Friday, August 9, 2013

Market Summary

The official rate is now at 2.5%, the lowest level since the central bank's establishment in 1959...


The ASX 200 moved 100 points or 2.5% between its highs and lows this week.  Poor Australian economic data and US Quantitative Easing ('QE') concerns offset positive Chinese trade data.
What is behind the volatility?
The volatility in markets was driven by comments from a US Federal Reserve member that the US QE program may be tapered in coming months. The QE program is keeping interest rates low in the US which in turn encourages investment in riskier assets such as shares (including emerging markets such as Asia). This in turn pushes up currencies in these markets (e.g. $AUD).

Consequently, any news suggesting a tapering of the QE program and a rise in interest rates in the US results in falls in share markets in Australia as overseas investors pull money out of shares and emerging markets. This also pushes down the value of the $AUD.

This 'flight' from emerging markets (Australia is viewed as a proxy for Asian markets) was behind the share market falls in June this year as well as earlier in the week. It is a key factor in our markets being more volatile than US markets.
Other factors are self-inflicted
The slowing Australian economy exacerbated by the state of government finances in Australia is also making investors skittish.

The blow out in the Federal Government deficit last week was a negative for markets. The announced deficit was bad enough, but the proposed return to surplus in 2015/16 is pure fantasy with revenue assumptions in the revised budget 'heroic'. And that assumes no further spending programs. The large spending increases announced by the government in the past two weeks would suggest that assumption is extremely optimistic. 

Business and consumer confidence in Australia is understandably poor given the state of government finances and the regulatory damage done in recent years to our ability to adapt to the end of the mining boom. The loss of 10,000 jobs in July is a symptom of the above and almost all economists expect unemployment to rise over the next year or so. Historically low interest rates reflect the slowing economy.
The story is slowly improving overseas
In contrast to the direction of Australian economic news, overseas news has been mostly positive in the past two weeks. US employment and economic activity readings were solid. Chinese trade data, manufacturing and services data suggested that slowing economic growth rates were stabilising. Even in Europe, the economic 'engine rooms', Germany and UK have shown signs of life, albeit subdued.

Risks remain in southern Europe despite significant restructuring, the Chinese banking system is still under pressure and the US recovery is only moderate. Nevertheless, the direction is broadly positive.

Australia's fortunes will be dictated by this slow recovery out of the GFC overseas. 
Investing in this environment
To state the obvious, once the US QE tapering starts, we will see a fall in markets. However given the June shake out and the time investors have had to position for the tapering, my view is that QE tapering may result in falls less than the 10% in June which took the ASX 200 to 4,632. A 5% fall from early August peak would bring us to around 4,800 if we do get the dip.

The point of the above is not so much to predict the actual rises and falls but to suggest that we expect to see downward volatility in the market. However, the falls should be less pronounced than previous years due to slowly improving economic conditions.

We remain of the view that yield will remain important and recommend buying quality companies on the dips.

 Index Change %
All Ordinaries 5,047 0 0.0
S&P / ASX 200 5,065 3 0.0
Property Trust Index 1,033 12 1.2
Utilities Index 5,396 -90 -1.6
Financials 5,580 17 0.3
Materials Index 9,363 -20 -0.2
Energy Index 13,190 -214 -1.6
       Thursday's closing figures
 Index Change %
U.S. S&P 500 1,697 -10 -0.6
London's FTSE 6,529 -153 -2.3
Japan's Nikkei 13,605 -407 -2.9
Hong Kong's Hang Seng 21,655 -434 -2.0
China's Shanghai 2,045 16 0.8

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