Market Review
31-Jul-2010
International Economic
Review
United States
US GDP growth slowed to an annualised rate of 2.4% in
the June quarter compared to 3.7% in the March quarter. Much of the slowdown
was driven by a smaller contribution from inventories and a surge in imports
which caused net exports to subtract 2.8 percentage points from growth.
Underlying domestic demand conditions looked solid, with growth in final sales
to domestic buyers accelerating to 4.1% from 1.3% in the March quarter.
Business investment also rose, adding 1.5 percentage points to GDP.
Most other economic data released in July continued
to be on the weaker side of expectations. The key labour market data, non-farm
payrolls, fell 125,000 in June as temporary census hiring came close to an end.
This was the first fall in employment in six months although the unemployment
rate moved modestly lower to 9.5% from 9.7% in June.
Housing starts fell another 5% in June to an annual
rate of 549,000. This is the lowest level in eight months. Retail sales also
fell another 0.6% in June following a 1.1% fall in May. Excluding autos, retail
sales fell 0.2%. The Conference Board's Consumer Confidence Index fell to 50.4
in July from 54.3 in June.
On the inflation front, headline CPI fell for the
third straight month in June (-0.1%), whilst core CPI rose 0.2%. The annual
rate of growth for headline and core CPI stand at a modest 1.1% and 1.0%,
respectively.
The closely watched ISM Manufacturing Index continued
to signal expansion but at a slower pace. The index registered 56.2 in June
from 59.7 in May. The non-manufacturing index also fell to 53.8 after being
steady at 55.4 for three consecutive months.
Europe
In Europe, sovereign credit and default concerns
continued to be the main focus. Hungary sought access to the previously agreed
€20bn loan facility but failed to reach a deal with the IMF and EU. News that
Moody's downgraded Portugal and Ireland's credit ratings added to the
nervousness in the market.
Euroland industrial production rose 0.5% in May,
bringing the annual rate to 6.1%. Retail sales rose a meagre 0.4% but that was
better than the 0.1% recorded in the previous month. Headline and core CPI were
unchanged in June, leaving their annual rates at 1.4% and 0.9%, respectively.
On the outlook, the two closely watched proxies for
European economic growth showed some diversion in their latest readings. The
German IFO Index rose slightly to 106.2 in July from 101.8 in June, while the
ZEW Economic Sentiment Index slumped another 7.5 points to 21.2 in July, having
peaked in April at 53.
Asia
In Japan, industrial production fell 1.5% in May,
bringing the annual rate down to 16.9% from 20.4% in April. The closely watched
proxy for the growth outlook, the Shoukou Chukin's Small Business Confidence
Index rose 0.7 points to 48.1 in June, its highest level since November 2007.
Deflationary pressures remain prevalent with annual headline and core CPI
standing at -0.7% and -1.5%, respectively. The unemployment rate continued to
tick higher to 5.3% in June.
In China, the pace of economic growth moderated to
10.3% annualised in the June quarter from 11.9% in the March quarter.
Industrial production fell to 13.7% in annual terms in June compared to 16.5%
in May while fixed asset investment growth remained around 25%. Headline CPI
was milder than expected at an annual rate of 2.9% compared to 3.1% in May. On
the outlook, both China's purchasing managers indices declined in the latest
readings. The Markit Index slipped 2.3 points to 50.4 in June while the
National Bureau of Statistic's measure fell 0.9 points to 51.2 in July.
Australian Economic Review
The much anticipated CPI figure came in lower than
expected, rising only 0.6% in the June quarter to be 3.1% higher in annual
terms. The underlying or core measures, the trimmed mean and weighted median,
both rose 0.5% to be up 2.7% over the year. These inflation measures are now
back inside the RBA's 2-3% target range.
Employment rose 45,900 in June following a revised
22,800 (previously 26,800) rise in May. This brought total jobs growth for the
calendar year to date to 180,000. June's rise was driven by part time
employment (+27,500) although full time employment also rose (+18,400). The
unemployment rate was steady at 5.1%.
Private sector credit growth slowed to 0.2% in June
from 0.5% in May. The housing credit component grew 0.4% while business credit
was flat and personal borrowing fell by 0.3%. The NAB Business Survey showed
confidence fell slightly to +4 in June following an 8 point plunge in the prior
month. Business confidence has been impacted by raising interest rates, the
falling A$ and global financial market uncertainty.
Retail sales rose 0.2% in May after a 0.6% rise in
April. Over the year, sales are up only 0.6% as higher interest rates and wet
weather dampened spending. Consumer confidence improved with the
Westpac/Melbourne Institute measure rising 11.1% to 113.1 in June. This is the
first rise in four months.
On the outlook, the annualised growth rate of the
Westpac-Melbourne Institute Leading Index, which indicates the likely pace of
economic activity three to nine months into the future, was 6.7% in May. This
was slightly lower than the 7.6% in April, but remains well above its long term
trend of 3%. The annualised growth rate of the Coincident Index was 3.7%, also
above its long term trend of 3.1%.
Equity Market Review
International Sharemarket Review
Global equity markets rebounded strongly in June despite
mixed economic data releases in the US and Europe. Shares were buoyed by better
than expected earnings reports in the US and the results of the European bank
stress tests in which only 7 of the 91 European banks failed to pass.
As investors became less risk averse, cyclical
sectors started to outperform whilst defensive stocks lagged. Financial stocks
were boosted by the European bank stress test results but US banks
underperformed due to the Dodd-Frank regulatory bill which was passed during the
month.
Major bourses performed for the month as follows:
Japan Nikkei 225 +1.6%
UK FTSE 100 +6.9%
US Dow Jones +7.1%
US S&P 500 +6.9%
German DAX
+3.1%
Australian Sharemarket Review
The Australian sharemarket enjoyed stronger
performance this month, with the S&P/ASX 200 Accumulation Index returning
4.5%. The main factors driving the strength in the market were:
* Relief over the outcome of the European banks'
stress tests. This eased conditions in global and local credit markets and enabled
the bank sector (+8.8%) to outperform the broader market.
* The Federal Government's decision to dump the
Resources Super Profit Tax in favour of a less imposing Minerals Resource Rent
Tax. This boosted the resource sector (+4.6%).
Defensive sectors such as consumer staples (+1.7%),
property trusts (+1.0%) and healthcare (+0.9%) underperformed in the month as
investors became less risk averse. The healthcare sector was also impacted by
the appreciation of the Australian dollar against the US dollar as many
Australian healthcare companies have significant US dollar revenues.
With the reporting season pending in August, several
companies updated the market on their earnings outlook. IAG (flat) and QBE
Insurance (-8.2%) warned that earnings would be below expectations whilst
Adelaide Brighton (+18.3%) and Macarthur Coal (+3.1%) upgraded their guidance.
Large Caps
The best performing Australian large cap stocks
during the month were Intoll Group (+41.3%), Downer EDI (+38.1%) and Centennial
Coal (+34.7%).
* Intoll announced that it was the subject of a
takeover offer by the Canadian Pension Plan Investment Board. The company's
shares rose 30% on the day of the announcement.
* Downer EDI rebounded strongly following news that
the company had won a $2 billion construction contract.
The worst performing Australian large cap stocks
during the month were Nufarm (-29.1%), Aquarius Platinum (-19.8%) and AWE
(-12.1%).
* Nufarm fell sharply after announcing that its FY10
net profit before one-offs was expected to be around $55-65 million. This
compares to the company's previous guidance of around $110-130m. The company is
experiencing margin weakness across all regions and weak seasonal conditions in
Europe and the US.
* Aquarius Platinum was impacted by several deaths at
its South African mine. This has prompted the South African government to look
more closely at the company's safety practices.
Small Caps
The best performing Australian small cap stocks
during the month were Arafura Resource Ltd (+69.0%), Rivercity Motorway
(+65.0%) and Deep Yellow (+57.7%).
* Arafura Resource Ltd was boosted by favourable
conditions in its key commodities - rare earth, phosphate and uranium. Rare
earth prices are at historic highs due to Chinese quota restrictions, uranium
prices have risen strongly in recent weeks due to buy side demand and phosphate
demand is increasing.
* Rivercity Motorway rallied sharply after reporting
the highest number of daily trips through its CLEM7 tunnel since tolling
started in April.
The worst performing Australian small cap stocks
during the month were Indophil Resources (-27.4%), Resolute Mining (-26.5%) and
Programmed (-21.3%).
* Indophil Resources performed poorly after relisting
its shares mid-month and announcing that it has not yet received clear
information on the potential ban on open pit mining in South Cotabato in the
Philippines.
* Resolute Mining was impacted by the general
weakness in gold stocks as investors moved into less defensive sectors.
Major indices
The major indices performed as follows during the
month:
S&P/ASX 200 Accumulation Index +4.5%
S&P/ASX 200 Industrials Accumulation Index
+4.4%
S&P/ASX 200 Resources Accumulation Index +4.6%
S&P/ASX Small Ordinaries Accumulation Index +5.2%
Listed Property
The listed property market underperformed in July
with the S&P/ASX 200 A-REIT Accumulation Index returning only 1%. This
mainly reflected an easing in global risk aversion which prompted investors to
move out of defensive sectors, like property, and back into financials,
cyclicals and resource stocks.
Trusts in the diversified (+2.3%) and industrial
(+2.0%) sectors outperformed, whilst the retail sector lagged (+0.1%). ING
Industrial Trust performed very strongly, rising 18.7%. This was in response to
speculation that the trust may divest Summit, rumours of a possible merger and
an announcement that ING is reviewing a number of strategic options for the
trust. Dexus Property Group also performed well (+5.8%) due to speculation in a
newspaper article that the trust may be taken over.
Goodman Group (-3.1%) performed poorly due to
concerns about global growth and on-going issues surrounding an asset swap.
Charter Hall Retail (-3.6%) also underperformed although this appeared to be a
pullback from the stock's very strong performance last month.
Fixed Income Review
Australian Fixed Income Review
The Reserve Bank of Australia left the official cash
rate unchanged at 4.50% in July. Having lifted official interest rates to more
"normal levels", the RBA is now on hold, assessing both local and
offshore developments. The bank has flexibility with policy to go either way
depending on how things play out in the months ahead. Ongoing global concerns
and still well behaved inflation makes it sensible to pause for now.
The latest run of economic data has been more mixed
with evidence that the rate hikes delivered thus far are having some impact.
This does not mean rate hikes are over. It simply means a pause to assess. The
well behaved June quarter inflation report and the Federal election campaign
seem certain to keep the RBA sidelined for now.
In terms of local fixed income market moves, July was
a fairly calm month delivering relatively modest moves. The benchmark 10-year
Government Bond closed 0.09% higher in yield at 5.20% whilst the more RBA
sensitive 3-year Bond also moved higher in yield, closing up 0.08% at 4.64%. In
spite of slightly higher yields, credit related gains within the benchmark
universe enabled the UBS Composite Bond Index to deliver a modest positive
return of 0.26%.
International Fixed Income Review
Sovereign credit and default concerns continue to be
a dominant theme in global fixed income markets. Bank solvency and liquidity
are still being questioned within Europe. The release of EU bank "stress
tests" provided some comfort towards month-end although criticisms of this
review persist. In the end, just 7 out of 91 European banks failed the stress
tests and corrective measures for these have begun.
US economic data that was released in the month has
definitely become more mixed. In his latest testimony, US Federal Reserve
Chairman Ben Bernanke described the outlook as "unusually uncertain".
In the EU, economic releases and confidence measures remain mixed, although
Germany has performed better. Japan has also experienced mixed data, raising
fresh concerns about growth.
Central banks provided no policy changes over the
month. Official interest rates in Japan, the US and UK remain effectively zero
(all 0.50% or lower) and the US Fed has flagged ongoing low rates for an
extended period. The European Central Bank (ECB) maintains its official rate at
just 1%.
In terms of price action, the major markets were
calmer than they have been in several months. The US 2-year Treasury note
closed at 0.55%, down 0.05% and 10 year Note, the global benchmark, closed at
2.91%, down a slim 0.02%. The global fixed income market, as measured by the
Barclays Capital Global Aggregate Index (hedged into A$), delivered a positive
return of 1.14%.
Market Outlook
31-Jul-2010
Economic Outlook
The softer than expected US second quarter GDP data
confirmed that growth momentum has slowed going into the second half of this
year. Whilst capital expenditure is firm and export growth is accelerating, the
hesitant consumer and continued weaknesses in housing suggest activity should
grow at a more modest pace in the next few months. The market is expecting the
economy to grow at an annualised rate of closer to 2% next quarter. More
broadly, however, the low interest rate environment, firming global demand and
the competitive US$ mean the slowdown should only be temporary hence we expect
the US economy to re-accelerate in 2011. The market will continue to keep a
very close eye on job creation and the Federal funds rate is expected to stay
low for an extended period.
European growth will continue to face headwinds. The
ongoing recovery in exports is expected to support growth but the momentum will
be less in the second half of this year as the support from the weaker euro
diminishes. The implementation of fiscal austerity packages will lead to a
slowdown in growth that should last until well into the next year. While there
was some relief that only 7 out of 91 European banks failed the EU capital
position stress test, there is still concern over the continued strain in the
banking system. Europe still has relatively tight financial conditions and
credit is not flowing freely in the economy.
In Japan, growth should continue in the near term
although the pace may slow in response to weaker growth in Japan's major
trading partners. Nevertheless, the recovery does appear to have broadened from
exports to private domestic demand. This reflects the rebound in corporate
profits and a modest improvement in labour and income conditions. The major
risk to a sustainable recovery in Japan continues to be the extent of
deflationary pressures throughout the economy.
In China, growth has slowed and inflation pressures
have eased. The tighter policy response by the authorities has curbed excessive
growth in targeted areas, including the much elevated property market. With the
recent weaker commodity prices also affecting domestic inflation measures,
policy could move towards neutral in coming months. Outright policy easing
would only occur if there was a deeper downturn in the economy.
For Australia, the domestic economy remains
resilient, with the labour market moving closer to full employment. Price
pressure looks to have moderated and inflation has returned to Reserve Bank's
2-3% target range. In this environment, the RBA will leave interest rates
steady in the next few months. The upcoming Federal election will most likely
be a "non event" for the economy in the short term as neither of the
major political parties is expected to unveil major spending initiatives. Both
parties are committed to returning the budget to surplus in FY13 which means
government debt is now projected to peak at 6% of GDP in FY12.
Sharemarket Outlook
The recent recovery in global equity markets is a
very promising development. Despite mixed economic data in the US and Europe,
investors are now focusing back on earnings and the current reporting season in
the US has been better than expected. To date in the Q2 2010 US reporting
season, 70% of S&P 500 companies have released earnings reports. In
aggregate, reported earnings have beaten expectations by 10.6%. This is a very
solid result which reflects a combination of stronger revenues and cost
control. On the negative side, some US companies have modestly revised down
their expectations for earnings in FY11. This highlights the importance of a
sustainable economic recovery to on-going earnings growth and sharemarket
performance.
The recent recovery in global sharemarkets is likely
to continue in the near-term as global risk aversion has diminished, cash
levels are high and investors are reweighting out of defensive stocks and back
into cyclicals and resources. Global interest rates are also expected to stay low
for the foreseeable future and this should support sentiment.
Risks to this outlook clearly remain, especially in
Europe where credit markets are tight and liquidity is not flowing freely
through the economy. European growth will also be constrained by austerity
measures as governments try to reduce large debt burdens.
In Australia, global developments remain important
but the main focus over the next few weeks will be the August reporting season.
Of particular interest will be management comments on the economic outlook and
earnings guidance for the year ahead. On the positive side, the Australian
sharemarket is not expensive and equities look very cheap compared to bonds
globally. Institutional cash levels are also quite high and this should provide
some support to the market if companies deliver on earnings.
Fixed Income Outlook
Australian Fixed Income Outlook
Our outlook for Australian fixed income is little
changed from last month. The RBA, having returned official interest rates to
longer run averages, has now paused in its policy tightening cycle to assess
local and global developments
The market is now pricing in an unchanged cash rate
of 4.50% right through until late next year. This suggests that the RBA has
policy flexibility. If global sovereign debt problems lead to significantly
weaker economic conditions, the RBA can implement rate cuts. By contrast, if
the situation stabilises and our economy continues to strengthen, the Bank may
resume tightening towards year end. At present, the jury is out.
Since the market is currently pricing in no further
rate rises, there is some risk to future returns. If sovereign debt fears
stabilise, the RBA may need to raise rates beyond neutral towards a restrictive
policy setting and some adverse performance impact may ensue. However, if the
sovereign debt situation causes a "double dip" recession, the RBA has
plenty of room to lower its key official interest rate. If this occurs, fixed
income returns may be reasonable but yields are already well below long-run
averages. This suggests that positive returns are possible but outsized returns
are unlikely from here.
International Fixed Income Outlook
The key drivers of international fixed income markets
continue to be large fiscal deficit positions in most countries and the pace of
global economic growth. Almost every developed country faces a sizeable budget
deficit and large borrowing requirement despite recently announced austerity
measures. This is the biggest test the EU has faced as a bloc since its inception.
Although the massive "flight to quality" into major global bond
markets in response to sovereign debt concerns appears to have stalled in July,
investors remain wary.
Economic headwinds clearly remain. Recent US data has
been mixed and the Eurozone has probably lost some growth momentum, although
core economies like Germany and France may benefit from stronger exports in
response to the weaker Euro.
The US Federal Reserve has flagged that the Funds
Rate should stay low for an extended period. Fed Chairman Bernanke has
described the outlook as "unusually uncertain." Inflation remains low
and of little near term concern. Core inflation at just 0.9% year on year is at
its lowest level since 1966 and headline inflation is just 1.1% (yoy).
In the US, expectations for the first rate hike have
been pushed back to late next year. If the US economy resumes its trend
improvement in the second half of the year, then rate rise expectations may be
brought forward. Should this occur, bond returns may be adversely
impacted.
The current sovereign debt problems are a worrying
and complicating factor for fixed income markets. We expect volatility in bond
yields to continue through the forecast period. With yields in all the major
markets trading well below long-run norms, there remains the possibility of a
period of very low, or even negative fixed income returns.
