Market Commentary - August 2012
by Brendan Gallagher
Investment market’s focus on Europe has continued to dominate headlines over the past quarter with Spain now replacing Greece on centre stage. Sovereign debt and banking issues of these countries, together with nervousness of the recent Greece elections, led to falling markets in May and early June. Since then, share markets have strengthened as each of the European spot fires has been extinguished.
The Australian share market has experienced a rollercoaster ride during the past 3 months with a high reached in early May of 4,429, falling below 4,000 by early June, recovering to 4,312 by 8 August. Market sentiment was a big factor in this initial fall and was dominated by uncertainty emanating from Europe and sluggish figures reported from the US. Contributors to this recovery include the telcos, banks, food, drug retailers and property.1 A focus on the yields that these sectors deliver has been a key driver for this pick up in performance.
The Australian share market has added 7.46% so far this year as measured by the ASX 300 Accumulation Index. Interestingly, small companies have not fared as well, falling 2.79% over the same period.
The Australian economy surprised on the upside recently, with economic growth of 1.3% for the first quarter of 2012 and 4.3% for the year. This strong growth can be attributed to a number of factors, which includes mining investment and a cyclical rebound from floods.2 Employment has been stable, with unemployment rates at 5.2%.
Inflation continues to fall and is now below the Reserve Bank of Australia’s (RBA) target range of 2-3%, prompting a further 0.25% rate cut by the RBA in June. The RBA has left official interest rates on hold at 3.5% in both the July and August meetings, but has not ruled out further cuts later in the year.
Although interest rates have fallen sharply, the Australian dollar remains strong. The yields on Australian bonds may be falling but they remain considerably higher than other developed markets. Instead of 0.8% to 1.5% for international bonds, our higher rates combined with their AAA rating makes our bonds quite attractive. Over 80% of Australian bonds are now owned by international investors.
Since the RBA lowered interest rates by 0.75% during May and June, the Australian dollar has risen from US 99 cents in June to $US1.06 in early August. This strong local currency continues to hurt a number of sectors in the Australian economy.
The lower interest rates though, offer a welcome relief for Australians with large mortgages. Although government and corporate debt has been reduced in recent years to relatively low levels, household debt levels remain high at 110% of GDP. The focus on reducing debt levels is being helped by lower interest rates and steady employment however, this in turn leads to weaker consumption, making life difficult for retailers.
In contrast to the RBA loosening monetary policy as inflation falls, the federal government is tightening fiscal policy. The only reasoning behind this policy appears to be political rather than a financial or economic prerogative. The government appears hell bent on delivering a small budget surplus in 2013 - an election year! So rather than stimulating parts of the economy that are clearly suffering, the federal government’s purse strings are being pulled tight so that our report card can be stamped “surplus”.
The headwinds facing the Australian economy continue to be falling commodity prices, albeit from record highs, and low levels of consumer and business confidence.
Global economic growth is expected to slow to 3.5% for 20123. Most of this growth will be contributed to by emerging economies, with the developed economies experiencing sluggish growth.
European leaders continue to be challenged by the balancing act of austerity policies needed to reduce debt, versus the need to stimulate the economy to promote growth. Their economies are slowing, and so many leaders are questioning the current mix of policies that are aimed at different outcomes - both of which are important. The structural issues of the 17 member countries of the Euro do not assist this process. Its inflexibility makes decisive implementation of policies very difficult.
The US federal election will be a major focus during the second half of 2012, as the large budget deficit will need to be addressed. A number of austerity measures that were included as part of the deal to increase the debt ceiling in mid 2011, will come home to roost in January 2013. Hopefully the government can renegotiate these measures, and if not, significant tax increases and spending cuts will commence. Also of interest will be US housing, where activity and prices have shown positive signs recently.
Japan experienced a difficult 2011 due to the Japanese earthquake and tsunami but 2012 is looking much better. The Bank of Japan is striving to increase inflation from the current level (zero) by implementing powerful monetary easing, leading to a weaker yen and helping export industries.
The slowing of Chinese economic growth has been an issue for a number of market commentators. While growth slowed markedly in the first half of 2012, this appears to have stabilised. The recent June quarter report indicated that the Chinese economy is growing at 7.6% - the envy of most of the world, however it is well below Chinese economic growth from a couple of years ago. The Governor of the RBA, Glenn Stevens, announced in August that their view of China is of more stable and sustainable growth.4 Growth of approximately 8.00% appears to be likely.
Property, specifically Australian Real Estate Investment Trusts (AREITS), continue to improve. In July, AREITS returned 5.55% and are up 22% for the year to date. With cash rates falling to less attractive levels, other avenues of extracting yield such as property, bonds and Australian shares are becoming more attractive.
The outlook appears to be more of the same where short term periods of uncertainty lead to fast changes in the market’s performances. For the second half of 2012, eyes will again be focused on European leaders as they weave their way through the multitude of issues. Increasing focus will be on the upcoming US elections and the fiscal policy decisions that the US government needs to address before the end of the year.
1 Van Eyk Research – Investment Market Report Australia August 2012
2 Lonsec Quarterly Outlook - September Quarter 2012
3 Lonsec Quarterly Outlook - September Quarter 2012
4 RBA – Statement by Glenn Stevens, Governor: Monetary Policy Decision 7. August 2012
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