The Switzer Market Review
Private Matters, July 2012
European jitters keep markets guessing
Most of June was again spent worrying about developments in Europe and how the global economy might be affected. The main focal points for analysts were the Greek election on 17 June and the European Union crisis summit in Brussels on June 29. Chiefly on the back of those events, traders breathed a sigh of relief – for now.
The Dow Jones rocketed up 2.2 per cent on the EU summit news and the S&P 500 jumped 2.49 per cent. The Dow was up 3.93 per cent over June, which, according to CNBC, was the best June result since 1997 at the height of the dot-com bubble. After September, June is regarded as the worst month for the market.
At the time of writing, for the year to date, the Dow was up 5.42 per cent, while the S&P 500 was 8.31 per cent higher. The local benchmark S&P/ASX 200 gained 1.35 per cent on the EU news. The index, however, put on only 0.45 per cent over the month and since the beginning of the calendar year was up a tiny 0.94 per cent. Over the financial year, the index dropped 11.1 per cent, while the Dow was up 3.8 per cent.
Leaders at the summit agreed that EU bailout funds be used to bring down bond yields for Spain and Italy without ramping up the austerity measures already in place. Germany has been insisting on excessive austerity, but backed down and was more supportive of European debtor nations.
Peter Switzer, founder of the Switzer Super Report, says Germany’s softer line is essential for a more lasting solution.
“While the exact details are yet to come, and these could disappoint the market, at the moment this is the best real confidence circuit-breaker we have seen come out of Europe in two years,” he says.
“There have been questions around how Chancellor Angela Merkel will sell this to her German followers, but she has already been shown some parliamentary support as late as 29 June.”
In mid-June, the Greeks chose to stay with the euro currency following round two of elections in just a couple of months after an initial failure to form a government. Investors had been worried about the outcome in Greece in the weeks leading up to the election and the effect it might have had on international economies and markets if it decided to leave the eurozone.
Day-to-day uncertainty around the Greek election, Spanish banks and the EU summit caused market volatility in June. Now that there is some sort of clarity on these issues, investors and traders will be waiting to see the details that still need to be thrashed out in Europe. Will the EU summit decisions help Europe resist a long recession? Only time will tell.
What happens on the Continent will have an impact on the economies of China and the United States, while also affecting global economic settings. This will ultimately influence commodity prices and growth in Australia.
Business owners and wealth builders need to know that we are not out of the woods yet, although the outlook is better now than a month ago. Over the past few years, business and investors have seen many challenges appear out of nowhere: the global financial crisis, unrest in Libya, the earthquake and tsunami in Japan, and the Australian dollar spiking to uncompetitive levels against the greenback and other currencies. These experiences underline the importance of risk management. That said, it looks as though the risks are starting to diminish on a relative basis.
One big plus has been the recent easing of monetary policy. While the Reserve Bank of Australia left the cash rate on hold at its July meeting, that decision followed cuts of 0.5 per cent in May and 0.25 per cent in June.
“Financial markets have initially responded positively to signs of further progress towards longer-term sustainability in European financial affairs, but Europe will remain a potential source of adverse shocks for some time,” says RBA Governor Glenn Stevens.
So what is the outlook for markets? Market analyst Matthew Kidman believes 2012 will continue to be tough but that conditions will be better in 2013. Kidman, speaking before the EU summit, advised investors to not be surprised if the All Ordinaries falls to 3500 or 3600 this year before heading higher next year, with the economy really recovering in 2014 and 2015.
“This year was always going to be a tough year because you’ve had a lot of stimulus in the system and the system is not better,” he says. “The problem really is you’ve had a runaway US market. It’s gained about 100 per cent over the last three years, which is a fantastic effort after the disaster of 2008 and early 2009. But to end a bear market, and we are not out of a bear market … what history tells us is that it’s got to end with companies on incredibly low valuations, or low P/Es. And it’s got to be that everyone’s virtually given up.”
Kidman says we are currently experiencing a ‘secular’ bear market. A traditional bear market is cyclical and sees the market fall 20 per cent. In a secular bear market, there can be a series of 20 per cent falls and rallies, but over that time traders do not make any money. For the US, this is the third secular bear market since 1929. The first lasted from 1929 to 1942 and the second occurred in the 1970s. In Australia, there were secular bear markets in the early 1970s with a bottom in 1974, and after the 1987 crash into the early 1990s.
“[This secular bear market] started in the US in 2000 and we joined in on the funeral in 2007 at the end of the resources boom,” says Kidman, who estimates that at a peak in 2007 the market was 45 per cent overvalued. He bases this assessment on taking the year-in, year-out return since the recession in 1992. At the moment, he argues that the market is 25 per cent undervalued.
Macquarie recently revised down its outlook for the S&P/ASX 200 from 4553 to 4323 by June next year. CommSec expects the index to reach 4650. However, these forecasts should be upgraded if the EU summit details impress the market. This ‘if’ remains the great unknown both for financial markets and the global economy, but it will not only be a European issue. Indeed, on the Monday after the EU meeting, Wall Street traders turned their attention to economic data in the US.
The Institute for Supply Management’s manufacturing index fell to 49.7 in June from 53.5 in May. Economists were expecting the index to slip to 52. On the day of the announcement, Thomson Reuters/University of Michigan Surveys of Consumers released its index of consumer sentiment. It fell 7.7 per cent to 73.2 in June, but the good EU news overshadowed this result.
Crunching the numbers
So how did the data in Australia stack up this month? Here is a rundown:
- Over the three months to May, employment across Australia rose by 60,400 and the unemployment rate was 5.1 per cent, according to the Australian Bureau of Statistics (ABS)
- The NAB business confidence index fell from 4.1 in April to -2.2 in May, a nine-month low
- The Westpac/Melbourne Institute Survey of Consumer Sentiment increased 0.3 per cent to 95.6 in June. A reading below 100 indicates consumers are more pessimistic than optimistic
- Car sales were up 22.4 per cent on a year ago in May, according to the ABS
- Total lending finance increased 6.3 per cent in April following a rise of 6.1 per cent in March, the ABS said. Total lending commitments were up 12.6 per cent on a year ago
- New homes sales increased 0.7 per cent in May after a 6.9 per cent rise in April, according to the ABS
- The number of tourists arriving in Australia in March rose 1.9 per cent to record highs, the ABS said. This fell by 0.5 per cent in April.
Carbon tax fallout
Data is still mixed. Of course, a number of companies may also be concerned about the introduction of the carbon tax on 1 July. Interestingly, Roy Morgan’s weekly consumer confidence index was “virtually unchanged” – up 0.4 points to 110 – on the weekend the carbon tax was introduced. This was also the weekend of the EU summit.
Uncertainty about the tax and its impact is another risk management issue for local businesses, despite 300 companies – including Westpac, AGL and GE – signing a statement of support for the carbon tax. For its part, the Australian Chamber of Commerce and Industry insists that most businesses are price takers and that the cost imposition of the tax could hurt a lot of bottom lines.
GE Australia’s president and chief executive officer Steve Sargent says his company has been putting a price on carbon since the mid-2000s for the business’s own internal investments.
“When you take a viewpoint that climate change is occurring and it’s highly likely that it’s been caused by man-made activities, you think, ‘what are governments going to do? What are communities going to demand? What are companies going to do?’ Very quickly you realise that it’s not a matter of if something is going to happen, it’s a matter of when. So we’ve taken the view – let’s make sure we’re positioned early in this trend and mitigate our risks and create the opportunities. If you take the viewpoint and start positioning yourself now, you’re going to be better off.”
Sargent says that by reducing energy usage GE has cut operating costs by more than $130 million a year since 2005.
The carbon tax and repercussions from the EU summit are a work in progress and they will have serious economic and political implications. If the carbon tax hurts Prime Minister Julia Gillard’s standing in the popularity polls, we could have a new PM before next year’s election!