The Switzer Market Review
Private Matters, December 2012
Santa rally offers prospect of a merrier new year
A lot happened in November, with US elections and the looming prospect of a fiscal cliff, Greek debt deal negotiations and improving Chinese economic growth data.
However, the big unknowns for global markets are enduring economic question marks hovering over the US and Europe. In the US, following Barack Obama’s win in November’s presidential election, all eyes turned to Congress as the Democrats and Republicans sought to resolve issues around the fiscal cliff. This refers to the simultaneous expiry of tax breaks and the introduction of tax increases and spending cuts, the result of which could push the US back into recession.
If Congress cannot come to an agreement by December 31, the US economy will lurch towards recession and the S&P 500 and Dow will suffer, as will all equity markets around the world. Australian markets will not be spared.
Surprisingly, Wall Street does not appear to be too concerned about politicians not quickly arriving at an agreement. During November, the Dow fell 0.55 per cent, while the S&P 500 added 0.29 per cent. For the calendar year to the end of November, the Dow was up 6.61 per cent and the S&P 500 had put on 12.62 per cent. In Australia, the S&P/ASX 200 lost a measly 0.24 per cent in November, while it was up 11.08 per cent for the year since January 1.
Looking at the Dow and S&P 500 on a daily basis, the markets have risen and fallen on the back of positive and negative news. For example, Senate Majority Leader Harry Reid, a Democrat, claimed there had been “little progress” with fiscal-cliff negotiations. Therefore, it is no surprise that markets sold off. The Dow was 0.69 per cent lower and the S&P 500 took off 0.52 per cent.
The next day, President Obama said he hoped there would be an agreement before Christmas, and Republican boss John Boehner discussed accepting some tax increases on the proviso that spending cuts were an option. On the back of such comments, the Dow gained 0.83 per cent and the S&P 500 put on 0.79 per cent.
In reality, the response to fiscal-cliff speculation has been largely positive. Why?
“In simple terms, just about everyone believes that a deal will be struck in Congress, and so they are buying stocks now to avoid the post-deal rush,” says Peter Switzer, founder of the Switzer Super Report. “Of course, this could set up the market for a buy-the-rumour, sell-the-fact situation, so you have to be careful.”
That said, Switzer thinks a deal will be confirmed by Christmas, setting up markets for a Santa Claus rally – it has happened eight out of the past 11 years! – with the recovery likely to roll into the early months of 2013.
Eyes on Europe and China
Europe has been the other big issue for economies and markets this year, with Greece and Spain dominating the headlines.
No major negative news has come out of the eurozone in recent times as the Continent witnessed some positive debt negotiations for Greece and Spain and lower interest rates on bond auctions for the likes of Italy and Spain. Of course, there could be a left-field event to send things spiralling down again, but for now it looks like these countries will “muddle through”.
China’s economy has also been a concern, but Shane Oliver from AMP Capital Investors argues that the worries about a hard landing will begin to fade in 2013.
“Already, if you look at the economic data coming out in China, it’s consistent with growth bottoming at around the 7.5 per cent level,” he says.
Oliver argues this will help commodity prices and, in turn, should underpin share price improvement for the likes of mining giant BHP Billiton and Rio Tinto. On the Reserve Bank of Australia’s cash rate, Oliver argues the cuts have been insufficient. Before Tuesday’s RBA meeting, Oliver made the point that the banks have not passed on the full rate cuts to businesses or to mortgage holders.
“Therefore, you have to cut the official rate more to get these actual rates that people pay to lower levels,” he says. “Housing, retailing, manufacturing, tourism – they’ve all been struggling. Those sectors need to pick up urgently.”
More rate cuts needed
At its November meeting, the RBA cut the cash rate by 25 basis points to 3 per cent. Oliver says there needs to be one or two more cuts early next year to get rates down to the lows he believes are necessary. Consumers with mortgages would then likely be less cautious and start spending again.
Geoff Wilson, from Wilson Asset Management, agrees with Oliver’s arguments. He says if you remove Australia from what is happening in the northern hemisphere, the “dynamics” for the country are “fantastic”. Yet from the feedback he has been receiving from industrial companies, it appears the east coast of Australia has been in recession over the past nine to 10 months.
“The (RBA) is cutting rates,” he said before November’s central bank meeting. “What do lower interest rates mean? That is significant. There will be a couple more cuts. There will definitely be another half per cent, maybe three-quarters, even one per cent reduction in interest rates. That means valuations go up. Lower interest rates, higher P/Es. It means the cost of borrowing for corporates goes down. (Consumers start coming back). Economic activity starts picking up.”
Wilson says the benefits of lower interest rates are starting to flow through. Sentiment from retailers with whom he has been speaking has revealed over the previous four to six weeks that business has started to improve. He is also seeing improvement in the housing cycle.
Wilson is regarded as one of the best valuers of companies on the stock market in Australia, so his views cannot easily be ignored.
Supporting this positive news, the Westpac-Melbourne Institute Survey of Consumer Sentiment reading for November rose 5.2 per cent to 104.3, an increase that suggests rate cuts could be starting to work.
“This is a welcome and surprisingly strong result. The index has reached its highest level since April 2011,” says Bill Evans, Westpac’s chief economist. “After a long 16-month period when the index held below 100 for 14 of those months, we are finally starting to see that the Reserve Bank’s 150 basis points of interest rate cuts is having an impact.”
So is the worst behind us? China may not see a hard landing, Europe is in a better position than last year, and the US economy is growing stronger, with the fiscal cliff hopefully being sorted out before the end of the year.
Credit data watcher, Veda, has an optimistic view on the year ahead for the local economy.
“The outlook for 2013 is looking better, with credit criteria appearing to loosen within the next six months, credit applications increasing and a decline in the gloom around economic conditions having a negative impact on their organisations,” says Moses Samaha, head of commercial credit and procurement risk.
Veda’s Credit Management in Australia 2012 report reveals that business sentiment is more positive, with economic conditions having a negative impact on 59 per cent of businesses compared with 74 per cent in 2011. Credit applications are up 32 per cent, even though lending criteria is now stricter. However, customer payments have deteriorated in the past six months for 53 per cent of participants. Switzer argues this “clearly shows it would be naïve to believe the economy is going gangbusters” and, if unemployment is to be contained, further rate cuts are needed.
The unemployment rate in October was 5.4 per cent, but 18 months ago it was 4.9 per cent, which means about 60,000 people have lost their jobs over that time. Business researcher Roy Morgan uses a definition for the jobless rate and reports. According to its data, November unemployment rose 0.3 per cent to 10 per cent, the highest result since January this year.
Will we see this head higher? Company profits dropped by 2.9 per cent in the September quarter, which was the fourth consecutive quarterly fall, according to Business Indicators from the Australian Bureau of Statistics. Profits are 13 per cent lower than the same time last year. Out of 15 industry sectors, eight saw sales falls. Electricity, gas, water and waste services saw sales rise 3.5 per cent, while professional, scientific and technical services sales fell 2.4 per cent. Mining sales were up 2.3 per cent, and inventories gained 7 per cent.
Interestingly, manufacturing sales were up 1.3 per cent. Sales in retail trade dropped 0.4 per cent. Wages and salaries were down 0.2 per cent in the quarter, the first fall since 2009.
CommSec’s Craig James says business conditions for many parts of corporate Australia are as tough now as during the global financial crisis.
“Profits have fallen for the fourth straight quarter, inventories have lifted for the fourth straight quarter and sales are sluggish across many key sectors,” he says. “Ask businesses if rates should be cut and you would get a resounding ‘yes’. Conservative consumers, a high Aussie dollar and tough global economic conditions have local businesses looking for some relief.
“Confidence is the key missing ingredient. Businesses and consumers are well placed to handle the tough operating environment, but they lack the confidence to start the ball rolling by investing, spending and employing. Everyone is waiting for someone else to take the first step.”
Among other data released recently:
- the NAB business confidence index fell from minus 0.3 points to minus 1.3 points in October. Business conditions fell from minus 3.3 points to a 41-month low of minus 4.8 points
- a record 72 per cent of businesses say they do not want finance, according to the October National Australia Bank Business Survey
- total new lending commitments were up in September (4.8 per cent), but down 7 per cent in the previous two months and down 1.8 per cent on a year ago, according to the ABS
- housing loans are up 4.4 per cent for the year
- commercial loans are down 6.2 per cent for the year, but the September reading was up 6.9 per cent, after falling 4.7 per cent in August
- the Australian Securities & Investments Commission says insolvency appointments were up 10 per cent in the September quarter on the previous quarter, with all states and territories, except for the ACT, experiencing a rise in insolvency appointments
- the November Veda survey reported an increase of 11 per cent in bankruptcies and external administration.
Much has happened this year as the wounds from the global financial crisis continue to mend. We are not yet out of the woods, but we are definitely on the way.
While the economy will grow slowly at first in 2013, it will pick up. Provided the RBA gets its interest rate policy right, many businesses that have struggled during the mining boom might see some light at the end of the tunnel.
The views and commentary provided in this article are those of Switzer Media & Publishing.