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The Switzer Market Review

Private Matters, June 2012

The Switzer Market ReviewUncertainty turns up heat on eurozone leaders.

Greece continued to be the spanner in the works of global markets during May, which is historically a sell-off month. The time-honoured rule of thumb for shares is, of course, "sell in May and go away".

The S&P 500 fell 6.8 per cent from 1405.82 on May 1 to 1310.33 on May 31. Locally, the S&P/ASX 200 plummeted 8.1 per cent from a high of 4435.9 on May 2 to 4076.3 on May 31. From October last year to May, the index had put on 14.6 per cent. Then came June!

On June 1, the S&P 500 dropped 2.46 per cent, while the S&P/ASX 200 lost 1.94 per cent to end below the 4000 mark. The index was last in the 3000s on November 25 last year.

The reason for the selloff at the beginning of June, other than the ongoing uncertainty in global markets, was a poor jobs report in the United States, where the unemployment rate rose slightly to 8.2 per cent. There was also further evidence of a slowdown in China, with the country's Purchasing Managers' Index dropping to 50.4 in May from 53.3 in April, according to the National Bureau of Statistics and China Federation of Logistics and Purchasing.

How long will the uncertainty continue? That remains to be seen, but considering the issues that need to be resolved it is likely markets will face challenges for most of this year.

Rudderless Greece

The rot set in when Greece failed to establish a coalition government following elections in May, and investors will continue to worry until the re-run on June 17, and a complex aftermath of establishing a stable government.

Matt Sherwood, head of investment market research at Perpetual, says the problem in Europe has been misdiagnosed, arguing that there is a bigger problem on the Continent than government debt. To remedy the situation, he suggests – tongue in cheek – that Germany should leave the eurozone!

“The biggest problem is the overvalued exchange rate, particularly in the periphery economies,” he says. “So Europe has to figure a situation out where all the Greek governments, banks, businesses and households can still be funded, yet the exchange rate has to come down. And really the only way that can occur would be for the strongest economy to leave the euro, which would be Germany, and then for the European Central Bank to quantitatively ease across the rest of the eurozone. And that simultaneously would increase their growth, it would fund their debt, it would stabilise their banks. That’s really what the market is looking for.”

He concedes, however, that this is not going to happen. 

“Germany is the biggest beneficiary of the euro. They’re the world’s second-biggest exporter, so they want their exchange rate as low as it can be. Their exchange rate continues to be weighed down by Spain, Ireland, Portugal, Greece and so on,” he says.

Sherwood explains that with Germany being a highly industrialised economy that sells a lot of hi-tech goods, a low exchange rate has been beneficial – more BMW 7 series vehicles are sold in China than in the rest of Europe. This is why Germany, led by Chancellor Angela Merkel, has been trying to keep the eurozone together.

“You lose one dead weight (and) you might lose three or four because you start a cascading effect,” says Sherwood, adding that in his opinion Greece’s place in the eurozone is unsustainable.

If Greece leaves, the eurozone will need to move to stop a contagion risk whereby other countries pull out because of their debt problems. Until the next Greek elections, doubt will prevail and the simmering banking problems in Spain will continue to put the pressure on eurozone leaders, including the European Central Bank.

Resources strength

To Australia: and new business investment rose 6.1 per cent in the March quarter, according to the Australian Bureau of Statistics (ABS). However, the resource strongholds of Western Australia, Queensland and the Northern Territory accounted for 95 per cent of the increase in investment spending.

National investment expectations for 2011/12 fell by 2.3 per cent in what was the second successive downward revision.

“The era of ‘new conservatism’ certainly doesn’t reside just with consumers – businesses are also hesitant to spend,” says CommSec’s Savanth Sebastian. “The good news is that businesses are hopeful that economic conditions will pick up over the next year. But if they don’t, as we’ve seen this year, spending plans will quickly be cut or shelved. As always, the further out businesses look, the less certain they are about their spending plans.”

If these forecasts come true, it could have an impact on employment in Australia. The ABS jobless figure for April was 4.9 per cent, down 0.2 per cent from a month earlier, but it rose again by 0.2 percentage points in May to 5.1 per cent.

Market research group Roy Morgan says, however, the real unemployment rate in April was 9.3 per cent, and fell to 8.2 per cent in May. So why are there stark differences between the ABS and Roy Morgan?

Michele Levine, CEO at Roy Morgan, says her company asks respondents: “Are you employed full-time or part-time? And if you’re not employed, are you looking for a job?”

“That’s the question we’ve asked for years and years and we say if you tell us you’re looking for a job, you’re unemployed,” Levine explains.

“On the other hand, the government statistics create a much tougher measure of unemployment. In order to be considered unemployed for the ABS, you need to basically have not worked and been absolutely available for work in the reference period – the week before. So you have to have been absolutely available, not doing anything else. Even if you worked for just one hour in that previous week, you won’t be classified as unemployed. That’s a really tough definition, and no wonder it’s a much lower figure,” she says.

Budget optimism

Confounding the general view that the economy is growing well under trend, the ABS in June unveiled national accounts showing economic growth of 1.3 per cent for the first quarter, double the forecast and the strongest in five years. The next set of figures will be closely watched.

It is also worth mentioning the Federal Budget, which came and went on the second Tuesday in May. The Government hopes to turn a $44 billion deficit into a $1.5 billion surplus.

Peter Switzer, founder of the Switzer Super Report, dubbed it the Dale Carnegie Budget – one designed to win friends and influence people! The economic growth forecast for 2012/13 was set at 3.25 per cent.

“This budget relies on the Reserve Bank continuing to cut interest rates and we’d need to see 0.5 per cent to 1 per cent worth of cuts to see growth of 3.25 per cent,” Switzer says. “You would also need the mining boom, which was worse than expected this year, to really kick in strongly, bringing with it the business investment stuck in the so-called ‘pipeline’.”

The RBA could be on its way to playing its part. The central bank cut the official cash rate by 25 basis points in June to 3.5 per cent following a 50-basis point cut the previous month. The effect of the June cut on consumer and business confidence remains to be seen, as evidenced by the latest Westpac - Melbourne Institute Survey of Consumer Sentiment. The index rose just 0.8 per cent to 95.3 in May, which Westpac chief economist Bill Evans described as “disappointing” following the RBA rate cut in May and the drop in the ABS’s unemployment rate in April.

“However, other factors appear to have offset these positives,” Evans says. “Firstly, there might have been a degree of disappointment among households that the standard variable mortgage rate was reduced by ‘only’ an average of 0.37 per cent. Secondly, increasingly disturbing news around Europe and specifically Greece is likely to have unnerved households.”

Among the other data released this month:

  • Retail trade figures fell 0.2 per cent in April after an increase of 1.1 per cent in March, according to the ABS
  • The Performance of Manufacturing Index lost 1.5 points to 42.4, which is an eight-month low. A reading under 50 represents contraction
  • The Performance of Services Index rose 3.9 points to 43.5
  • The RP Data-Rismark Home Value Index showed capital city home prices dropped 1.4 per cent in May after a 0.8 per cent fall in April. Home prices were down 1.8 per cent, while apartment prices increased 1 per cent
  • The NAB business confidence index, which was taken before the May 1 rate cut, increased from 2.6 in March to 3.7 in April. Business conditions dropped to -0.1 from 3.4
  • Company profits dropped 4 per cent in the first quarter of calendar 2012, according to the ABS, and were 0.5 per cent lower than a year ago.
  • Vehicle sales, on a positive note, were up 24.1 per cent in May compared with the same month last year, according to the Federal Chamber of Automotive Industries.

Murky outlook

Official indicators reveal tough conditions in recent months, and it will be interesting to see how they change in June and beyond. It is hard to be optimistic at this point in time.

Meanwhile, for those looking for a business tip from the coalface, Jack Singleton, chairman of 1300 Flowers, says it is important for those who advertise to work out what is working and what is not, or “measure everything you do”, whether online or offline.

“We’re now measuring things offline with methods and technologies that have been introduced to us online,” he says.

“It’s that old expression: ‘half the money I spend on advertising is wasted, the only problem is I don’t know which half’. No one has any excuse for not knowing which half is working. Find out the half that’s working, cut the half that isn’t, and try to find new ways to be even better than the half that’s working.”

If the stock market follows what happened last year between May and October, then 2012 will be a rough ride. Given the lack of help from the market, the economy and policymakers, maybe it is time to look at being better at business and learning from cutting-edge performers. Doing so is a critically important characteristic of great business builders.

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