Kreston marker update week ending Friday 23th October 2009

Kreston ANZ

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News 2009

Kreston Dormers

Kreston Dormers Financial Services Pty Ltd

Please find below and attached our 'Weekly Market Update'.

We are continuing to get feedback and suggestions for improvement on the report, so if you have any suggestions please let us know

If you would like to discuss this email in more detail, please contact your financial adviser, Mark Johnson or Nick Pike on 1800 064 959.

Market Summary

Markets had a breather after strong rises over the previous 2 weeks with the S&P/ASX 200 down 0.2%. Banks and Energy were the major reason for the fall down 1.0% and 2.0% respectively.

	Friday	Week	%
All Ordinaries	4,860	-14	-0.3
S&P / ASX 200	4,860	-10	-0.2
Property Index	944	3	0.3
Utilities Index	4,326	41	1.0
Financials Index	5,000	-60	-1.2
Materials Index	11,971	105	0.9
Energy Index	16,737	-341	-2.0

The Australian market mirrored the US S&P 500 which fell - 0.4% for the week and the UK FTSE was - 0.3% weaker. In Asia the Nikkei rose 0.5% for a third week of rises and Hong Kong’s Hang Seng also rose, up 1.0%.

Business news centred on the rise in the Australian dollar which we review in the feature section.

Overseas News

Bloomberg reported that 79% of the 104 companies on the US S&P 500 that have reported so far had exceeded profit expectations. This would be a strong positive for the economy and markets if the trend continues through this quarterly reporting season.

In contrast to the above, builders in the US started on fewer homes in September than forecast. Housing starts rose 0.5% and less than expected rise was attributed to the anticipated end to the tax credit for new home owners.

You would expect that based on the above news that the US Federal Reserve is unlikely to raise interest rates at its next meeting.

Australian News

The minutes of the RBA October meeting showed RBA’s inflation concerns resulting from keeping interest rates too low for too long. Markets expect rates to rise to 4.0% from 3.25% by February 2010.

Woolworths (WOW) reported increased sales of 7.4% (excluding petrol) for the September quarter compared to the previous year which was below analyst expectations. CEO, Michael Luscombe stated that the company had been meeting competition through price reductions.

BHP is starting to see the positive impact of re-stocking as the global economy improves although they stated that there is still no evidence of ‘sustainable demand improvement’. The company does not expect to see the sustained improvement before mid-2010.

The Rise & Rise of the Australian Dollar

The rapid rise in the Australian $

The Australian dollar (AUD) was trading at $US 0.94 in July 2008 on the back of very strong commodity prices, before falling 35% to $US 0.61 in November 2008 as the global economy deteriorated.

We are now trading around $US 0.93 representing a 52% gain from November 2008 lows.

The rise has been on the back of the improving global outlook. Australia and the AUD are seen as a commodity country/currency and a reflection of the health of the global economy. The improving economic news offshore has flowed through to Australia’s economic prospects and our currency.

Why is the AUD rising ?

The value of one currency compared to another is impacted by a lot of different factors. In the case of the AUD we need to compare what is happening in Australia compared to other countries.

However, in the interests of simplicity we have largely focused on Australia compared to the US.

a) Interest rates

The value of a country’s currency compared to another currency is largely driven by the difference in interest rates between the two countries.
The Reserve Bank of Australia (RBA) recently increased interest rates by 0.25% to 3.25% and intimated they would continue rising. In the US, official interest rates are 0% to 0.25% and the US Federal Reserve does not seem to be in a hurry to raise them. Consequently investors have been moving funds to Australia to obtain better interest rates.

b) The strength of the Australian economy

Interest rates are largely driven by the relative strength of the economy (although not in all cases).
At the moment Australia and commodities (and thus Australia) are viewed as a ‘safer’ place to invest money relative to the US.
Expectations for the greater growth in the Australian economy over the short and medium term means that investment monies are flowing from the US to Australia and pushing up the price of the AUD.
An example of increased investment flows to Australia is that that overseas interests now own 45% of the Australian share market which is the highest proportion since the 1990’s (AFR).
Other examples are Chinese investment in mining companies and residential real estate, foreign students studying in Australia and even the high levels of migration to Australia and migrants bringing in their wealth.

c) Speculation

Speculators will move money in and out of the AUD based on their perception of future movements. Their expectations will be based on interest rates and the strength of the economy but the movement will be accentuated through speculators creating additional momentum.
An example of ‘speculative momentum’ was the rapid rise in oil prices in 2008 which was attributed to speculators moving from the USD to the safer oil.
This is why movements in currencies, stock markets and other assets tend to overshoot.

d) Official intervention

Central banks will intervene to attempt to dampen the more extreme and adverse movements in the currency.
For example, it is likely that the Reserve Bank of Australia is now selling AUD’s to try to limit its rise due to interest rate rises.
This intervention is unlikely to change trends unless of course you are China which has pegged the Yuan to the USD, despite stating they are allowing it to at least partially float (but that is another story).

Will the strength in the AUD last ?

The answer is ‘In the short term at least’.

I spoke to a hedge fund manager who has managed the currency desk for one of the major Australian banks. After he hesitated, as it is very difficult to predict for anybody, his view was that the Australian interest rates would peak in 18 months and thus the AUD may trade around parity (1 AUD = 1 USD) for around 12 months and possibly higher for short periods.

His logic was that markets will begin anticipating this narrowing of the interest rate difference between the US and Australia 6 to 12 months before it happens. This will flow through to currency prices and share markets. In that case, we could expect the AUD to remain strong for the next 12 months.

His major proviso is that the global recovery continues.

Over the longer term the AUD may trade above its average of around $0.72 since it floated in 1983 due to continuing commodity demand from Asia.

Somewhat paradoxically, weaker economic news on the US housing front this week resulted in the AUD dropping almost $0.01 against the USD on Tuesday night, whereas you might have expected it to rise (as our economy is stronger). The reason for this is that if the US economy went back into recession, Australia’s economic fortunes would be similarly damaged and thus we would not be viewed as the ‘safe haven’ status we currently ‘enjoy’. We expect movements such as this to be short term.

What will be the impact on the different sectors in the economy ?

The rising AUD is generally not a positive for Australia although individual sectors are affected differently.

From an economic perspective a :

a negative for Australia’s large Current Account Deficit as it encourages imports and makes our exports and domestic producers less competitive.
a positive for inflation as goods are cheaper for consumers e.g. flat screen televisions.
poor for overseas investment as it costs more for a foreign investor to buy the same asset located in Australia.

From an industry perspective a stronger AUD is :

bad for exporters as Australian goods become dearer and less competitive in overseas markets. Alternatively if Australian company’s goods are priced in USD they will receive less for the goods. The health sector operating in the US (e.g. CSL, Resmed, Cochlear), resource sector (miners and mining services companies), farming and agricultural companies (e.g. Incitec Pivot) are all examples of being negatively impacted.
a plus for importers as the goods imported cost less. Examples include Woolworths, Alesco, JB Hi Fi.
good for airlines, and particularly Virgin as it has not hedged its jet fuel prices to the same extent as Qantas. Other overseas maintenance, levies and charges and capital expenditure will similarly fall in price when converted to AUD.
of the banks, NAB would be the most affected due to its exposure in the UK.

What should you do as investor ?

The strength in the AUD is a reflection of the expected strength of the economy which is good news for investors.

While currency should be taken into account when assessing individual companies, currency movements are very difficult to predict, so we regard strength in management and operational robustness of companies to be more important.

Also the expectations of a strong currency would have been largely built into current share prices.

Consequently we do not recommend a wholesale realignment of investments on the basis of the expected strength in the AUD.