The Experts

The big picture

At the time of writing, the profit-reporting season was drawing to an end. So prepare to be inundated with post-mortems of the results by analysts, investor websites and the media over the coming week.

So how did it go? We have assessed the results for the 104 ASX 200 companies that reported results for the year to June. In aggregate, profits lifted by almost 87 per cent over the year to $40 billion. Clearly, bellwether companies like BHP Billiton and News Corp significantly affect this result. But stripping out those companies still reveals a 30 per cent lift in aggregate earnings. And averaging the results reveals a similarly impressive 45 per cent lift in earnings. In the smaller sample of 34 ASX 200 companies reporting half-yearly results, earnings have lifted on average by 78 per cent compared with a year ago.

Interestingly, the lift in profitability wasn’t driven by consistent gains in sales (revenue). In fact, average revenue growth was just under five per cent – but neither were businesses slashing expenses to boost profitability. On average, across the major companies, expenses fell by five per cent over the year. But, unlike last year, write-downs certainly weren’t an influence on profit results. A year ago companies (especially in finance and property sectors) were forced to downwardly mark to market the value of assets but over the past year asset values stabilised and there were rare upward revisions.

One other standout feature of the profit-reporting season has been the sharp lift in cash holdings. As at 30 June, the 138 ASX 200 companies that have reported results had cash holdings of almost $100 billion, up 13 per cent on a year ago. Not only are companies back in the black but they are cashed up for expansion. Retained earnings are even healthier at $136 billion, up 15 per cent on a year ago.

Bloomberg has also compared the latest profit results with analyst expectations. Of the companies that reported full-year earnings, 45 per cent were above consensus earnings per share estimates while 55 percent fell short of estimates. Note that, Bloomberg assigns results to either positive or negative surprises and doesn’t have an “in line” category. Most positive surprises were in the basic materials sector (58 per cent) while only 32 per cent of results in the financials sector beat expectations.

While there was some disappointment on earnings from an analyst perspective, the lack of guidance from companies has also been a concern. Overall, analysts and investors alike should be happy with the health of company balance sheets, but, as always, it is the uncertain future that dominates. And that suggests that the share market will continue to move sideways until better signs emerge on the US economy.

The week ahead

In the coming week, not only does the calendar flip over from August to September but winter comes to an end. And as is usual with a change in seasons, there will be barrage of economic data to usher in the transition to spring. In fact, there are no fewer than a dozen key indicators to be released over the week with GDP (economic growth) figures one of the standouts on Wednesday.

On Monday, the Bureau of Statistics releases data on profits, sales and inventories. On Tuesday (“terrific Tuesday”), retail trade, building approvals, government finance, private sector credit and the current account are issued with a speech by Reserve Bank Assistant Governor Guy Debelle thrown in for good measure. The Performance of Manufacturing index is released on Wednesday alongside the GDP figures while international trade is issued on Thursday and the Performance of Services index and tourism data are slated for Friday.

At this early stage of data collection, we expect that the Australian economy grew by 1.1 per cent with household spending and dwelling construction both higher and the trade sector likely to add a small 0.1 percentage point contribution to growth. Overall, the result will signify that Australia is well on its way to notching up 20 consecutive years of economic growth, but it will mask the weakening in economic momentum over the past two months.

This loss of momentum has clearly shown up in consumer spending, up just 0.5 per cent over the past five months. But the longer that the Reserve Bank stays on the interest rate sidelines, the better the outlook for retailers will be. We expect that retail trade lifted 0.4 per cent in July after a 0.2 per cent gain in June.

Dwelling approvals probably rose by 1.5 per cent in July, for the simple fact that recent declines appear over-done. In fact, approvals have fallen in five of the past six months and fell by 3.3 per cent in June.

Of the other data, expect another solid trade surplus, flat readings for manufacturing and services activity and further weakness in tourism flows.

If the US is to avoid a ‘double-dip’ recession, it all boils down to whether there is a pickup in job growth. If jobs aren’t created, consumers don’t spend and businesses don’t receive income, causing them to constrain investment and employment. Certainly businesses have been making money but they have been more focused on cutting debt rather than growing.

Unfortunately, economists don’t believe that the start of the jobs recovery began in August with predictions that only 44,000 private sector jobs were created in the month. And unemployment is tipped to have lifted modestly from 9.5 per cent to 9.6 cent with no change in the average number of hours worked.

The other economic indicators are expected to provide mixed readings. Personal income and spending may have both lifted by 0.3 per cent (Monday). And consumer confidence may have also edged higher in the latest month (Tuesday). But economists believe that the ISM manufacturing index eased from 55.5 to 53.3 in August (Wednesday) while the ISM services index may have also softened in the month (Friday).

Other indicators to watch over the week include house prices (Tuesday), construction spending, auto sales and the ADP employment index (Wednesday), and pending home sales (Thursday).

Share market

If the conventional wisdom is to be believed, the Australian economy will continue to be protected from any gloom in the US and Europe by virtue of its strong links to Asia, especially China. But that rationale certainly hasn’t played out on the share market – for this year at least. Two-thirds of the year is almost over and the Australian share market has fallen by just over 10 per cent. By contrast the US Dow Jones is holding up far better, even with an economy at risk of a double-dip recession. The Dow Jones has only fallen 3.5 per cent over the year with the Nasdaq down 5.6 per cent. Even in Europe the German Dax has only fallen one per cent this year while the UK FTSE is down by 5.6 per cent.

We haven’t changed our projection for the end of the year, but it is looking more challenging by the day. CommSec continues to tip the All Ordinaries/ASX 200 at 4800 points by end year. While company balance sheets are healthy and the outlook for the Australian economy remains promising, our share market continues to track offshore markets closely, especially the US Dow Jones.

Interest rates, currencies and commodities

The gap between fixed and variable mortgage rates has narrowed markedly in recent months and the process may have further to go. The Reserve Bank reports that three-year fixed rates are around 7.5 per cent currently, compared with 7.4 per cent for the standard variable rate. Earlier this year, fixed rates were just over one percentage point higher than variable rates. In large part the gap has narrowed because variable rates have risen. But fixed rates have also eased 30 basis points between April and July. And with market rates down around 25 basis points over the past fortnight, fixed housing rates could fall even further, dropping below the variable rate. Just goes to show that you always need to keep your eye on the ball.

The Australian dollar is on track for a very average year. Over the past 25 years, the Aussie dollar has fluctuated on average by US13.5 cents a year. So far this year the Aussie dollar has moved US13.2 cents.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

When it comes to investing, there will always be differences of opinions. Some investors prefer shares, others property or fixed interest. And, of course, the preferences change over time. And when it comes to shares, again there are differences of opinions on the outlook for individual companies, sectors or entire markets.

And certainly that’s what makes a market – a variety of views on companies, sectors and economies. But if there is one source of agreement among longer-term investors, it is that uncertainty is a major negative influence – which means the unclear election result on Saturday is sure to rattle some nerves.

Of course, traders may have a different view, as they rely on volatility to provide opportunities. Still, to successfully trade, you do actually have to be successful in picking the trends.

But getting back to the election, it’s important to remember that, in a big picture sense, not much would have changed if one clear party had won power. The Reserve Bank will still be setting interest rates. The public service will still be the same (unlike in the US where an election leads to wholesale changes). And the Aussie dollar, bank bill and government bond rates will still be set by the market.

The other important point is that both sides of politics aim to get the budget back into surplus in the next three years. In fact, rather than trying to outdo one another with spending promises, both major parties are trying to outdo one another with the size of the budget surplus they are likely to achieve in coming years.

In terms of policies, there is not much that separates the major parties. Certainly Labor is committed to a mining tax and the Coalition is opposed, but this is still a tax that is proposed, not yet enacted. If Labor ultimately wins but with loss of seats in Western Australia and Queensland, it may seek to make changes to the tax. Indeed changes are possible given that smaller miners are looking for concessions.

There are also differences between the major parties on ways to improve the speed of internet access. But while each party has different ways at addressing the situation, both are committed in improving the service.

But as we noted above, no matter which party ultimately governs, the uncertainty has rattled investors. In particular, a hung parliament or a minority government could cause foreign investors to trim their exposure to Australia, putting downward pressure on the share market and the Australian dollar.

While it has been very much a “Seinfeld election” – an election about nothing – Australia is fortunate in having two major parties/groupings that have credible policies that will serve our interests well in coming years.

The week ahead

There are just two key pieces of economic data to be released this week – figures on construction work on Wednesday and capital expenditure or investment figures on Thursday.

For almost two years, construction activity has been driven by the public sector. But certainly the stimulus is now winding down, so it will be interesting to see the break-up of results for the public and private sectors in the June results.

Also of interest will be the size of order books – that is, the work yet to be done. In the March quarter, work yet to be done hit a record high of $44 billion, indicating that the outlook for the construction sector remains very positive.

And the other factor in the spotlight is construction costs. In the March quarter, construction costs rose by 0.7 per cent to stand 2.4 per cent higher than a year ago. Costs have been creeping higher over the last couple of quarters, but if the trend is arrested in the June quarter then the Reserve Bank will have even more reason to stay on the interest rate sidelines until 2011.

In terms of business investment, we expect that spending rose by 2.7 per cent in the June quarter after a flat result in the previous three months. Economists usually get a fair idea of the June quarter result as companies tend not to revise their short-term spending plans too much. So a weak result would raise eyebrows.

Certainly most eyes will be on the expectations for business investment over the 2010/11 year. There was only a modest 3.7 per cent increase between the first and second estimates for the year and the third estimate will need to rise around 10 per cent to around $115 billion to prevent economists from downwardly revising their views on economic growth.

In contrast to Australia, there is a well-stocked cupboard of economic releases in the US in the coming week. Figures on existing home sales are released on Tuesday with durable goods orders and new home sales data on Wednesday. On Thursday, the weekly unemployment insurance claims data is issued while the GDP (economic growth) results for the June quarter and consumer sentiment estimates for August are released on Friday.

Overall, economists aren’t expecting big things from the home sales results. Existing home sales are expected to have fallen by four per cent in July while new home sales may have edged 2.5 per cent higher. The existing housing market appears to be stabilising but there is still almost nine months of ‘normal’ supply of homes on the market. Inventories of new home sales also remain high at an estimated 7.6 months of ‘normal’ supply.

Economists tip a solid 3.4 per cent lift in orders of durable goods in July – goods with a lifespan of more than three years like cars, aircraft and defence equipment. But given that this would be the first lift in business spending in three months, it won’t be wildly celebrated.

The second estimate of economic growth in the June quarter will probably be revised lower in response to the latest trade data that showed a lift in imports. Economists believe that the US economy grew at a 1.4 per cent annual pace in the quarter, well down on the 3.7 per cent annual pace in the March quarter.

Share market

The Australian earnings season winds down over the coming week.

On Monday, Ansell, Caltex, NIB Holdings and Challenger are due to report. Westpac also issues a quarterly update on Monday.

On Tuesday, the list of earnings results includes Aristocrat, Foster’s, GPT, Mirvac, Origin Energy, SEEK, Sonic Healthcare and Perpetual.

The big days of the earnings calendar are Wednesday and Thursday. On Wednesday, APA Group, BHP-Billiton, Pacific Brands, Suncorp-Metway are amongst those to report. And on Thursday, AGL Energy, Amcor, Envestra, IAG, Transfield and Woolworths are expected to report.

Among those issuing results on Friday are Fairfax Media and Harvey Norman.

So far 72 of the ASX 200 companies have reported either full-year or half-year earnings. The good news is that most of the major companies are back in the black. In fact, just eight companies have posted losses for either the year to June or half-year to June. And not only are dividends back in vogue but the majority of companies have actually announced increases in their interim or final dividends. The other standout feature of the results is the amount of cash that companies are sitting on. As at 30 June, companies were sitting on almost $60 billion in cash, up almost 30 per cent over the previous period, be it six months or 12 months ago.

Interest rates, currencies and commodities

The election result will be the main issue for currency markets on Monday morning. Since the result is inconclusive, it is likely foreign investors will consider trimming positions on the Aussie dollar as soon as trade starts up in New Zealand.

Of course, it is impossible to tell just how markets will react, as political uncertainty in Australia is a very new concept for investors to get their heads around. Still, the fundamental planks of support for the Aussie dollar won’t have changed – interest rates are relatively high, commodity prices are firm and Australia’s major trading partners are in strong shape.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

Is there a new speed limit for the economy? In the recent Statement on Monetary Policy, the Reserve Bank broadly left unchanged both its economic growth and inflation forecasts for the period out to 2012. On current figuring, the Reserve Bank expects the economy to grow by 3.25 per cent this year and 3.75 per cent in 2011, before a further pick up to around four per cent by the end of 2012.

The interesting point is the Reserve Bank has generally assumed a speed limit for the economy of around 3.25 per cent. That is, if growth exceeds 3.25 per cent, inflation is more likely to accelerate, leading to higher interest rates.

Next year that speed limit will be exceeded by half a percentage point with 2012 growth around three-quarters of a percent above a level considered to be ‘normal’. With that degree of speeding, you would expect that underlying inflation would also be accelerating, breaching the upper limit of the two to three per cent target band.

But not so. Over 2011, the economy is assumed to expand by 3.75 per cent but underlying inflation doesn’t budge. In fact, inflation is only assumed to creep up to three per cent in 2012 at a time when the economy is presumably headed to four per cent growth.

So what gives? Well, part of the answer is that the Reserve Bank assumes that the “cash rate moves broadly in line with market expectations”. While it is possible to gauge those views, it is important to note that they are reasonably well developed over the next few months, but are less robust over the next few years.

Still, there are views on the cash rate over the next twelve months with the one-year overnight indexed swap contract standing at 4.65 per cent. And the 30-day interbank cash rate futures contact has an implied yield of 4.72 per cent in October 2011. In other words, financial market participants only expect one rate hike at most over the next year.

To get views over the entire 2.5 years of the forecast horizon requires a different focus – 90-day bank bill futures. The December 2012 contract has an implied yield of 5.14 per cent, around 40 basis points above the current physical yield for 90 day yields.

So the Reserve Bank is assuming that two rate hikes over a 2.5 year period will be sufficient to keep inflation in the target band. If that is the case, it gives the impression that the speed limit has been lifted. That is, the economy may now be able to grow at a 3.5 to 3.75 per cent rate without leading to higher inflation. How the Reserve Bank has come to this view is uncertain, but it would be consistent with either consistently higher population growth or productivity or a new view of the efficiency of the economy.

The week ahead

A quieter week is in prospect with the spotlight on the Reserve Bank and wage data. The Reserve Bank releases minutes from its 3 August Board meeting on Tuesday while the Reserve Bank Governor delivers a speech on the same day and the Deputy Governor fronts the lectern on Friday. In terms of wages, the wage price index is released on Wednesday with average weekly earnings on Thursday.

Before we get to the main events, the support act comes in the shape of car sales data to be released on Monday. Overall, the headline result on sales appeared good with 82,376 motor vehicles purchased in July, up 8.3 per cent on a year ago. But the seasonally adjusted results are unlikely to look as good and we suspect that sales fell by 4.5 per cent in the month.

The fact of the matter is that the government tax break boosted car sales in late 2009/early 2010 and we are now in the ‘hangover phase’. But the good news is that the job market is healthy, interest rates are stable and car affordability is the best since the mid-1970s. So the car market may be down, but it’s not out.

Investors will no doubt scour for fresh insights into Reserve Bank thinking when the minutes of the latest Board meeting are released on Tuesday. But the Statement of Monetary Policy has probably provided all the necessary views and information that investors need for now.

Still, we can look forward to yet more from the Reserve Bank on Tuesday evening (8pm Sydney time) when the Reserve Bank Governor delivers a speech entitled ‘The role of finance’. Deputy Governor Ric Battellino delivers a speech to a Queensland business audience on Friday morning.

The other key focus over the week will be the latest figures on wage trends. The wage data is backward looking, so we are unlikely to see much evidence of wage pressures. We tip a 0.9 per cent lift in the wage index for the quarter and growth of around 3.1 per cent for the year. When you consider that the Reserve Bank only really gets concerned when wages are growing above four per cent, the data is unlikely to unsettle investors. On Thursday, the average weekly earnings data will provide dollar estimates for wages with mining leading the way with annual wages above $100,000 a year. Imports data is also out the same day.

Turning to the US, the pivotal day for economic data is Tuesday with housing starts, producer prices and industrial production all slated for release. Housing starts are tipped to rise modestly by two per cent after two months of declines. And industrial production is expected to have lifted by 0.5 per cent in July after a tepid 0.1 per cent lift in June. Both those indicators would give investors heart that the US economic recovery is still on track.

The producer price data provides a different focus – the issue of deflation or inflation. The core rate (excludes food and energy) is tipped to rise 0.1 per cent and 1.3 per cent over the year. A result in line with that expectation would mean that the issue stays unresolved – inflation still exists, but it remains very low.

The other indicators to watch over the week include the Empire State index and capital flows data on Monday. And, on Thursday, the leading index is released together with the influential Philadelphia fed index. The leading index is tipped to rise 0.1 per cent in July after a 0.2 per cent fall in June.

There are a number of speeches scheduled by Federal Reserve presidents but the one to watch is on Thursday when St Louis president James Bullard takes to the lectern. Bullard recently warned about the risk of the US going down the ‘Japanese road’ of low growth and deflation.

Share market

The Australian earnings season is well and truly in focus in the coming week.

On Monday, BlueScope Steel, Leighton Holdings, Lend Lease and Newcrest Mining are among those reporting.

On Tuesday the line-up includes CFS Retail Property Trust, GWA International, OneSteel, Primary Health Care and UGL Limited.

On Wednesday, APN News & Media, Boral, CarSales.Com, CSL, ConnectEast, Skilled Group, SMS Management and Woodside Petroleum are among those reporting.

On Thursday, AMP, ASX, Brambles, Downer EDI, Healthscope, PaperlinX, QBE and Wesfarmers are among those that are expected to report earnings results.

And on Friday, Billabong, Duet Group, Spark Infrastructure, Prime Media, Platinum Asset and Consolidated Media are expected to issue their results. ANZ also issues a trading update on Friday.

Interest rates, currencies and commodities

When investors revise their views on the global economy, the Aussie dollar and the Aussie share market tend to move in lock-step, and that’s what we saw this week. Early on Monday, the Aussie dollar was trading at US92 cents and talk of parity again emerged. But by Thursday, the currency had retreated to just above US89 cents.

Similarly, the ASX 200 index peaked just below 4600 points on Monday but by Thursday it had retreated to 4400 points. Commodity prices have undergone similar corrections – the sort of corrections we have seen time and again over 2010. Investors have regularly been getting too far ahead of themselves and have been forced to revise views. Still, when you look at 2010 as a whole, the impression is that markets have been marking time.

US and European economies are recovering, but it is clearly taking time. Many investors had been hoping for ‘V-shaped’ recoveries like in Asia, but they tend to forget that the eye of the GFC storm was in the North Atlantic and the economies will take longer to heal.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

The ‘hot button’ issue on global financial markets is deflation, or falling prices. This issue has been brewing for some time with a rash of retailers and consumer-product manufacturers forced to trim prices. But the issue has been given another kick along after the St Louis Federal Reserve President, James Bullard, cited the risks of the US falling into a Japanese-style situation of weak growth and deflation.

Certainly the Federal Reserve chairman Ben Bernanke doesn’t see a deflation risk, believing that inflation will gradually move higher from levels around one per cent to two per cent. And while other Federal Reserve members are also more positive, believing that the Fed should drop its guarantee of rates remaining low for “an extended period”, others no doubt share Bullard’s concerns – all of which sets up an interesting meeting of the Federal Reserve next Tuesday. Some in the market believe that the Fed is close to another round of ‘quantitative easing’ – buying securities in exchange for cash to stimulate the economy.

How real is deflation? In the US, the inflation rate stands at 1.1 per cent while the core rate (excludes food and energy) stands at just 0.9 per cent. In Germany, inflation stands at 1.1 per cent, the Swiss inflation rate stands at 0.4 per cent and Japan is still in the grip of deflation with prices down 0.7 per cent on a year earlier.

Of course, most people would see Australia in a different situation with firmer economic growth and a tighter job market. But as is clear with most things, Australia is very much influenced by global trends. And, of course, if overseas producers are being forced to trim prices to stay competitive, those trends will also be reflected in Australia. Add in the fact that the Australian dollar is stronger, putting downward pressure on import prices and tourism-dependent areas of the economy. And then there is the relentless decline in prices of technology goods and commensurate increase in speed and quality.

Think deflation is still some way off in Australia? More than a third of items in the Consumer Price Index are cheaper now than a year ago. Electrical goods, clothing, cars, sporting equipment, toys, furniture, phone/data services and airfares are all down on a year ago together with food/grocery items like fruit, eggs, breakfast cereals, meat and toiletries. Less than a third of CPI items grew at a faster rate than the headline rate of inflation in the year to June such as utility costs, housing, property rates and education fees and many of these are set once a year and lag other trends in the economy.

While deflation sounds like good news for consumers, it puts downward pressure on profits and wages as well and it can be hard to eradicate once entrenched – just ask the Japanese.

The week ahead

Usually the Reserve Bank features prominently in the weekly schedule of events – that won’t be the case in the coming week with its main contribution being to provide the latest estimates credit card lending on Thursday.

But certainly there is a full week of economic data releases. On Monday, housing finance figures are released together with job advertisements. The NAB business survey is issued on Tuesday with consumer confidence and lending finance slated for Wednesday. And the latest employment report is issued on Thursday alongside the aforementioned credit card figures.

The distinction between the number and value of home loans probably continued with the June data. The number of loans refers just to owner-occupier loans – people buying homes to live in, rather than as an investment. The number of loans may have fallen two per cent – the eighth fall in nine months – but the value of loans, which includes investor activity, may have risen by two per cent. Investors see value in housing as an asset class at present but owner-occupiers are still spooked by the rapid fire rate hikes earlier this year.

The other economic indicators should be more positive. Job advertisements probably rose in July, but at a far slower pace than in previous months as the economy softened. Business sentiment probably rose in response to the revised mining tax proposal. And consumer confidence probably stabilised in August, as judged by the weekly Roy Morgan confidence rating.

Both the lending finance and credit card lending figures probably remained subdued in June with businesses and consumers still cautious about taking on more debt.

Employment probably rose for the eleventh time in 12 months, reflecting the strength in job ads earlier in the year. But while jobs grew by around 25,000, that increase would be just enough to offset new entrants, keeping the jobless rate at 5.1 per cent.

Turning to the US, the feature is likely to be the Federal Reserve meeting on Tuesday. There are rumours that the Fed will provide another batch of “quantitative easing” in order to give the economy a kick-start. That move could be more negative rather than positive as confidence is the main factor holding employers back from creating jobs rather than interest rates or lack of money. Profit levels are certainly OK. The Fed decision is announced Wednesday morning Australian time.

Of the economic data, the highlights are late in the week with retail sales, consumer prices and consumer sentiment all released on Friday. Earlier in the week, productivity data is out on Tuesday with trade and the monthly budget on Wednesday and import/export prices on Thursday.

Overall, we expect tame inflation (core rate 0.1 per cent), modest retail sales (up 0.4 per cent) and flat consumer sentiment (reading near 68).

It is also important to point out that monthly Chinese economic data is released over Tuesday and Wednesday.

Share market

The Australian earnings season cranks up a notch in the coming week. Effectively, three big weeks lie ahead as the bulk of the ASX 200 companies issue results. On Monday, Bendigo and Adelaide Bank and JB Hi-Fi are among those reporting. On Tuesday, the line-up includes Alumina, Bradken and Cochlear. NAB also issues a trading update on Tuesday. On Wednesday, CBA, Computershare and Stockland are among those reporting. On Thursday, Telstra, James Hardie, Coca Cola Amatil, Qantas, Austereo, SingTel and Transurban are among those expected to report earnings results.

Ahead of the peak earnings period, it’s worthwhile to update our views on the broader market. Overall, we believe that the share market is fairly valued at present with healthy earnings results in the current season likely to be followed by more subdued results for the current six month period through to December. The ASX 200 and All Ordinaries are expected to reach 4800 points by end year, 5100 points by June 2011 and 5400 points by December 2011. While the forecasts appear conservative, the Australian share market is still in a tight relationship with the US Dow Jones and it is clear that the jury remains out on the health of the American economy.

Interest rates, currencies and commodities

Football commentators regularly fall in to the trap of saying that it was a ‘game of two halves’. Well, the adage may end up being apt for the commodities markets this year. The CRB futures index eased over January and February before consolidating over March and April and then easing further to late May. But after again consolidating over June and the most of July, there are suggestions that the CRB could claw back lost ground over the remainder of 2010. From January to May, the CRB fell 15 per cent. But from the trough, the CRB has managed to rebound 12 per cent.

The interesting point is that a raft of commodities – clearly with different fundamental drivers – have posted solid gains over few weeks. Oil, sugar, base metals, iron ore and wheat are amongst those showing the strongest trends at present, with wheat doing the best, up 70 per cent in the space of almost two months. Sugar has also lifted around 40 per cent since early June while iron ore is up 21 per cent in just the last three weeks.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

Economists have got it wrong again and I’m not just talking about the latest inflation data, although it is related. Rather, it has been the perception that the Australian economy is barrelling along, meaning that rates would have to go up substantially over the next few months.

The last time that most economists got it wrong was just over a year ago, concluding that Australia would slip into recession like the rest of the world and that interest rates would fall to two per cent or below. Of course, it didn’t happen. The Reserve Bank cut interest rates to only three per cent and the government pumped money into the economy and consumers thought this was great. Most of the people we spoke to at the time, especially across regional Australia, wanted to know why there was so much gloom and doom – times were good.

In short, consumers kept spending, house prices flattened but didn’t fall and businesses decided to hold onto staff, cutting hours and pay, rather than people.

Fast-track to the present day and Aussie consumers are feeling decidedly more uncertain. People were just starting to realise that that the global financial crisis was ending when the Reserve Bank started lifting interest rates. And this was no gentle exercise – the rate hikes were the most aggressive in 16 years.

The rate hikes together with higher utility charges have represented a major hit to budgets at a time when many have not seen their wages return to ‘normal’ levels. And businesses are still very cautious about granting pay rises. Sure, people have held onto their jobs, and are generally happy about life, but the mood is different. People aren’t willing to spend unless the goods are ‘on special’. The perception is that budgets are under pressure and people feel that they need to respond by trimming debt and cutting back on the luxuries.

This is the mood we have sensed on travels across the country in the last few months – a mood of conservatism. The simple fact is that having a job is no guarantee that people will spend. If they don’t have to spend and are still uncertain about the future, they won’t, thus the low reading for the CPI – plenty of discounting by retailers and other consumer-focused businesses to get people into the stores and stock moving.

It’s important to note that the ‘new conservatism’ is international. In the US, Europe and New Zealand people are making harder choices about their purchases and debt is still being shunned. In the late 1980s, there was ‘irrational exuberance’, now there is ‘new conservatism’.

Clearly, this trend also extends to investments as well. In the 1970s and early 1980s, the share market price-earnings ratio held near 10 to 11 rather than the long-term average of 15 to 16. A return to those risk preferences may be on the cards. In short, risk is out, conservatism is in.

The week ahead

The usual monthly meeting of the Reserve Bank Board is held on Tuesday. But fortunately we don’t need to devote numerous column inches to what may, or may not, go on. It is clear to all that the Reserve Bank doesn’t need to touch rates and not just next week – it can stay on the sidelines for a number of months.

Of course, nothing comes for free – the Reserve Bank has earned its place in the sun courtesy of interest rate hikes late last year and early this year. The Reserve Bank thought underlying inflation would ease to 2.75 per cent with the tighter rate settings and it got its forecasts spot on. The only interest in Tuesday’s meeting is what the Reserve Bank has to say about monetary policy settings – perhaps indicating a neutral stance rather than a tightening bias.

Of the economic data, it’s the usual suspects at the start of a new month. On Monday (a bank holiday in NSW), the Performance of Manufacturing gauge is issued together with the TD Securities/Melbourne Institute monthly inflation gauge. On Tuesday, retail sales and building approvals data are released with international trade, house prices, tourism arrivals and the Performance of Services index all to be released on Wednesday. And then next Friday, the Reserve Bank is back at centre-stage with its quarterly Statement on Monetary Policy.

We expect that retail trade rose 0.4 per cent in June while building approvals rose by five per cent and the trade surplus was again large at $2 billion in June.

Turning to the US, data in the coming week could prove more pivotal than usual. The simple fact is that investors are trying to decide whether the economy is half-full or half-empty and the key indicators could make the minds up for many people.

On Monday, the ISM manufacturing gauge is issued together with construction spending. Personal income and spending figures are released on Tuesday, together with auto sales and factory orders. The ISM services gauge is released on Wednesday, together with the ADP employment report. And the all-important non-farm payrolls (employment) report is issued on Friday.

Overall, economists aren’t tipping stellar results, but the data should still indicate that a slow recovery is still on track. The ISM manufacturing gauge is expected to ease from 56.2 to 55 and the services equivalent is seen easing from 53.8 to 53.5. Any reading over 50 indicates expansion, so the results would be encouraging.

US economists tip a 0.6 per cent fall in construction, 0.2 per cent rise in personal spending and 90,000-lift in private sector employment. But there is a fair degree of uncertainty in the jobs forecast with economists tipping anything between a 19,000 and 150,000 gain in employment. The jobless rate is expected around 9.5 per cent.

Share market

The US corporate earnings season winds down over the next fortnight while the Australian reporting season gets into gear. Just as we’ve seen in the US reporting season, investors will do well to dissect how the money has been made. In the US, actual profits have generally beaten analyst forecasts, but cost cutting has proved important rather than sales. And clearly that’s not a sustainable situation.

On Monday, Crane Group is expected to report, with Hills Industries and Navitas set down for Tuesday. Amongst those reporting on Wednesday are AXA Asia Pacific, West Australian Newspapers, ASG Group and Hutchison Telecommunications. On Thursday, News Corp, Rio Tinto and Tabcorp are expected to releases their results, while Resmed is slated to report on Friday.

Interest rates, currencies and commodities

What a difference a week can make! Before the inflation data, financial markets thought there was a 14 per cent chance of an August rate hike and a 30 per cent chance of a move within two months. Now financial markets say there is a zero chance of an August rate change, and there is only a one in three chance of any lift in rates over the next six months.

Most would conclude that the Aussie dollar has taken the ‘surprise’ inflation figures in its stride. While the currency dropped almost a cent in immediate response to the data, it is still over US89 cents, and hovering not far away from the highest levels seen over the past two months. In fact, the Aussie dollar has averaged US84 cents over the past three years and averaged US73 cents since floating in December 1983. As highlighted in the inflation report, the high Aussie dollar represents good and bad news. Consumers are winners from cheaper imports and overseas holidays. But domestic tourism is suffering as shown by the record six per cent fall in domestic travel costs – covering flights and accommodation.

While the tourism industry may not be happy about the dollar, motorists would have a different opinion. The Aussie dollar has actually matched the rising oil price, keeping pump prices low. In fact, the Singapore gasoline price in Australian dollar terms is at the lowest levels in seven months and $10 a barrel below the highs in May. If current levels are maintained, then motorists will be on track to record savings of around $7 on a tank of petrol. And the good news extends to the inflation rate. Again, if current levels are maintained, petrol prices would be down around three per cent for the September quarter, taking 0.1 to 0.2 percentage points off quarterly growth of the CPI.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

Inflation is back in the spotlight in the coming week. Given that the price readings are only done once a quarter, not monthly like in most countries, it is understandable that the figures will command attention – the RBA is pushing for monthly consumer price figures, but we’ll have to see how that goes.

It’s important to note that the Reserve Bank doesn’t just look at the bottom-line (or headline) CPI measure. No, it actually looks at seven measures each quarter. And that’s because prices tend to be volatile, so the Reserve Bank wants to be sure that it’s the strength of the underlying economy that is causing price pressures to rise or fall, not just one-off factors like petrol, fruit or vegetables.

There are three measures of underlying inflation that the Reserve Bank focuses on. Two are so-called statistical measures – the weighted median and trimmed mean. These measures are constructed by removing more volatile components of the CPI to get a sense of what prices are generally doing.

The third measure is one of the exclusion measures – that is, parts of the CPI are removed from the calculation. It goes by the title of the CPI less volatile items (fruit, vegetables and petrol) and deposit and loan facilities or CPIX.

The headline CPI is currently growing at a 2.9 per cent annual pace, while the average of the three underlying measures stands at three per cent. Courtesy of one-off measures like the hike in tobacco excise, the Reserve Bank expects headline inflation to rise “to a little above three per cent" in the June quarter. And the Bank tips the underlying rate “to be below three per cent for the first time in three years”.

Economists generally expect headline inflation to have risen by between 0.7 to 1.1 per cent in the June quarter, meaning annual inflation will lift to between 3.1 to 3.5 per cent. Overall, the RBA would be happy with a result of 0.9 to one per cent or below. For underlying inflation to meet its forecast, the Bank would want to see quarterly growth of 0.8 per cent or below – unless, of course, the statistical measures for previous quarters are revised – it does happen.

A 0.9 per cent result for underlying inflation would mean that the annual rate creeps up from three per cent to 3.1 per cent – hardly a disaster. So don’t immediately assume rates are going up with a 0.9 per cent lift in underlying inflation – as always, the Reserve Bank will be slicing and dicing the figures to make sure no rogue element has been responsible for underlying inflation remaining just outside the preferred two to three per cent target band.

The week ahead

There is no doubt that inflation dominates centre-stage in the coming week. Data on business inflation (producer prices) is released on Monday, while the more important consumer price index is slated for Wednesday.

As noted above, currently the headline rate of inflation stands at 2.9 per cent, while the Reserve Bank says that underlying inflation is around three per cent.

The headline rate of inflation in the June quarter would have been boosted by seasonal increases in medical fund premiums, a 25 per cent lift in the excise tax on tobacco and higher costs of home purchase and deposit and loan facilities. The petrol price rose by 1.4 per cent in the quarter, adding just 0.05 percentage points to the CPI growth rate, down from 0.2 percentage points in the March quarter. But factors restraining the inflation rate in the quarter include broad discounting by retailers, cheaper electrical goods (courtesy of a firmer currency), cheaper discount airfares and falls in fruit and vegetable prices.

Overall, we expect that headline inflation lifted by around one per cent in the quarter, pushing the annual rate up to 3.4 per cent. The underlying rate probably rose by around 0.7 per cent with annual inflation around 2.9 per cent.

The other events to watch over the week include the Housing Industry Association’s trades report (Tuesday), the HIA’s new home sales report (Thursday) and private sector credit and the RP Data /Rismark home price report (both on Friday). Given the focus on population growth by all sides of politics at present, Bureau of Statistics figures on migration to be released on Thursday are also worth a look.

We expect that private sector credit (lending) edged up by 0.4 per cent in June, lifting the annual growth rate from 2.7 per cent to three per cent. And judging by anecdotal information, home prices probably recorded more orderly growth in the latest month with the annual rate likely easing to the 11.5 to 12 per cent range.

In the US, there is a healthy spattering of economic data over the week. On Monday, new home sales data is released together with the Chicago Fed index. On Tuesday, the Case Shiller home price series is released alongside consumer confidence and the Richmond and Chicago regional manufacturing gauges. On Wednesday, orders for durable goods are released together with the Federal Reserve Beige book summary of economic conditions. And on Friday, the first estimate of economic growth in the June quarter is issued alongside the employment cost index and Chicago purchasing managers index.

Overall, economists are tipping another uninspiring set of numbers, indicating that the economy is still finding it hard to get some momentum. Home sales may have lifted six to seven per cent in June from record lows, home prices were probably flat in the month and consumer confidence is tipped to ease in line with the recent fall in the University of Michigan measure. And durable goods may have merely recovered the ground lost in May.

But the GDP (economic growth) report may be reason for some cheer. While Americans remain downbeat, the economy was probably tracking along at a near three per cent annual rate in the June quarter, or close to the ‘normal’ pace. This follows data showing GDP growing at a 2.7 per cent annual rate in the March quarter. If Americans chose to put the global financial crisis behind them and get on with business then the world as a whole would be thankful.

Share market

The US corporate earnings season continues in the coming week with more than 730 companies to report. To date, companies have been beating consensus earnings forecasts, and generally by a comfortable margin. But where the problems are occurring is the next line of detail – the revenues and expenses. Companies have generally been successful in cutting costs but revenues are a different matter – restrained by budget-constrained consumers and cautious businesses. Still, if companies are making money and balance sheets are improving, then they will have scope to invest, hire and acquire in coming months. And if companies don’t put the pile of cash to work, investors would be justified in seeking to put the money to work elsewhere in the market.

The following US companies are still to report:

• Tuesday: BP, DuPont, Office Depot, Lockheed Martin, US Steel
• Wednesday: Conoco Phillips, Boeing, Visa
• Thursday: Colgate-Palmolive
• Friday: Merck and Chevron

Interest rates, currencies and commodities

If you want to know where the Aussie dollar is headed, follow the share market, as the relationship between the two has been very precise since the start of the year. In fact, the correlation (or measure of relationship) between the All Ordinaries and the Aussie dollar (against the US dollar) stands at 0.85, where a ratio of one would indicate a perfect relationship. And the correlation is actually even stronger at present than that between the Aussie dollar and a key gauge of commodity prices – the Commodity Research Bureau index (ratio of 0.79).

Australian wheat growers – especially in the east – have reason to be positive at present. Seasonal conditions remain favourable, suggesting that the coming crop could be near 22 million tonnes – the best in five years, although down from the record crop in 2003/04 (26.2 million tonnes).

But at the same time, wheat prices are lifting, not falling, reflecting the dry conditions in the Northern Hemisphere. The wheat price has risen almost 36 per cent from the early June lows and is up almost 13 per cent on a year earlier. And despite the vagaries of the currency, the wheat price is also up four per cent on a year ago in Australian dollar terms.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

One issue that is starting to receive more attention is the correlation between individual stocks, sectors and share markets. The Wall Street Journal ran an article entitled ‘The herd instinct takes over’ citing research showing that stocks are trading in lock-step more than at any time since the 1987 share market crash. The analysis indicates that investors are spending less time picking individual stocks, instead using broad-based techniques such as use of exchange-traded funds or program-trading techniques.

The research by Birinyi Associates measures the 50-day average correlation (co-movement) between the direction of the US S&P 500 index and that of its member stocks. A perfect correlation of 100 per cent would mean that all member stocks track the index. The average correlation since 1980 is 44 per cent. Last week, the research found that the correlation hit 81 per cent – the highest rate since the 1987 crash.

It’s unsure why the practice is occurring but it is disturbing. Perhaps professional investors believe that, in terms of cost/benefit, there is less value in spending the time to track a raft of stocks. Retail investors may also be disenchanted with ‘stock-picking’ and ‘buy-and-hold’ strategies, preferring exchange-trade funds.

And this practice doesn’t appear limited to just US stocks – entire markets, such as our own share market may be affected. It is difficult to know, of course, unless you surveyed a raft of hedge funds, fund managers, investment banks and professional traders, and clearly they wouldn’t be too keen to divulge too much about their strategies.

Still, it has been the case in Australia for some time that the ASX 200 has closely tracked the US Dow Jones index on a daily basis. In fact, the simple daily correlation since January 2009 stands at 92 per cent. The extent of that correlation is difficult to reconcile. For instance there has been a significant difference between Australian and US economies over that time.

Interest rate levels are far different. Australia has a higher proportion of stocks in the resources sector while the economy is tied more to China than the US.

Movements in the US share market no doubt shape the futures market pricing and the correlation between changes in the overnight share price index futures contract and the physical index for the following day is also precise. In fact, since the start of the year, the correlation stands at 94 per cent.

Take, for instance, trading on Thursday. The overnight SPI futures closed down 19 points on Thursday morning. At the end of trade on Thursday, the ASX 200 was down 19.9 points. Much transpired over the day including a rash of Chinese economic data but the futures market estimate proved an eerily accurate predictor. Clearly, it doesn’t always line up, with trade on Tuesday a case in point. Still, it’s worth asking the question about role the research of individual stocks is playing in the broad movements of the share market.

The week ahead

Economic events have dried up, with little in the way of market-moving economic data, statements or speeches in the coming week. Instead, the focus will shift to profit results to be issued from major US companies.

In Australia, the highlight is a speech by the Reserve Bank Governor on Tuesday. The speech, entitled ‘Some long-run effects of the Financial Crisis’, suggests that Glenn Stevens will spend most of the time focusing on medium-term issues. But many will also want to hear his views on short-term issues like the next batch of inflation figures and the implications for interest rates. Certainly, if the Governor wants to send a message, this will be the forum to so.

Of the other events, again it is the Reserve Bank that is centre-stage with the minutes from the 6 July Board meeting to be released. The statement issued after that meeting contained a number of references to the inflation outlook, so financial market participants will be especially interested in any further details provided in the Board minutes.

In terms of economic data, there are a few items on offer over the week. On Monday, June data on imports will be issued – one of the timeliest indicators of spending in the economy. On Tuesday, there will be another reading on spending in the economy in the shape of CBA’s Business Spending Indicator. And then on Friday, the “inflation reporting season” kicks off with data on export and import prices to be issued. The main drivers of prices tend to be the Aussie dollar, oil prices and other key commodity prices such as coal and iron ore. But the data may also give a sense about how prices of imported consumer goods are travelling and the implications for the consumer price index to be released on 28 July.

The US economic calendar is also sparsely populated but again it will be the central bank – the Federal Reserve – that will be in the spotlight. Federal Reserve chairman Ben Bernanke delivers semi-annual testimony to the Senate Banking Committee on Wednesday and then follows this up a day later with testimony to the House of Representatives Financial Services Committee.

Minutes of the last Federal Reserve Open Market Committee meeting proved illuminating with members mulling whether they would need to provide further stimulus to the economy in coming months. Given that the Fed is still tipping ‘normal’ economic growth of around three per cent this year, it is surprising that members are worried that economic momentum is slipping.

In terms of economic data in the US, figures on housing starts will be issued on Tuesday with existing home sales and leading indicators on Thursday. As always, there are the weekly indicators to consider such as department store sales, claims for unemployment insurance and new applications for home loans.

Share market

A relative ‘who’s who’ of the US corporate world will be reporting earnings over the next fortnight. So far, earnings results have been encouraging, but clearly the results and future guidance will be pivotal for US and Australian share markets. Some of the major results due this week include:

• Monday – IBM, Delta Airlines
• Tuesday – Goldman Sachs, Bank of New York, Domino’s Pizza, Apple, Yahoo!, State Street
• Wednesday – Morgan Stanley, US Airways, US Bancorp, Wells Fargo, eBay
• Thursday – 3M, Caterpillar, American Express, E*TRADE, Microsoft
• Friday – McDonalds, Kimberley Clark

Interest rates, currencies and commodities

It’s amazing how quickly views can change. From mid-May up until 8 July, financial market pricing suggested that an interest rate cut was more likely than a rate hike. But stabilisation on equities markets, combined with stronger domestic employment and a rebound in consumer confidence, and all of a sudden rate hikes are back on the menu. Current pricing suggests a 20 per cent chance of a rate hike at the August meeting. Clearly inflation data on 28 July will be pivotal to views.

But it is important to note that financial types aren’t getting carried away. The six-month overnight indexed swap rate stands at 4.6 per cent, just above the current 4.5 per cent cash rate.

Ninety-day bank bill yields have consistently held 30 to 40 basis points above the cash rate since late April with the current differential at 40 basis points. Bank bill futures are pointing to a modest lift in yields by the end of the year. Implied yields on 90-day bank bill yields stand at 4.92 per cent with physical 90-day bills at 4.9 per cent.

It may not be a major focus for farmers in Australia, but consumers (especially chocolate lovers) will be disappointed – cocoa prices have hit 32-year highs in London trade. While other commodity prices have mixed in recent months, cocoa prices have soared in response to strong demand in Europe. Supplies have also been constrained as a result of the destocking that occurred in 2008/09.

In the same vein, but with more relevance to Australian farmers, the sugar price has also gravitated higher over the past two months, lifting from lows of US13.70 cents a pound to around US17.30c/lb currently. One key development has been the news that the world’s second biggest exporter, Thailand, has had to buy back sugar to address a domestic shortage.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

I think the constant barrage of economic data has left investors more confused than informed. That’s why it pays to stand back from time to time and look at the bigger picture. And once you do that, it’s clear the economy has recently lost some of its gloss.

Let’s look at the industry surveys first. Both the construction and services sectors are going backwards, according to the latest activity surveys. The NAB business conditions index also fell in the latest month, as did business confidence. And while the manufacturing sector also weakened in the latest month, the gauge stands at 52.9, so only modest growth is occurring.

Next, consumer spending. Certainly spending has disappointed for some time with retail spending up just 0.2 per cent in May to be just 1.2 per cent higher over the year – the slowest annual growth in nine years. Consumer confidence has also slumped over the past three months to highlight just how nervous people are.

The housing sector also has hardly been flash of late. New lending has fallen in nine of the last 10 months and the number of loan commitments stands at nine-year lows. Approvals to build new homes have also slumped over the past two months – the biggest back-to-back decline in seven years. Home sales also dropped 6.4 per cent in May while home prices are now growing at a far slower five per cent annualised pace.

One area of strength is the job market with employment up in nine of the last 10 months with employees also working longer hours. The unemployment rate stands at just 5.2 per cent and is expected to fall further during 2010, given the continued lift in new jobs being advertised on websites.

Overall, it is hardly surprising that the Reserve Bank has suggested the cash rate will be stable for some time. And it is clear that it is the softness in our own economy, rather than Europe, that is the key reason why interest rates are on hold. Higher interest rates and the withdrawal of government stimulus are certainly restraining consumer and housing spending.

And then there is the flow of people. More Australians are travelling overseas and inbound tourism is going backwards, taking spending power away from the economy. In fact, the tourism deficit is the biggest on record (34-years). And the number of migrants coming to Australia is down by 90,000 (on an annual basis) compared with a year ago. The combined effect is to remove $2 billion of retail spending from the economy.

The week ahead

If ever a week were to be described as “normal”, it would be the week ahead. Both in Australia and the US, there is a solid batch of economic indicators to be released – the data load being neither paltry nor excessive.

In Australia, housing finance and credit card lending figures are issued on Monday with lending finance and the NAB business survey on Tuesday. On Wednesday, consumer confidence data and Federal Treasury’s ‘Modellers Database’ are expected to be issued – the latter containing the latest estimates of private sector wealth. Detailed labour force figures are slated for release on Thursday together with car sales.

The housing finance data should kick off the week in positive fashion with the number of loans by owner-occupiers expected to have lifted by one per cent in May. The increase is only modest, but with the number of loans at nine-year lows, any gain has got to be positive.

It’s also possible that readings of business and consumer confidence may have bounced a touch in the latest month after recent weakness. Stable interest rates and resolution of the resource tax debate are positives, although the health of the so-called ‘advanced’ economies remains a major worry together with the soggy share market. Business profits also remain under pressure, due to the perceived need to discount goods to entice consumers to spend.

The other indicator to watch is new car sales. At face value, the June result looked healthy with industry data showing car sales were at record highs in the month. But once adjusting for seasonal factors, the result looks less impressive. We are tipping a three per cent fall in sales in the month.

Still, with the job market in good shape and car affordability at the best levels since the mid 1970s, the outlook remains favourable, pointing to sales around a million units this year.

Turning to the US, there is a bevy of ‘top shelf’ indicators to be released over the week. On Tuesday, the latest trade data is issued alongside the monthly Treasury budget numbers. On Wednesday, retail sales and the minutes of the last Federal Reserve meeting are released. Producer prices and industrial production data are out on Thursday with consumer prices and consumer sentiment rounding out the week on Friday.

Main interest is in the ‘activity’ readings, namely retail sales and production. And while consensus forecasts point to soft results, that may actually prove a blessing – that is, the bar is set quite low. Economists expect flat non-auto retail sales in June while production is tipped to rise by just 0.1 per cent.

Consumer sentiment will also be in focus, but yet again a decline is tipped with the gauge seen easing from 76 to 74 in July. The Empire State manufacturing index and Philadelphia Fed index will also be scrutinised on Thursday. Inflation indicators are unlikely to trouble investors over the week with core rates of producer and consumer prices both tipped to have lifted 0.1 per cent in June.

The other focal point over the week is Chinese GDP and other key monthly data, due for release next Thursday.

The US earnings or profit-reporting season kicks off on Monday. As is traditionally the case, Alcoa gets proceedings underway with earnings of 14 cents per share tipped for the second quarter, far better than the 26 cent loss a year ago. Other companies that are expected to report over the week include Intel and YUM! Brands on Tuesday, JP Morgan Chase, Advanced Micro Devices and Google on Thursday with Bank of America, Citigroup and General Electric on Friday.

In aggregate, analysts surveyed by Thomson Reuters tip S&P 500 companies to report a 27 per cent annual lift in profits, with materials and energy companies expected to do best while profits in the telecom and utilities sectors are expected to be slightly down on a year ago.

Interest rates, currencies and commodities

One way of tracking activity in the coal sector (especially thermal coal) is to monitor the number of ships waiting to load off the port of Newcastle. At the end of June, the queue had lengthened to 61 – the highest level in three years. But one complication to tracking this queue is the fact that a new vessel arrival system is being implemented, designed to reduce the number of ships waiting at anchor. The new system is designed to regulate the flow of ships moving through the port. Still, even with the new terminology, the port authorities advise that 12 vessels were anchored off port as at 5 July with another 53 in transit. Our commodity research team note that thermal coal demand is holding up but the increase in the ship queue may also reflect ship owners competing for ‘spot’ orders in response to excess freight capacity at the moment.

A broader measure of demand for dry commodities like coal, iron ore and grain is the Baltic Exchange’s main sea freight index, the Baltic Dry index. Some investors have been concerned about the sharp fall in the index from 4200 in late May to around 2100 at present. But it’s important to note that both demand and supply influences may be at work. While demand may have softened to some extent, more vessels have come into operation to match the surge in demand for raw materials in recent years. In the 17 years to mid-2002, the Baltic Dry index averaged 1290 and was regularly between 1000 to 2000 points over the period.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

The past financial year has certainly been a rollercoaster ride and, while volumes have been light over the past few months, investors can certainly be forgiven for taking a step back and taking stock of where they stand.

Many events have stood out – the recovery in global credit markets, the unprecedented injection of stimulus by governments around the world, the rebound in economic growth, the Dubai sovereign debt issues, the possibility of Greece defaulting on its debt obligations and the resulting European Debt Crisis. And in recent months the BP oil spill and the possibility of a double dip global slowdown.

But when people look back at the figures, 2009/10 will stand out for the extraordinary volatility. On the Australian share market, the All Ordinaries traded through a record range of almost 1340 points. The intra-day low of 3710.1 points set on 7 July 2009 strengthening to highs of 5048.6 set on 15 April. In percentage terms, the shift from the lows to the highs of the year equated to 36 per cent – interestingly, the percentage shift in the prior year from highs to lows was 42 per cent. Only the 1987/88 period has been more volatile in the modern era with a drop of 50 per cent from the highs to the lows.

While the Australian share market recovered substantially from the lows, it will end the financial year with total returns up 13.7 per cent. The first “up” year in the past three – following a 22.1 per cent fall in 2008/09 and a 12.1 per cent in 2007/08. But in each of the four previous years, share market returns were above 20 per cent. So once you average returns for the past six years, it comes out as growth of 11.6 per cent a year – better than the 10.4 per cent average return over the last 20 years.

In recent weeks, concerns about a double dip slowdown in the global economy have gained voice, especially following the poor housing and labour market data in the US and the continued sovereign debt concerns emanating from Europe.

The G20 meeting over the past weekend tried to find a balance in curbing stimulus and reducing budget deficits, but also ensuring that growth remains buoyant. US President Barrack Obama has probably been most vocal in urging his counterparts to focus on spurring growth. However, the European economies have their own problems, particularly attempting to get public debt back to levels that allow investors and markets to be more comfortable.

Interestingly, the domestic economy is in much better shape. Public debt levels are manageable and, rather than looking to half deficits like our overseas counterparts, the focus for Government is returning the budget to surplus over the next few years. The Australian economy grew by 0.5 per cent in the March quarter and in annualised terms, growth now stands at 2.7 per cent. Most economists and the Reserve Bank now generally expect our economy to return to trend growth – 3.25 per cent – over the coming financial year.

The week ahead

After remaining out of the limelight for the past couple of weeks, the Reserve Bank gets back to business this week, holding its July Board meeting on Tuesday.

The Reserve Bank certainly has a lot of mixed information to weigh up. The economic data in recent times has been patchy, consumers are still reluctant to spend and there are clear signs that the growth in property prices is cooling. Yet as the Reserve Bank has pointed out in recent times, the strength of the labour market and the resulting labour shortages that are already occurring in some sectors is concerning.

On balance, we expect the Reserve Bank to leave rates on hold with the cash rate remaining at four per cent on Tuesday. The process of normalising rates has been completed and any further rate hikes would signal a tightening cycle – which is unlikely to occur until the Reserve Bank views the June quarter inflation data.

In terms of economic data, the AiG Performance of Service index is released on Monday along with the TD Securities monthly inflation gauge and the ANZ job advertisements series. Trade data is released on Tuesday, while the AiG Performance of Construction index is slated for release on Wednesday. Closing out the week on Thursday is the June jobs report.

The economic data is likely to provide more positive signals. We expect that the trade balance will post a second consecutive surplus of around $500 million. The higher iron ore and coal prices are now starting to filter through to trade data and as such larger trade surpluses are a possibility in coming months.

And the jobs data is also likely to be pretty positive. We expect that employment rose by around 20,000 in June, and with the participation rate assumed to have remained unchanged that means the unemployment rate will hold around the 5.2 per cent level. Federal Treasury assumes that full employment is around five per cent, so the job market is clearly in good shape.

But on the other side of the coin, the TD inflation gauge will be closely watched given the Reserve Bank’s recent commentary that the upcoming June quarter CPI data will tip the balance for the next rate hike.

Turning to the US, there is not much market moving data on the economic front. Investors will rightly focus on the latter part of the week and, in particular, the retail sales release from the International council of shopping centres (ICSC). In recent times, the US Fed has indicated that consumer spending has eased modestly. Consumer spending effectively makes up 70 per cent of the economic growth figure.

Other US data to watch over the week includes ISM non-manufacturing survey released on Tuesday, while data on initial jobless claims is issued on Wednesday. US consumer credit is slated for Thursday and wholesale inventories close out the week on Friday.

And overall, the results should be encouraging. US economists expect that the ISM non-manufacturing survey recorded a modest increase from 55.4 to 55.5 in June. Consumer credit is expected to remain flat, while wholesale inventories are expected to rise by 0.5 per cent.

Share market

As is clear from the sideways trend in US and Australian share market indices over the past month, relatively light volumes investors are now bracing for earnings results. And with economic data providing mixed signals on the recovery, markets will look to the earnings season to justify a bid for equities.

Over the past year, companies have been able to beat what has been relatively conservative analyst estimates. However, given the recovery in earnings that has been much anticipated for the past six months, it is unlikely companies will surpass expectations to a great degree.

In fact, the last month has been dubbed “confession season”, given the significant and sizeable companies that have downgraded profit guidance. Interestingly, the ASX200 is trading on 11.9 times forward earnings – a 20 per cent discount to its decade average.

Interest rates, currencies and commodities

On currency markets, the Aussie dollar traded through a US17 cent range against the greenback over 2009/10. The Aussie reached lows of US77.04 cents on 7 July before rising to US94.06 cents on 16 November. The 22 per cent movement between the highs and lows was well above the average 15 per cent annual movement that has been recorded by the Aussie dollar over time. And probably just as remarkable is the fact that the Aussie dollar has rebounded from levels near US62.50 cents back in February 2009 to above US94 cents in the space of just over nine months.

And commodity markets certainly have not been immune to the incredible swings. The oil price has traded through a 48 per cent range from lows to highs over the past financial year, while the thermal coal price has recorded a 65 per cent range. However, what is more astounding is the movement in the iron ore price. Over 2009/10 the spot iron ore contract has traded through a 145 per cent range – clearly the rebound in the Chinese economy has been the main catalyst.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The big picture

After beating a retreat in the early months of the year, volatility returned to the share market with a vengeance in May. In the 21 trading days of May, the All Ordinaries either rose or fell by more than one percent on 15 occasions. That was the most volatile period since the height of the US financial crisis in November 2008.

Some investors – namely traders – don’t see the lift in volatility as a bad thing. Clearly if the market is moving and you pick the trends right then there are more opportunities to make money. Longer-term or ‘buy and hold’ investors have a decidedly different view – concerned at the daily fluctuations in the value of their portfolios.

This is where knowledge of the ‘beta’ of stocks may come in handy. Essentially, beta refers to the extent that a company’s share price moves in line with the market. If the stock is essentially more volatile then it will have a high beta while companies that have a low beta may see little movement in their share price when the market is moving.

No ratio or approach is fool-proof but it is interesting to have some idea of the beta values maintained by stocks in a portfolio, especially if you have a view about where the market is going and are seeking to maximise potential gains or to protect against losses.

Some investors may feel that if they have holdings covering the biggest companies in the market, they have greater protection from sharp swings in the broader market. The S&P/ASX 20 (biggest 20 stocks) covers just 10 per cent of stocks in the ASX 200 but represents two-thirds of capitalisation of the broader index. But the prominence and importance of the top 20 stocks don’t translate to low volatility. In fact, according to the data from Bloomberg, beta values of the top 20 stocks range from 0.523 (Telstra) to 1.299 (BHP-Billiton). Eleven of the 20 stocks have betas below one compared with the ASX 200 index while the remainder have betas above one.

What about the S&P/ASX 50 – an index that represents 83 per cent of the capitalisation of the ASX 200 index? A similar proportion of the companies – that is, 28 of the 50 stocks – have beta values below one. But the betas also cover a greater range of 0.416 to 1.497.

As would be expected, stocks in the resource sector tend to have the highest betas, led by Fortescue (1.497) and Worley Parsons (1.474). Interestingly, GPT (1.426) is also near the top of the rankings. Steel stocks like BlueScope (1.415) and OneSteel (1.375) also have high betas. At the other end of the scale are telecom and food stocks, including Coca Cola Amatil (0.416), Telecom NZ (0.531) and Telstra (0.523). Suncorp-Metway (1.003) and Orica (0.994) are more likely to track the broader market.

The week ahead

Economists have been starved of data over the past fortnight and the situation is not going to improve greatly over the coming week. While there is a spattering of indicators to be released, they are heavily concentrated over Wednesday and Thursday.

On Wednesday, figures on lending (private sector credit), job vacancies, new home sales and home prices are released. And on Thursday, the Performance of Manufacturing index, retail trade and building approvals data for May are slated for release.

Ordinarily, the retail spending and building approvals figures would dominate attention. And while that is certainly the case again, in the coming week, there will also be plenty of interest in the home price data. In April, prices just edged 0.2 per cent higher – the lowest reading in four months. Another modest result would be well viewed. It would suggest that recent rate hikes are working to slow housing demand and that the housing market is on track for more sustainable annual price growth of between five to eight per cent. While homebuyers would celebrate slower price growth, they would also be hoping the Reserve Bank stays on the interest rate sidelines for longer.

The chances of the Reserve Bank leaving cash rates stable would get a further boost if retail spending remains sluggish in May as most retailers are reporting. Overall, we expect that sales rose just 0.3 per cent in May after posting growth of 0.4 per cent over the previous five months. The era of “new conservatism” doesn’t look like ending any time soon as retailers are forced to keep discounting to move goods from the shelves.

Building approvals may have edged two per cent higher in May, but given the volatility of the series, clearly we don’t hold the forecast with much certainty. Still, approvals look to be flattening out in a 14,000 to 14,500 range, lifting annual approvals near 170,000. If this outcome is sustained, it would go a long way in stemming the perceived shortfall of houses and apartments, especially if activity was concentrated in NSW and Queensland.

Turning to the US, the main interest is in the non-farm payrolls data on Friday. And after the weaker than expected performance in May, forecasts are centred on around 75,000 jobs being lost in June. The temporary hiring of census workers over the last few months has added a degree of volatility to the labour market results. And for a better indication of the recovery on the employment front, analysts will look to the change in private sector payrolls, where 120,000 jobs is expected to be created up from just 40,000 last month. The jobless rate is expected to remain steady at 9.7 per cent.

Of the other indicators, personal income and spending will be released on Monday with the Case/Shiller home price series and consumer confidence on Tuesday. The ADP employment index is issued on Wednesday with Chicago purchasing managers survey. On Thursday, the Challenger job lay-offs series is released together with the ISM manufacturing index, car sales, pending home sales and construction spending.

A sharp slide is expected for pending homes sales (-20 per cent), as the expiry of the homebuyer tax credit results in a hangover effect taking place. Similarly, softer results are tipped for the ISM Manufacturing Index (59.1 expected), consumer confidence (62.8 expected) and total vehicle sales are expected to drift marginally lower.

Share market

One factor that can complicate analysis of global share market performance is the movement in currencies. As a result, global fund managers, including hedge funds, tend to track performance in a common currency – namely the US dollar. And looking over the past year, the majority of major global share markets have posted healthy gains. Of the 44 share markets tracked by FactSet, all but five have recorded solid gains over the past year. Indonesia leads the gains, up 65 per cent, followed by Argentina and Turkey. The US share market has lifted 29 per cent, ahead of Australia, up 26 per cent, and the world index, up 23 per cent.

One factor holding Australia back in recent months has been the performance of the resource sector. Since the end of March, the non-energy minerals sector has fallen 13 per cent in US dollar terms, versus gains of 20 per cent in the US, six per cent in Canada, four per cent in Chile and a flat performance in South Africa.

Interest rates, currencies and commodities

The big story over the past week was the decision made by the Chinese central bank to allow its currency to fluctuate again. From 2005 to 2008, the Chinese Yuan was allowed to move up to 0.5 per cent on a daily basis, the end result being a near 18 per cent appreciation against the greenback over the period. The exchange rate policy was suspended at the height of the global financial crisis. But now Chinese authorities believe the time is ripe for the process of daily exchange rate adjustments to begin again.

The move is potentially positive on a number of fronts including defusing trade tensions with the US, and boosting household spending and restraining inflationary pressures via cheaper imports. The path of currency appreciation is likely to prove gradual, as was the case from 2005 to 2008. The fact that Chinese authorities have re-started the process is yet another sign that the global economy is on the mend.

Australia is potentially a winner from Chinese currency appreciation as well. If the Yuan strengthens, then Chinese businesses have greater purchasing power to buy our raw materials. The important point in all this is the word ‘potentially’ – there’s always the risk of other things coming from left field.

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