SCOREBOARD: Surplus negativity

Wall Street's sharp drop to end last week should lead the local stock market lower, and MYEFO's due out too.

Friday night saw the biggest drop in US stocks since June, spooky because it was the 25th anniversary of Black Monday. We’re getting into a messy period. All the fundamentals suggest the rally should continue, but the problem is the news flow – not to forget the fiscal cliff overlay. Tough times.

For the Aussie market this week, there probably won’t be a great deal of macro guidance here or abroad. Fair to say it’s probably not going to be a great day today what with all the action on Wall St on Friday – big moves on the downside with the S&P500 down 1.7 per cent, the Dow off over 200pts, while the Nasdaq fell 2.2 per cent (our own SPI fell almost 1 per cent).

Then, and from the macro side, we do get some key data, but it’s unlikely to give us any insight as to the sustainability or otherwise of said rally. So, the government’s mid-year outlook is due out today, with the government apparently committed to delivering a surplus next year. At budget this was forecast to be either $1.5 billion (cash) or $2.5 billion (accruals basis) and reports this morning are this is still the target. As in past years, the rhetoric is tough – savings will be made "they will be significant. But they will be targeted and responsible, minimising the impact on the economy”.

We’ve heard this every year though. The truth is spending hasn’t been cut at all (following a surge during the GFC) and indeed continues to increase. Instead, the government’s strategy to reach surplus has been to rely on a pickup in revenue. This by the way is why suggestions that fiscal policy is contractionary are incorrect – by definition. In previous budgets and updates we’ve seen accounting tricks and PR more than anything. The fact is the budget should already be in surplus given the economy is at its strongest in over 4 years, unemployment low etc. Indeed Australians are wealthier than ever and monetary policy is stimulatory – there are simply no excuses why the government continues to borrow money in this environment. We should be shoring up our finances much more aggressively while the economy can handle it – you know, save our pennies for a real downturn. Instead we have too many people running around saying how weak the economy is now – when it’s strong! So instead of saving money for a rainy day, we’re needlessly still in deficit – frittering it away. It’s no wonder why many nations often never get to clean up their books – the incessant call to spend, spend, spend!

The other news comes from the inflation numbers on Wednesday at 1130 AEDT. The consensus is that CPI will rise by about 1 per cent for the third quarter to be 1.6 per cent higher annually. Core inflation as measured by the trim and weighted median, is forecast to rise 0.6 per cent for the quarter and 2.2 per cent for the year. There are a few things to note here. Both headline and core inflation have been quite volatile over the last year or so, not helped by the changes the ABS made to the methodology. However this volatility means that current inflation is almost certainly being understated. The trick for policy is in determining what true inflation or underlying inflation is doing, abstracting from volatility, because it is very easy for people/policy makers to be caught out by that volatility – fooled by it.

Recall in 2011 Australian economists, and this also goes for the RBA Board, were convinced that domestic demand was weak, citing below trend GDP growth. I argued at the time that this weakness was illusory or due to temporary factors and this turned out to be correct. I would argue that there is a similar process underway with inflation now. On my estimates, true inflation is nowhere near 1.6 per cent as suggested by the headline rate, and it is most likely even higher than the 2.0 per cent rate suggested by the cores – something closer to 2.5 per cent would be much more accurate. Sill not bad given the strength in consumer spending, low unemployment rate etc, but certainly not a rate that should spark the complacency that the headline rate appears to – and not a rate that justifies some of the lowest lending rates in over 20-years.

There isn’t much else data wise for Australia, but there are a few things abroad worth noting – again nothing game changing. Treasuries after operation twist ends. Last meeting they announced further purchases of MBS (The Bank of Canada and the RBNZ also meet this week). Otherwise US GDP figures are due on Friday – the first estimate of Q3 GDP is expected at 1.8 per cent. There are a few bits and pieces otherwise, but I’ll discuss them on the day.

That’s it for now, have a great day….

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