Reasons to be cheerful despite woes

In the tortured jargon of financial markets, this year's earnings reporting season is likely to "surprise to the downside". As breezy as that sounds to the uninitiated, that unfortunately is a euphemism for disappointment.

In the tortured jargon of financial markets, this year's earnings reporting season is likely to "surprise to the downside".

As breezy as that sounds to the uninitiated, that unfortunately is a euphemism for disappointment.

Even if earnings outstrip expectations, the gloomy mood surrounding global equity markets has cast a pall over the full-year reporting season with investors squarely focusing on the negative.

In the supposed perfect world of continuous disclosure, technically there should be no surprises. Every corporation has a legal obligation to keep the market informed of anything that may affect its share price, including earnings estimates calculated by stockbroking analysts that may not accord with the company's own forecasts.

In reality, it never works that way. The numbers never come in exactly as analysts have calculated. And this year, even if corporations report in line with the guidance they have delivered to the market, it is likely to be viewed as a disappointment.

But there are some good fundamental reasons why that cloud of negativity that has overhung the local bourse for the past three years could, or at least should, lift in the medium term. More on that later.

Unfortunately, the latest monthly survey of business confidence from the National Australia Bank released this week inched further into negative territory as mounting gloom over Europe's sovereign debt calamity overrode the Reserve Bank's recent hack into official interest rates.

Gloom seems to be a universal theme. While manufacturers, retailers and those exposed to the domestic market have laboured under the weight of a strong Australian dollar for the past few years, that was outweighed by the booming earnings among major resource companies.

This year, however, has brought little joy on that front with commodity prices, particularly energy, recording dramatic falls. And even if metal prices are still well above their long-term averages, investors focus on the future, not the past.

Wall Street traditionally kicks off its end of financial year reporting season well before Australia. But the headlines to Tuesday night's market report, as the first big American firms unveiled their annual accounts, summed up the contradictory mood.

"US stocks closed sharply lower Tuesday as investors digested a positive start to the earnings season, a eurozone deal to help support Spain and its banks, and disappointing Chinese trade data."

It was the same old story the negatives far outweighed the positives in the collective mood of traders.

American and European investors have become addicted to the economic equivalent of methamphetamine. The only thing that gets them excited these days is the prospect of further stimulus. But as the classical economic theory of diminishing returns predicts, by the time you've indulged in your third round of stimulants, the novelty and the satisfaction afforded by such action begins to shrink.

The prospect of QE III (the third round of American banknote printing) is unlikely to have the same impact as the second, and certainly far less than the first.

On that front, it is interesting to compare the performance of the Australian and American stockmarkets and the relative health of the two economies.

Ever since early 2009, Wall Street has boomed and until a few months ago was close to bursting through to a new record. If you believed the hugely enthusiastic and perhaps chemically enhanced traders on the floor of the New York Stock Exchange, who seem to have blithely ignored economic reality, we've been firmly in the grip of a bull market.

During this period, however, America's economic growth has been anaemic, residential real estate values have barely budged from crash levels and unemployment has remained stubbornly high despite real interest rates that are below zero.

Our experience has been almost the exact opposite. On any measure, the Australian economy has been the envy of the developed world with solid growth, low unemployment and low inflation. But our stockmarket is still around 40 per cent below its 2007 peak.

After a brief spurt in mid 2009, the Australian market stagnated. Each time it has attempted to bust through 5000 it has been knocked back into its box, either by fears of another global economic meltdown or by the suffocating effects of a surging Australian dollar.

Corporations with foreign earnings have seen revenues slashed by the currency revaluation while domestic operators have had to contend with a flood of cheap imports.

Those forces, however, may have run their course. Reserve Bank governor Glenn Stevens recently warned that we could no longer rely on the stronger currency to keep inflation in check. That's because the effect of that currency rise has now been fully factored into our prices. It is the change in future that will have an impact, not the current level of the currency.

Similarly, it has been factored into our corporate earnings. Unless the currency rises substantially further (and there appears little prospect of that) the dollar effect already has weeded out the companies that can no longer survive greenback parity.

The Wall Street boom, in contrast, is showing all the signs of running out of gas. The artificial shot to corporate earnings from a deliberately manipulated weaker greenback - designed to reinvigorate American industry and export earnings - is losing its potency.

The Australian economy is undergoing a painful process of readjustment. The good news is that a great deal of that pain may already have been absorbed. Reasons to be cheerful, part 1.

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