• While share markets mostly rose over the past week helped by a delay to action regarding Syria and on the back of more evidence that the global economy is improving, gains were limited as bond yields rose sharply as stronger US data fuelled expectations that the Fed will start to taper its monetary stimulus this month.
• In Australia, the focus in the week ahead will likely be on the aftermath of the Federal election which if the polls and betting agencies are correct will see a new Liberal/National government. Based on stated policies, key policy changes under a Coalition Government are likely to be the abolition of the mining and carbon taxes, reduced company tax but offset by a levy on large companies to pay for paid parental leave, a refocusing in government spending towards infrastructure, a delayed increase in the superannuation contribution, smaller government, a greater focus on returning the budget to surplus and a range of inquiries (including into the labour market and productivity) which will likely pave the way for less regulation and more economic reform. The likely change in Government towards what would appear to be a more business friendly approach will probably provide a boost to confidence and past experience points to a post-election bounce in shares. This has averaged 5.4% over three months for elections since 1983. However, much will depend on whether conservative forces gain control of the Senate – the prospect of a double dissolution election next year would not go down well – and how hard the new Government goes in cutting spending with an announcement on this front likely in November.
• While an attack on Syria has been delayed it still looks likely with a key US Senate committee approving it, on the grounds its limited and tailored and doesn’t involve troops on the ground. It now goes to a Congressional vote on September 9. As with all US led military interventions in the Middle East, the concern is that it will lead to a wider confrontation threatening oil supplies. Given this it wouldn’t be surprising to see further share market weakness and oil price strength in the run up to any strike, even though Syria only produces 300,000 barrels of oil a day. This is consistent with past experience which saw share market weakness/oil price strength in the run up to interventions followed by a recovery in share markets from around the time it commences. The 1991 Iraq invasion, the December 1998 bombing of Iraq, the March 2003 Iraq invasion and the March 2011 Libyan bombing saw US shares fall 5.6%, 3.5%, 14% and 6.3% respectively in the run up only to see the losses recovered within two months. A similar pattern could be expected this time around, particularly as it becomes clearer that any intervention will be limited and that surrounding countries are unlikely to become involved.

Major global economic events and implications

• US economic data was mostly positive, adding fuel to expectations that the Fed will soon start to slow its monetary stimulus. The ISM manufacturing conditions index improved further in August, the non-manufacturing ISM rose to its highest since 2005, labour market indicators improved, construction spending rose solidly and auto sales rose to their highest since 2007. However, higher mortgage rates and higher oil/gasoline prices are clearly a bit of a headwind for US growth and so if the Fed slows its monetary stimulus following its September 17-18 meeting, as appears likely, it may only cut it back by $10bn a day.  
• Final Eurozone business conditions PMIs confirmed the recovery already evident in the flash readings. As expected the ECB and the Bank of England left monetary policy unchanged but with the ECB retaining a dovish bias. Italy remains a risk point though with the threat remaining that members of Berlusconi’s party will withdraw support for the Government if Berlusconi is forced out of his Senate seat.
• In Japan, the Bank of Japan left monetary policy unchanged but Governor Kuroda made clear it can respond if a planned hike in the GST impacts growth. The Yen fell through 100 to the $US as a result.
• Chinese business conditions PMIs mostly improved in August or stayed around solid levels, adding to confidence that 7.5% growth remains on track for this year. House prices continued to rise in August but the new Chinese leadership seems to be less concerned about it, perhaps concluding that demand curbs are ineffective and the only solution is via increases to supply.

Australian economic events and implications

• In Australia, June quarter GDP data showed that growth remains sub-par at 0.6% quarter on quarter or 2.6% year on year, the same pace it has averaged since the June quarter 2012, reflecting soft consumer spending and investment. The bad news is that growth is below the pace necessary to stop unemployment rising, but the good news is that growth has not collapsed. Other indicators presented a soft picture as well with retail sales very weak, business conditions PMIs still soft and the trade balance back in deficit.
• However, there are some positive signs: house prices continue to rise, building approvals rebounded in July consistent with an ongoing recovery in dwelling construction, household savings remain high at 10.8% indicating a significant buffer in household budgeting, productivity growth is solid at 2.2% and inflationary pressures are weak with falling real unit labour costs and a benign reading on inflation from the latest TD Inflation Gauge.
• The RBA surprised no one in leaving interest rates on hold. What was surprising though was that its post meeting statement was virtually identical to that from last month leaving out yet again any explicit easing bias. As a result it has yet again missed an opportunity for a free kick in pushing the $A down. The risks still point down though for rates particularly if the $A holds up from here, economic data remains soft and the post-election Government embarks on more spending cuts.

Major market moves

• Share markets mostly rose on the back of good economic data and the delay to any attack on Syria, but with gains limited as Fed tapering looks likely this month. Australian and Japanese shares fell slightly.
• While the $A rose earlier in the week as the RBA left out any explicit easing bias from its post meeting statement and GDP growth was fractionally stronger than expected, its gains were limited as the $US strengthened.
• Bond yields rose sharply in most major countries, including Australia, as stronger US data fuelled expectations for Fed tapering. US and Australian ten year bond yields rose to their highest since 2011.

What to watch over the next week?

• Globally, Syria will probably be the big one to watch with the US Congressional vote on approving a US strike. Don’t expect much from the G20 leaders’ summit though, other than the usual hot air from such events – it’s unlikely to have any impact on what the Fed does or on what the US does regarding Syria.
• On the data front the focus is likely to be on China though with key activity data due Tuesday likely to show that the improvement in growth evident in July continued into August. In particular, growth in industrial production is likely to have continued to edge higher rising 9.9% year on year, up from a low of 8.9% in June. Meanwhile, inflation (Monday) is likely to show a slight moderation on the back of a fall in food prices.
• In the US, it’s a pretty quiet week till Friday when August retail sales are expected to show a 0.3% gain and producer price inflation data is expected to remain benign. Consumer confidence data will also be released.
• In Australia, the aftermath of the election will likely dominate. On the data front though it will be interesting to see whether the NAB business confidence survey (Tuesday) and the consumer sentiment survey (Wednesday) show an improvement on prospects for a change of Government. Odds are they probably will. Expect an ongoing rising trend to be evident in housing finance data (Monday) but another round of soft jobs data (Thursday) with employment likely to be flat and unemployment rising to 5.8% from 5.7%.

Outlook for markets

• Shares are vulnerable over the next month or so with various events and risks that could trigger investor nervousness including the Fed’s September meeting where it will likely start to taper its monetary stimulus, US Government funding and debt ceiling negotiations, the nomination of the next Federal Reserve chairperson, various imbalances in the emerging world, a likely military intervention in Syria, political instability in peripheral Eurozone countries and post-election fiscal tightening in Australia.
• However, a pullback should be seen as a buying opportunity as the broad trend in shares is likely to remain up: valuations are not dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other developed countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.
• Despite the bond sell off so far this year, sovereign bond yields still remain low and point to low medium term returns from bonds as yields gradually adjust higher in response to the improving global growth outlook. An unwinding of years of massive inflows into bond funds though runs the risk of causing a more aggressive rise in bond yields and hence losses on sovereign bonds.
• With commodity prices in a downtrend and the Australian economy deteriorating versus the US, it’s likely the $A will fall further. Given its overvaluation in terms of relative prices and costs, expect the $A to fall to $US0.80.

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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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The economic growth data is backward-looking. But more recent figures have generally remained soft. We believe the Reserve Bank should cut rates again, especially given the downside risks to global growth and are pencilling in a move in August.

To read CommSec’s report, click here.

7 June 2012

The post Mining states propel growth to a five year high appeared first on AdviserVoice.

This is roughly double consensus expectations. 

The key drivers of the upside surprise were household consumption which grew by a very strong 1.6% and a 19.7% rise in new engineering construction, which is mainly mining related. 

These numbers are great news and highlight that Australia is much stronger than comparable developed countries. Eg while Australia grew 4.3% over the year to the March quarter, the Euro-zone was flat, the UK contracted 0.1%, the US grew 2% and Japan grew 2.7%. 

However, our assessment is that it would be very dangerous to assume that this sort of growth will continue. Sure the mining boom has a way to go, but more timely data for April and May suggest that retailing, housing related activity, manufacturers and services sectors are continuing to struggle suggesting a return to softer sub trend growth in the current quarter and beyond. 

Its also worth noting that much of the strength in consumer spending related to strong gains in normally volatile services related items such as health, transport and education which are likely to fall back in subsequent quarters. 

In other areas the house hold savings rate remained high at 9.3%, productivity growth was 1.9% in the quarter and 3.9% over the year and state final demand growth continued to highlight the two speed economy with WA up 14.5% over the last year and Northern Territory up 16.9%, but NSW growing just 1.9% and Tasmania contracting 0.8%. Additionally the terms of trade has fallen for two quarter in a row and measures of inflation were low and falling (eg the household consumption deflator is up just 1.4% year on year). 

With March quarter growth likely to prove to be a bit of an aberration (just as the March quarter contraction in GDP was last year), real gross national income softening and inflation low our view remains that the RBA has more to do in terms of cutting interest rates. We see the cash rate falling to around 2.75% by year end.

7 June 2012

The post Australia boom – March quarter GDP +1.3%…boom time or is it? appeared first on AdviserVoice.

Key points

• Global oil prices remain under upward pressure from turmoil in the Middle East and North Africa. This will dampen global growth and add to the financial pressure on Australian households.
• The global and Australian economies and share markets can probably live with current oil price levels. However, a sustained sharp rise in the oil price to $US140 would make life a lot more difficult.

Oil prices are surging again

After a dip last week on the back of the tragedy in Japan the US West Texas Intermediate oil price is back above $US105 a barrel and Asian Tapis oil prices are around $US120 a barrel.

Source: Thomson Financial, AMP Capital Investors

Increasing tensions in the Middle East and North Africa (MENA) have been the primary driver, with the US and various European countries now intervening militarily in Libya to enforce a no fly zone, along with escalating tensions in Bahrain, Yemen and Saudi Arabia. The tensions between Sunni rulers and Shiites in Bahrain risk a further escalation, possibly drawing in Shiite dominated areas in Saudi Arabia and Shiite dominated Iran.

In addition, the lessening of the risk of a full blown nuclear meltdown in Japan has shifted the focus back to increased oil demand from Japan in order to make up for reduced nuclear power production and as part of rebuilding demand following the earthquake. This is all occurring at a time when global demand for oil is rising on the back of the global economic recovery and a long term deterioration in the pace of new oil discoveries.

The rise in the oil prices is pushing up energy costs world wide. Australia is no exception, and the rise to date has pushed up local petrol prices to an average of around $1.45 a litre. As can be seen in the next chart there is a pretty close relationship between the local petrol price and the world oil price in Australian dollars. Roughly each $US10 a barrel rise in the world oil price translates to around an 8 cents a litre increase in Australian petrol prices. If world oil prices stay at current levels expect petrol prices to rise another 3 to 5 cents over the next few weeks.

Source: Thomson Financial, AMP Capital Investors

The war in Libya has affected most of its normal 1.8 million barrels per day of oil production. Prior to the unrest in the Middle East, OPEC had 5 million barrels a day of spare oil capacity and so Saudi Arabia and other gulf states have been able to make up for lost Libyan production.

Source: Bloomberg, AMP Capital Investors

However, Libyan crude oil is light and cheaper to refine compared to the heavy Saudi oil grades, so this has added to the price of light oil grades such as Brent and Tapis. Secondly, while OPEC can make up for lost Libyan production it, would only take a spreading of unrest and production disruptions to say Kuwait, Iran or part of Saudi Arabia to wipe out all of the spare capacity. Finally, some suspect Saudi Arabia may be exaggerating its spare capacity. So it’s little wonder the oil price contains a risk premium, estimated to be around $US10-15 a barrel. If the unrest spreads, a further increase in oil prices is likely.

While not experts on the Middle East, our sense is that, although the turmoil will continue to bubble on for a while, further significant oil supply disruption will be avoided. As such the issue will become background noise for global investment markets. However, as the risks are skewed towards more disruption and higher oil prices its worth considering at what level the surge in the oil price would create a problem for the economic outlook.

At what level will the oil price become a problem?

It’s true that past surges in world oil prices have preceded US recessions and sharp global downturns. See next chart.

Source: Thomson Financial, AMP Capital Investors

However, other factors have also been involved – notably significant monetary tightening, and we are not seeing that now. Much of the rise over the last two years has also been due to stronger demand with supply concerns only adding $US10-15 a barrel this year. It’s also the change in the oil price that matters, not its level, as businesses and consumers gradually get used to higher oil prices. Trouble normally ensues if the oil price doubles over 12 months. We are not quite there yet. Our assessment is that the world can probably live with oil around $US100 a barrel, and we expected it to reach that level this year anyway.

The following table estimates the impact on GDP growth of a $US10 rise in the price of oil for the year ahead in the second column and then applying that to the impact of oil at $US110 a barrel and $US140 a barrel.

Impact on GDP growth of rising oil prices, % points

* Relative to a base case of $US100. Source: IEA, IMF, OECD, AMP Capital Investors

Global growth this year is currently forecast to be around 4.3% by the IMF so if the world oil price settles around $US110 a barrel then global growth would be reduced by around 0.4% but would still be solid at around 3.9%.

However, a sustained spike to $US140 a barrel would be much more worrying as it would slice around 1.6% off world growth, 1.2% off US growth and 1% off Australian growth. Asia is the most vulnerable, reflecting its heavy reliance on imported oil and its more intensive oil use. Australia is less vulnerable as it is a net energy exporter.

The rise in the oil price will also boost inflation with roughly a $US10 a barrel rise adding 0.5% to inflation in the US and Australia and 0.7% to inflation in Asia.

What would central banks focus on – inflation or growth? The European Central Bank is more likely to focus on headline inflation and so raise interest rates as it is threatening to do. However, the US Federal Reserve is likely to see a fuel inspired boost to inflation as temporary and would probably give more weight to weaker growth.

At this stage it’s too early to get overly worried given that it’s quite possible that significant tensions in the Middle East and North Africa will be confined to current countries. Just as the much feared nuclear meltdown didn’t happen a week ago, a worst case oil price surge may be avoided. The bottom line is that current oil price levels are probably not enough to derail the global recovery. However, if oil prices rise to $US140 a barrel the threat would be significant – both via the direct hit to growth and the indirect hit if central banks in some countries respond to higher inflation via interest rate hikes.

What about Australia?

For Australia, the strong Australian dollar is acting as a buffer against the rising oil price. Australia is also a net energy exporter and so the rise in the oil price is providing a boost to national income via higher gas and steaming coal prices. We also see the RBA giving more weight to the growth reducing impact of higher oil prices rather than the boost to headline inflation and so don’t see it responding with a rate hike, providing underlying inflation stays benign.

The real problem for Australia is that the rise in oil and petrol prices will add to consumer caution. While higher energy prices boost national income, and hence resource sector investment, the rise in petrol prices over the last month has already added another $5 a week to the weekly petrol bill for a typical Australian family. It is now just $10 a week below the 2008 high.  Coming on the back of solid increases in costs for electricity, insurance, fresh food and education this will only cut further into consumer discretionary spending power. More bad news for retailers.

Source: AMP Capital Investors

Implications for shares

The surge in oil prices is great news for energy shares, but not so good for the rest of the share market. However, shares can probably still perform well with current oil price levels, helped by the improvement in valuations after the recent correction. However, a sustained sharp rise in the oil price to around $US140 would make life a lot more difficult.

The post Rising oil prices – what is the tipping point for growth? appeared first on AdviserVoice.

• The GDP (economic growth) figures were released last week. And the question we are getting asked most is what is the story with inventories – that is, unsold goods. Inventories provided the biggest contribution to economic growth in the December quarter. But strangely the inventories to sales ratio fell.
• Inventories are goods sitting on shelves, work in progress or stockpiles of raw materials like coal and wheat. If they are rising, it may point to softer production or imports ahead. In this note we provide a view on the apparent inventories puzzle. And it all appears due to prices – especially lower import prices.

Inventories – the true story

• Most people probably wonder what all the fuss is about – inventories (stocks) hardly seem a big story. But if we import or produce goods and they don’t get sold, then some adjustment may need to occur. If we import too much, it may actually be positive – we can cut future imports. However if we produce too much, that is a different story. That may lead our businesses to trim production because we have enough goods sitting on shelves.
• In the December quarter, inventories seemingly accounted for all economic growth – inventories contributed 0.8 percentage points to growth and overall economic growth was 0.7 per cent. But, strangely, when you compare the level of inventories to overall sales, the ratio actually fell to a record low. That is, it doesn’t seem as though we have too many inventories after all.
• Well it seems that part of the answer is contained in prices. It seems that we brought in more of cheaper imported goods. But if those goods haven’t been sold as yet, that can produce some inconsistencies or quirks in the data. (The Bureau of Statistics notes that “For national accounting purposes, the physical change in inventories during a period should be valued at the prices prevailing at the time that inventory changes actually occur.” The problem is that many businesses use historical cost accounting methods so the ABS has to calculate an Inventory Valuation Adjustment (IVA) to calculate true changes in volumes and values.)
• We use the word ‘seems’ because no one can ever know the full story with inventories. Did companies import a lot more goods and then didn’t sell them as hoped? Or did they import the goods because the deals were good and they wanted to stock up on the expectation of stronger sales ahead. Still, whatever the case, companies need to sell the goods in question eventually.

So what do the figures show?

• The accompanying tables give a detailed picture of what really happened to inventories in the December quarter.

• The sector that provided the biggest contribution to GDP in terms of the change in inventories was wholesale trade (adding 0.36 percentage points). Retail trade and “other non-farm” (mainly mining) provided 0.13pp, with manufacturing, farm and public authorities all adding 0.06pp.
• So the greatest change came from wholesale trade. These are firms that  purchase goods (generally in bulk) for the purpose of on-selling (and generally to retailers). Now wholesalers may import the goods or buy in bulk from domestic manufacturers for on-selling.
• The next interesting point is to compare the real (inflation-adjusted) change in inventories to that in current prices. The biggest difference is wholesale trade. In real terms inventories rose by $797 million; in current price terms, inventories rose by only $381 million. Farm inventories also rose by $807 million in real terms and by $1297 million in current prices.
• Clearly farm prices are rising sharply – accounting for the higher figure in current prices. But the wholesale trade sector appears to have stocked up with cheaper goods, thus the lower build-up of stocks in current price terms compared to real terms.

• In real terms, non-farm inventories rose by $935 million; in current price terms the book value of stocks actually fell by $640 million. Now sales in current prices rose by $505 million – all of which was domestic sales. So the overall inventories to sales ratio (comparing goods in current price terms) actually eased from 0.673 to 0.668.
• If prices of imported goods are falling and cheaper imported goods are flooding in to the country, the lower prices are reflected in the book-value value of inventories. Domestic sales will end up reflecting the cheaper goods in future months.
• A reasonable conclusion is that wholesale trade sector stocked up with cheaper goods that haven’t been sold as yet. Businesses and consumers will hope they will be able to buy these cheaper goods in coming months.

Implications for investors

• The puzzle seems to have been solved – wholesalers bought cheaper imports and these haven’t been sold as yet. As we stress, no one knows the full story, but across all sectors stocks (inventories) provided a boost to economic growth.
• Inventories don’t appear excessive in relation to sales and it doesn’t appear that production needs to be wound back – but perhaps import growth will soften. Still, it’s hard to see inventories boosting GDP in the March quarter.
• Will wholesalers pass on the savings of a stronger dollar and lower technology prices to retailers? And then will retailers pass these savings on to consumers? Certainly businesses and consumers are price conscious and are driving hard for bargains.
• The bottom line is that deflation is still a key issue for the business community, especially retailers. Pressure on margins and profitability will continue. But lower retail prices are positive for consumers and inflation, potentially keeping interest rates lower for longer.

The post The inventories puzzle solved appeared first on AdviserVoice.

Headline developments of the past week

• There was good news out of China with January inflation coming in lower than expected owing to a lower than expected rise in food prices. However, this is unlikely to head of further monetary tightening as non-food inflation actually rose more than expected. Credit data also came in weaker than expected but Chinese import and export data both surprised on the upside but may have been distorted by the Chinese New Year. We remain of the view that China is unlikely to tighten aggressively enough to crunch its economy.
• While higher inflation has already hit emerging market shares, it hasn’t so far been much of an issue for shares in developed countries. Plenty of spare capacity suggests that central banks in the US and Europe have no need to tighten any time soon. However, this won’t necessarily stop investors from worrying about it. In fact, an up tick in inflation rates in the US, Europe and the UK is seeing the debate about when central banks will start to tighten in these countries hot up. As a result, worries about when and by how much interest rates will rise in key advanced countries could become a source of angst for investors.

Major global economic releases and implications

• US economic data continued to add to confidence that the US economic recovery is becoming stronger. Industrial production fell marginally in January but this followed a strong rise in December and manufacturing conditions surveys from the New York and Philadelphia regions point to strong industrial production going forward. While retail sales were subdued on the back of snow storms in January they are up a solid 7.6% from year ago levels. And although homebuilders can see no improvement in demand, at present, housing starts rose in January. On top of this mortgage delinquencies and new foreclosures are now falling and the US leading index rose in January. Meanwhile, in recognition of the improvement in the US economy the US Federal Reserve revised up its growth outlook slightly, but it remains sceptical that unemployment will come down fast enough and it remains relaxed about inflation. However, while the Fed remains relaxed for now a pick up in core inflation in January, albeit only to 1% year on year, is seeing debate about the timing of the Fed’s move towards tightening heat up.
• European GDP growth for the fourth quarter of 2010 was less than expected at 0.3% quarter on quarter or 2% year on year. This may have been due to cold weather. However, strong business confidence readings and rising consumer confidence point to a further acceleration in European growth. UK inflation reached 4% in January, but Bank of England Governor Mervyn King played down talk of an interest rate hike.
• Japanese GDP shrank by 0.3% in the December quarter of 2010, but most leading indicators point to a rebound in growth ahead. The main causes of the contraction were the expiry of government stimulus measures and negative external demand, which is likely now reversing..
• The strength of growth in Asia and the problem of rising inflation were highlighted by news that Singapore grew 12% through last year and that it has revised up its inflation forecast. This points to more monetary tightening which in Singapore’s case means further appreciation in the Singaporean dollar.

Australian economic releases and implications

• Australian economic data was mixed. Housing finance rose in December, adding to the impression that it has stabilised after a sharp fall into early 2010, and the Westpac leading index rose. Against this motor vehicle sales fell in January and skilled vacancies fell in February with the floods likely playing a role in both.
• In Australia, the December half earnings reporting season has been pretty solid so far. Certainly not the big downer many had feared. Of course BHP Billiton shot the lights out with an 88% rise in profits but good results were also seen from Dominos Pizza, Lend Lease, Qantas and Wesfarmers over the last week. So far 49% of companies have come in above expectations compared to a norm over the last seven years of 46% and 73% of companies have reported a rise in profits on a year ago. Interestingly despite the gloom and doom amongst many investors the ratio of positive to negative outlook statements is running at around 4 to 1 compared to 2 to 1 last August. However, we are still only 46% of the way through the reporting season. Two themes are apparent. First, there is a huge divergence between the very strong results seen from resources companies, solid gains from the banks and more mixed and constrained results from the rest of the market. Second, Australian companies are starting to return cash to shareholders via increased dividends or share buybacks. With corporate cash holdings at record levels and gearing low there is plenty of scope for further increases in dividends and more buybacks going forward, both of which are positive for the share market.

Source: AMP Capital Investors

Source: AMP Capital Investors

Major market moves

• Despite increasing worries about inflation and ongoing unrest in various countries in the Middle East, share markets had another solid week on the back of increasing confidence in the global growth outlook. Australian shares were also supported by better than feared profit results.
• Despite stronger growth data and emerging inflation concerns in developed countries bond yields fell, partly on tensions in the Middle East.
• Commodity prices were mixed with oil, gold and food prices up but some metal prices falling. The Australian dollar continued to range around parity against the $US with no clear direction.

What to watch in the week ahead?

• In the US, consumer confidence data (due Tuesday) is likely to show a further improvement, durable goods orders (due Thursday) are likely to rebound after a weak December, existing home sales (Wednesday) and new home sales (Thursday) are likely to fall back a touch in January after strong gains in December and house prices are likely to have recorded a slight fall in December.
• In Australia, data for construction spending (due Wednesday) and business investment (Thursday) will help firm up expectations with respect to how weak December quarter GDP data due March 2nd  will be. A speech by RBA Governor Glenn Stevens will be watched closely for clues regarding the interest rate outlook but it’s unlikely that the message will be any different from that of the last two weeks, ie, that the RBA retains an optimistic medium term outlook but is happy to leave interest rates on hold for now.
• In Australia, it will be the biggest week in the December half reporting season with about 90 major companies due to report including Amcor, Mirvac, Woodside, Oil Search, AGL, Coca Cola, IAG, Origin, GPT and Woolworths. The results are likely to continue to reflect the two speed Australian economy with resources and related stocks doing very well on the back of the surge in commodity prices but non-bank industrials likely to be much more constrained reflecting the soft housing and retail sectors and the strong $A.

Outlook for markets

• After months of strong gains globally, shares are overbought and due for a correction. With investor sentiment towards shares running at high levels a range of factors could provide the trigger including inflation worries, Middle East tensions and the renewed rise in bond yields in debt troubled European countries. However, any pullback in shares should be seen as a buying opportunity as the fundamental backdrop for shares is very positive. Valuations are reasonable, the global economic recovery is looking stronger, the corporate sector is cashed up and starting to buy back shares and boost dividends, and investors are only just starting to switch from bond funds into share funds.
• The broad trend in the $A is likely to remain up as the US dollar and the euro remain under downwards pressure, interest rates in Australia remain relatively high, and high commodity prices keep the terms of trade near early 1950s highs. By year-end, the $A is likely to have reached $US1.10.
• The risk of a sharp back-up in global bond yields this year is very high. Bond yields, particularly in the US are still below longer-term sustainable levels and bond funds are now starting to see outflows.

The post Weekly market & economic update – 18 February 2011 appeared first on AdviserVoice.

• The underlying budget deficit continued its modest improvement, easing from $59.3 billion in the twelve months to November 2010 to $58.5 billion in the 2010 calendar year. CommSec estimates that the budget deficit equates to 4.5 per cent of GDP.
• Each monthly budget deficit over the next six months needs to improve by almost $3 billion compared with the same months of 2010 ($17 billion in total) for the Government to meet its full year budget deficit target of $41.5 billion.
• The best improvement in the budget position over a six-month period in the past has been just $8.7 billion. Still, the biggest deterioration has been $37 billion. The target is not impossible, but still difficult given the slowdown of the economy and recent floods.
• Annual revenues stand at seven-month highs while annual expenses lifted to record highs in calendar 2010.

What do the figures show and what does it mean?

• The Government has plenty of grounds to be worried about missing its deficit target for this year. The annual budget deficit stood at $58.5 billion in December, down only slightly on the $59.3 billion shortfall in the year to November. The Government is aiming for a budget deficit of $41.5 billion in the 2010/11 year, but that does look like a big ask given the recent slowdown by the economy and complication of the floods.
• Basically for the next six months each monthly budget result needs to improve by $3 billion compared with a year ago. The annual budget deficit needs to improve by $17 billion over the next six months to hit the Government target.
• The good news is that budget revenue in December was higher than a year ago. And rolling annual budget revenues hit a seven-month high in December at $295.3 billion. The problem is that expenses are still growing. In December alone expenses were $4.7 billion higher than a year ago. Annual budget expenses hit a record high of $353.4 billion in calendar 2010.

• Annual budget revenues are certainly growing again, but are up just 0.3 per cent on a year ago. By comparison annual expenses are 4.9 per cent higher than a year ago.
• GST revenues totalled $47.6 billion over calendar 2010, just short of the record high of $47.9 billion in the year to October 2010. Annual GST revenues are a healthy 9.6 per cent higher than a year ago, no doubt a pleasing result for state and territory governments across the nation.
• So what does it all mean? The Government will have to continue to look for savings and will have to hope that the Reserve Bank does stay on the interest rate sidelines so that the economy can motor out of the current soft patch. And consumers and businesses may need to brace for either budget spending cutbacks or higher taxes.
• The Government may argue that the budget deficit of $36.7 billion for the six months to December 2010 is still below the Mid Year “profile” of $37.4 billion. But at the end of the day the Government needs to achieve a full-year result of $41.5 billion. According to the budget estimates, it is revenues that need to improve markedly in the next six months while annualised expenses are expected to remain broadly unchanged.

What are the implications for investors?

• If there isn’t substantial improvement in the budget numbers over the next two months, the Government will be under pressure to come up with big spending or tax initiatives in the May budget. Still, if the Government is forced to tighten fiscal policy more significantly, it may allow the Reserve Bank to stay on the interest rate sidelines for longer.
• Further, if the budget deficit remains persistently large, the minority Government will come under renewed political pressure, adding to business and consumer uncertainty. Given the deterioration of the budget position under Labor in the early 1990s, the current Government is keen to display strong economic credentials. Still, the near term budget forecasts have been complicated by the floods and cyclone but the Government will need to hope the economy rebounds quickly in the second half of 2011.

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• The recent floods and softer-than-expected economic data have caused the Reserve Bank to tinker with short-term forecasts, but the longer-term forecasts are unchanged.
• Given the weaker near term growth forecasts, CommSec has pushed out its rate call from April to May.
• The December 2010 GDP forecast has been slashed from 3.50 per cent to 2.75 per cent and the June 2011 forecast has been cut from 3.50 per cent to 3.25 per cent. Inflation forecasts have also been slashed to 2.25 per cent in December 2010 and June 2011.
• The rebuilding after the floods are assumed to boost GDP from 3.75 per cent to 4.25 per cent. There has been no change to underlying inflation forecasts from December 2011.

What does it all mean?

• The latest Monetary Policy statement highlights the Reserve Banks thinking on the impact of the recent natural disasters. The floods across three states, softer-thanexpected economic data and the latest cyclone have resulted in a profound downgrade on near term growth prospects for the Australian economy.
• While near term growth looks subdued, the Reserve Bank is certainly more optimistic about the second half of this year. The central bank believes that growth over the medium terms is likely to be spurred on by the considerable amount of rebuilding that will take place over the second half of 2011. In fact December 2011 growth forecasts have been upped by half a percent to 4.25 per cent. And despite robust growth the icing on the cake is that inflation will remain contained well into 2013.
• The bottom line is that interest rates are going nowhere for now. The pattern of growth will change in response to the floods but there is no change to inflation in the medium term.In fact near-term inflation is lower than the Reserve Bank had initially expected.

• Interest rates look to be on hold for the next two months. The March quarter inflation data to be released in late April in the next signpost to watch. We continue to expect higher rates in the second half of 2011 as all growth cylinders start to fire. The cash rate is expected to be 5.50 per cent by end year.
• When the floods struck there were some wild forecasts by economists about what the impact would be on economic growth and inflation. The RBA has set the record straight, expecting short-term negative effects on growth to be broadly cancelled out by longer-term rebuilding activity.
• In net terms, the Reserve Bank believes that the floods will reduce economic growth in 2010/11 by around half a percentage point. In dollar terms, that is around $6.5 billion. The boost to GDP in the two years from June 2011 is estimated at quarter of a percentage point a quarter. Overall by mid 2013, the RBA is assuming that GDP will be little changed compared with the pre-flood baseline.
• Interestingly given the recent debate on the impact of on online retailing, the Reserve Bank has waded into the discussion noting that online retailing effectively makes up a very small component of the overall retail picture. In fact the Reserve Bank believes that while online retailing has been growing at a rapid pace it is equivalent to around 3 per cent of total household consumption. Clearly calls for a GST to be applied to online retailing are premature given the costs of accounting and collecting the revenue.
• The labour market was once again in focus given the stronger than expected employment growth over 2010. And the results may surprise some people especially given the Reserve Bank expects employment growth to slow. And coupled with a pickup in productivity this should ensure that the unemployment rate will ease gently over time – a result that should temper some of the expectations for rate hikes.

Key quotes and observations from the statement

• Economic growth forecasts: “GDP is expected to grow by around 4¼ per cent over 2011, boosted by the recovery in coal production from the effect of the floods. Growth is expected to remain at an above-average pace of around 3¾–4 per cent over the rest of the forecast period. In year-average terms, GDP is forecast to grow by 2¾ per cent in 2010/11, 4¼ per cent in 2011/12 and 4 per cent in 2012/13.”
• Inflation outlook: “The medium-term outlook for inflation is broadly unchanged. In underlying terms, inflation is expected to be around 2½ per cent later in 2011, before picking up gradually to 3 per cent by late 2012. In the next few quarters, year-ended CPI inflation is likely to remain above underlying inflation, largely due to the effects of the earlier increase in tobacco excise and significant increases in the prices of utilities.”
• Economic outlook: “The Bank’s medium-term outlook for the Australian economy remains broadly unchanged from that in the November Statement, although the floods in eastern Australia will have a temporary effect on GDP outcomes over coming quarters.”
• Medium-term outlook still strong: “With GDP growth expected to be above trend over much of the forecast horizon, pressures on capacity are likely to emerge in parts of the economy as the structural adjustment to the large change in relative prices takes place.”
• Flood impact on inflation: “In terms of headline inflation, the floods are expected to add around ¼ percentage point to CPI inflation in the March quarter – mainly through higher fruit and vegetable prices – with much of this being reversed in the following quarter.”
• Flood impact on economic growth: “the recent floods will have a material effect on the near term profile of Economic Insights Reserve Bank signals rates on hold GDP, with growth in the December and March quarters notably lower than would otherwise have been the case, followed by a strong recovery in the June quarter as coal production picks up and the rebuilding effort gets under way. Over the four quarters to December 2011, GDP is expected to increase by 4¼ per cent. This is higher than was expected at the time of the November Statement, but this revision reflects the lower starting point as a result of the flooding in December 2010.”

• Weak household sector: “Nominal retail sales remain weak and retailers report that consumers continue to be very value-conscious. Housing credit growth is also subdued compared with the standards of previous years, although it is only a little below the pace of growth in household income. Nationwide measures of housing prices have been broadly flat since mid 2010. Overall, many households appear to be taking a more cautious approach to their finances than was the case in earlier years. With business investment expected to grow strongly, this more cautious approach, if it is maintained, would reduce the pressures on capacity that are likely to arise over the period ahead.”
• Job market isn’t overly tight: “Businesses are reporting that the labour market has tightened, although most are not experiencing significant difficulties in hiring employees. The labour market appears tightest for some miningrelated and skilled occupations.”
• Flood impact on GDP: “the Bank’s preliminary estimate – made prior to an assessment of the impact of Cyclone Yasi – is that GDP growth in each of the December and March quarters could be around ½ percentage point lower than what it otherwise would have been, with the biggest impact arising from the disruption to coal production in Queensland. However, assuming no further significant weather disruptions, the recovery in coal production, bounce-back in delayed private spending and commencement of replacement and repair spending are estimated to bring the level of June quarter GDP back close to its pre-flood forecast. This profile implies a reduction in the level of GDP in 2010/11 as a whole of close to ½ per cent compared with the outlook immediately prior.”
• Flood impact on inflation: “Overall, price increases related to the floods could contribute around ¼ percentage point to headline inflation in the March quarter, although much of this is likely to be reversed fairly quickly. The effect on underlying inflation would be lower.
• Flood impact on insurers & banks: “Australia’s general insurance industry is well placed to cope with a large increase in claims expenses.” In terms of the banking sector the RBA said: “The impact of the floods on the banking sector is also likely to be limited.”
• Online spending: “There are, however, no official data on the total value of online purchases, although a range of industry estimates suggest that these purchases are equivalent to around 3 per cent of household consumption. Industry reports and the Bank’s liaison also suggest that online purchases have grown strongly over recent years.”
• Growth of online spending: “Since 2005, the value of online spending on debit and credit cards has grown at an average annual rate of more than 15 per cent, although over the past year there has been little change in this type of spending.”
• Share of online spending: “online payments account for only around 10 per cent of total domestic payments on credit and debit cards.”
• International electronic purchases: “In total, the value of international electronic purchases has grown at an average rate of 15½ per cent since 2005, which is faster than the growth in electronic domestic purchases of 10 per cent. It is likely that much of this growth in international purchases reflects the significant increase in the number of Australians travelling overseas.”

What is the importance of the economic data?

• The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the short-term outlook for interest rates.

What are the implications for interest rates and investors?

• Rates are effectively on hold for the next couple of month. There is no pressing need for the RBA to change rates either up or down. Price pressures are contained, growth while sluggish in the near term is likely to pick up pace in the second half of the year. And even the job market is looking better with firms having little difficulty in finding staff.

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