rise). The economy has grown 2.8 per cent over the past year, only modestly below the decade average growth rate of 3.0 per cent.

• Contribution to growth: The biggest contributions to growth came from net exports (+0.6 percentage points) followed by household consumption (+0.4pp), inventories and public investment (both +0.2pp) and government consumption (+0.1pp). The biggest drag on growth was non-dwelling construction (-0.2pp).
• States & territories: The best description of the performance of States and Territory economies is state final demand plus net exports. The Northern Territory had the fastest quarterly growth in the December quarter (up 5.7 per cent), followed by Queensland and Tasmania (both up 0.8 per cent), Victoria and Western Australia (both up 0.7 per cent), NSW (up 0.6 per cent), the ACT (up 0.1 per cent) and South Australia (up less than 0.1 per cent).
• Industry sectors: Just seven of the 19 industry sectors contracted in the December quarter.
• Productivity: Gross value added per hours worked in the market sector rose by 1.0 per cent in the December quarter – the strongest growth in almost two years. Annual productivity growth stands at 1.8 per cent.
• Household spending: Only three of the 17 sectors recorded weaker spending in the quarter. Household spending rose by 0.8 per cent in the December quarter (strongest gain in seven quarters) and by 2.6 per cent over the year. Clothing & footwear rose by 3.0 per cent but Communications fell the most, down by 2.0 per cent.

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• Global share and bond markets got a big lift over the past week as first Larry Summers dropped out of the race to replace Ben Bernanke as Fed chairman, reducing fears of a more bearish Fed, and more importantly the Fed surprised markets by maintaining its asset purchase program at $US85bn a month. The combination saw bonds, shares and commodities rally sharply and the US dollar fall.
• While the Fed may have confused investors, it clearly became concerned by the combination of mixed data recently, the rapid back up in bond and mortgage rates, the approaching government funding and debt ceiling debate and a concern that the leadership transition at the Fed may render its forward guidance less credence. As a result it elected not to taper. The key message from the Fed is very supportive of growth. It won’t risk a premature tightening in financial conditions via a big bond sell off and tapering won’t commence until there is more confidence that its expectations for 3% growth in 2014 and 3.25% growth in 2015 are on track. In terms of timing, it hard to see tapering commencing before the Fed’s December meeting and it may not come until early next year. The downside though is that the Fed has likely just delayed the inevitable and arguably an opportunity for a smooth reduction in quantitative easing has been lost with more volatility a likely consequence.
• The decision by Larry Summers to withdraw from the race to run the Fed and the re-elevation of current Fed vice-Chair Janet Yellen as the favourite has substantially boosted confidence that the Fed will continue with its current growth supportive approach. However, there is a fair way to go yet but at least the other alternatives are perhaps seen as a bit less uncertain than Summers might have been.
• In Europe, the focus in the week ahead is likely to be on the reaction to German Federal election (Sunday 22 September). This is likely to see the return of Angela Merkel as Chancellor with the main uncertainty relating to whether she will lead a coalition with the Free Democrats (as at present) or the Social Democrats (as over 2005-09). Either outcome is unlikely to pose a threat to Germany’s relationship with the rest of Eurozone and so is unlikely to have significant investment implications, beyond any initial kneejerk response.

Major global economic events and implications

• US economic data released over the last week indicated that tapering has just been delayed and is still ahead of us. Industrial production showed a nice gain and regional manufacturing surveys point to further improvement ahead. The NAHB home builders’ survey also held at a high level and existing home sales rose solidly suggesting that the softness seen in housing starts and permits is temporary. One thing is clear though and this is that inflation remains benign with August data showing headline inflation of 1.5% year on year and core inflation of 1.8%.
• In the Eurozone inflation also remained benign in August at 1.3% year on year and ECB officials remain rightly dovish.
• Chinese house prices continued to rise in August, but the authorities seem less concerned about it of late – perhaps realising that the only real solution is to address supply side constraints.
• While the pressure on India has faded a bit this month, with the Fed’s non-taper decision helping, its outlook remains problematic with inflation increasing again in August despite soft growth.

Australian economic events and implications

• It was a quiet week in Australia with the Minutes from the last RBA Board meeting being the main focus. Two key points emerged. First, the explicit easing bias is back after being absent yet again from the post meeting statement earlier in the month. While the RBA has reiterated that any move is not imminent, declining mining investment, restrained non-mining investment, soft consumer spending, rising unemployment, the bounce back in the $A and benign inflation indicate the risks are still tilted towards another rate cut. Second, the RBA looks to be getting a little bit more concerned about the risk of a new housing bubble – even though RBA Assistant Governor Edey and Board member John Edwards pointed out its not one yet – with the Board being briefed on RBNZ moves to limit high loan/valuation ratio loans, Board members agreeing it’s important banks maintain prudent lending standards and concern about property gearing in self-managed super funds. I must admit I am not a fan of old fashioned/back to the past “macro prudential controls” because they just distort the financial system. But a direct move to limit home lending growth (such as raising the capital banks are required to put aside for home lending) is preferable to raising interest rates if the property upturn is getting too hot. So far it’s not too hot (housing credit is running at just 4.7% versus 21% in 2003), but it’s worth keeping an eye on.
• Meanwhile the downgrading of WA’s credit rating to AA+ by Standard and Poors highlights how some Australian governments have squandered the mining boom. After a massive boom WA should have minimal debt and big budget surpluses but unfortunately that’s not the case. More broadly it highlights risks for the new Federal Government if it doesn’t maintain the path back to surplus. Privatisation should be back on the agenda big time as it is the quickest way to get public debt down, at the same time that it will help keep super funds in Australia and put public assets into private hands where they can be managed far more efficiently.

Major market moves

• Share markets had a strong week as investors celebrated good news from the Fed.
• Commodity prices were also buoyed by the continuation of QE3 at its current pace as did the $A.
• Bond yields fell sharply on the back of dovish news from the Fed.

What to watch over the next week?

• Monday is PMI day with preliminary business conditions PMIs being released in China, Europe and the US. All are expected to show a continued trend improvement consistent with improving global growth prospects.
• In the US, expect further gains in house prices (Tuesday) and rises in new home sales (Wednesday) and pending home sales (Thursday) after falls in July. Durable goods orders (Wednesday) are also likely to see a bounce after a fall in July, consistent with a broad recovery in business investment.
• The focus is now turning to Congressional negotiations regarding a new Budget (required by October 1) and an increase in the debt ceiling (required by mid-October). Expect the usual cantankerous argy bargy between both sides of politics to cause bouts of financial market nervousness ahead of the usual last minute deal. With the US budget deficit having fallen to 4% of GDP (from a 2010 peak of above 10%) it will be harder for the Republicans to push too hard without risking alienating the public, which they probably don’t want to do ahead of mid-term elections next year.
• Along with Eurozone PMI’s for September, the German IFO index (Tuesday) is expected to show a further improvement. Confidence indicators will also be released Friday and will likely show a further gains.
• Japanese inflation data (Friday) is expected to show further evidence that deflationary pressures are fading.
• In Australia, the RBA’s financial stability review (Wednesday) is expected to show that Australia’s financial system remains sound with banks seeing improvement in asset performance and funding, business balance sheets in good shape and households exercising prudence. However, the RBA is likely to reiterate the need for banks to maintain “prudent lending standards” and that it is keeping an eye on the increase in property gearing in self-managed super funds. August job vacancies (Thursday) are likely to have remained soft.

Outlook for markets

• Shares are still at risk of hitting a speed bump in the month ahead as we go through the seasonally weak September/October period with potential triggers being the budget and debt ceiling negotiations in the US and a return of Fed taper fears.
• However, any pullback is likely to be just another bull market correction which should be seen as a buying opportunity as the broad trend in shares remains up. 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. So by year end we see further upside in global and Australian shares with gains continuing next year.
• Government bond yields are falling after having risen too far too fast, but are likely to resume a gradual upwards trend as it becomes clear that the global economy is picking up momentum and as Fed tapering comes back into focus. Low yields and an unwinding of years of massive inflows into bond funds point to poor sovereign bond returns ahead.
• The short covering rally in the $A was given a boost by the Fed’s decision not to taper, but the downtrend is likely to resume once extreme shorts have been squeezed out, tapering comes back into focus and as the RBA retains an easing bias.

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

The post Weekly market & economic update – week ending 20 September appeared first on AdviserVoice.

Queensland floods 2013

The floods across Queensland and northern NSW are currently estimated to cost the insurance industry around $126 million so far.

• And while estimates will change over time, these floods need to be put into perspective. The 2010/11 Brisbane floods cost $2.4 billion.
• At this stage CBA insurance analyst Ross Curran believes the cost of the floods is a manageable event for the domestic insurers.
• The impact on crop production is likely to be minimal. In fact CBA commodity analyst Luke Matthews believes the rains will help improve planting moisture for winter crops (wheat, barley chickpeas) which will be planted from April. In addition there is a net benefit for cotton, sorghum, sunflower and sugarcane (despite some losses in some regions), while livestock producers will benefit from increased pasture availability.
• The major negative is likely to be for horticultural crops (melons, tomatoes, berries, leaf crops) which will have been water damaged.
• CommSec expects the Reserve Bank to look through the near-term impact of the floods. We expect no change to interest rates in the early part of 2013 and see no reason to change our GDP growth forecasts of 3- 3¼ per cent for 2013.

What does it all mean?

• One thing we can never escape here in Australia is natural disasters. Whether it is drought, floods, bushfires, cyclones or hail storms, natural disasters are part and parcel of our wide, brown land. And the Queensland floods are no different. While the latest flooding would bring back painful memories of the 2010/11 floods, Australians are dealing with the immediate issues, and when the waters subside, we will deal with the necessary clean up and rebuilding.
• Current insurance estimates put the floods across Queensland and northern NSW at around $126 million. And while estimates will change over time these floods need to be put into perspective. The 2010/11 Brisbane floods cost $2.4 billion.
• First the floodwaters need to subside so that the impact to buildings, farms and infrastructure can be determined. And any estimate of the total cost involves actuarial assessments by insurance companies, builders and valuers.
• It needs to be remembered that we have a $1400 billion economy and the federal government finances are in good shape, so the impact can be absorbed. Floods are also less damaging than cyclones or hail storms.
• At this stage CBA insurance analyst Ross Curran, believes the cost of the floods is a manageable event for the domestic insurers. Prudent policy across the domestic insurers have ensured that over the past couple of years they have increased their natural peril allowance to absorb the costs of the latest floods. Our analysts remain comfortable with the domestic insurers and would be buying on weakness.
• There have been some suggestions that the floods may push up food prices, leading to higher inflation in coming quarters and as a result ensure that the Reserve Bank holds off from providing further rate cuts. And while there is some truth to the matter, it is likely that the Reserve Bank will look through the short-term flood impact. No doubt it will carefully assess the impact of higher food prices on inflationary expectations. However any decision to hold off on further rate cuts will be more likely as a result of the improving global economic conditions and healthy gains in sharemarket indices. We expect no change to interest rates in the early part of 2013.
• The impact on crop production is likely to be minimal. In fact CBA commodity analyst Luke Matthews believes the rains will help improve planting moisture for winter crops (wheat, barley chickpeas) which will be planted from April. In addition there is a net benefit for cotton, sorghum, sunflower and sugarcane (despite some losses in some regions), while livestock producers will benefit from increased pasture availability.
• The major negative is likely to be for horticultural crops (melons, tomatoes, berries, leaf crops) which will have been damaged with the flooding. The disrupted supply of some fruit and vegetable products may result in firmer prices but the shortfalls may be met via imports in some cases, by frozen product or supplies from other regions of Australia. It may be that growers from other regions will lift supplies to meet market demands. And consumers will substitute high-priced or unavailable items for other fruit, vegetables, frozen product – or do without completely.

What about the impact on the economy?

• In the short-term there is the impact of lost production and activity. But in many cases this will be made up over time. Given that the floods have hit early in the quarter, lost production may be made up over February and March, minimising the impact to GDP. There may be a modest reduction in export output in the March quarter that will be recovered over the June and September quarters. Further, any reduction in building and production over the March quarter will be offset by repair and rebuilding activity over the remainder of the year. We see no reason to change our GDP growth forecasts of 3- 3¼ per cent for 2013.
• The cost of the floods will be met by governments, donations, reinsurance and private individuals. But the net cost is a different figure. Some coal and farm producers in other parts of the country will benefit from increased prices and demand. And builders, construction companies and retail operations will face increased demand for services and goods when repair and rebuilding work get underway.

What are the implications for interest rates and investors?

• While the Reserve Bank will carefully assess the impact of higher food prices on inflationary expectations, it is likely that policymakers will look through the near-term impact of the floods.
  Overall the Reserve Bank would be more relaxed about interest rate settings at pre
• ent. The rate cuts last year continue to work through the economy and while policymakers may consider cutting rates further, a move is unlikely to take place at the next Board meeting in February, given the improving economic outlook.

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State of the States

How are Australia’s states and territories performing?

Each quarter CommSec attempts to find out by analysing eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.

Just as the Reserve Bank uses decade averages to determine the level of “normal” interest rates; we have done the same with the economic indicators.

For each state and territory, latest readings for the key indicators were compared with decade averages – that is, against the “normal” performance.

There are two stand-out territories: Western Australia & the Northern Territory. Western Australia still is the best performing economy in the nation but the gap has closed to second-placed Northern Territory.

Western Australia comes out top on four of the eight criteria: retail trade, equipment investment, construction work done and population growth. Western Australia is still second on two of the eight indicators, third on another and fifth on dwelling starts.

The Northern Territory is ahead of the ACT, and then there is a gap to Queensland, Victoria and NSW with little to separate then. Then there is a sizeable break to South Australia followed by Tasmania.

Looking ahead, CommSec expects little change in the rankings but the Northern Territory has the greatest scope for further improvement. Some rebuilding work will provide a boost to the Tasmanian economy.

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• In November, full-time jobs fell by 4,200 after rising by 17,600 in October. Part-time jobs rose by 18,100 after falling by 7,400 in October. Full-time jobs have only fallen once in the past five months.
• The unemployment rate decreased from 5.4 per cent to 5.2 per cent in November. The participation rate fell from 65.2 per cent to 65.1 per cent – near six year lows.
• The number of hours worked rose by 0.1 per cent in November after falling by 0.3 per cent in October and now stands 0.3 per cent higher than a year ago.
• Unemployment across states and territories: NSW 5.1 per cent (5.2 per cent in October); Victoria 5.5 per cent (5.4 per cent); Queensland 6.0 per cent (6.1 per cent); South Australia 5.3 per cent (5.6 per cent); Western Australia 4.1 per cent (4.6 per cent); Tasmania 6.7 per cent (6.7 per cent); Northern Territory 3.8 per cent (3.9 per cent); ACT 4.1 per cent (4.0 per cent).

What does it all mean?

• The doomsters have got it wrong – again. More jobs created, more hours worked and fewer people unemployed. Overall the Australian economy is holding up well despite a very uncertain global environment. While there are a number of high profile company failures and job losses, beneath the surface small and medium-sized business are still keen to put on more staff. The anecdotal evidence is that it is hard to attract and retain staff and today’s jobs figures back up these observations.
• It was certainly encouraging to see the lift in overall employment. In fact total employment has increased for three consecutive months, hours worked is on the rise and the slide in the unemployment rate is certainly a confidence booster for the economy. However it is not all smooth sailing. The cynics would look at the fall in full-time jobs coupled with the participation rate – which is holding at near six-year lows – and conclude something more concerning.
• The truth is somewhere in the middle. The labour market is healthy without shooting the lights out. And while it is encouraging that employment grew, more forward looking indicators like job advertisements have suggested that further labour market gains may be more circumspect. In fact internet and newspaper job advertisements have fallen for eight consecutive months, suggesting job growth is likely to flat-line in coming months.
  It is clear that while employers aren’t keen to hire unless they have to, however they aren’t firing existing staff either. While jobs are being lost in some industries, clearly they are being created in other industries. Overall it does seem like a fair proportion of Aussie businesses are holding onto existing staff and waiting for an improvement in economic conditions.
• Over the past year the missing ingredient in the domestic economy has been confidence, however there are anecdotal signs that there is an improvement in confidence. Rate cuts, a pickup in housing activity, rising share markets should provide some level of encouragement to policymakers, households and businesses.
  In a perverse way the unemployment rate fell because more people have given up the search for work. Over the past couple of months a smaller proportion of people are in the workforce – people in jobs or are looking for work – with the participation rate holding just shy of the 6-year lows.
• The Reserve Bank won’t look too deeply into today’s data as figures in coming months will be more telling. But the data is consistent with the Reserve Bank retiring to the sidelines and assess more information. Chances of further rate cuts have receded modestly.

What do the figures show?

• Employment rose by 13,900 in November after a revised gain of 10,100 jobs in October (previously +10,700). Economists had expected a flat result. In November, full-time jobs fell by 4,200 after rising by 17,600 in October. Part-time jobs rose by 18,100 after falling by 7,400 in October. Full-time jobs have only fallen once in the past five months.
• The annual employment growth rate rose from 0.9 per cent to 1.1 per cent in November. The working age population rose by 24,500 in November after lifting by 24,400 in October. The working age population grew by 1.69 per cent over the past year.
• The unemployment rate decreased from 5.4 per cent to 5.2 per cent in November. The participation rate fell from 65.2 per cent to 65.1 per cent – near six year lows. The number of hours worked rose by 0.1 per cent in November after falling by 0.3 per cent in October and now stands 0.3 per cent higher than a year ago.
• Unemployment across states and territories: NSW 5.1 per cent (5.2 per cent in October); Victoria 5.5 per cent (5.4 per cent); Queensland 6.0 per cent (6.1 per cent); South Australia 5.3 per cent (5.6 per cent); Western Australia 4.1 per cent (4.6 per cent); Tasmania 6.7 per cent (6.7 per cent); Northern Territory 3.8 per cent (3.9 per cent); ACT 4.1 per cent (4.0 per cent).
• Queensland recorded the biggest job gains in November (+27,700), followed by Western Australia (+5,400), Northern Territory (+300 in trend terms). Jobs fell most in NSW (-18,000), followed by Victoria (-13,800), Tasmania (-3,200), and South Australia (-1,300). Employment was flat in the ACT in trend terms.

What is the importance of the economic data?

• The Labour Force estimates are derived from a monthly survey conducted by the Bureau of Statistics. The population survey is based on a multi-stage area sample of private dwellings (currently about 22,800 houses, flats, etc.) and a sample of non-private dwellings (hotels, motels, etc.). The survey covers about 0.24 per cent of the population of Australia and includes all people over 15 years of age, except defence personnel.
• If more people are employed, then there is greater spending power in the economy. But at the same time companies may adjust the work hours of employees. If employees work less hours, and therefore get paid less, then spending power in the economy is reduced.

What are the implications for interest rates and investors?
The jobs data will be closely watched by the Reserve Bank in coming months. An array of indicators has suggested that activity levels have bottomed out and showing modest signs of improving. And while policymakers will want to get a better gauge of the impact from the recent stimulatory efforts further rate cuts still remain on the cards.

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• Mining recorded the biggest increase in value added in 2011/12, up 6.7 per cent, ahead of agriculture, up 6.3 per cent.
• The Bureau of Statistics has released other detailed estimates on the economy’s performance in 2011/12. The net worth (wealth) of Australia – total assets less liabilities – stood at $8,367.7 billion as at June 30 2012, up by 2.4 per cent over the year in real terms (up 1.3 per cent , nominal) after a 2.6 per cent increase in 2011/12.
• The value of all Australian homes hit a record $1,599.9 billion at June 30, up 2.7 per cent over the year.
  Labour productivity in the market sector fell by 0.3 per cent in 2010/11 after a strong 2.7 per cent increase the previous year. Productivity was best in agriculture (up 15.2 per cent) while it was worst in mining (down 16.4 per cent).

What does it all mean?

• The annual National Accounts data has certainly provided a treasure trove of information on the domestic economy. And while it may not be market moving data it will certainly help policymakers garner a clearer picture of the current economic landscape. 
• The latest data has quantified the dependence of the economy on the mining sector. Over 2011/12 the mining sector became the biggest driver of the Australian economy surpassing the Financial & Insurance sector.
• In fact it was the mining sector that recorded the biggest increase in value, adding 6.7 per cent in 2011/12. And whichever way you cut it, the mining sector looks set to play an important role in the economic recovery. The result also confirms the disparity in growth across the states truly highlights the multi-speed nature of the economy.
• In recent times the Reserve Bank has admitted that the mining investment boom may peak earlier than previously anticipated. However the main driver of the mining growth story over the next decade is going to be the volume boom that comes with more producing assets and larger capacity.    
• The Reserve Bank would be more disappointed with the weakness in labour productivity over the past year. Productivity has been discussed by policymakers on numerous occasions in the past year. The terms of trade has peaked and any growth in real wages over the mid-term needs to be as a result of a pickup in productivity. Otherwise it is likely to fuel inflation. Interestingly the mining sector has been the least productive over the past year – largely due to the strong hiring in the sector and the time it takes to embed a relative new labour force. And more importantly, given lower commodity prices and high costs of production it is likely that the mining sector will become more productive over the coming year.
• In recent weeks there have been signs of an improvement taking place in the global economy. However the Reserve Bank is likely to remain focussed on the downside risks to the global economy. No doubt the ongoing patchiness across the domestic economy and cautiousness being shown by consumers and businesses will continue to ensure that the Reserve Bank remains on an easing bias.
• In addition given that the terms of trade index has peaked, it has ensured that there is additional capacity in the economy to allow the household sector more breathing space. As such CommSec expects the Reserve Bank to cut interest rates by a quarter of one per cent next week.

What do the figures show?

• Mining has become the biggest driver of the Australian economy. The gross value added of the Mining sector was $139.95 billion in 2011/12, ahead of Financial & Insurance services at $137.55 billion. Mining recorded the biggest increase in value added in 2011/12, up 6.7 per cent, ahead of agriculture, up 6.3 per cent.
• The net worth (wealth) of Australia amounted to a record $8,367.7 billion at 30 June, up 2.4 per cent in real terms after a 2.6 per cent gain in 2011/12. In volume terms net worth was a record $8486.1 billion.
• Household wealth stood at $6,373.4 billion in 2011/12, down 2.3 per cent in nominal terms. The net worth of Australian businesses (non-financial) hit a record high of $691.6 billion at June 30.
• The value of all Australian homes stood at a record $1,599.9 billion at June 30, up 2.7 per cent over the year.
  National net saving rose from $126.3 billion (9.0 per cent of GDP) to $144.3 billion (9.8 per cent of GDP) in 2011/12.
• Labour productivity rose by 2.9 per cent in 2011/12 after rising by 0.2 per cent the previous year. Capital productivity fell by 3.0 per cent in 2011/12, after a 2.4 per cent fall the previous year. In the market sector, multi-factor productivity rose by 0.3 per cent in 2011/12 after a 0.9 per cent fall the previous year.
• Labour Productivity was strongest in agriculture (up 11.1 per cent) followed by wholesale trade (up 7.6 per cent). Productivity fell the most in mining (down 12.1 per cent) followed by electricity, gas, water and waste services (down 3.7 per cent).

What is the importance of the economic data?

• The Australian Bureau of Statistics releases the Australian System of National Accounts publication each year. The data includes the national balance sheet, estimates of productivity and a comprehensive assessment of Australia’s performance over the last financial year.

What are the implications for interest rates and investors?

• The mixed nature of current economic conditions is clear from the latest National Accounts data. Northern Territory, Western Australia and Queensland are benefitting from the mining boom. But other states are struggling.
• At present there are downside risks to domestic growth, however the longer term story is sound. An improvement in business conditions is the key to businesses committing to investment plans, which in turn will drive activity levels once the recovery becomes more entrenched. But the Reserve Bank will need to do its part by keeping interest rates in a stimulatory setting over the near term. In addition, productivity still remains an issue, with further ongoing improvement needed. We continue to pencil in a further rate cut in next week.

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• More budget savings. The Government has announced measures to boost the budget bottom line by $1.4 billion this year and a further $8.9 billion in the following three years. Included are changes to private health rebates, payments to businesses for apprentices, payments to schools and universities as well as a reduction in the baby bonus are amongst measures.
• Revenue measures. Included are changes to Visa Application charges; changes to concessional fringe benefit tax treatment of some benefits; introduction of monthly pay as you go instalments for large companies.

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Solid quarterly growth. In the September quarter the economy grew by 2.2 per cent, above the consensus estimate of 1.8 per cent.

Monthly economic indicators. Retail sales in September were up 14.2 per cent on a year ago (consensus 13.2 per cent); industrial production was up 9.2 per cent (consensus 9.0 per cent); and fixed asset investment over the first nine months of 2012 was up by 20.5 per cent (consensus 20.2 per cent).

The data suggests Chinese authorities will be cautious about further stimulus.

What does it all mean?
Sighs of relief all round. The latest Chinese economic data readings were either in line or slightly above expectations. The good news is that there are no signs of the economy stalling. And for Australia and the world economy generally, that is a very positive development.

For some, the bad news is that growth rates for spending, production and investment were all above forecast, suggesting to the Chinese authorities that there isn’t urgency about providing more stimulus to the economy.
The latest data is further confirmation that Chinese authorities have achieved the fabled ‘soft landing’ for the economy. Inflation is contained and activity is starting to lift again, rather than weaken.

What do the figures show?
The Chinese economy grew at a 7.4 per cent annual rate in the September quarter (consensus 7.4 per cent), down from the 7.6 per cent annual rate in the previous quarter. For the September quarter GDP grew by 2.2 per cent after rising by 1.8 per cent in the March and June quarters.

Economists had tipped 1.8 per cent quarterly growth. Industrial output expanded at a 9.2 per cent annual pace in September, up from 8.9 per cent in August and above forecasts centred on a result near 9.0 per cent. Production growth appears to have bottomed and may lift modestly over the next few months.

China’s urban fixed asset investment, such as spending on roads and power plants, grew at a 20.5 per cent in 2012 to date (January – September), above forecasts (20.2 per cent) and up from 20.2 per cent in the eight months to August.
Retail sales grew at a 14.2 per cent annual rate in September (forecast 13.2 per cent), up from 13.2 per cent in the year to August and up from 13.1 per cent in the year to July.

What is the importance of the economic data?
China’s National Bureau of Statistics releases its monthly economic statistics around the 10th of each month. Quarterly GDP data is released around the 16th of January, April, July and October. 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 Reserve Bank would be comforted by the latest Chinese economic data. And, on balance, the results mean that the Reserve Bank may be more tempted to stay on the interest rate sidelines in November. We are still pencilling in a rate cut, but it is by no means a lay-down misere.

Consider the fact that US housing activity is strengthening; Europe appears to be stabilising; China’s economy is still humming along; and domestic confidence levels are rising. Confidence has been the missing ingredient. If Aussie confidence levels lift, then the Reserve Bank will be very reticent about cutting rate again.

Today’s Chinese economic data will serve to support the Aussie dollar near US103-105 cents. Good news for consumers, bad news for a raft of businesses.

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