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| Kreston Dormers Financial Services Pty Ltd |
The ASX 200 was flat this week with Materials offsetting other sectors' weaknesses. Materials 'caught up' with recent rises in other sectors.
Markets were volatile with daily +1% rises and falls the norm. Trading has been within 4,600 and 4,300 on the ASX 200 over the past 3 months as we wait clarity as to whether the recent slowing of the US, European and Chinese economies is a trend or whether growth stabilizes. The next couple of months should provide an answer.
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| |
Index |
Change |
% |
| All Ordinaries |
4,465 |
10 |
0.2 |
| S&P / ASX 200 |
4,447 |
6 |
0.1 |
| Property Index |
865 |
-3 |
-0.3 |
| Utilities Index |
4,223 |
-70 |
-1.6 |
| Financials Index |
4,331 |
-29 |
-0.7 |
| Materials Index |
11,893 |
280 |
2.4 |
| Energy Index |
14,677 |
-70 |
-0.5 |
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Bank Term Deposit rates were unmoved this week.
| Term |
Rate % |
Change in rate |
| 3 months |
5.65 |
0.00 |
| 6 months |
6.00 |
0.00 |
| 12 months |
6.11 |
0.00 |
| 3 Years |
6.80 |
0.00 |
| 5 years |
6.95 |
0.00 |
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Overseas markets finished on a positive note but overall weekly outcomes were mixed. The US S&P 500 fell -0.3% as news on a slowing economy was offset by positive company profit reports. The UK FTSE was 2.1% stronger and is up over 10% in the past three weeks. In Asia, Hong Kong's Hang Seng rose 1.6% and should be higher again when it opens today. Japan's Nikkei fell -1.9%.
In Australia, the Federal Election date has been set and Woolworths and BHP provided sales and production updates. Overseas, US company news was good but the US Federal Reserve is uncertain of the US economy's direction. European banks report their stress test results on Friday.
In the Feature Section we discuss why share markets have been weaker of late.
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Australian News
The Federal election was called for 21 August. Whilst not looking forward to enduring the debate, one pleasing aspect from both political parties was the promise not to 'pork barrel' i.e. significant new and unfunded spending initiatives. Also comforting were statements that both parties see returning the budget to surplus as a priority. Time will tell.
Woolworths (WOW) reported 4th quarter sales up 4.3% excluding petrol. The discretionary Big W, Dick Smiths and Hotels sales were all down while the non-discretionary sector rose but at a lower rate than previous quarters. The result was not as strong as hoped although CEO, Roger Luscombe stated that 2010 suffered in comparison to 2009 as the government stimulus handout pushed 2009 higher.
In a show of confidence in the market, listed investment company Djerriwarrah (DJW) increased borrowings by $50m to invest in shares and options at the bottom of the 4,300 to 5,000 trading range.
BHP iron ore production was up 16% in the June quarter when compared to the same quarter in 2009. Oil also increased although thermal coal production (used for energy production) was down 8%.
The company's outlook was less upbeat, "Uncertainty surrounds the near term prospects for growth in the developed world as governments adjust fiscal policies following a period of significant stimulus and subsequent increase in sovereign debt levels".
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Overseas News
The US reporting season so far has delivered better than expected company profits. However, revenue has been weaker in some companies which adds to other indicators suggesting the US economy is slowing.
In commenting on the overall economy, Federal Reserve (the Fed) officials stated that "we also recognize that the economic outlook remains unusually uncertain". The Fed Chairman, Ben Bernanke stated that "we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation's productive potential" That is Fed-speak for 'we have concerns about the recent weaknesses in economic data and we will keep stimulating the economy if necessary.'
There has been a real 'tug-o-war' between positive company news and weaker economic data.
The results of stress tests for 91 of Europe's largest banks are due out on Friday, European time. Stress testing is used to assess the impact of adverse change in economic conditions on a bank's loan book and profitability. The exercise is intended to improve the confidence in European banks and banking system. Those banks 'failing' the test will be required to raise more capital.
The three scenarios to be tested are:
1. Projected Tier 1 capital in 2011. The higher the ratio the greater the ability to absorb losses.
2. An adverse scenario although details have not been provided. This might include:
a. Europe or specific countries double dipping into recession or at least lower growth Europe-wide,
b. Rising interest rates and higher unemployment,
c. A fall in housing or commercial property markets.
3. A sovereign shock which must include the banks' estimated losses on sovereign debt and other parts of their banking book. This is not a sovereign default scenario but tests conditions where higher sovereign borrowing costs push up the costs of borrowing by the private sector.
In 2009, the US undertook a similar process that resulted in ten major banks being required to raise additional capital. This exercise was important to restore confidence in the US banking system.
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Feature Article
Economic Growth and Recent Market Weakness
There has been considerable good news on company earnings and economic activity has been recovering from 2008/09 lows. Nevertheless markets have been weaker of late due to concerns around slowing growth rates across the global economy.
The Good News
The last UK reporting season saw the majority of companies outperform expectations. Similarly, German companies are delivering strong results as exports rise rapidly due to the weak Euro.
Nearer to home, Asian companies and economies are performing strongly and Australia's growth and economic situation can only be described as robust.
In the current US reporting season, Bloomberg reported that '83 percent of S&P 500 companies have beaten the average analyst estimate for second-quarter profit so far in the earnings reporting season'. To illustrate the strength of the rebound to date, the chart below shows earnings from US companies over the past 75 years (adjusted for inflation).
The chart shows the depth of the fall in top 500 US companies in 2008/09 was dramatic. On the other hand, although the recovery has not reached 2007 levels, the strength of the rebound has been pronounced.
The one 'trend' that has been of concern in the company results has been that revenues in some major companies have been lower than expected so some profits are being realised through cost cutting. This is consistent with lower consumer confidence which in turn has the potential to reduce growth in the US.
Falling government spending will impact growth
In the face of the good news above, across major developed and developing economies, why has the share market been so weak?
The answer is that there are concerns around economic growth:
• The obvious first issue is sovereign debt, particularly in Southern European countries such as Greece, Spain, Ireland, Portugal and to a lesser extent, Italy. The immediacy of this issue has abated somewhat as the European Central Bank is backing debt rollovers for the next 3 years. However, this has solved their liquidity problem, not the longer term ability to repay debt.
• Related to this issue is the large government spending cuts by European governments. This is not restricted to the weaker economies and larger European countries such as Germany, France and UK are also reducing government spending.
• In the US, the government stimulus programs have gradually been lapsing or unwinding thus raising concerns around growth.
• Finally, China has been tightening credit (lending) to dampen economic growth.
• Coordinated spending cutbacks and tighter economic policies must reduce growth.
Why is growth so important?
Put simply, without growth, the indebted countries will not be able to reduce deficits and repay debt, and in fact debt will increase. Growth means taxes increase and thus governments (and households) are able to service and repay debt.
The stimulus programs put in place in 2008 and 2009 'subdued' the falls in GDP that might have otherwise occurred. However, this was done at a cost of increasing government or sovereign debt which eventually must be paid back. This in turn requires growth in the economy as stimulus programs are unwinding.
Growth Expectations
The 'coordinated' spending cuts in Europe, the dampening of China GDP and some falling growth indicators in the US has caused economist to lower growth estimates for 2010 and 2011.
The International Monetary Fund (IMF) in its latest 'World Economic Outlook' forecast world economic growth for 2010 is a reasonable 4.5% and 2011 at 4.25%. However growth rates vary widely between countries – refer the table below of projected growth rate of the top 10 countries (by GDP):
| Country |
2011 IMF % growth prejections |
% of global GDP |
| Global |
4.3 |
0 |
| United States |
2.9 |
20 |
| China |
9.6
|
13
|
| Japan |
1.8 |
6 |
| India |
8.4 |
5 |
| Germany |
1.6 |
4 |
| UK |
2.1
|
3 |
| Russia |
4.1 |
3 |
| France |
1.6 |
3 |
| Brazil |
4.2 |
3 |
| Italy |
1.1
|
3
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| Total |
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63% |
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* Rounded to nearest 1.0% based on IMF numbers 2009
China, India, 25% of the global economy) are expected to show robust growth in 2011. Growth of 2.9% in the US, which accounts for 13% of the global economy is reasonably positive but insufficient to quickly improve the unemployment situation. The other five countries in the Top 10 accounting for around 19% of the world economy are expected to exhibit anemic growth of less than 2% (although positive).
The next ten economies (positions ten to 20 by size) make up around 16% of the world GDP. Only two of those economies (Canada 2.8% and Spain 0.6%) are expected to grow less than 3% with Spain the obvious weakness. Other countries in this group including Australia (3.5%) are expected to grow between a respectable 3.2% and robust 6.2%.
Whilst the IMF is predicting reasonable global growth in 2011 when considered as a whole there are wide disparities between countries.
Emerging economies are expected to grow at a generally robust pace compared to muted or anemic growth in developed countries.
The impact on share markets
If the above projections were certain to come to pass, markets would probably be satisfied. However, the IMF and other commentators view that 'risks are to the downside'. In other words, due to the uncertainty of the impact of governments pulling back spending, projected growth rates are at risk.
Economists and analysts are divided on the possibility of some advanced economies double-dipping into recession, particularly in Europe and possibly the US. On balance, the majority remains of the view that this will not happen but all recognize that the risk has increased.
One thing the share market dislikes is uncertainty. Until these 'double dip' concerns abate, the market is likely to stay weak.
Due to the levels of debt, it is expected that economic growth will remain subdued in developed countries for the next few years as debt is repaid (deleveraging). More of the 'U' shaped rather then 'V' shaped recovery is likely. This will in turn limit share market growth.
We expect the Australian ASX 200, currently around 4,400 to range trade between levels of 4,000 and 5,000 for the short term (the remainder of this year) with the top end of the range more likely by the end of the year.
With this in mind, we will discuss possible investment strategies in future Updates.
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