Market Updates

Three key indicators in 2012

Lots of economic and market data is produced each week and month. Understanding how this data relates to investment issues is the challenge for investors. While inflation and economic growth rates will continue to occupy attention, there are three useful summary indicators that directly relate to key issues affecting the investment markets such as how the European debt crisis is being managed, growth trends in China and the progress of US companies.

The first indicator is the difference between German 10 year government bond yields and their Italian counterpart. A tightening of this spread indicates improved confidence in Europe’s debt situation. Heightened uncertainty about the ability of Italy to sustain current debt levels has seen the spread between Italian and German 10 year bond yields as wide as 5.53%. If investor’s become more confident that European governments are able to engineer a viable debt stabilisation program, this spread should tend to stabilize and trend down. End of the month the spread was 5.28%.

Emerging economies continue to drive global growth. The purchasing Managers Index (PMI) in China is an indicator of the activity of Chinese manufacturers and exporters. A reading above 50 indicates that it is generally contracting. As China has been attempting to slow its growth levels to a more sustainable growth trajectory, stabilization in China’s PMI around 50 is a good indicator of China’s resilience to an uncertain economic environment. Some economists suggest a number below 47 would be an indicator the economy is slowing too much. In December, China’s PMI climbed to 50.3 up from 49.0 in November.

As the United States is the world’s largest economy it is a key driver of investor sentiment. The Institute for Supply Management (ISM) Index measures activity in the US manufacturing sector. The dividing line between contraction and growth is 50. In December, the index climbed 1.2 points to 53.9 points, the highest reading in six months. As many US corporate are large, multinational companies, the ISM indicates that US corporate are continuing to grow and take advantage of global growth opportunities.

End of year there were small positive shifts in these indicators. The more stable environment saw growth assets rise in the fourth quarter.

Australian Shares

The S&P/ASX 300 Accumulation Index fell 1.4% in December 2011. While Australia’s Gross Domestic Product is one of the strongest in the developed world (+2.5% year-on-year growth) soft domestic demand. A high $A and uncertainty surrounding the near term outlook for the global economy hurt the share market.

The Consumer Discretionary underperformed, down 3.9%. JB Hi Fi and Billabong announced profit downgrades in the month. Retail sales unexpectedly stalled in November, ending four months of gains said the Bureau of Statistics. Sales came from spending on recreational goods and books (+0.3%) and at restaurants (+0.1%). Sales at retail stores as a whole slowed to 0.1%. Spending on clothing declined the most, down by 0.4%.

Australians have been saving at a rate that has not been seen since the late 1980s. The ratio of household savings to disposable income rose to nearly 10.0% in 2011.  By contrast the personal savings rate in the United States was 3.5%, according to the November data.

The Manufacturing sector in Australia expanded for the first time in six months. The Australian Manufacturing Index rose to 50.2 in the month, compared to 47.8 in November. The dividing line between expansion and contraction is 50. The survey polled more than 200 companies about production, new orders, deliveries, inventories and employment.

International Shares

The MSCI World ex Australia Index (hedged) rose 1.0% and the MSCI World ex Australia Index (unhedged) rose 0.2% in December. Economic data from the United States and Asia displayed strength and changes in European governments showed more promise around resolving sovereign debt troubles. This helped global share markets to rise.

The S&P 500 was up 0.9% in December and ended the December quarter up 11.2%. The US economy grew for the 31st consecutive month. Improvement in American manufacturers underpinned the positive performance of the US share market, as there was a strong expansion in production growth and new orders for goods.

MSCI Asia share markets rose 1.0% as positive data from Asia’s 10 largest economies, excluding Japan, signalled that Asian economies are withstanding the knock on effects of Europe’s debt troubles and austerity measures. Economic activity in these economies grew an average of 5.2% in the December quarter.

Listed Property

In Australia, the S&P/ASX 300 A-REIT Index fell 2.6%. Underperformance in the Retail sector was the main contributor to the fall. Worse than expected sales leading up to Christmas hurt sentiment.

The UBS Global REIT Investors Index (hedged in $A) rose 2.2% in the month. Positive economic data from the US saw the region strongly outperform (+4.5%). The next top performing region was Hong Kong (+0.6%) which benefited from tight supply.

Debt Markets

The Barclays Capital Global Government Index (hedged in $A) rose 2.1% in December and the Global Credit Fixed Interest Index rose 2.4%. Investors favoured government debt and the income earned from corporate bonds.

The chart shows the spread between German and Italian 10 year government bond yields. The extra yield investors require to participate in Italian debt offerings has become an important obstacle for the government to reduce its deficit. The higher yield equates to a higher borrowing cost. This makes it more difficult for Italy to repay its debt. It also means there is less free cash flow available to stimulate the economy.

Yields in Italy rose above 7.11% in December before falling back down to 6.92%. The announcement of new austerity measures helped sentiment.  Italy’s new Prime Minister, the business minded Mario Monti, unveiled austerity measures that aimed to slash the cost of government, combat tax evasion and foster economic growth. This included spending cuts, raising the retirement age and reinstating property taxes that were abolished in 2008. The measures aim to eliminate Italy’s budget deficit by 2013.

In Australia, the Reserve Bank of Australia (RBA) reduced interest rates in December. The official cash rate is now 4.25%. This helped lower lending rates, which are now around their average level for the past 15 years.

Australian government bonds rose 1.0% in December. Australia has strong debt dynamics and offers higher yields for 10 year government bonds in Australia ended December at 3.87%. Yields on 10 year US government bonds were 1.88%. This encouraged investors to invest in Australia for the higher yield.

Economic indicators

Share market analysis

Sector summary

Notes:

1. GDP and inflation rate is most recent data available.
2. Data for China’s PMI sourced from AMPCI

Politics of last resort rattle share markets

November was a hard month for share markets as investors lost confidence in the ability of European policy makers to resolve the sovereign debt crisis.

The month began with ongoing civil and political problems in Greece, including a referendum that threatened October’s Greek bailout package. Investor concern soon spread to other European economies, in particular Italy. Yields of Italian 10 year government bonds rose to over 7.0%, which is 3.0% higher than five months ago. The increased costs of borrowing created new fears surrounding the sustainability of Italy’s sovereign debt.

While the situation in Europe is very fluid, economic data across Europe is generally poor. A contraction in growth for the Euro area is likely, but its intensity and length is hard to forecast. The outcome will be influenced by political developments and the response by the European Central Bank (ECB).

By the end of the month, Greece and Italy had new governments. These governments are led by well credentialed, pro-European economists and businessmen. The new Prime Minister of Greece, Lucas Papademos is a former ECB vice-president. Italy’s new Prime Minister Mario Monti is a distinguished economist and served as a European Commissioner between 1995 and 2005. In addition, the more financially stressed countries of Portugal, Ireland and Spain have all undergone government changes.

While there remain difficulties for European policy makers continue to reach a consensus, the new governments have already shown a stronger commitment than their predecessors towards implementing necessary reforms and committing to the European Union as a whole.

As European policy makers have shown greater signs of coordinating a resolution, the ECB has indicated that it is firmly committed to taking stronger action, supporting troubled bond markets and the financial system. The ECB also said it would support a fiscal union. While new policy initiatives will take time to implement and significant challenges remain, the new faces and progress in Europe is encouraging.

Australian Shares

In November, the S&P/ASX 300 Accumulation Index fell 3.4%. Investors were concerned that risks Europe’s sovereign debt crisis would impact global growth, prompting a cutback in the demand for Australia’s goods and services.

While negative news flow surrounding the global economy overshadowed investor sentiment, corporate earnings in Australia outperformed. According to the Bureau of Statistics in the September quarter gross operating profits rose 4.8%, above the forecasted 3.0%.

In the quarter, profits for mining companies rose 5.0% and construction jumped 21.7%. The earnings of financial and insurance service companies surged 36.1%. On the other hand, the profits of manufacturers fell 3.0% and the earnings of retailers declined 2.9%. Cautious consumers and a strong $A has negatively affected this area…

International Shares

The MSCI World ex Australia Index (hedged) fell 0.9% and the MSCI World ex Australia Index (unhedged) rose 0.9% in November. The fall in the value of the $A impacted returns. Economic and corporate activity in the United States and China showed signs of strength. However, investors were greatly influenced by a worsening of the sovereign debt problem in Europe.

November was another volatile month. The chart below shows the widening of daily price movements of the S&P 500 in the last four months.

In November the S&P 500 fell 0.5%. While the month saw excessive amounts of negative news flow from Europe, the US share market was underpinned by a strong corporate earnings season and a stable domestic economic backdrop.

Overall profit growth for US corporate was up 18% year-on-year as at November. The September quarter earnings season saw 70% of corporate in the S&P 500 beat profit expectations. In addition, the US economy expanded at a moderate pace, led by gains in manufacturing and consumer spending.

Holiday purchasing helped sales at electronic stores increase 3.7% the most since November 2009, according to the US Commerce Department. In addition, sales for online retailers and mail order companies rose 1.5%, the most in nine months. Holiday hiring also helped the US unemployment rate fall 0.4% to 8.6%. This was the best result in over two years.

In China, data suggested a consistent level of economic growth around 9% and a moderation in inflation levels. Inflation cooled to 5.5% in November down from 6.1% as at the end of the September quarter, and a peak of 6.5% in July.

Throughout the year Chinese policy makers have focussed on stabilising growth. China’s central bank has raised interest rates three times in 2011 and lifted the reserve requirement ratio for banks six times. This has cleared the way for monetary easing and the implementation of growth policies if the situation in Europe should decline.

Data in the month showed signs of sustained consumer demand in China. Retail sales, imports and fixed asset investments remained strong. However, industrial production and export growth slowed, largely due to the pessimistic outlook for overall global demand due to Europe’s debt problems. This saw the share market in China fall 8.3% in local currency terms.

Listed Property

In Australia, the S&P/ASX 300 A-REIT Index rose 2.7% in November. Globally, Australia was the top performing region in the month. The 0.25% reduction in the official cash rate in the month boosted the performance of listed property securities that garner profits from residential and retail sales such as Stockland Group (+7.3%) and Westfield (6.5%).

The UBS Global REIT Investors Index (hedged in $A) fell 3.2%. The worst performing regions were Hong Kong (-7.7%) and Continental Europe (-6.0%).

Debt Markets

The Barclays Capital Global Government Index (hedged in $A) fell 0.2% in November and the Global Credit Fixed Interest Index fell 1.8%. Investors were less confident in government debt and corporate issuers given increased worries about the potential impacts of Europe’s debt crisis on the global economy. In response to developments in Europe, central banks across the world announced a coordinated agreement on 30 November to lower the cost of short term financing for the global financial system.

Sovereign debt issues in Europe pushed bond yields higher in countries like Spain, France and in particular Italy where 10 year government bond yields rose above 7%. This rise in yields means investors are signalling the lack of confidence in the near term economic outlook for countries like Italy. Increased borrowing costs also means the task of deficit reduction becomes harder, making sovereign debt burdens less sustainable.

In Australia, the Reserve Bank of Australia (RBA) reduced interest rates by 0.25% in November and December. The official cash rate is now 4.25%. The RBA said they revised down inflation forecasts. The RBA has plenty of room for further rate adjustments if the situation in Europe deteriorates. The RBA also said its GDP growth forecasts for the next year is 3.25%, up from Australia’s GDP growth ending September 2010, which was 3.1%.

Economic indicators

Share market analysis

Sector summary

Notes:

1. GDP and inflation rate is most recent data available