Caton’s Corner - November 2012

Share markets had a mixed month. The ASX200 rose by 3%, finishing at 4517, its highest month-end close since June 2011. It has now risen in nine of the ten months so far this year, to be up by a total of 11.3%. The US share market, as measured by the S&P500 index, fell by 2% in the month, but is up by 12.3% year-to-date.

In the US, the end of the month was disrupted by hurricane Sandy, which caused the NYSE to close for two days, and is estimated to have cost somewhere between $10 billion and $45 billion. This could mean that Sandy is as expensive as was hurricane Andrew in 1992, but this will still leave it at less than one-third of the cost of Katrina in 2005.

Natural disasters always have costs, not all of which can be adequately measured in monetary terms, but their macro-economic effects are almost always fleeting. 140 years ago, the British economist and philosopher, John Stuart Mill, remarked on “the great rapidity with which countries recover from a state of devastation the disappearance, in a short time, of all traces of the mischiefs done by earthquakes, floods, hurricanes, and the ravages of war.”

Incidentally, the last time a weather event caused a two-day market shutdown was as long ago as 1888.

International Developments

During the month, the third-quarter GDP release for China suggested that the trough of the slowdown has passed, although some of the other data are less convincing on this score. I remain of the view that the Chinese are very adept at getting that economy going again, and have considerable leeway to do so. It is frequently suggested that stimulatory policy may be constrained by inflation or by the fear of igniting a property bubble. Neither of these is a real constraint at present. Inflation has come down to less than 2% from more than 6% in the middle of last year, and property prices are not an issue right now.

In 2011, there was something of a property price bubble. Measures were put in place to limit the ability of non-residents to purchase property, while residents find it difficult to purchase a second dwelling. Last year, prices were rising in almost all of the 70 major cities this year the performance has been far more mixed.

That said, what stands out in China is the extraordinarily high share of GDP devoted to residential construction (in excess of 6%, compared with 3% in many other economies). This share is so high mainly because it reflects the continued migration from rural areas to the cities.

China is, of course, on the brink of a leadership transition, with the 18th National Party Congress set to convene on 8 November. The change in leadership is unlikely to lead to abrupt change in policy, but the new team will have to grapple in the medium term with some substantive issues. Among these will be handling the transition from investment-led growth to greater emphasis on consumption. The growing issue of income inequality will also need to be addressed.

I have made the point before that Australia is now extremely dependent on China. This is mainly a good story, but there will be bumps in the road from time to time. Our increasing dependence is illustrated in the chart below. More than 28% of our exports now go to China. This ratio is higher for Hong Kong (52%), approximately ties with Taiwan, and ahead of every other country.

Source: Datastream

In the United States, no progress was made in the resolution of the “fiscal cliff”. This was not unexpected, given the political pre-occupation with the forthcoming Presidential election. Something will be done about the cliff eventually, but it’s in the nature of the US political process that there will be posturing and delay, meaning that uncertainty will hang over markets for some months yet. The US reported a surprisingly large fall in the unemployment rate, from 8.1% to 7.8%, in September. That economy is still showing forward momentum, but at an only-moderate pace.

It’s been “all quiet on the European front” in the past month, with borrowing costs continuing to decline. The Greek long bond rate, for example, has fallen by some 10 basis points in the past three months. Prices move in the opposite direction, and a fall of this magnitude means that the price of a Greek bond has more than doubled since late-July. How many readers thought to buy Greek bonds three months ago?

The month also saw the 25th anniversary of the “crash” of 1987. As if on cue, the US market fell on the day.

The Australian Picture

In the month, we got somewhat disquieting news on both the labour market and inflation. It is becoming progressively more obvious that employment growth in Australia has slowed to a crawl, being up by just 0.5% in the past year, while the unemployment rate rose from 5.1% in August to 5.4% in September. This is still a very low level compared with other developed nations, but the trend is now clearly upwards.

The headline CPI rose by 1.4% in the September quarter, with much of this due to the introduction of the carbon tax. Of somewhat more concern was a solid increase in underlying inflation. This now stands at 2.5% in year-to terms, which is right in the middle of the RBA’s target range, but it’s up from 2% in the year to the June quarter. Inflation is certainly not a worry, but nor can it be completely ignored.

The Reserve Bank cut the cash rate in October, and it’s doubtful this will be a “one-off”. The Bank has shown a tendency to move on Melbourne Cup Day, having changed the cash rate in November in each of the past six years. This is no coincidence there is a greater probability of a move in the month immediately after new inflation news, and also immediately before the RBA’s quarterly Statement on Monetary Policy. This year, the fact that the cash rate is already very low, and the “heavier than expected” inflation news, may lead the Bank to hold its fire, possible waiting for more international news and one more labour-market report. I would put the odds of a cut in the coming week at close to 50%, with a 75% chance of a cut by the end of the year.

The Bottom Line

In early-July I somewhat reluctantly cut my end-year forecast for the ASX200 from 4700 to 4500. I have split the difference, raising it back to 4600.

Chris Caton
Chief Economist

The views expressed in this article are the author’s alone. They should not be otherwise attributed.

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