Sydney, Australia (PressExposure) December 21, 2010 -- Share markets had a mixed November. The ASX200 index almost exactly reversed its October gains, falling by 1.7%. The US share market fell by about 1%. The main concern during the month was clearly eurozone debt, with particular emphasis on Ireland.
November was something of a microcosm for 2010 to date. With a month to go in the year, the Australian share market is below its 1 January level. It is one of just three major markets in negative territory, with Japan and China for company. It's true that in recent weeks both Brazil and Hungary have slipped below zero, but they don't count as major markets!
If it's Tuesday, it must be Belgium's turn
The eurozone debt issue clearly isn't going away quickly. In fact, it appears to many to be getting worse. Ireland has been granted at least a temporary reprieve, with aid forthcoming from the IMF and the European Union. But others, particularly Portugal, Spain and Belgium, remain in the cross-hairs. Of these, Spain is by far the largest in economic size (close to 12% of the total European economy and bigger than Greece, Ireland, Portugal and Belgium combined), and hence the biggest potential risk. Having said that, its public debt to GDP ratio is relatively low.
The euro-debt issue is clearly important for the European banking system, and if there is a default at any stage the banks will suffer. But there are important differences from late-2008, when the full severity of the GFC struck. Back then, no-one knew who was holding what on their balance sheets, or what the "assets" were worth. Now at least, not only is the problem smaller but it is far more transparent. A default, full or partial, would hurt, but it would be a clearly survivable event.
The Domestic Scene
November was an interesting month for domestic news. In the first week, the RBA surprised most analysts by increasing the official cash rate, for the first time in six months. Let me say that the surprise was mainly about timing; a rate rise that had been confidently expected in early-October did not eventuate. Given that, there still seemed to be no strong case to hike just a month later. But a further increase at some stage was always on the cards.
The Governor, Glenn Stevens, hinted strongly that the RBA still has a bias to raise rates further, but that it was in no hurry. It would be prudent to assume perhaps two more rate increases in 2011. There are two further points worth making.
First, whenever interest rates are increased, we always eventually get to a point where market analysts expect more hikes than are actually delivered. It's doubtful that we are already at that point, but it is not out of the question.
Second, the RBA is well aware that consumers and businesses do not borrow at the official cash rate. So when we get so-called "out-of-cycle" increases in the variable mortgage rate, as occurred in early-November, what this almost certainly means is that the RBA will increase the cash rate one fewer time than it otherwise would.
There were two interesting pieces of economic news in the month. First, the labour market continued to add jobs at an impressive pace, but the unemployment rate blipped up from 5.1% to 5.4% in October. This is an unusually large movement in a single month. It is not a sign that the labour market is worsening, but nor is it a sign that it's so good that people who had previously "dropped out" are rejoining. The rise in estimated unemployment in the month probably mainly reflects statistical noise; if this is the case, the rate will fall again when we get the November figures.
Second, GDP growth for the September quarter was surprisingly low. GDP increased by just 0.2% after average gains of 0.8% in the previous three quarters.
Once again, not too much should be made of this apparent slowdown; the Australian economy remains in good shape. But the fact that two very important economic indicators both showed some signs of softness in the month certainly justifies caution by the RBA in raising rates further. It is likely to be March at the earliest before the cash rate rises again.
Meanwhile, the Australian dollar continued to be volatile. A month ago I suggested that it hadn't really yet reached parity with the US dollar. Well I now have to concede that it certainly did that, rising past 101 US cents. But my view that the currency shouldn't be that high remains, and it now sits at 96-97 cents. For those looking to purchase travelers' cheques (or international equities), you have probably missed the best opportunity, but the rest of the world remains on sale for Australians.
As I wrote last month, the Australian dollar is being buffeted by worldwide forces and currency realignments. In the month, Fed chairman Bernanke made a strong case that the developing economies are keeping their currencies artificially low. There are prizes for guessing the number 1 developing economy that he had in mind.
Looking Forward to 2011
While nothing is ever certain, I think it's a reasonable expectation that 2011 will be a better year for investors. The worst fears holding markets back are unlikely to eventuate, although they won't disappear overnight. The global recovery is likely to continue, albeit slowly.