WEEKEND ECONOMIST: Dodging the double dip

The markets had a positive week, but we can expect some volatility as we head into the seasonally weak months.

The past week has seen generally soft global economic data – notably in China and the US. But despite this, share markets have had another positive week helped along by better corporate news and a solid start to the US profit reporting season.

While shares have had a great bounce from oversold levels two weeks ago and further gains are possible in the next few weeks, the bounce so far has come on poor volumes suggesting a lack of conviction. So with double dip worries likely to remain in the next few months we may see more volatility into the seasonally weak months of August, September and October. However, we remain of the view that a double-dip recession globally will be avoided, and with shares now very good value, monetary conditions likely to remain favourable and China likely to start easing some time in the next few months, shares are likely to put in a reasonable rally in the December quarter and through 2011.

The Australian Government released revised economic and budget forecasts where the main changes were a slight reduction to growth forecasts but upwards revisions to commodity price forecasts offsetting the impact of the softening of the resources tax and enabling a stronger return to surplus by 2012-13.

In terms of the approaching Australian Federal election, it's worth noting that from a macro-economic policy perspective there is little difference between either side of politics, with both committed to returning the budget to surplus and maintaining low inflation. However, significant policy differences are likely in terms of health, industrial relations, possibly the mining tax and government involvement in the economy with a Coalition government likely to be less interventionist. Historically, there is some evidence that the uncertainty around election results in a period of sharemarket softness during election campaigns with a relief rally soon after it’s over.

Perhaps the key event in the week ahead will be the release of the stress tests of 91 European banks, representing 65 per cent of the European banking sector. While much debate surrounds the tests, if the US stress test results from last year are anything to go by it should have a positive impact in terms of boosting confidence in the European banking system, particularly to the extent that it will help improve transparency regarding the vulnerability of individual European banks. In the US, data for housing sales and starts are likely to remain soft following the expiry of the first home-buyer tax credit. The US leading index is also due for release and the US profits reporting season will hot up with 100 major companies due to report in the week ahead.

In Australia, it’s a relatively quiet week ahead for data releases, but the RBA board minutes for July will be released and the RBA Governor is set to deliver a speech regarding the long-run effects of the financial crisis. The minutes are likely to reinforce the now more mixed outlook for interest rates. Since the last RBA board meeting, stronger Australian economic data for employment and consumer sentiment have increased the chance of a rate hike in August, particularly if June quarter inflation data surprises on the upside.

Dr Shane Oliver is head of investment strategy and chief economist at AMP Capital Investor