“It has posted a real return of 7.4% a year since 1900,” noted Paul Taylor, Head of Australian Equities at Fidelity and Portfolio Manager of the Fidelity Australian Equities Fund.

“If you invested $1 in the Australian market in 1900 it would be worth A$3,054 at the beginning of this year.”

Australia outperformed other major markets such as the US and the UK. South Africa was the next closest performer, as shown below, followed by Sweden then the US.

The maximum return of the local equity market was 51.5% in 1983, according to the research by the team from the London Business School. The minimum return of the market was -42.5% in 2008.

Mr Taylor attributed the long-term outperformance of the Australian equities market to five factors:
– strong population growth
– good natural resource base, 
– good corporate governance, 
– high dividend yield
– high real dividend growth.

“These factors are still very much in place,” he said today.

“The Australian market is attractively valued at well below long-term average levels in terms of earnings, dividend yield and valuation levels. Over the past year the macro economic concerns have overshadowed bottom-up fundamentals and company valuations. At some stage they will revert to the mean.”

Commenting on the review, Steven Tang said it was the largest sector review undertaken by Zenith as it includes all Global, Regional, Country (ex-Australia), Global Small Companies and Index funds.

The Zenith 2011 International Shares Sector Review appraised 180 International Shares products and confirmed:

• 12 were rated HIGHLY RECOMMENDED; and
• 39 RECOMMENDED.

The key changes to the Recommended List post the review include the addition of 7 new funds across various categories, 2 upgrades and 5 downgrades for existing funds.
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Steven Tang noted that it is often assumed that investors are willing to pay higher fees for active management based on the skill of the underlying manager and consequent presumed outperformance of a passive benchmark. However, it is logical to assume that this ability to outperform is contingent on the manager being truly active i.e. adopting positions away from the passive benchmark.
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“Zenith believes that the international share sector affords the greatest scope for active management, relative to all other sectors, given the size and breadth of the investable universe,” added Steven Tang.

Relative performance has been good since MFS started managing the fund and it is meeting its objective over each rolling three-year period to March 31, 2011.

Pleasingly, this has also been achieved with lower volatility relative to the benchmark.

“The fund is actively managed by 10 equity research analysts. Each analyst is responsible for stock picks in their industries so each analyst is a portfolio manager. Experience levels vary significantly—the most junior has only three years and the most senior has 24. The team structure provides a good platform for junior members to develop their portfolio management skills but it also means that relatively junior members are making investment decisions. It is preferable to see experienced analysts in this kind of structure, but we are generally comfortable that the manager takes its time in allowing analysts to get up to speed on industries and grow into the MFS culture,” said S&P Fund Services analyst Simone Gavin.

Ms. Gavin added that average team tenure is improving but continues to be low relative to some higher rated peers, reflecting a number of departures within the longer-standing analytical ranks over the past few years. That said, since our last review the team appears to have settled and our conviction will increase further with continued stability and consistency in industry coverage.

The funds affected by this announcement are:

Many investors buy gold producing companies to gain a leveraged exposure to movements in gold prices. The S&P/ASX All Ordinaries gold index increased just 38% over the three years to May 2011 while the US dollar gold price rose 73% and the Australian dollar gold price was up 55%.

“Among the 47 stocks within the Australian index, only 22 rose by more than the rise in the Australian dollar gold price,” said John Robertson, E.I.M. Capital Managers.  Only 19 rose by more than the rise in the US dollar gold price.

The stock prices of gold companies can perform poorly against movements in the physical gold price because:
gold stocks are exposed to equity market conditions which might be less buoyant

• operational risks can affect output adversely
• development risks can delay production starts
• the financial condition of the company may retard market valuations

All or some of these factors can detract from a company’s share price compared to the gold price.

“The range in stock returns can be enormous.  Over the three years to May 2011, the weakest performing gold stock in the index lost 79% while the strongest returned 1900%.  The largest and best known stock in the sector, Newcrest Mining, delivered a sub-par return of 25%.

“Investors seeking the leverage equity investments can deliver need to structure the gold segment of their portfolios to take account of the high probability that the share price of a gold producer, no matter how well known, could fall short of the gold price rise thy are seeking to capture,” said Mr Robertson.

E.I.M.’s Emerging Resources Company Share Fund has delivered an annualised rate of return after fees of 16.7% over the five years to 31 May 2011 putting it in 4^th place in the Morningstar rankings of over 2,000 retail investment trusts in Australia.

Paul Taylor, Head of Australian Equities at Fidelity and Portfolio Manager of the Fidelity Australian Equities Fund, provides his outlook for the Australian stock market and why the market is presenting so many opportunities for stock pickers.

It could be a good time to buy Australian equities, according to one of the country’s best performing fund managers.
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Where do you see the Australian market heading for the rest of 2011?

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“While we are positive on the outlook for the Australian market in 2011, there are some black macro clouds hanging about. One is the European sovereign debt crisis, which began as concerns around Greece, spread to Ireland and could engulf Portugal and Spain. Another is the instability or geopolitical risk in the Middle East and north Africa that is boosting oil prices. A third is that the Chinese government is trying to slow the country’s economic growth to control inflation. Then there are the repercussions from Japan’s earthquake. Lastly, there is still a question mark over the US economy even though many economic indicators, from retail sales to production, are improving.
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“But when we look through these clouds we see a lot of positive signs within the Australia stock market. The market is trading cheaply on a 12-times price-to-earnings ratio, which is below the historical average of over 16-times. It is offering a dividend yield of about 4% to 5%, which is historically attractive. Australian companies are in good shape. They have repaired their balance sheets; in fact, some have built up such large cash reserves you could say they have lazy balance sheets. The Australian economy is in relatively good shape.
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“At a stock level, we are seeing some exciting opportunities – some great companies are trading at cheap prices.”
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What do you see as the main themes that will surface in the market in the next 12 months?
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“Over the next 12 months we are likely to see the continuing theme of a two-speed economy; a strong resources sector but also a strong Australian dollar and higher interest rates with their negative consequences for other segments of the economy. We could also see further merger and acquisition activity as companies with strong cash flows and balance sheets identify value in the market and potentially look for more growth opportunities. This could be both onshore and offshore activity.
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“The significant growth in smart phones, tablets, mobile telecommunications, online retailing and online media distribution is also likely to be a growing theme in the market over the next year and beyond with implications across multiple sectors.”
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What are your top overweight holdings and why?
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“Key sector overweights for the portfolio are the industrials, healthcare, materials and energy sector but these outcomes are built from the bottom up. So what we’re seeing in those different sectors are good companies at bargain prices. We think in this environment you want to be focused on pricing power; you want to be focused on the growth of the company.

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“What we’ve seen generally is that the valuation of the whole market has gone down based on these big macro fears, but the market is not discriminating between companies. That’s why we are seeing great stock-selection opportunities. When the whole market is priced at a lower level, there’s a great opportunity to pick up high-quality, high-growth companies on cheap valuations. And that’s what we have been doing across sectors.
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“In terms of sectors, mining services and engineering firms should benefit from the significant investment planned in major resource and infrastructure projects. This strong demand should lead to an improvement in contract terms like a move to a cost-plus basis and higher charge-out rates. Healthcare should see strong structural growth and should be relatively unaffected by the rising interest-rate environment. Within healthcare, I like the industry leaders and those stocks benefiting from structural growth themes.
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“If I look at some of the key overweight stocks positions in the Fund – Rio Tinto, Wesfarmers, MAp, Commonwealth Bank, ANZ and Oil Search – they are there because we think they are good companies with solid balance sheets and strong growth opportunities that are attractively valued.”
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What are your views on material stocks?
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“Within the mining sector, we prefer the big-cap miners over the smaller miners. We see the big miners as great investment opportunities at the moment.
x
“Right now all the miners – big and small – are trading on similar multiples, which is unusual. History tells us that the big miners such as Rio Tinto and BHP Billiton should trade at significant premiums to the small-cap miners because they have diversified earnings streams and quality management, are proven operators and own the tier-one assets – the low-cost, long-life mines.
x
They should trade at a premium to the small-cap miners. But when commodity prices are rising, the market generally gets excited about small-cap miners.
x
“The fact that all miners are trading on similar valuations opens up a fantastic opportunity to invest in the big miners because that’s where the value is. To us, the great opportunity is Rio Tinto. On top of having the low-cost, long-life mines, Rio Tinto is trading at a valuation discount to BHP Billiton. So within the mining sector, Rio Tinto to us is the standout investment.”
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What are your views on the banks?
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“Australian banks are reasonably valued at the moment. They are offering a good dividend yield. While their lending growth is slowing, their margins are improving. So from a sector point of view, I think banks are reasonable investments at the moment.
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“Within the banking sector, our preferences are for Commonwealth Bank and ANZ. We think these two banks are the best positioned because they have the best growth opportunities and have the lowest-cost funding.”
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What do you think are the key risks for the next 12 months?
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“There are probably a few key risks for the Australian market over the next 12 months, the first of which is interest rates. The market still expects the Reserve Bank to boost interest rates in the second half of 2011. A cash rate at 5.25% from 4.75% now could add to pressure in the consumer-discretionary, in the household-spending, sector.
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“The second key risk is China. Chinese authorities are trying to slow economic growth to about 7% to 8% a year, which is still high by world standards. The question if they succeed is: are the Chinese still going to buy commodities at the same rate?
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“Another risk is whether a destabilising macro issue eventuates. In Europe, people are nervous about Portugal and they’re saying if there’s an issue with Portugal it could spread to Spain. These risks are likely to hang over the market at least for 2011.”

Traders are showing greater signs of confidence and are tackling more adventurous investments according to the latest Share Trader Insights Survey launched today by CMC Markets Stockbroking.

CMC’s bi-annual Share Trader Insights Survey measures the trading behaviour of over 500 active share traders and compares the results with previous surveys conducted in 2010.

Overall, confidence is on the rise with 40% of traders planning to invest more money into the share market and only 18% are planning to do nothing – a marked drop from the 33% planning to sit on their hands in the H2 2010 survey. Trader confidence is also reflected by a spike in the number of investors wanting capital growth, rising to 30% from 25% since the last survey, while wealth preservation as an investment goal has fallen to 13% from 15%.

Banks and major resources companies such as BHP Billiton and Commonwealth Bank continued to dominate traders’ top 25 stock picks, but there were some signs of further diversification with companies such as Bluescope Steel, Qantas, Commonwealth Property Office Fund and JB Hi-Fi all increasing in popularity.

“The fact fewer investors are opting to sit on their cash is a strong sign of confidence. It’s a big departure from previous findings which showed investors were either cautious about trading or largely sticking to the large names in domestic equities,” said David Land, chief market analyst with CMC Markets. “Investors are again looking at share trading as a means to grow, rather than protect, their wealth.”

Getting savvy with social media

CMC Markets also surveyed traders’ use of social media and online tools for gathering information and increasing knowledge.

Online articles (22%) and online guides (15%) are the most important sources of information for increasing trading knowledge, followed by more traditional media forms including personal finance magazines (13%), newspapers (13%) and trading magazines (10%). According to the survey, trading tips are most in demand (19%), followed by analyst reporting (14%) and commentary (12%).

Looking at social media, trading websites are the most popular forms of social media for increasing their level of investment knowledge (used by 57% of traders) with forums, blogs and webinars also high on the list.  Facebook gained favour with only 9% of traders and was marginally more popular than Twitter with 8%. By age, 25 -34 year olds comprised almost half of traders who used Facebook and 59% of those who used Twitter were under 35. Meanwhile investors aged 45 and over were more likely to use an iPhone.

“The research confirms the social media phenomenon is extending to our trading habits with trading websites and i-Phone apps considered a useful source of information. This is consistent with our experience; CMC has seen a steady increase in traffic to our online trader tips and blogs,” said Mr Land.

SGX gets thumbs down while Chi-X more warmly received

Traders were also quizzed on their reaction to current events including the proposed takeover of the Australian Securities Exchange (ASX) by the Singapore Stock Exchange (SGX) and the entry of alternate exchange Chi-X to the Australian market.

Only half of investors knew the ASX is a publicly listed company and 24% think it is government owned. Therefore it’s not surprising 32% said they were opposed to the takeover, 35% were supportive and 32% were neutral.

By contrast, 43% were neither opposed or supportive of Chi-X, 35% were supportive and only 22% were actually opposed.

“The fact people don’t mind another entrant into the market, yet are opposed to a takeover of the ASX tells us there is much emotion and nationalistic sentiment tied to the ASX with many people believing it’s a state-owned asset of national significance,” said Mr Land.

Herd Index shows timing the market is still tricky for traders

The survey also encompasses the CMC Markets Herd Index, which measures trading patterns against market movements. The Herd Index has continued the pattern of previous surveys with 44% of traders moving money into the market during January 2011 as the All Ordinaries Index rose.

“The Herd Index shows investors are continuing to move money in to the market when it is on its way up, then out when its going down, meaning they are entering and exiting at the wrong times,” Mr Land said.

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Traders are showing greater signs of confidence and are tackling more adventurous investments according to the latest Share Trader Insights Survey launched today by CMC Markets Stockbroking.

CMC’s bi-annual Share Trader Insights Survey measures the trading behaviour of over 500 active share traders and compares the results with previous surveys conducted in 2010.

Overall, confidence is on the rise with 40% of traders planning to invest more money into the share market and only 18% are planning to do nothing – a marked drop from the 33% planning to sit on their hands in the H2 2010 survey. Trader confidence is also reflected by a spike in the number of investors wanting capital growth, rising to 30% from 25% since the last survey, while wealth preservation as an investment goal has fallen to 13% from 15%.

Banks and major resources companies such as BHP Billiton and Commonwealth Bank continued to dominate traders’ top 25 stock picks, but there were some signs of further diversification with companies such as Bluescope Steel, Qantas, Commonwealth Property Office Fund and JB Hi-Fi all increasing in popularity.

“The fact fewer investors are opting to sit on their cash is a strong sign of confidence. It’s a big departure from previous findings which showed investors were either cautious about trading or largely sticking to the large names in domestic equities,” said David Land, chief market analyst with CMC Markets. “Investors are again looking at share trading as a means to grow, rather than protect, their wealth.”

Getting savvy with social media

CMC Markets also surveyed traders’ use of social media and online tools for gathering information and increasing knowledge.

Online articles (22%) and online guides (15%) are the most important sources of information for increasing trading knowledge, followed by more traditional media forms including personal finance magazines (13%), newspapers (13%) and trading magazines (10%). According to the survey, trading tips are most in demand (19%), followed by analyst reporting (14%) and commentary (12%).

Looking at social media, trading websites are the most popular forms of social media for increasing their level of investment knowledge (used by 57% of traders) with forums, blogs and webinars also high on the list.  Facebook gained favour with only 9% of traders and was marginally more popular than Twitter with 8%. By age, 25 -34 year olds comprised almost half of traders who used Facebook and 59% of those who used Twitter were under 35. Meanwhile investors aged 45 and over were more likely to use an iPhone.

“The research confirms the social media phenomenon is extending to our trading habits with trading websites and i-Phone apps considered a useful source of information. This is consistent with our experience; CMC has seen a steady increase in traffic to our online trader tips and blogs,” said Mr Land.

SGX gets thumbs down while Chi-X more warmly received

Traders were also quizzed on their reaction to current events including the proposed takeover of the Australian Securities Exchange (ASX) by the Singapore Stock Exchange (SGX) and the entry of alternate exchange Chi-X to the Australian market.

Only half of investors knew the ASX is a publicly listed company and 24% think it is government owned. Therefore it’s not surprising 32% said they were opposed to the takeover, 35% were supportive and 32% were neutral.

By contrast, 43% were neither opposed or supportive of Chi-X, 35% were supportive and only 22% were actually opposed.

“The fact people don’t mind another entrant into the market, yet are opposed to a takeover of the ASX tells us there is much emotion and nationalistic sentiment tied to the ASX with many people believing it’s a state-owned asset of national significance,” said Mr Land.

Herd Index shows timing the market is still tricky for traders

The survey also encompasses the CMC Markets Herd Index, which measures trading patterns against market movements. The Herd Index has continued the pattern of previous surveys with 44% of traders moving money into the market during January 2011 as the All Ordinaries Index rose.

“The Herd Index shows investors are continuing to move money in to the market when it is on its way up, then out when its going down, meaning they are entering and exiting at the wrong times,” Mr Land said.

The post Confidence returns as traders get active and more adventurous, CMC Markets survey says appeared first on AdviserVoice.

The big picture

• The big issue across the globe at present is inflation. At the start of the year sharply rising food prices prompted riots in Algeria, with dissatisfaction quickly spreading to Tunisia and Egypt. The unrest in Egypt also served to unsettle other regimes across the Middle East as evidenced in anti-government riots in Jordan, culminating in the dismissal of the government.
• And it’s not just food prices that have been soaring, textile prices have risen sharply over the past five months with cotton doubling in price to record highs and wool hitting the highest levels in 23 years.
• While some may blame speculators for the higher prices, for most markets it is simply the result of supply and demand. Emerging economies have grown strongly, prompting higher demand for food, clothing and other staples. But supply has been struggling to keep up – a function of weather, a delay in response to the surprising strength in demand and industrialisations in many countries that has led to a reduction of agricultural land.
• Of course in some respects, higher prices for agricultural commodities is positive for emerging and developing nations, reliant on commodities for income. But while producers gain, poorer workers, especially in manufacturing and tertiary sectors, are faced with higher living costs. Thus the rising levels of unrest across the developing world as people complain that governments are failing to look after their interests.
• Many advanced nations must wonder what all the fuss is about. In the US, the headline rate of inflation stands at 1.5 per cent while the core rate (excludes food and energy) is just 0.8 per cent. In Australia, recent figures showed underlying inflation at decade lows in the December quarter while the measure of retail prices actually fell by 0.1 per cent.
• But as economies in the US and Europe continue to recover, fuelled by arguably the most stimulatory monetary policies on record, inflation will become a more pressing concern. Certainly longer-dated US treasury bond yields have risen sharply with 10-year yields up 32 basis points in just the past eight days, hitting a 10-month high of 3.76 per cent on February 8. And over the past four months, US 10-year yields have risen by 133 basis points, out-pacing a 75 basis point lift in equivalent Australian bonds.
• China has lifted interest rates for the third time since October last year to head off inflationary pressures and we can expect a progression of other central banks to tighten policy over coming months.

The week ahead

• Lending figures dominate the domestic economic calendar over the coming week while in the US there is a solid array of top-shelf economic indicators due for release.
• On Monday, figures are expected to show another solid lift in housing lending with borrowers locking in commitments made before the November rate hike. Overall we expect that the value of loans lifted by 3 per cent in December after a 2.9 per cent increase in November. But the real test will come when potential borrowers decide to actually take up the commitments made by lenders.
• On Tuesday, data on lending commitments is made, covering personal, lease and commercial categories as well as the housing figures revealed a day earlier. On the same day the Reserve Bank will release minutes of its February 1 Board meeting while ABARES will release its latest Crop Report.
• On Wednesday, the January new car sales figures will be recast by the Bureau of Statistics. Industry data has already been released showing sales of 73,584 vehicles, down 1.7 per cent over the year. CommSec expects the seasonally adjusted estimates provided by of ABS to show a fall of around 2 per cent for the January month.
• On Thursday, detailed monthly employment statistics are released together with January imports data. And on the same day Assistant Governor Philip Lowe presents views on the economy when he fronts an Economics and Political Overview conference conducted by business group, CEDA.
• Overseas, the week starts with key economic data from China. On Monday, trade data is released while on Tuesday the customary barrage of inflation, production, consumer spending and investment figures are released. The old adage used to be that if the US sneezed, the world caught cold. Now it is more accurate to say if China sneezes the world would catch a cold and Australia would get pneumonia.
• In the US, a bevy of market-moving statistics will be released over the week. On Tuesday, retail sales data is issued together with capital flows, business inventories, trade prices and the Empire state index. Economists expect another solid 0.6 per cent lift in retail sales in January after a similar strong gain in December.
• On Wednesday, industrial production figures are issued alongside housing starts and producer prices. The Federal Reserve also releases minutes of the January 26 meeting on the same day. Production is tipped to rise 0.5 per cent with housing starts up 2 per cent to 540,000 and core producer prices (excludes food and energy) up 0.2 per cent.
• On Thursday, consumer prices, the leading index and Philadelphia Fed index are released. Core consumer prices are tipped to edge just 0.1 per cent higher.

Sharemarket

• The Australian profit-reporting season continues in the coming week. And if the past week has been anything to go by, expect companies to be generally sombre on the outlook, especially for consumer-focussed businesses.
• Amongst those to report on Monday include Bendigo Bank and Leighton Holdings. On Tuesday Brambles, Foster’s, Primary Healthcare, MAp group, Commonwealth Property and CFS Retail are scheduled to release earnings. A rash of companies will report on Wednesday including BHP Billiton, CSL, SEEK, The Reject Shop, SMS Management and Dominos Pizza. It’s another big day for earnings reports on Thursday with Coca Cola Amatil, ConnectEast, Prime Media, Qantas, Santos, Westfield and Wesfarmers scheduled to report. And on Friday Automotive Holdings, Billabong, Fortescue, James Hardie, Duet and Consolidated Media are amongst those to report.

Interest rates, currencies & commodities

• Little to report in currency land with major currencies largely trending sideways against the greenback over the past week. What is remarkable is the relative absence of volatility – a trend in evidence across all financial markets. The Aussie dollar is seemingly comfortable near parity against the greenback, holding between US98.5 and 102.0 cents over 2011.
• Bond yields have lifted sharply over the past week as investors have become more confident about the US economic recovery, and similarly more worried about a lift in inflationary pressures. Australian 10-year bond yields have lifted to 10-month highs of 5.75 per cent with 3-year yields up to 5.30 per cent. Interestingly, short-term rates have been largely stable with 90-day bill yields holding near 4.90 per cent.
• In contrast to the inflationary fears, commodity prices have actually retreated over the past week, dragged down by lower energy prices. The CRB futures commodities index hit 28-month highs of 342.17 on February 1 but has since eased by around 1.0 per cent.
• But while overall prices have eased, a key area of strength on commodity markets has been fibres. Cotton prices have lifted to record highs with prices doubling in just under five months. Also doing well is wool with the eastern market indicator soaring to 23-year highs. Demand from Europe has strengthened, Chinese demand has remained firm but supply hasn’t kept pace. In fact wool prices have lifted 45 per cent in US dollar terms in just over four months.

Headline developments

• Nature continued to wreak havoc in Australia, with Cyclone Yasi smashing into North Queensland as a category 5 storm (the highest they get) leaving a trail of devastation. Fortunately due to great preparation and the fact that it missed major population centres there appears to have been only one or two fatalities and the damage was less than feared. Nevertheless it will still have a major impact on the economy. 75% of Australia’s banana crop has been wiped out, up to 20% of Australia’s sugar cane crop has been affected, it will add to the disruption of mining production caused by the floods and will likely have an adverse affect on tourism. Coming on the back of the floods the combined affect is likely to detract 1% off March quarter GDP, likely pushing growth into negative territory, before a return to normal production and flood related rebuilding kicks in pushing growth up strongly from the June quarter. It will make the economy look like it’s on a roller coaster ride. The devastation to the banana crop is also going to have a big impact on inflation. If the experience of Cyclone Larry six years ago is any guide banana prices are likely to rise 250% of more adding at least 0.5% to inflation. This suggests that the combined impact of the floods and cyclone will add 1% to inflation spread across the March and June current quarters.
• While the Reserve Bank of Australia left interest rates on hold after its Board meeting and indicated no urgency to adjust interest rates for the time being, its clear from its Statement on Monetary Policy that it retains a tightening bias. Beyond the short term impact of the floods and Cyclone – which it has indicated it will look through – it sees a slight positive boost to growth coming from rebuilding over the next few years and this combined with a stronger outlook for the global economy, more confidence in the outlook for strong resources investment and expectations that inflation will rise to the top of the target range by the end of 2012 suggests that interest rate hikes are still well and truly on the agenda. That said, we see little reason to change our view that the RBA will sit tight until around mid year – as it waits to get more clarity regarding the conflicting impacts of the floods and Cyclone before then raising rates by a total of 0.5% to 0.75% by year end.
• Turmoil in Egypt remains a concern with worries that it could disrupt trade and oil flows through the Suez Canal or spread to oil producing countries in the Middle East. The latter seems unlikely though given that Saudi Arabia and other oil rich countries tend to use their huge oil revenues to keep cost pressures down for their citizens which in turn helps to subdue dissent. However, this won’t stop markets from worrying about it though as long as the turmoil continues.

Major global economic releases and implications

• US economic data was favourable, suggesting that growth has remained solid into the New Year. Strong gains were recorded in the ISM business conditions indexes, vehicle sales, labour market indicators and weekly mortgage applications. US December quarter earnings continued to surprise on the upside with 71% coming in better than expected. It’s also worth noting that the December quarter GDP data saw the level of GDP rise above its pre recession high – in other words the recovery in the US is actually over and it has now entered an expansion. The improvement in the US economy is clearly being recognised by Fed Chairman Ben Bernanke but he reiterated that the Fed wants to see a sustained period of stronger job growth and that core inflation remains too low. So the US is in a classic sweet spot of improving growth and profits, low underlying inflation and easy money – an environment which is usually very positive for shares.
• It’s a similar story in Europe, which saw more solid business conditions surveys both in the euro-zone and the UK, but the European Central Bank sounding reasonably relaxed about the inflation outlook despite the boost from higher commodity prices. Euro-zone unemployment remained steady at 10%, but unemployment fell to its lowest level since November 1992 in Germany.
• Chinese manufacturing conditions slipped in January, suggesting that tightening measures are starting to impact and possibly adding to confidence that additional tightening won’t become aggressive.
• Elsewhere in Asia export data continued to surprise on the upside in India and Korea, Korean and Japanese industrial production was strong in December and GDP growth remained robust in Taiwan in the December quarter. Clearly strong growth is continuing in Asia, although the pace has slowed from a year ago.

Australian economic releases and implications

• Australian economic data over the past week provided a mixed picture. Credit data remained soft but looks to be stabilising. Business confidence fell sharply but this appears to be mainly due to the floods with business conditions actually improving a bit. New home sales were soft in December as were underlying building approvals. House prices rose modestly in the December quarter but have been largely flat for nine months now. Finally the trade surplus held steady in December despite the floods and points to a modest positive contribution to December quarter GDP growth.

Major market moves

• Share markets had strong gains as solid economic and earnings data offset worries about the turmoil in Egypt. While insurers had a volatile ride, Australian shares rose to their highest level since April last year led by resources stocks on the back of higher commodity prices. The increase in confidence also saw bond yields rise, with investor flows now shifting aggressively away from bonds and into shares on a global basis.
• Commodity prices had solid gains on the back of increasing confidence in the global recovery. Sugar prices hit a 30-year high after crop damage in Australia and India. Strong commodity prices also saw the $A push back above parity against the $US.

What to watch in the week ahead?

• It’s a pretty quite week ahead on the data front in the US with only the trade balance and data for consumer sentiment due on Friday. Consumer sentiment will be watched for further signs of further improvement, although recent freezing weather in the US may have a dampening impact.
• Chinese economic data for January will be watched for signs of a cooling in growth. Trade data is due for release on Thursday and credit and money supply data will be released on Friday. Anecdotal evidence suggests that credit growth was strong in January, as is usually the case at the start of each year.
• In Australia, RBA Governor Steven’s testimony before a Parliamentary committee on Friday is likely to simply reiterate what we have heard over the last week which is essentially that current interest rate settings are appropriate, but that it retains a positive view on the medium term growth outlook and still sees inflation heading up to the top of its target range, all of which is consistent with more rate hikes this year.
• On the data front in Australia, we expect a modest rise in December retail sales (due Monday) to leave real retail sales for the quarter down slightly, consumer confidence (Wednesday) is likely to have been little changed in February after a big flood induced slump in January and employment data (Thursday) is likely to show an increase of 15,000 in January leaving the unemployment rate at 5%.
• The Australian December half earnings reporting season will start in earnest with Cochlear, Rio and Telstra due to report amongst others. The results are likely 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 slowing housing & retail sectors and the strong $A.

Outlook for markets

• After months of strong gains globally and with measures of investor sentiment running at high levels and February normally being a soft month, shares are at risk of a short term correction. However, any pullback should be seen as a buying opportunity as the fundamental back drop for shares is very positive. Valuations are reasonable, the global economic recovery is looking increasingly sustainable, the global liquidity backdrop is very favourable with very low interest rates in key countries, the corporate sector is cashed up 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 at some point this year is very high. Bond yields in key advanced countries are still well below longer-term sustainable levels, at some point market expectations are likely to swing back towards monetary tightening in the US and Australia and the record inflows into bond funds seen in recent years are now reversing.

Headline developments

• The Australian Government announced that it needs around $5.6bn to help rebuild flood affected areas and that it will source $1.8bn of this from a temporary levy on taxpayers with the remainder coming from spending cuts. It makes sense for the Government to still be aiming to return the budget to surplus by 2012-13 as the economy is likely to be a lot stronger by then. However, given that consumer spending is already pretty soft it would have been preferable to see more of the burden placed on spending cutbacks as opposed to households. While the impact of the levy on average income earners is modest (eg only $250 for someone on $100,000) and it is temporary, news of another impost won’t help consumer spending with households already facing sharp increases for food prices, utility bills, insurance premiums, rents and health costs.
• China announced another round of measures to cool its property sector including increases in required down payments for second homes and a ban on the purchase of second homes in all major cities. Quite clearly the tightening process is continuing in China as it struggles to stop capital inflows associated with its management of the Renminbi from spilling over into consumer and asset price inflation. However, so far the tightening is measured and targeted and so we remain of the view that China will not crunch its economy.
• Japan is the latest major advanced country to see its sovereign debt rating downgraded because of its bleak public debt outlook. However, it’s unlikely to have much impact as Japan is actually a net lender to the rest of the world and 95% of Japanese public debt is held by domestic investors. The longer term concern for Japan though is what happens when more of those domestic investors start to retire, as the Japanese population is aging rapidly, and so start running down their holdings of Japanese bonds.

Major global economic releases and implications

• US economic data was generally solid. While house prices remain weak reflecting the lagged response to the ending of the first home buyer tax credit, pending home sales and new home sales rose adding to confidence that the housing sector has found a base. On top of this, consumer confidence rose strongly in January, underlying durable goods orders are continuing to rise and the ISM business conditions index for December was revised up suggesting that manufacturing conditions are even stronger than thought. While unemployment claims spiked in the last week this was mainly due to bad weather. Meanwhile, despite the improvement in the economy it’s still not enough to satisfy the Fed, particularly with underlying inflation measures trending down and unemployment still high and so as a result it is continuing with its quantitative easing program (QE2). President Obama’s State of the Union address also went down well with investors as it continued the shift to a more pro-business stance that has been evident since the Democrats drubbing in the mid term elections late last year. Good economic data, a dovish Fed and an increasingly pro-business President are all good news for investors and US shares in particular for the year ahead.
• US earnings results continued to surprise on the upside, with so far 72% of results coming in better than expected. December quarter 2010 profits are on track to come in 32% above year ago levels.
• Euro-zone data was positive with solid readings for business conditions and confidence in January and a strong rise in industrial new orders. UK GDP fell in the December quarter (partly due to bad weather) adding to confusion over the outlook for the UK economy with inflation surprising on the upside. This confusion was evident at the last Bank of England meeting which seemed to come close to raising interest rates. With the UK yet to feel the impact of recent fiscal tightening, a monetary tightening at this stage would be very dangerous.
• Japanese economic data was mixed with less price deflation than expected and an unexpected fall in the unemployment rate but weak retail sales. Tightening to control inflation continued in Asia with the Reserve Bank of India raising its key interest rates by another 0.25%, with further tightening likely.

Australian economic releases and implications

• Australian inflation data for the December quarter was surprising benign and leaves inflation comfortably within the RBA’s 2 to 3% target range. While food prices are rising solidly, discounting is keeping a lid on inflationary pressures generally leaving plenty of scope for the RBA to leave interest rates on hold in the face of uncertainty caused by the floods. We expect rates to remain on hold out to May at least.

Major market moves

• Share markets generally rose over the last week helped by positive economic and earnings news. The lower than expected rise in Australian inflation also helped the Australian share market by further taking pressure off interest rates.
• Commodity prices were mixed, but with the gold price continuing to fall as the improving global growth outlook is reducing investor demand for assets like gold that benefit from monetary reflation and provide a hedge against a falling US dollar. The Australian dollar and euro rose against the $US.

What to watch in the week ahead

• In the US, the key ISM business conditions survey (due Tuesday) is likely to show a further strengthening in the manufacturing sector and payroll employment data (Friday) is likely to show a gain of 150,000 jobs. Data for personal income and spending (Monday) will also be watched closely but is likely to confirm the pick up in consumer spending evident in other data. December quarter earnings results will continue to flow.
• The European Central Bank meets Thursday, but is likely to leave rates on hold. The EU leaders’ summit on Friday may be more important given the issues around extending the European sovereign debt rescue fund.
• The Reserve Bank of Australia is likely to leave interest rates firmly on hold. Recent economic data has had a soft tone and the benign December quarter inflation data has provided plenty of leeway for the RBA to sit back for several months and assess the impact of the floods on the economy. We expect rates to remain on hold out to May at least but for rate hikes to resume from mid year as flood rebuilding activity combines with mining related investment to push economic growth back up again. The RBA’s Statement on Monetary policy will likely be watched for more clues as to how the Bank sees the floods impacting the economic outlook. Australian data for private sector credit (due Monday) will be watched for further signs of improvement, December quarter house price data (Tuesday) is likely to show flat house prices in the final quarter of the year and building approvals data (Thursday) will be watched for any signs of a rebound after the fall in November. The NAB business confidence survey for December will also be released on Tuesday.
• In Australia, the December half earnings reporting season will start with Crane, NewsCorp and Tabcorp due to report. The results are likely 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 and at risk of further earnings downgrades reflecting the slowing housing and retail sectors and the strong $A.

Outlook for markets

• Share markets are vulnerable to a short term correction. After very strong gains since August last year many technical indicators show that shares generally are overbought, measures of investor sentiment are at high levels suggesting that a lot of good news is factored in and the seasonal tendency is for share market strength in December and January to be followed by weakness in February.
• However, shares are likely to put in good gains through 2011 as a whole so any short term pullback should be seen as a buying opportunity.  Shares are cheap, the run of better than expected global economic data is continuing suggesting that 2011 is on track for strong economic growth which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very easy monetary conditions in key countries, the corporate sector is cashed up and US mutual fund investors are starting to shift out of bond funds into share funds.
• The Australian dollar is at risk of a further correction in response to ongoing uncertainty about the impact of Chinese tightening on commodity prices and as a result of the negative impact on local growth from the floods. However, the broad trend is likely to remain up as the $US 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 at some point this year is very high. Bond yields in key advanced countries are still well below longer term sustainable levels, at some point market expectations are likely to swing back towards monetary tightening in the US and Australia and the record inflows into bond funds seen in recent years are now reversing.