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The Switzer Market Review

Private Matters, May 2012

The Switzer Market ReviewCan rate cuts tempt the bears to emerge from the economic wilderness?

So begins the month of May, a time when investors have traditionally been known to stay away. In fact, investors last year stayed out of the market until about October — but it remains to be seen if they will be similarly bearish this year.

Data on the local economy has been leaning towards the negative, and while the large Reserve Bank of Australia (RBA) rate cut on May 1 could help, there are other pressing concerns. For wealth builders and business owners, keeping an eye on the crucial indicators over the next few months will be crucial.

Rollercoaster ride

Last year, over the May to October period, the benchmark S&P 500 dropped from 1363.61 on April 29 to 1099.23 on October 3, a fall of 19 per cent. Since then, until April 30 this year, the market has headed 27 per cent higher to 1397.91.

In Australia, the S&P/ASX 200 hit a high of 4913.8 on April 21, 2011, before falling to 3863.9 on September 26. That’s a 21 per cent fall. Since then until the end of April, it has risen around 14 per cent to 4396.6.

UBS’s Art Cashin, the longest-serving broker on the floor of the New York Stock Exchange, told CNBC that he thinks it’s a case of déjà vu when it comes to developments with the US economy and Wall Street. He says the economy is showing signs of a slowdown as jobless claims rise and indications emerge of what he calls “distribution days”, where volumes pick up on days when the market dives.

Cashin also points out that when options expire (which this year was the second last week of April) it’s often the last good week before the May sell-off can start.

Bob Doll, the chief equity strategist at the world’s biggest fund manager, BlackRock, is a little more optimistic.

“The US economy is a bit stronger today than it was a year ago,” he told CNBC. “Questions about the US economy or the European debt situation caused the market to stop going up, but I think we’ll resume the grind higher for the back part of this year.”

On another positive note, at the point when 287 companies on the S&P 500 had reported profit figures, 73 per cent had beat earnings estimates. Tech giant Apple announced that its revenue for the quarter jumped to US$39.2 billion from US$24.7 billion in the same quarter a year earlier.

While no one can say with certainty what will happen in May and subsequent months this year, it’s important to be aware that it can be a period of worry for investors. A poor showing on the stock market and in the economy will be a concern for business owners.

Patchy confidence

So how are Australian businesses feeling right now? According to NAB’s monthly business survey, business confidence rose from one point in February to three index points in March. Over the same period, sentiment about business conditions increased from three index points to four.

“Businesses appeared slightly more confident about near-term activity in March than in February, although a degree of caution still seems to be inhibiting hiring and investment decisions,” the survey stated. “Positive data out of the US, which helped push the Australian dollar lower and reduced Euro banking concerns probably aided sentiment.”

As a point of comparison, market researcher Roy Morgan reported that its business confidence index fell for the second month in a row in March and is currently at 108.9. For the six consecutive months to January 2012, the index rose and reached a peak of 118.7. The researcher says the subsequent falls indicate that “ongoing economic uncertainty continues to cause concern for Australian businesses”.

Peter Switzer, founder of the Switzer Super Report, reveals what he believes are the questions a business owner might be thinking when looking at investing a million dollars into a business:

  • Could Europe create another GFC and global recession?
  • Could my bank be caught in an international credit crunch and withdraw my line of credit?
  • What will the carbon tax do to my business?
  • When will the RBA cut rates further and how many cuts will there be?
  • Will the banks pass on any further rate cuts or could they actually raise rates?
  • What will the elimination of the budget deficit in one year do to demand?
  • Could the Aussie dollar surge back to 110 US cents?
  • Is it likely that I will have to cope with another pay rise on top of a planned increase in superannuation?
  • What is going on in Canberra?

The questions speak for themselves: business owners have a lot of negativity to consider at the moment. The news out of Europe changes often and continues to surprise, and will be important to watch in coming months.

Battling retailers

One of the biggest challenges for retailers in Australia is competition from online traders. Retail spending was up 0.2 per cent in February after an increase of 0.3 per cent in January. In the past four months, total retail activity has increased by just 0.4 per cent.

Annual spending growth totalled just 2 per cent and, in annual terms, sales at chain stores were up 1.9 per cent on a year ago – the weakest annual growth rate in 15 months.

“It’s a completely new world,” says RBS Morgans’ Simon Bond. “The internet continues to blow up existing business models. I was talking to a chap who’s been in retail for 30 years and he was telling me just last week that it’s the toughest environment he’s ever seen. He feels that where we are in regard to online selling and internet sales is not halfway through or towards the end. This is just the beginning.”

So how can these concerns be allayed? The RBA moved to play its part on May 1, slashing the official cash rate by 0.5 per cent to 3.75 per cent. Many economists have been calling for the RBA to move on rates for some time, but early signs suggest banks are not passing on the full cut.

Garry Weaven, chair of Industry Funds Management, an investment service provider to the superannuation industry, believes rate cuts will have a marginally beneficial effect on the stock market.

“The stock market has been extremely difficult and will continue to be quite difficult,” he says. “Fortunately, we’ve departed and diversified quite a lot away from the stock market for many, many years now. Still, the stock market is central to superannuation returns and I think a lower interest rate environment will be good for that. I also think that a high relative interest rate tends to promote major corporations going offshore for their borrowings, and that’s not necessarily a good thing long-term either.”

The rest of the economy continues to struggle, as evidenced by these economic realities:

  • Total lending finance fell 6.5 per cent in February, and CommSec economist Savanth Sebastian points out that “on a trend measure, the pace of lending has now fallen for five consecutive months, with the 1.7 per cent slide in February marking the biggest monthly fall since mid-2008 – a period that was at the height of the global financial crisis”.
  • The Housing Industry Association (HIA) – JELD-WEN New Home Sales Report showed a 9.4 per cent drop in March, falling to 11-year lows. “It is not too late to turn the situation around and prevent new housing from revisiting a GFC low,” says HIA chief economist Dr Harley Dale. “Interest rate cuts, while no panacea, can provide substantial assistance in restoring confidence and activity. Needless to say, Australia’s banks need to pass all official rate cuts on in full. Their actions to date on interest rates have damaged economic confidence and activity.”
  • China’s economy is growing at an 8.1 per cent annual rate, down from 8.9 per cent only three months before. It was the slowest annual growth rate in two-and-a-half years, though it is still a good rate.
  • Australia’s trade deficit of $480 million in February followed a $971 million deficit in January. Exports fell 2.1 per cent, reflecting less China demand while imports fell 3.9 per cent, suggesting weaker demand locally.
  • The latest GDP growth reading was a poor 0.4 per cent, which annualises to 2.3 per cent.
  • The Westpac-Melbourne Institute Index of Consumer Confidence dropped by 1.6 per cent in April to an eight-month low of 94.5.
  • The TD Securities/Melbourne Institute monthly inflation gauge rose by 0.3 per cent in April, which tells us inflation is no threat and business is actually experiencing deflation!

There has been much negativity around, but the question now remains: How will the economy react to the 50 basis point rate cut? Will business and consumer sentiment improve, and will the Australian dollar, currently at about US$103 cents, now head lower?

Further, events from left field – probably out of Europe – could appear this year, which may affect the local and global economy. Ensuring you’re aware of the issues that could affect the determinants of wealth and business growth is always the main game, but especially so in these challenging post-GFC times.

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