International markets - the state of play

With talk of interest rate rises shifting to the possibility of a rate cut, Dr Ron Bewley weighs up the outlook for asset classes in Australia and abroad.

June was definitely a month of mixed signals. It started with the Reserve Bank of Australia stating its intent to raise interest rates twice this year, and ended with more sober comments and the market pricing in a rate cut.

It would seem the balance is right for one rate increase later in the year. Market economists – unlike the money market – are still going for a bit more than one rise.

The dollar fell to just above US$1.04 on this sentiment but rapidly jumped up nearly three cents. Some of this optimism (if we can call it that) is due to the Greek parliament passing ‘austerity measures’.

Retiring at 50 on a pension based on 95 per cent of the last wage might become a thing of the past – but not without some more rioting. 

The real problem is unlikely to go away.

What Europe is trying to do is prevent the ratings agencies triggering a default. If they do, all the credit default swaps, which serve as insurance against such an event taking place, will have to be paid.

If the agencies believe the restructuring is voluntary they might let it go to the keeper. But who would voluntarily take a 30 per cent payment now in cash, 20 per cent at some unspecified time and the remaining 50 per cent in 30 years? Sounds like a Greek default to me.

The one thing that was really overplayed in Australia was the gross domestic product (GDP) release.

Since half of Queensland’s mines were under water, the fall in exports was technical and not demand driven. When the mines are back on track we should see a bumper number to cancel out the negative.

But journalists writing stories on the worst GDP figure in decades did fill some space.

Commodities prices also saw some big swings. Gold came off its high to fall to $1,500 and lifted back up a little again.

Oil was off a high of $113 down to $90 before another kick up. The US did release some oil reserves onto the market to get some stability at home before the driving season and, of course, the upcoming election campaign.

Our stock market slumped 10 per cent in the second quarter of 2011 but ended the month will a small rally. Broker forecasts have not been revised downwards. The August reporting season will be a ‘show and tell’ of massive proportions.

Until then, any behaviour is fair game. A solid reporting season should see a nice rally and make the ‘go away in May’ crowd feel pleased.

The one sector that does look a bit exposed is consumer discretionary (ie, David Jones, Harvey Norman, etc). Are Australian consumers going to permanently demand more favourable margins?

So with another financial year behind us and not much positive action on our stock market, we do need relief from the dollar.

The second round of quantitative easing (QE2) in the US has ended, so the ‘trainer wheels’ on the US economy are off.

The deadline for both sides to agree on lifting the debt ceiling to avoid a US default is 2 August. But with a debt of around 100 per cent of GDP and rates close to zero, the US can afford repayments – but what if rates jumped up to 5 per cent? What would happen to US growth then?

Thankfully, for us, China is looking in control at least for a few years to come.

Australian equities

While we seem hopelessly adrift from the performance of the US stock market, the difference can still be accounted for by the exchange rate.

The end-of-financial-year rally on the back of the Greek vote on its austerity measures put 4,600 back in the picture.

So much for the technical analysts who claimed if we breached 4,477 it would be all doom and gloom. We breached it twice but bounced back strongly.

Broker forecasts have remained very stable over the month – implying a capital gain of about 15 per cent over the next 12 months – providing our dollar stays where it is or falls.

While we have the market very underpriced – and the fear gauge and volatility are all good – the bruising some investors took in recent months might make them a bit slow to take up the challenge.

Foreign equities

The USA’s S&P500 finished the month at about 1,300 – or where it was in June 2008 when our index was 900 points higher than it was at the end of June this year. There seems to be less good news out of the US, but there is a lack of bad news too.

The concern is what will happen to the US market after QE2 stopped on June 30. Management of debt rollover will continue and some speculate the Federal Reserve is ready and willing to jump back in if needs be.

Much of the world has been living in a world of mounting debt and fiscal challenges. When QE2 started it was often referred to as the ‘Bernanke put’.

There was, in effect, a put option (or ‘floor’) under the S&P500 due to the Federal Reserve’s chairman, Ben Bernanke. There has to be some concern that the US market might fall without QE2. Whether or not it does fall, some additional short-term volatility seems likely.

Bonds

Sovereign bonds are typically returning very little or are too risky to go near. On the other hand, Australian corporate bonds seem to suffer neither of these shortcomings.

But with term deposits in some cases above 6.5 per cent, is it necessary to look further for a low-risk income stream?

Interest rates

The Governor of the RBA, Glenn Stevens, must be about the only person who thinks we need one or two rate rises this year – but even he softened his view towards the end of June.

The mining boom isn’t going to soften any time soon, but fiddling with interest rates isn’t going to change the adverse impact of that sector on the rest of us.

Outside of resources, few are doing well and some retailers are doing badly.

A rate increase now could only hurt sentiment and cause further hoarding of cash.

House prices slipped a little over the year. There is no boom to slow down or bubble to burst.

Currency

At the end of June, the Aussie reached a 26-year high against the UK pound sterling.

Against the US dollar there has been even more turbulence than normal but, at least, the recent $1.10 peak should not be breached again soon.

Interestingly, the Financial Review survey for the rest of the calendar year has no forecast above $1.10 – except from a Financial Review columnist.

There is some leaning toward a falling dollar, with $1.02 being the median forecast for Christmas and $0.95 the low forecast. Again, it all depends on what the US does.

If it moves, $0.95 might seem high, but who can predict what the US government will do 12 months out from an election? 

Oil

Oil dramatically fell from over $110 to under $100 in days at the beginning of May and dipped down to $90 in late June, only to finish our financial year a few dollars higher.

The US government released some supplies to the market in order to take some pricing pressure off the table. It only released one day’s supply for the world to slash prices – but, importantly, that was enough to account for lost production from Libya and the rest.

Gold

Gold peaked at $1,557 on June 22 only to fall to $1,500 three days later. That hasn’t stopped some commodities traders talking up silver prices that remain well off their peak.

Australia

The Senate produced a report against the mining tax at the end of June, and few politicians were popular in the opinion polls.

James Dunn, a media commentator, put the National Broadband Network (NBN) case very succinctly.

It took ages to dismantle Telstra’s monopoly in communications only to create a new monopoly, the NBN, to take over. The Greens are chest-beating as they take the balance of power in the Senate.

There is no clear economic or political path that seems destined to take us far forward, and there seems to be no coherent and compelling alternative. Perhaps that is the stuff of minority governments.

Everyone is, or should be, worried about how to deal with the two-speed economy.

We didn’t do well in the wake of the 70s mining boom and the Dutch had the ‘Dutch Disease’ named after them for their similar problem of dealing with the profits from the North Sea gas inflow in the 1970s.

China

There hasn’t been much good or bad commentary about China in June, and that’s a good thing. We all need some stability in our lives and that, for the time being, is China.

While no one can say with any degree of certainty how long the China story will last, it seems like more than five years and that is long enough for us to get our houses in order.

United States

President Obama appears to be getting a little edgier over the failure to reach a compromise over the debt ceiling decision due before 2 August to side-step a default.

If it is just a game of brinkmanship on both sides then it is a game that is not helping the global economy.

In three months, it will be three years after the Lehman Brothers collapse. While Greek and US defaults are of a different nature, any default is a bad thing.

The US economy is travelling at a bit more than a limp. Some positivity was taken for one weak month in house prices after many months of falling prices.

Restoration of the US economy has to be slowed down by the shadow of their debt mountain. But, thankfully, no one significant is talking about double dips and the like. It will just be a long hard slog for them.

Europe

The UK is seemingly coping with its problems and is pushing forward, while Germany remains the powerhouse.

It is hard to see the single currency remaining intact forever but it is equally hard to see anyone let a country run free. The chaos that would follow an exit by Greece and a 50 per cent devaluation of the drachma would eclipse any of the rioting we have seen to date.

This problem was foreseeable in general before the union. Currency union without fiscal and political union is a union with much less chance of success than matrimony.

The rest of world

Japan got a nice reading of its industrial production as it recovers from its man-made and natural disasters. It is hard to work out what impact Japan’s problems had on the world economy – but at least they are now coming out of the woods.

New Zealand can’t win a trick – two more big earthquakes and even a Chilean ash cloud to compound their problems. Hopefully the Rugby World Cup will help them rebuild.