The new financial year has started off positively with share markets gaining some ground as confidence returned but with investors remaining cautious. There are three key reasons for this return of confidence.
- Firstly, July kicked off the reporting season in the US and earnings were greater than consensus expectations for more than 80% of the companies reporting. However most of the earnings upside surprises came from cost cutting rather than top line revenue growth. Concerns remain about whether earnings strength is sustainable as cost savings are one off and companies need to sustainably grow revenues in order to increase earnings. The US unemployment rate remains high and this is affecting consumer confidence leading consumers to also reduce spending.
- The second reason was an increase in confidence in European stability. The “stress tests” conducted on the financial health of European banks showed that banks were solvent with only 7 banks failing the test. The key question that remains is: Were the test results real? For example the test did not contemplate any default of sovereign debt in Europe.
- Finally the Chinese government’s latest economic reporting showed that the economy is slowing as illustrated by slowing retail sales, reduced manufacturing output, a slow down in bank lending and lower headline inflation. This has lead to an expectation that the Chinese government will take steps to “take the brakes off the economy” that are currently restricting its growth potential.
During July the Australian share market rose 4.5% as measured by the S&P/ASX 200 Index. Investors were buoyed by the government’s change of heart on the Resources Super Profits Tax which helped to remove some uncertainty. Australia’s economy continued to be in good shape highlighted by the continued growth of employment numbers and a reported annual inflation rate of 3.1%. This information reduces the likelihood that the RBA will raise interest rates in the near term.
The Federal election announced for August 21st has dominated the media and the campaign is in full swing with the Coalition making it closer than most people expected. Both parties appear committed to reducing the budget deficit but there are major areas of policy differences relating to resource taxes, emissions trading, the national broadband network and superannuation. The uncertainty of the outcome of the election may further contribute to some short term market volatility.
Michael Lannon
Managing Director