A slowdown in global economic momentum and renewed sovereign debt issues in peripheral Europe weighed heavily on global equities in the June quarter. Industrial output slowed from the first quarter as shortages of automotive and electronics components imported from Japan developed. Leading indicators including the manufacturing and services Purchasing Manager Index (PMI) weakened in the quarter, suggesting that economic momentum had slowed from previous quarters. In emerging economies, policymakers continued to tighten monetary policy to combat inflation.

There was also not much positive news to emanate from Europe. Apart from posting a strong first quarter GDP result, leading indicators suggested that output in the second quarter would slow. Greece was under considerable pressure as there were concerns of a sovereign debt default. Importantly, economic growth in the US slowed in the first quarter of this year after expanding strongly in the previous quarter.

In Australia, the S&P ASX200 Index was down 4.5% for the quarter, but up 7.1% on an annual basis. The defensive sectors performed strongly in the quarter as risk aversion saw investors rotate out of cyclical stocks.

To read more, download a PDF version of this report: Quarterly Economic and Market Commentary July 2011

Globally the March quarter was notable for emerging signs of growth in industrial output in the US and the major European economies, Germany and France. Growth in China and other Asian economies was accompanied by concerns of a buildup of inflationary pressures.

Equities extended the rally that began mid last year as corporate profits continued to surprise on the upside. However, there was a brief selloff in equities as political unrest in the Middle East and North Africa unsettled investors. The pullback intensified following the massive earthquake and subsequent tsunami and nuclear damage in Japan in mid-March. By the end of the quarter, equities had shrugged off these concerns and rebounded strongly to finish in positive territory.

In Australia, overall the economy continued to expand in the March quarter; however the widespread floods of prior months are expected to reduce output in the first quarter of 2011. The S&P ASX 200 Index finished up 2.0% over the quarter, with energy the best performing sector. Since the end of quarter, resource and mining services stocks, in particular, have continued to add impetus to the index.

Download a pdf version of this report: 2011.04.15 Quarterly Economic and Market Commentary

The final quarter of the year saw global equity markets rally strongly, building on the momentum in the third quarter.  In the US a number of fiscal and monetary decisions were made including further quantitative easing and cuts to taxation.  While the US and Japan provided further stimulus to their economies, China continued to tighten monetary policy to curb inflation.

In Australia, the economy continued to expand in the third quarter but at a slower pace.  The S&P ASX200 finished positively for the quarter but underperformed most global indices on a local currency basis.

As widely anticipated, the US Federal Reserve announced another round of quantitative easing to stimulate the economy.  The Fed viewed that the current rate of recovery has been insufficient to meet its dual mandate of maximum employment and price stability.  Subsequently the Fed decided to expand its holdings of longer-term securities by US$600 billion by the end of the second quarter of 2011 at a rate of US$75billion a month.  The average duration of the securities will be 5 to 6 years.  The Fed has committed to regularly review the pace of its asset purchase program in light of incoming information.

In the quarter, the US government extended the Bush tax cuts and provided additional fiscal stimulus measures through payroll tax cuts, jobless benefits and business tax credits for capital spending.  The combination of accommodative monetary policy and an expansionary fiscal policy is likely to promote growth in coming quarters.

Recent economic data released in the US was quite positive.  The pace of consumer spending picked up in the lead up to Christmas with retail sales posting strong gains in October and November.  Consumer confidence increased to 54.1 in November after being below 50 in prior months.  Exports reported a large gain in October with industrial supplies and agricultural goods the strongest component.  Business investment in equipment and software remained relatively strong.  The latest estimate of the unemployment rate edged down to 9.4% in December from 9.7% in November, although part of the drop was due to the participation rate falling over the period.  The average increase in nonfarm payroll employment over the quarter was close to the pace of preceding months, which showed that there was yet to be a marked improvement.  The housing market showed little improvement in the quarter as construction activity and demand remained weak.

In the Eurozone, sovereign debt issues continued to pose a risk to the region.  Ireland accepted a €85 billion support package to strengthen its banking system.  The contagion had spread to other peripheral economies, which saw sovereign yield spreads over those of German bunds rise to new highs, although they fell back towards the end of the quarter.  As a result, the Euro remained weak.

Economic data released in the quarter continued to suggest a slow recovery in the Euro area.  GDP increased 0.3% in the third quarter, although disparities between members remained.  Germany performed strongly as GDP rose by 0.7% in the quarter, and indicators such as PMIs, consumer and business confidence showed further strengthening in the economy, which could boost domestic demand.  In contrast, growth in Greece continued to contract and stagnated in Spain.

China continued to grow at a strong pace in the third quarter with GDP growing by 9.6% year-on-year.  GDP growth continued to be supported by industrial production, investment and consumption.  Much of the focus in the quarter was on the recent inflation readings.  Inflation picked up in the quarter as China’s annual CPI rose to 5.1% in November, after rising 4.4% in October.  Food prices were a main contributor surging 11.7% in November.  Though inflation had been contained in the first half, it was expected that inflationary pressures were building up over the second half.  In response to these pressures, the People’s Bank of China (PBC) decided on 26 December to raise the RMB benchmark deposit and loan rates of financial institutions by a further 25 basis points to 5.81%.  The PBC also raised the RMB reserve requirement ratio for depository financial institutions a further 3 times after raising it 3 times earlier in the year.  Despite the increase in interest rates, real interest rates remain low.

India’s economy continued to be robust with growth increasing by 8.9% for the quarter to September from a year earlier.  Agricultural and service sectors performed particularly strongly.

Calendar year 2009 growth in GDP and the forecasts for 2010 and 2011 for Australia and other major regions are shown in the table below.

Growth in Gross Domestic Product (Dec 10 Forecast)

Sources: Consensus Economics, Macquarie Research

Domestic Economy and Financial Conditions

In Australia, GDP data released in the third quarter showed that growth slowed from the previous quarter.  GDP rose 0.2% in the third quarter, below consensus of 0.4%.  This reduced the year-on-year growth to 2.7%.  Though private demand slowed, it was the main contributor to GDP growth.  Net exports and inventories partially offset the growth in the quarter.  After the release of the lower than expected growth figure, economists revised down their growth forecasts for the coming quarters.

Business investment posted a positive figure for the first time since the fourth quarter of 2008 increasing by 2.1% over the quarter.  Private consumption growth rose 0.6%, somewhat softer than expected.

The percentage changes on year on year and quarter on quarter growth in GDP are highlighted in the graph below.

Sources: ABS, UBS

Terms of trade data released in the third quarter provided further evidence that the terms of trade is likely to remain elevated throughout 2011.  The terms of trade increased 0.8% to another record high, after increasing 11.9% in the previous quarter.  Total capital expenditure rose 1.5% in the September quarter with the majority of the expenditure in the mining sector. The ABS capital expenditure survey released in the quarter suggests that there will be strong investment growth in the current financial year which will also broaden beyond the mining sector.
Terms of Trade and Engineering Commencements

Sources: ABS,ANZ

There were strong price gains in both bulk materials and base metals over the quarter.  Copper prices gained 19.3% on tight supply conditions.  Iron ore prices remained elevated as spot prices rose to approximately US$170/t (cost and freight to China).

On a slightly negative note, household spending and credit growth remained weak over recent months.  Strong employment growth and rising incomes would suggest that both spending and credit growth would be higher than current levels, but it seems that consumers remain cautious.  Retailers continued to provide discounts over the Christmas period to stimulate spending.

ABS released revised data on the household savings ratio in the quarter.  The household savings ratio was revised upwards from 2006 by 2% to 5%.  This suggests that consumers saved more of their incomes in the past few years than initially thought.

Percentage change in household savings ratio (1996 to 2010)

Sources: ABS, UBS

The labour market remained relatively tight as the unemployment rate dropped back to 5.2% in November after rising to 5.4% in October.  The participation rate surged to a record high of 66.1%.   Jobs growth for the month was fully accounted for by full-time jobs, whilst part-time jobs were flat.

Since the beginning of December, torrential rain across Queensland has resulted in one of the worst floods in history disrupting the production and export of coal and farm produce.  Many large resource companies have declared ‘force majeure’ on coal sales.  This allows companies to miss deliveries due to circumstances beyond its control.  Food prices are likely to rise as shortages emerge.  Although too early to assess the size of the impact on the Australian economy, some economists estimate that the impact could be in the range of 0.25 to 0.5% of GDP.  This is likely to be spread across the final quarter of 2010 and the first quarter of 2011.

Core inflation was 2.4% for the September quarter, below expectations.  Housing and alcohol and tobacco were the main drivers of inflation.

Global Equities

The final quarter of the calendar year saw gains in global equity markets with Germany and US leading the way.  As anticipated, the Fed introduced further quantitative easing which the market welcomed.  Global equity markets were also supported by the release of more positive economic news from the US.

Movements in major global indices as at 31 December 2010 ranked in order of quarterly performance are listed below.

Brothers.  Banks, materials and energy were the best performing sectors.

In November, the Fed decided to provide further quantitative easing by expanding its holdings of longer-term securities by US$600 billion by the end of the second quarter of 2011.  As noted in our previous Quarterly Commentary, we found it anomalous that equities rallied while bond yields fell.  Since the announcement, bond yields of intermediate and longer maturities have risen strongly.  As more positive economic news was released over the quarter, analysts revised down the ultimate size of the US$600 billion asset-purchase program.

The DAX 30 Index (Germany) was the best performer in the quarter and was one of the best performers over the calendar year.  German companies have benefited from the weak Euro as their exports continued to improve throughout the year.

The Shanghai Stock Exchange Composite Index was one of the poorer performers in the quarter.  The index gained 5.7% for the quarter and fell 14.3% for the year.  The performance of the index was disappointing compared to other asset classes such as direct property.

After a poor performance in the September quarter, the Nikkei 225 Index gained 9.2%.  In October, the Bank of Japan (BoJ) implemented a comprehensive easing package which included an asset purchase program of ¥5 trillion.  The BoJ reduced its policy rate to virtually zero from 0.1% and said that it would keep rates at virtually zero until it is satisfied price stability is achieved.  Since the announcement, the Yen has stabilised against the USD.

The following graphs show the movements in major regional indices over the past 12 months.

S&P 500 Index (United States)

FTSE 100 (United Kingdom)

DAX 30 (Germany)

Shanghai Composite (China)

Sensex (India)

Australian Equities

The Australian stock market as measured by the S&P ASX 200 Index ended the quarter up 3.5%, but down 2.6% for the calendar year.  In local currency terms, the S&P ASX 200 Index was one of the worst performers in the quarter compared to global indices.  On a common currency basis, the Australian dollar pushed the local market up in rankings.  The index reached its high in April and was about 200 points below this point at the end of the year.

The Australian dollar gained a further 5.8% against the US dollar in the quarter.  The AUD/USD reached close to $1.02 by the end of the year for the first time since 1982.  The strength of the AUD has been a result of elevated commodity prices.  Also worth noting is that the Australian dollar reached a new high against the Euro towards the end of the quarter due to European sovereign debt issues flaring up.

The graph below shows the movement of the AUD/USD over the past 12 months.

Sectors of the market posted mixed results in the quarter.  The materials sector continued to perform strongly from the last quarter. The sector was supported by strong commodity demand and elevated prices.

The energy sector also performed well in the quarter.  The price of crude oil increased 12% in the quarter and set a new two year high in December.

Bank stocks underperformed the market on a softer credit growth outlook.

Consumer related stocks lagged the market as retail sales and credit growth remained subdued in the quarter.

Industry sector performances for the quarter and year ended 31 December 2010 ranked in order of quarterly performance are tabled below.

Cash

During the quarter, the Board of the Reserve Bank of Australia increased the cash rate by 25 basis points.  After deciding to leave rates unchanged in October, the Board increased the cash rate in November.  The Board’s view was that the strong terms of trade and tight labour market posed inflationary risks over the medium term.  As a result, the Board decided to get ahead of the inflation curve by increasing the cash rate to 4.75%.  After the announcement, banks decided to increase interest rates above the 25 basis points RBA increase due to increased funding costs.

At its meeting in December, the Board decided to leave the cash rate unchanged.  The Board noted that household consumption and borrowing remained restrained and this would limit the inflationary pressures that are expected to build from the strong terms of trade and mining investment.
Some economists now predict that the RBA will not increase cash rates until the second quarter of 2011.

90 day and 180 day bank bill yields increased over the quarter to 5.03% and 5.24% respectively.

Fixed Interest

Australian 10 year Government Bond yields increased over the quarter from 4.96% to 5.51%.

The performance of the hybrid market which largely comprises floating rate hybrid securities was flat over the December quarter after a strong performance in the September quarter.  A gradual improvement is expected from hereon as credit spreads continue to improve, auguring well for this asset class.

Listed Australian Property

The Australian Real Estate Investment Trust (A-REIT) sector underperformed the broader market in the December quarter with the ASX200 Real Estate Investment Trusts index ending down 2.8%.  A-REITs continued to trade at a discount to Net Tangible Asset (NTA).

Over the quarter, the better performers in the sector included Charter Hall Office, Australand Property and ING Industrial Fund while Commonwealth Property Office Fund, Mirvac Group and ING Office Fund underperformed.

Investment Outlook

Despite the strong performance of the Australian equities market over the last half of calendar 2010, it has been a rather disappointing year for Australian equities.  The S&P ASX200 Index also underperformed most global indices on a local currency basis.   Moving into 2011, we remain cautiously optimistic on the outlook for equity markets.  We expect the performance of Australian equities to continue to be influenced by global economic and financial conditions.  Sustainable growth from China and a further recovery in the US will bode well for equity markets.

Our views remain largely unchanged on China and emerging economies.   Rising consumer wealth and wages, strong capital inflows and industrialisation are likely to promote economic growth.  However, strong growth poses risks to inflation, a situation currently faced by China where the most recent annual CPI reading fell above the government’s target rate of 3%.  Although current monetary policy is accommodative, a period of monetary tightening could potentially hinder growth and demand for commodities.  It is a risk, but given the track record of policymakers, we believe China can maintain a balance between containing inflationary pressures and sustainable growth.  Chinese policymakers could also allow the Yuan to appreciate more significantly, which could ease inflationary pressures.

The US is expected to continue to recover in 2011 with accommodative monetary policy and fiscal stimulus measures in place.  It seems that the US is willing to do all it can to prop up the economy in the near term.  While this does not address the problem of the mounting debt that will need to be dealt with down the track, the US needs to instill confidence in the consumer.  The new fiscal measures announced during the quarter are likely to promote growth through an increase in consumer spending.  In the year ahead, we do not expect the Fed to tighten monetary policy as growth is unlikely to reduce unemployment materially and inflation will remain soft.  We think that a continual improvement in corporate profits is likely to support capital spending and employment growth.

European sovereign debt is likely to be a perennial issue in 2011 and beyond until policymakers can come up with a credible plan that supports the borrowing needs of peripheral economies.  Until investors are convinced, the sovereign debt issue has the potential to create contagion in the financial sector.

Australia’s close trade ties with China and other emerging economies means that we should continue to benefit from strong commodity demand.  However, a strong terms of trade and mining investment is expected to build inflationary risks over the medium term.  The RBA has a difficult task to contain inflationary risks without causing harm to consumers and small businesses.  We think that the RBA will err on the side of caution and keep interest rates on hold until the second half of 2011 as economic data released in the quarter showed that household consumption and borrowing remained restrained.  This has somewhat surprised us given that rising incomes and strong employment growth usually supports consumption and borrowing.  It seems that it will take some time for the benefits from the resources sector to spill into the broader economy.  In light of all this, we expect the resources and mining services stocks to continue to outperform the market in 2011.

On balance, we believe it should be a relatively good year for equity markets.  The Australian equity market seems reasonably valued and is pricing in some of the risks in the market.  The consensus one year forward price to earnings (PE) ratio is approximately 13 times, which is below the PE of about 15 times at the same time last year.  We will continue to take a cautious approach and evaluate our recommended asset allocation on an ongoing basis.

Wayne R Morgan BSc (Hons), GDipAppFin, F Fin, AFP
Managing Director

Jimmy Ly BCom
Financial Analyst

Morgan Wealth Management Group Pty Ltd
Australian Financial Services Licence No 234555

Download a pdf version of this report: 2011.01.14 Quarterly Economic and Market Commentary

The September 2010 quarter ended up strongly as risk appetite returned to global equities. It was not all smooth sailing throughout the quarter as volatility continued to unsettle equities. The volatility in equities was largely dictated by similar macro factors in the last quarter.

Global growth up until the first half of the year has been strong, but growth from hereon is expected to slow. It will be a long while before the US and EU economies sort out their structural issues.

Much of the future growth will come from China and emerging economies. Growth in China eased to 10.3% in the second quarter. Leading indicators suggest that China’s growth will slow to a moderate pace rather than a sharp correction.

In Australia, there was plenty of news to keep us interested. The Federal election in August left neither major party with a majority in the lower house. However, Prime Minister Julia Gillard was able to form a government with the support of Green and Independent MPs. Australian equities rebounded from the poor performance of the previous quarter. In August, most Australian companies reported on their results for the year ended 30 June 2010. Those results were mostly in line with expectations but management were more conservative on the outlook than expected.

Download a pdf version of this report: 2010.10.14-Quarterly-Economic-and-Market-Commentary

The June 2010 quarter was characterised by resurgent uncertainty in growth prospects for the global economy. That uncertainty has had a large negative impact on global equity markets during the last quarter and continues to overhang them. The uncertainties have centred on the sovereign debt issues in Europe, the strength of the US recovery and a slowing of the economy in China.

In Europe, uncertainty is likely to continue for some time as the extent to which austerity measures currently being introduced in many EU countries, and the UK, drag on demand both in the EU zone and globally. In the US, there are now tentative signs of economic recovery with increasing consumer spending and equipment investment data released in recent weeks. In China, inflation looks to have been contained at around target levels of 3% which would indicate the prospect of a contained slowdown.

In Australia, household spending appears to be slowing with some recent fall back in leading indicators. Recent comments from the Reserve Bank of Australia suggest that interest rates will be on hold at least for the short term, however with unemployment continuing to fall, there is the prospect that any resurgent inflation may need to be contained with harsher monetary policy settings in the future.

Ultimately, the Australian economy’s recovery will depend largely on how the current uncertainties impact world recovery.

Download a pdf version of this report: 2010.07.09 Quarterly Economic and Market Commentary

Most global equity markets have now recovered the pullback of mid January to mid February to end the March quarter higher. Fears stemming from sovereign debt issues and Chinese authorities slowing growth have largely been put aside as markets focussed on other factors. We would expect a sustained, but uneven, global recovery in 2010 and beyond with Asia and Australia leading and Europe lagging. Increasingly, a number of central banks have started exiting their earlier policy support measures and are now starting to look to raise their official interest rates. In China, higher reserve provisions have not sufficiently curbed credit growth and higher interest rates and an appreciation of the Yuan will probably be required to prevent a further overheating in its economy.

In Australia, the economy continues to grow strongly. Fundamentals are continuing to point upwards and the risks to domestic growth and commodity prices continue to be on the upside. This would suggest that the Australian equity market overall should be well supported by both revenue and earnings growth in the remainder of 2010. Risks however remain and we believe that a level of volatility in markets will continue for some time.

Going forward, sovereign debt issues of European countries, fears of the effects of a moderation of growth in industrial growth in China, are likely to continue to pose risks to the improving global growth outlook.

Download a pdf version of this report:2010.04.21 Quarterly Economic and Market Commentary