Headline developments of the past week
The news on the European debt crisis was mostly positive with the ECB providing another €529.5bn in cheap three-year funding to banks. After allowing for rollovers of existing borrowing, this implies a net €300bn in new liquidity being pumped into the European banking system. While it may not be lent out quickly just as with quantitative easing in the US, it has helped head off a financing crisis as banks are now pre-financed for three years and it has taken pressure off banks to sell bonds in troubled countries.
In other news, the German Bundestag approved the latest Greek bailout, finance ministers gave the go-ahead for the EFSF bailout fund to start raising funds for loans to Greece, the Greek private debt restructuring was declared not to be a credit event so credit default swap insurance won’t be triggered (not yet anyway, but they may still when some investors are impelled to participate) and Spain and France had successful bond auctions. Ireland declared it will have a referendum on the agreed fiscal compact, but whether it says yes or no won't prevent it going ahead elsewhere or change the Irish fiscal austerity program.
And finally, the G20 finance ministers meeting argued Europe’s debt firewall needs to be strengthened before IMF crisis funding is boosted, with European leaders now looking to provide capital faster to its new fund as a result. To the extent most of the news was positive Italian, Spanish and French bond yields fell to new lows for the year adding to confidence that the debt crisis is being contained.
In Australia, it’s back to normal on the political front with PM Julia Gillard defeating Kevin Rudd 71/31. This is unlikely to result in any major policy changes.
Major global economic releases and implications
US data releases were mixed, but consistent with reasonable growth. The big surprise was a fall in the ISM manufacturing conditions index. However, it remains in expansion territory and occasional pullbacks are normal so best to wait for next month’s release. While durable goods orders fell this partly reflects a seasonal adjustment bug and the expiration of accelerated depreciation.
On the positive side, pending home sales, consumer confidence, weekly mortgage applications and chain store sales all rose and weekly unemployment claims fell further and the Fed's Beige Book was a bit more upbeat. While Fed Chairman Bernanke acknowledged the improved jobs market and failed to mention QE3, this doesn’t necessarily mean QE3 is off the agenda as he also said the jobs market is far from normal and long-term unemployment is near record levels.
In Europe, industrial confidence rose slightly in February and credit growth in January was less worrying suggesting a credit crunch has been averted by cheap ECB financing for banks. Unemployment rose to 10.7 per cent.
Japanese data was mixed with stronger rises in retail sales, industrial production, construction orders and housing starts but unchanged unemployment at 4.6 per cent, a fall in household spending and ongoing price deflation.
Chinese manufacturing PMIs rose in February suggesting growth is stabilizing at a still solid level. Average house prices fell for the sixth consecutive month, adding to the case for further policy easing.
Elsewhere in Asia, Indian GDP growth slipped to 6.1 per cent in Q4 but leading indicators point to stabilisation ahead.
Australian economic releases and implications
In Australia, the two-speed economy reigns supreme with the December quarter business investment intentions survey pointing to very strong capex growth in 2011-12 (+38 per cent) and 2012-13 (+37 per cent) but essentially all of this coming from the mining sector.
Other data releases were soft with business investment and construction activity falling in the December quarter, retail sales, building approvals and private credit all remaining lacklustre in January, new home sales falling sharply and house prices falling slightly across January and February.
The December half profit reporting season is now essentially wrapped up. While there have been some bright spots, overall the results were soft with companies suffering from weak revenue growth, sticky costs and pressure from the strong Australian dollar.
Only 31 per cent of companies exceeded expectations, versus 37 per cent in the June half results and a norm of 45 per cent. Sixty-eight per cent of companies reported positive year on year profit growth, but investors greeted results cautiously with 52 per cent of companies seeing their share prices underperform the market on the day results were released.
The absence of much upside surprise has seen 2011-12 consensus earnings growth expectations fall to three per cent (from seven per cent a month ago) with the biggest downgrades in resources, non-bank financials, media and retail stocks. There may be a bit of light though because outlook statements have become a bit more favourable. That said consensus 2012-13 expectations for a 12.6 per cent rise in earnings look way too optimistic.
Shares were mostly higher over the last week, with better economic data and easing EU debt concerns helping. Australian shares fell slightly after a 2.6 per cent gain the previous week. The 4300 level for the ASX 200 is proving to be difficult resistance for now.
Commodity prices were mixed with gold falling sharply, oil taking a breather after strong gains but metal prices up. The Australian dollar made it back to around 108 US cents.
What to watch over the week ahead
The week ahead will be a busy one. In Australia, the RBA should be cutting interest rates when it meets on Tuesday, but it probably won’t. Sure mining is strong, but it's trickle down to the rest of the economy is proving to be just a few drips, particularly with mining investment projects relying heavily on imports. Moreover, retailing, housing, manufacturing and tourism are all struggling, layoffs are increasing and the rise in bank mortgage rates and the $A have led to very tight monetary conditions. And this is at a time when inflation is benign. Our view is the cash rate should be 0.25 to 0.5 per cent lower. However, going by its recent commentary, the RBA doesn't agree. So expect rates to remain on hold for the next few months with the next cut not till May.
On the data front, expect weak Australian December quarter GDP growth (Wednesday) of just 0.5 per cent or 2.2 per cent year in year, a 10,000 loss of jobs in January (Thursday) but a still hefty January trade surplus (Friday).
In China, February data (Friday) is likely to show a further cooling in inflation to 3.5 per cent, a further slowing in industrial production and fixed asset investment and soft credit growth. All of this is expected to be consistent with further monetary easing.
In the US another strong 200,000 payroll report is expected on Friday.
Central banks in the eurozone, the UK and New Zealand are all expected to leave monetary policy unchanged.
Shares are vulnerable to a consolidation or correction in the short-term given high levels of investor sentiment, strong gains year to date and the oil price surge. However, any pullback globally is likely to be mild and the broader trend is likely to remain up. Valuations are attractive, particularly against very low bond yields, the risk of a eurozone meltdown has faded, momentum in global economic indicators is positive, global monetary conditions are getting easier and easier and there is lots of cash on the sidelines. We continue to see the S&P/ASX200 pushing up to 4800 by year-end, but thanks to tougher monetary conditions in Australia and the strong Australian dollar, the Australian share market is likely to remain a relative laggard.
Low global bond yields in major countries suggest low returns unless Europe’s debt crisis intensifies. Good quality Australian corporate debt is a better bet.
Beyond the current consolidation/correction, the broad trend in the Australian dollar is likely to remain up, helped by more global quantitative easing, solid commodity prices and better global confidence. A retest of 110 US cents is likely.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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