THE WEEK AHEAD: Mixed signals

Australia’s economy might be one of the strongest in the world, but our sharemarket performance has been sluggish in the first three months of the year.

Looking across global markets near the end of the March quarter there is an interesting conundrum.

In Australia the key sharemarket gauges have barely moved, up around 0.5%. But in the US, the Dow Jones has lifted by over 4% with the broader S&P 500 up 5% and the Nasdaq up over 6%. In the UK, the FTSE has lifted almost 5% while even the Japanese Nikkei has risen by 2%. The only real laggard is Germany, with the Dax up 1.4%.

And emerging markets have done even better in the first three months of 2010 with around half of all markets lifting by over 4%.

The conundrum is the seeming disconnect between the performance of the Australian economy and the performance – or under-performance – of the sharemarket.

In 2009, the Australian economy was the only advanced economy to have grown. It was also one of only two advanced economies not to have experienced a recession over 2008 or 2009. Looking ahead, the outlook for the economy is positive, especially given the links to the Chinese economy. And as the economy returns to a more ‘normal’ growth pace, earnings are expected to rise.

In contrast all other major economies are emerging from recession. The outlook for many of these economies is decidedly cloudy, especially given the weight of large budget deficits and the need, at some point, to lift rates from historic lows.

So what gives? Well, there are a number of possible explanations. One explanation is the ‘bounce back’ effect – the perception that economies that fell sharply have potential to rebound sharply. As economies bounce, the view is that earnings may follow. In contrast, the downturn in Australia was much flatter.

Then there is the currency. The general view is that the Australian dollar will lose ground later in 2010 as central banks in the North Atlantic start to lift interest rates to more normal levels. So if the Aussie dollar does lose altitude that means that the value of Australian shares in US dollar terms will also fall. For global investors that don’t seek hedge protection, currency changes are super-important.

And in Australia there is also the fact that investors are spoilt for choice at present. Banks are offering attractive term deposit rates, property returns are rising and the outlook for sharemarket returns is also positive. But some investors are still wary about shares given the uncertainties about the global economy.

Overall we expect the Australian sharemarket to rise over 2010 but it is clear that it won’t have it all its own way. Other asset classes are also attractive at present, meaning there is scope for investment diversification.

The week ahead

The Easter holiday period looms, but investors have a number of key indicators to digest before taking a well-earned break. New home sales data is released on Monday while retail trade, building approvals, private sector credit (lending) and home prices are all slated for ‘super’ Wednesday. And on Thursday the Performance of Manufacturing index, job vacancies, monthly trade data and TD inflation figures round off the week’s releases.

Retail spending soared by 1.2% in January, but it seems that half-yearly discounting played a key role in causing consumers to part with their cash. We expect that spending grew at a far more sedate 0.3% pace in February. Taking into account the large 0.9% fall in December, that would mean that annualised growth for the past three months was just 3.6% – well below the 5.5% long-term average.

The bottom line is that consumers remain cautious about spending, despite surveys showing that confidence levels are historically high.

And the volatility likely continued with the dwelling approval series in February. In January, approvals seemingly slumped by 7.0% after lifting by 5.2% with the ‘lumpiness’ of apartment approvals at the heart of the problem. Overall we expect the zig-zag pattern continued in February with approvals up 4%.

Of the other indicators, the trade deficit likely widened in February to $1.8 billion with imports up over 2% while exports probably eased. And while anecdotal evidence suggests that home prices lifted again in February, strength was likely confined to the top end of the market with first home buyers now retreating to the sidelines.

In the US, the interesting quirk in the coming week is that the pivotal non-farm payrolls (employment) data is released on Good Friday but the US sharemarket will be closed. That may be good or bad, depending on your perspective. On the one hand, economists are tipping the strongest monthly job growth in over two years. Investors may be disappointed that they won’t be able to celebrate the result. Still, if the result comes in way short of estimates, it may turn out to be a good thing that the sharemarket is closed.

On average, economists are tipping job growth of around 200,000 – which if it turns out to be right would be the strongest lift in jobs since November 2007. It may also signal the end date for the recession. But weather has played a role. Had it not been for bad weather in February, the data may have printed with solid job gains. So to some extent seasonality and weather may account for the good March numbers.

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 and New York purchasing managers surveys. On Thursday the Challenger job lay-offs series is released together with the ISM manufacturing index, car sales and construction spending.

Overall, the results should provide further confidence that the US economy is on the mend and silence some of the speculation about a double-dip recession. In particular, personal spending probably rose 0.3% with the ISM index showing that manufacturing is still expanding (reading of 56.5 expected, above the 50 ‘dividing line’).

Sharemarket

The key Australian sharemarket indexes are on track to post modest gains for the quarter of just under 1%. Still, it would be the fourth consecutive quarterly gain and indicate that the recovery is still solidly on track. It is also important not to forget dividends, which are being reinstated or increasing. For the March quarter, total returns on shares will probably lift by around 2%. Overall, we haven’t changed our forecasts, believing that the All Ordinaries/ASX 200 will lift to 5,150 by end June and 5,600 by end year.

Interest rates, currencies & commodities

There is still just over a week to the next Reserve Bank Board meeting, and at this stage the decision looks finely balanced. The global economy continues to heal and the local construction sector is running at full pace. But consumers and businesses are wary about opening their wallets while inflation pressures well contained.

Current market pricing suggests there is a 52% chance of the Reserve Bank lifting rates on April 6. And financial market participants also remain coy on the likelihood of rate hikes in coming months. The overnight indexed swap rate stands at 4.23% in four months and 4.53% in nine months. Currently the cash rate stands at 4.00%. Overall this suggests that the Reserve Bank may lift rates only twice between now and the end of the year. It is hard to argue with the pricing based on current evidence, but conditions have a habit of changing – and quite quickly.

It’s good news for all sweet tooths, but bad news for our sugar growers with the price of sugar continuing to slump from 29-year highs. At the end of January the sugar price was hovering near US30 cents a pound. But now the price is closer to US16.7c – a decline of 45% in just under two months. In part technical factors have contributed to the retreat in prices. But, as always, it also gets down to demand and supply. The top producer, Brazil, is expected to lift output by 15% while number two producer, India, is also expected to boost production with farmers encouraged by high prices.