The big picture

• In the US, investors have been cheering the election result. That may seem odd, given the fact that it appears a recipe for doing nothing – a Republican-controlled House of Representatives, Democrat-controlled Senate and a Democrat in the White House. One study found that returns for the Dow Jones almost doubled in periods when there was a divided government compared with periods when one party ruled the White House and Congress.
• The theory goes that when the Government is divided there is less political interference with the economy, allowing companies and consumers to get on with business.
• So how does that theory apply to Australia? Unfortunately we don’t have a lot of past experience to work on. When a hung parliament last occurred between September 1940 and August 1943 the Sydney sharemarket lifted by 9.6 per cent or 3.2 per cent a year – around half the average annual average growth over the past 135 years. Still, the Second World War adds another complication to the analysis.
• When the most recent incarnation of a hung parliament became a reality in August, opinion was divided about the impact. Some thought it would prove positive with greater consultation between the parties and independent members. Others thought that little would get done.
• Unfortunately it appears that the latter will now be the more likely outcome. Despite initial optimism, there is no spirit of co-operation in the new Parliament. As a result little is getting done. And that means that businesses are still struggling to get certainty on key issues like the resource rent tax, pricing of carbon emissions, faster internet, migration and broader tax reform.
• The lack of certainty on the resource rent tax is stifling investment across the mining sector. Simply, how can you commit to a long-term investment with the knowledge that the tax regime could be dramatically altered? The final mining tax proposal and legislation are unlikely to be submitted until late 2011. That means that major mining companies may either further delay key projects or look to opportunities outside the country.
• Similarly, environmental issues. The Government has asked the Productivity Commission to give guidance on overseas carbon pricing schemes but the report is not due until May 2011. And Ross Garnaut has been asked to update his 2008 report. Again it will be a six-month process with no guarantees at the end.
• Add in the fact that there is a $43 billion National Broadband Network being built without a cost-benefit study and both the Opposition and Labor are putting limits on migration and it is clear that the economy is at risk.

The week ahead

• Another quiet week is in prospect in Australia with only three events of note on the economic calendar. In the US, the key date is Wednesday with at least seven indicators scheduled for release.
• In Australia, data on construction work done is released on Wednesday with business investment (private capital expenditure) on Thursday while on Friday the Reserve Bank Governor delivers testimony to Federal Parliamentarians.
• The “construction work done” release from the Bureau of Statistics provides a raft of information on the construction sector. Not only are estimates provided on home building, commercial and engineering construction activity in the September quarter, but there are also more forward-looking estimates such as commencements and work yet to be done.
• In the June quarter construction work completed hit record highs while work yet to be done was only marginally below record highs. At face value the construction sector appears in good shape. But the problem is that new approvals have slid by 25 per cent over the past nine months, pointing to weaker conditions ahead.
• Business investment has also been soft over the past year with spending falling in three of the past four quarters. But in contrast the outlook for investment has been upbeat, suggesting that investment lifted by 6 per cent in the September quarter. If the optimism about investment is to be maintained, the estimate of spending in 2010/11 will need to lift from $123.3 billion to around $131.5 billion.
• The Reserve Bank Governor faces a grilling by Federal Parliamentarians on Friday. Usually questions centre on inflation, interest rates and the job market, but this time around Glenn Stevens may get more than the odd question on bank funding. It’s clear that Federal politicians have incomplete knowledge of the topic, while at the last Reserve Bank Board meeting, members discussed the topic at length. Hopefully the Governor can fill the knowledge gap of politicians as well as some of the assembled media.
• In the US, the big day in the coming week is Wednesday with all manner of indicators due for release. Amongst the indicators to be released are personal income & spending, durable goods orders, new home sales, consumer sentiment, jobless claims and home prices. In addition minutes of the last Federal Reserve meeting will also be released.
• Personal income and spending are both expected to have risen by 0.4 per cent in October; new home sales may have lifted 4 per cent; and small gains are likely in durable goods orders and consumer sentiment.
• Earlier in the week GDP (economic growth) figures are released on Tuesday together with data on existing home sales. The US economy probably grew at a 2.3 per cent annual pace in the September quarter with existing home sales up modestly. Overall the data should give investors added confidence that the US economy is continuing to heal.

Sharemarket

• Many investors have been disappointed at the performance of the sharemarket this year. While the US Dow Jones has lifted by over 6 per cent, the ASX 200 has dropped 5.5 per cent while the All Ordinaries is down 2.5 per cent.
• However to get a better sense of how the Australian market has fared, its worth taking a different perspective. The capitalisation of the sharemarket is probably a better measure in the current environment, reflecting moves by companies to shift from debt capital to equity. Over 2010, the capitalisation of the All Ords has lifted 4.4 per cent and now stands 17 per cent lower that the November 2007 record high. By comparison, the All Ordinaries index is still 32 per cent below its high point.

Interest rates, currencies & commodities

• Politicians of all persuasions criticised the banks for lifting rates on loans by more than the movement in the cash rates. Banks were accused of being greedy and losing touch. A number of journalists and other commentators added to the debate. But that was before the Reserve Bank released minutes of the last Board meeting. According to the minutes, members spent some time considering the evidence. The conclusion was that old loans were being rolled over at higher spreads, leading to the risk that the higher funding costs would need to be passed on. Reserve Bank Board members took time to consider the issues, now it is up to others to get up to be brought up to speed.
• It may seem perverse, but the sharp lift in longer-term US treasury yields in recent days is clearly a positive development. Over the past seven days, US 10-year bond yields have risen by almost 40 basis points to 2.86 per cent. Given the fact that the Federal Reserve has embarked on QE2 – the second leg of quantitative easing or bond purchases – the lift in yields may seem surprising. But investors are starting to get the sense that the US economy is indeed recovering. At the same time commodity prices are rising and both these developments point to higher inflation. Clearly one of the biggest risks for holders of long-term government bonds is higher inflation, and bond investors are voting with their feet, moving to other asset classes.

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The Self Managed Superannuation Funds Professionals Association (SPAA) has today warmly welcomed the appointment of Mr Bill Shorten MP to the position of Assistant Treasurer and Minister for Superannuation and Financial Services.

“We congratulate Mr Bill Shorten MP on his appointment as Minister for Superannuation and we look forward to working with him to advance the interests of the hundreds of thousands of Australians who choose to manage their own superannuation,” said Andrea Slattery, CEO of SPAA.

“The $390 billion self managed superannuation sector is now the largest sector in the $1.2 trillion superannuation industry by assets and number of funds, and represents the most engaged segment.”

“We note and support Minister Shorten’s comments that improvements to superannuation represent an opportunity to increase the quality of life of all Australians and deliver us a sustainable future. We are confident Mr Shorten’s background as trustee of two superannuation funds will stand him in good stead in his new role developing policies to benefit the broader retirement savings sector.”

“SPAA is keen to progress policies that raise standards of professional advice and help all Australians saving for retirement. We look forward to progressing the Future of Financial Advice Reforms and the implementation of the SPAA/Australian Artists Association guideline on investing in art through self managed super funds.”

“SPAA would like to work with the new government to find a workable solution to the excess superannuation contributions issue, where Australians legitimately trying to save for retirement, often by making catchup contributions later in life, are penalised with tax of up to 93% for making inadvertent errors.”

“SPAA is also keen to consult with the new government on the possibility of restoring the original superannuation contribution caps in full. The caps were halved in the 2009 Federal Budget against the backdrop of the GFC and have only been partially restored. SPAA believes the current caps, at $25,000 for those under 50 and $50,000 for those over 50 (the latter cap applying to those with less than $500,000 in superannuation), prevent large numbers of Australians from being able to save adequately for retirement.”

“SPAA would like to take the opportunity to thank the former Minister for Superannuation Chris Bowen for his very good work and to congratulate him on his new appointment as Minister for Immigration. We also look forward to working with Senator Nick Sherry in his new portfolio of Small Business,” Ms Slattery said.

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Headline developments of the past week

• US President Obama announced plans for another round of fiscal stimulus including increased infrastructure spending, accelerated tax write-offs for new investment that would allow companies to write off all new investment undertaken before the end of 2011 and an extension of the Bush tax cuts for those earning less than $US250,000. However, while the plan would provide a modest economic boost it is questionable whether it will pass through Congress.
• Meanwhile, Japan announced details of an $US11bn package designed to boost the economy by 0.3% and indicated that it will intervene to cap the Yen if needed. While the stimulus is modest it adds confidence to our view that Japan will avoid a swing back into recession.
• Worries about European banks and highly indebted countries returned, although these settled a bit with a successful Portuguese bond auction.
• In Australia, the Labor party gained enough support from independents to form government, but with only a 76 to 74 seat majority in the lower house. The national broadband network, the mining tax, a tax summit, action on climate change, increased spending in regional areas and a return to budget surplus by 2012-13 look to be the key policy outcomes. The requirement for ongoing support from regional independents should act as a counterweight to the possibly less business friendly influence of the Greens. The first test will be whether the new Government sticks to its scaled down mining tax or reverts to something more onerous as the Greens might prefer, although this may take some time to play out. A concern is that with a wafer thin majority and the need to bring along a diverse range of people the new minority Government will be timid when it comes to undertaking reforms to boost the supply side potential of the economy.
• There were no surprises from the Reserve Bank of Australia which decided to leave the cash rate unchanged for the third month in a row at 4.5%. However, the addition of the phrase “for the time being” in describing monetary policy as being appropriate suggests the RBA has a mild tightening bias which is consistent with its concerns about capacity constraints and expectations for underlying inflation to start rising again in the second half of next year. The RBA’s tightening bias is likely to have strengthened further following the August labour market report which showed another solid gain in employment and a fall in unemployment, such that a rate hike next month is looking increasingly likely assuming that the global growth outlook doesn’t deteriorate any further.

Major global economic releases and implications

• US economic news had a slightly positive tone. While the Fed’s Beige book of anecdotal reports confirmed signs of a slowdown in the pace of economic growth, weekly unemployment claims fell more than expected, weekly mortgage applications to purchase a home are continuing a very modest recovery and the trade balance improved sharply in July suggesting that it won’t be the big detractor from September quarter growth that it was in the June quarter.
• German economic data was disappointing with falls in factory orders and industrial production in July.
• Chinese property data is presenting a confusing picture with some private sector data suggesting that property sales and prices rebounded strongly in August but official data showing that annual growth in property prices in 70 major cities slipped to 9.3% in August from 10.3% in July and that prices were actually flat in the month. The property collapse many feared a few months ago just hasn’t happened but it’s unclear as to whether the market has taken off again. Given the confusing picture from August data and a likely increase in the supply of apartments hitting the market this month and next it would seem premature for the authorities to further tighten property measures. While growth in Chinese exports slowed slightly in August, growth in imports picked up which is normally a sign of strength in domestic demand.
• Japanese economic data was mixed with a solid rise in machine orders and a fall in bankruptcies but falls in bank lending and economic confidence. June quarter GDP growth was revised up to 0.4% quarter on quarter from a previously reported 0.1%, which should go some way to allaying double dip fears.

Australian economic releases and implications

• Economic data releases in Australia continue to reveal solid growth momentum. Employment surprised again on the upside in August pushing the unemployment rate down to 5.1% and with the ANZ job ads series still rising, further labour market improvement is in prospect. Expect unemployment to fall below 5% by year end. Housing finance commitments were essentially flat in July and appear to have stabilized after earlier falls in response to rising interest rates. On the inflation front the TD Securities/Melbourne Institute inflation gauge was pretty benign in August.

Major market moves

• After a poor start, global share markets climbed higher on better economic news. Australian shares were little affected by news that a Labor/Green independent alliance would form government and rose in line with global shares.
• Despite softer commodity prices the Australian dollar rose above $US0.92 on the back of the stronger than expected employment report in Australia.

What to watch in the week ahead?

• In the US, all eyes will likely be on the New York and Philadelphia regional manufacturing surveys which gave such a bad lead to the national ISM manufacturing survey last month. Data for retail sales and industrial production are likely to show signs of the slowdown in US economic growth. August inflation data is likely to remain benign.
• Chinese economic data for August is likely to confirm that while the economy has slowed from the blistering pace earlier this year, it remains robust and certainly hasn’t collapsed. Inflation data is likely to rise slightly to 3.5% year on year, but this is due to a weather related boost to food prices with underlying inflation remaining much lower.
• In Australia, the NAB business conditions and confidence survey is likely to show a rise after recent weakness and consumer confidence is expected to strengthen further on the back of another month of interest rates staying on hold and more good news on the labour market. Dwelling commencements for the June quarter are likely to rise by 5% in response to the earlier strength seen in building approvals. A speech by RBA Assistant Governor Lowe will be watched closely for any indications as to how the RBA has interpreted recent strong economic data for Australia.

Outlook for markets

• Shares are likely to remain on a bit of a roller coaster ride over the next month or so reflecting the ongoing uncertainty as to whether there will be a double dip back into recession in the US and other industrialised countries and normal cyclical weakness at this time of year. However, beyond the near term uncertainties we remain of the view that shares will see strong gains into year end and then through 2011. Shares are very cheap relative to government bonds, investors are still very bearish which is positive from a contrarian perspective and once it becomes clear that the US/global recovery is continuing (albeit slowly) there is likely to be a big reversal of investment flows – out of government bonds and back into equities.
• The $A is likely to remain volatile in the short term, but should rise on a six to 12 month horizon as it becomes clear that the global recovery is continuing, commodity prices are remaining strong and that Australian interest rates are remaining well above global rates.
• Double dip and deflation worries may keep bond yields low in the short term, but medium term returns are likely to be poor reflecting low yields and excessive public debt levels in many developed countries.

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