News: Market Update - February 2010

Summary

The global economic recovery is on track, emerging and newly industrialised Asian economies such as China and India are recording faster growth than developed economies.

The Australian economy remains on track with the Reserve Bank of Australia (RBA) upgrading both economic growth and inflation forecasts suggesting an optimistic economic outlook.

February saw share markets globally end the month higher, although some countries did experience losses, caught up with concerns over Greece
managing its debt commitments.

Economic highlights

The global economies near-term prospects have improved significantly, with the International Monetary Fund (IMF) indicating in the latest edition of its World Economic Outlook Update that global growth should reach 3.9% this year, rising to 4.3% in 2011. These projections represent significant upgrades from the respective forecasts of 0.8% and 0.1% made in October 2009.

At a regional level, the IMF anticipates that growth will be primarily driven by the emerging and newly industrialised Asian economies, in contrast to a more pedestrian pace of growth in the developed world. This reflects its concern over the ability of growth in the developed nations to persist once the impact of various stimulus measures fades.

The IMF has a positive view with regard to the outlook for Australia, reflecting the strength of demand for Australia’s commodity exports from countries such as India and China. However, we caution that Chinese demand is vulnerable to any moves by the Chinese authorities to restrain monetary growth and ease the pace of the country’s economic expansion.

Australia

Economic data released over the course of February was broadly supportive of the view that there is considerable underlying resilience in the domestic economy. Notably, the number of residential building approvals rose by 2.2% to 14,869 in December, reaching its highest level since May 2004. The result followed a similarly strong performance in November and lifted the annual rate of growth to 53.3%. At the regional level, growth appears to be spread across the states, which bodes well for the overall prospects for builders and materials suppliers as the year unfolds.

News flow within the domestic credit market was highlighted by the announcement from the Federal Government on the 7th February of its intention to end the debt guarantee scheme for the commercial banks and the states. After 31 March, the banks will no longer be able to issue guaranteed debt, while the corresponding cut off date for the state governments is 31 December. The Government’s intention in allowing extra time for the states is to provide them with an adequate opportunity “to establish liquidity in new unguaranteed bond lines”. Existing guaranteed debt will remain covered until it either matures or is bought back and extinguished by the issuer. The Government acted on the advice of the Council of Financial Regulators, which indicated that “bank funding conditions have improved such that the Guarantee is no longer needed”. Moreover, the removal of the guarantee is not expected to “materially affect banking sector funding costs”.

United States

Consumption spending in the US started 2010 on a positive note, with retail sales posting a rise of 0.5% for the month of January. The January increase followed upward revisions to the November (+2.0%) and December (-0.1%) results. The detail of the January result revealed general merchandise (+1.5%), electronics (+1.2%), and sporting goods (+1.0%) categories all posting increases of at least 1%. Automobiles and parts posted a flat result, reflecting the ending of the Government’s Care Allowance Rebate Scheme, commonly referred to as the cash for clunkers scheme.

In a further sign of economic improvement, the US Federal Reserve (Fed) decided to raise its discount rate by 0.25% to 0.75% with effect from 19 February. The discount rate is the rate at which the Fed lends funds to US banks, and is distinct from the federal funds rate, which is the rate at which US depository institutions lend overnight funds to each other. The Fed stated that its intention in raising the discount rate was to encourage institutions to make greater use of the funding markets, and to approach the Fed as a last rather than a first resort. In reality, this is already occurring, as the level of primary credit borrowing from the Fed has fallen significantly from the levels of late 2008, when the private credit markets were effectively frozen. Importantly, the move does not reflect a change in the Fed’s monetary thinking, and does “not signal any change in the outlook for the economy or for monetary policy”. Moreover, responsibility for the discount rate lies with the Board, while the federal funds rate is determined by the Federal Open Market Committee (FOMC).

China

In early January, the People’s Bank of China (PBOC) moved to increase the reserve requirement ratio (RRR) for its major banks by 0.5% to 16%, the first increase in the RRR since it last peaked in June 2008. The PBOC followed this move with a further 0.5% increase in mid-February. The RRR has traditionally been used as a primary tool to fine tune monetary policy and, accordingly, investors suspected that this may foreshadow a tightening phase. Adding to these suspicions, the pace of new lending growth remains significant, with more than RMB1 trillion in new loans granted over the month of January. Evidently, a significant portion of this lending continues to be directed towards housing, with urban house price inflation clearly entrenched within an upward trend. Prices rose by 1.3% over the month, lifting the year-on-year rate of increase to 9.5%. In a further sign of expectations with regard to inflation and potential interest rate hikes, there has been a significant move on the part of both consumers and businesses to shift funds out of term deposits and into demand deposit accounts. By shifting funds to at-call accounts, investors are typically able to avoid the erosion in purchasing power that occurs when funds are committed for a fixed period within a rising interest rate environment.

United Kingdom

The Bank of England (BoE) left the Bank Rate unchanged at its February meeting. However, its quantitative easing program, the Asset Purchase Plan, was put on hold for the first time since its introduction in March last year. The BoE has indicated its intention to evaluate the impact of its actions to date, and has given itself the option to continue purchasing bonds “should the outlook warrant”. When the Plan was first introduced, the intention was to purchase £75 billion worth of assets. However, subsequent revisions have lifted the total amount spent to its current level of £200 billion.

Asset sectors

International sharemarkets

The MSCI World (ex Australia) Index rose by 2.0% in local currency terms over the month of February. This translated to a rise of 0.6% in Australian dollar terms, reflecting the impact of a broad-based rise in the value of the Australian dollar. The currency gained ground against Sterling (+6.0%), the Euro (+2.6%) and the US Dollar (+0.7%), although it finished the month lower against the Japanese Yen (-0.9%).

At the regional level, there was a marked disparity in performance. In Europe, the leading markets of France (-0.8%) and Germany (-0.2%) both lost ground, with weakness similarly evident in Japan (-0.7%). Conversely, the US markets posted solid gains, led by the technology-oriented NASDAQ Composite Index (+4.2%). The broadly-based S&P 500 Index (+2.9%) and the Dow Jones Industrial Average (+2.6%) of leading stocks also benefited from the improvement in US investment sentiment.

The MSCI Emerging Markets Index declined by 0.1% in local currency terms, with currency movements further lowering this return to -0.4% in Australian dollar terms.

Australian sharemarket

The S&P/ASX 200 Accumulation Index rose by 2.2% over the month of February. The market initially weakened amid deepening fears that the difficulties facing Greece in managing its debt commitments may lead to a renewed round of tightness in the global credit markets. Amid significant comment and speculation as to potential outcomes, investors appeared to favour the view that a solution would eventually be found, and shifted their attention to corporate profit results.

At the overall level, results broadly matched expectations, although variability was clearly evident at the sectoral level. A review conducted by Goldman Sachs JB Were showed that, for the period ended 31 December 2009, net profit after tax (NPAT) rose by 10% across the broader industrials sector. The banks represented a particular area of strength, as lower bad and doubtful debt charges resulted in the sector posting an average increase of 47% in NPAT.

At the individual stock level, Caltex Australia (+16.8%) was the top-performer, followed by Wesfarmers (+15.2%), Transfield Services (+12.8%), Ansell (+12.5%) and Macquarie Airports (+12.2%). Notable underperformers included Toll Holdings (-20.9%), Primary Health Care (-20.5%), Arrow Energy (-15.5%), CSR (-11.2%) and Energy Resources of Australia (-11.1%).

Property securities

The UBS Global Investors Index finished 3.2% higher in February in local currency terms. At the regional level, most of the major markets gaining ground. North America (+5.6%) was the best performer, followed by Singapore (+1.4%), Japan (+0.6%) and the UK (+0.5%). Continental Europe (-0.8%) was the sole major market to end the month in negative territory.

The S&P/ASX 200 A-REIT Accumulation Index rose by 1.5% in February, underperforming the broader sharemarket. At the sectoral level, the diversified (+4.8%) sector posted a particularly strong gain, with the leaders (+1.7%) and commercial (+0.1%) sectors also achieving positive returns. This left the retail (-0.8%) sector as the sole area of weakness.

At the individual stock level, the spread for the overall sector widened to 22.1% in February. Specific outperformers included Charter Hall Group (+11.2%), Stockland Trust Group (+8.8%) and Abacus Property Group (+7.7%). Underperformers included Ardent Leisure Group (-10.8%), ING Industrial Trust (-5.6%) and Macquarie Office Trust (-5.1%).