The Switzer Market Review
Private Matters, August 2012
Europe still the main game for nervous investors.
It is getting monotonous. Concerns about Europe plagued markets and economies during July and, while there was some reprieve at the end of the month, the question is whether enough has been done. Even more curious is how a stock market rally could come out of hopes and prayers on central banks in Europe and the United States.
During the month, the S&P500 added 1.26 per cent, while the Dow put on 1 per cent. Locally, the S&P/ASX 200 was 4.26 per cent higher. On August 1, the index was at 4,262.8, before dropping to 4,221.5 on August 3, but then it pushed higher to 4272.6 by August 6, an increase of 1.21 per cent. The S&P500 was at 1375.32 on August 1, fell to 1365 the next day, but rose 1.9 per cent on August 3 to 1390.99.
Three events caused the ups and downs of the indices and held the attention of market and economy watchers in the final week of July and the first week of August. The results of each have repercussions for businesses and wealth builders in Australia.
- The Federal Reserve’s monthly monetary policy meeting
- Comments from European Central Bank (ECB) president Mario Draghi
- Job numbers in the US.
There were hopes that the Federal Reserve would make some mention of a third round of quantitative easing (QE3), but instead it indicated that such a move is still an option in the background should the time come.
Following its monthly meeting, the Federal Open Market Committee commented: “The committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.”
Peter Switzer, founder of the Switzer Super Report, says this is good and bad news.
“If the US can recover without QE3, well, that’s great, but if the economy keeps heading down then the delayed QE3 could prove to be a bad policy decision. That said, as I have always argued – Europe is the main game.”
The Federal Reserve will also leave interest rates low until 2014 (currently the target range for the federal funds rate is at zero to 0.25 per cent). Operation Twist, whereby long-term bonds are bought by the Fed and short-term bonds are sold, will be maintained. This lowers long-term interest rates, which should stimulate borrowing in areas such as housing and business investment.
The Dow and S&P500 both lost 0.29 per cent on the news, but markets were really waiting for what would come the next day - an ECB meeting.
Eurozone magic trick
The world was counting on eurozone leaders coming up with a credible plan to provide some sort of clarity for global economies and stock markets to get them back on track. In the week prior, Draghi had used language such as “whatever it takes” and colleagues in the Eurogroup spouted similar rhetoric. The meeting came and went, and the Continent is pretty much in the same position, at least until September when the ECB meets again.
However, in the following days, investors were enthused by news the ECB will start buying Italian and Spanish debt in September.
“You have to give Mario Draghi a great compliment – he pulled a David Copperfield,” Art Cashin, the director of floor operations at UBS Financial Services, told CNBC. “While everyone was looking at the broken arm Spain had, he talked about how strong their legs were – he took everybody’s focus from the 10-year and put it on the two-year. And by doing that, he bought them a lot of time.”
The day after Draghi made his announcement, the US Department of Labor released job numbers for the month. Non-farm payroll employment rose by 163,000 in July, well up on economists’ expectations of 100,000 jobs. The unemployment rate increased to 8.3 per cent from 8.2 per cent. Investors liked the news and the Dow and S&P500 put on 1.69 per cent and 1.9 per cent, respectively.
US companies have also been reporting earnings. At the point when 400 of the S&P500 companies had reported, 67 per cent detailed performances that were better than expected.
Long-term concerns about Europe are far from being allayed, but the Continent is heading in the right direction. In addition, the US has QE3 to fall back on should things get really bad. It is believed the Fed would prefer not to go down that track too hastily, although some economists and market analysts have predicted we will see it as soon as September.
This is a tricky time for investors and businesses that have been spooked by Europe over the past two years. A positive breakout or another ‘here we go again’ slide in stocks as well as confidence – for business and consumers – could be on the cards.
Unsurprisingly, the Reserve Bank of Australia left the cash rate on hold at 3.5 per cent at its August meeting. The last time it cut rates was in June, by 25 basis points.
Reserve Bank governor Glenn Stevens summed it up like this: “China’s growth has moderated to a more sustainable pace, but does not appear to be slowing further. Conditions in other parts of Asia have recovered from the effects of last year’s natural disasters, though the ongoing trend is unclear and could be dampened by the effects of slower growth outside the region. Growth in the US continues, but at only a modest pace. The most significant area of weakness continues to be Europe, where economic activity has been contracting and policymakers confront the very difficult task of seeking to put both bank and sovereign balance sheets onto a sound footing, while promoting conditions for improved long-term growth.”
He added that financial markets responded positively to signs of progress, but that “Europe will remain a potential source of adverse shocks for some time”.
The latest Deloitte CFO Survey underlines the impact of Europe on local chief financial officers of Australia’s major publicly listed companies.
The survey recorded the lowest levels of optimism since it began in 2009. Deloitte COO Keith Skinner says the second-quarter results reveal that only 16 per cent of CFOs are more optimistic about their company’s financial circumstances than they were three months ago. This represents a dramatic turnaround from the upswing in sentiment seen in the first-quarter results (38 per cent), with the European Union being the big cause for this negativity.
“The uncertainty in Europe escalated substantially during the last quarter and that had a significant impact on CFO optimism (88 per cent),” Skinner says. “If Greece had withdrawn from the eurozone as many had feared, the impact on the European economies could have had a trickledown effect that could have included a potential slowdown in the Chinese economy – a possibility that would have made many Australian CFOs understandably nervous.”
On issues other than Europe, 84 per cent of CFOs identified government policy as a concern, while 36 per cent claimed it was having a “significant impact”, with the carbon tax and Minerals Resource Rent Tax the main concern for CFOs.
Skinner says the issues being experienced in other economies around the world are overshadowing many positives in the Australian economy. The nation’s annual economic growth reading stands at 4.3 per cent, and unemployment is at a respectable 5.2 per cent. Inflation is just over 2 per cent and Australia has a AAA credit rating.
“These all point to a sound financial system,” Skinner says. “Ironically, it’s probably the fact that we’re coming off such a strong performance that CFOs here are so nervous. We may have seen Australian corporate profits dip in the past year, but they are still close to a record high share of the Australian economy and 20 per cent higher than their average over the last 50 years.”
A survey from the Australian Chamber of Commerce and Industry (ACCI) shows that business conditions and the outlook for businesses continued to edge lower in the June quarter.
“Australian businesses, especially those outside the mining and mining-related industries, continue to face a challenging business environment amid global economic slowdown, the strong Australian dollar, weak consumer demand and rising input costs,” says Greg Evans, director of economics and industry policy at ACCI.
Crunching the numbers
So how did the data stack up this month?
- Retail trade increased by 1 per cent in June, according to the Australian Bureau of Statistics (ABS). This follows a 0.8 per cent rise in May. Annual spending growth lifted from 2.1 per cent to 3.7 per cent.
- Private sector credit rose 0.3 per cent in June. This follows a 0.5 per cent increase in May
- Business credit was up 0.5 per cent after gaining 0.8 per cent in May. Business credit is 4.4 per cent higher than a year ago, which is the best annual growth rate in more than three years
- Dwelling approvals fell 2.5 per cent in June, after they rose a huge 27 per cent in May
- The RP Data – Rismark Home Value Index reported that capital city home prices rose 0.6 per cent in July and apartment prices increased 0.7 per cent
- The Consumer Price Index (CPI) rose 0.5 per cent in the June quarter, in line with expectations. The CPI is 1.2 per cent higher than a year ago
- Net household wealth per capita rose for the second quarter in a row from $47,269 to $50,786 in the March quarter
- The Westpac – Melbourne Institute Survey of Consumer Sentiment increased 3.7 per cent to 99.1, from 95.6 in May
- The number of tourists arriving in Australia jumped 3.4 per cent in June
- Australia recorded a turnaround on trade, with a deficit of $313 million in May transforming into a small $9 million surplus in June.
Not all the news was so good.
- The Performance of Services Index fell 2.3 points to 46.5 in July, marking the 19th month of contraction in the past 24 months. A reading under 50 represents contraction in the sector
- The Performance of Manufacturing Index fell 6.9 points to its weakest reading in more than three years of 40.3 in July
- The Performance of Construction Index fell 2.2 points to 32.6 in July
- The NAB business confidence index fell from -2.2 to -2.7 in June, a 10-month low
- Job ads on the internet and in newspapers dropped 0.8 per cent in July, according to the ANZ job advertisements series. The number of job ads in newspapers was down 3.2 per cent, while internet ads were 0.7 per cent lower.
So these important indicators were mixed, but tending to the positive. While Australia’s economy is in a good position, it is subject to concerns about a slowdown in China, the US economy and news out of Europe. Until Europe is out of the woods and global markets are back on track, which could be some time away, business owners and wealth builders need to be prepared for volatility.