THE BIG PICTURE: Reading weak signals

The past financial year has certainly been a roller coaster 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 sharemarket, the All Ordinaries traded through a record range of almost 1,340 points. The intra-day low of 3710.1 points set on July 7, 2009 strengthening to highs of 5,048.6 set on April 15. In percentage terms the shift from the lows to the highs of the year equated to 36% – interestingly the percentage shift in the prior year from highs to lows was 42%. Only the 1987/88 period has been more volatile in the modern era with a drop of 50% from the highs to the lows.

While the Australian sharemarket recovered substantially from the lows, it will end the financial year with total returns up 13.7%. The first “up” year in the past three – following a 22.1% fall in 2008-09 and a 12.1% in 2007-08. But in each of the four previous years sharemarket returns were above 20%. So once you average returns for the past six years it comes out as growth of 11.6% a year – better than the 10.4% 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, reducing budget deficits, but also ensuring that growth remains buoyant. The 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, in particular, attempting to get public debt back to levels that allow investors and markets to be more comfortable.

Interestingly the domestic economy is 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% in the March quarter and in annualised terms growth now stands at 2.7%. Most economists and the Reserve Bank now generally expect our economy to return to trend growth – 3.25% – over the coming financial year.

The week ahead

After remaining out of the limelight for the past couple of week 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. The impact on the inflationary front.

On balance we expect the Reserve Bank to leave rates on hold with the cash rate remaining at 4% 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% level. Federal Treasury assumes that full employment is around 5.0%, 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 and given consumer spending effectively makes up 70% on the economic growth figure.

Other US data to watch over the week include 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%.

Sharemarket

As is clear from the sideways trend in US and Australian sharemarket indices over the past month, and 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% discount to its decade average.

Interest rates, currencies & 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 July 7 before rising to US94.06 cents on November 16. The 22% movement between the highs and lows was well above the average 15% 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% range from lows to highs over the past financial year, while the thermal coal price has recorded a 65% 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 145% range – clearly the rebound in the Chinese economy has been the main catalyst.

Craig James is chief economist at CommSec.