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AMP Capital Investors Limited ABN 59 001 777 591, AFSL 232497

Investment Strategy & Economics

Weekly market & economic update


By Dr Shane Oliver, Head of Investment Strategy & Chief Economist
14 OCTOBER 2011

Headline developments of the past week


> The noises out of Europe have remained positive with the Troika (ie the IMF, ECB, and EU) appearing to the clear the way for the payment of the sixth tranche of bailout funds for Greece, all countries now ratifying the July 21 enhancement of the EFSF (taking it to 440bn euros) and Chancellor Merkel and President Sarkozy reaffirming plans to recapitalise banks and devise a more durable solution for Greece and Europes debt problems by the November 3rd G20 leaders summit. That solution appears to allow for a 30 to 60% write down in Greek debt, recapitalising banks to ensure they can withstand it and boosting the fire power of the EFSF. > Much uncertainty remains though as to how Europe will support its banks, beef up the bailout fund and ensure a controlled default of Greece (because thats what it looks to be heading for), and even if it does deliver to market expectations by the early November deadline it wont mean the end of European debt problems because fiscal austerity will continue to bear down on growth leading to further disappointments in terms of countries not meeting deficit reduction targets. And whats more investors may start to wonder whether Belgium is the next Ireland, having participated in the nationalisation of Dexia with its already high public debt to GDP ratio. Nevertheless, recent indications are that Europe is moving to head off some form of worst case Lehman style economic meltdown. Two weeks ago investment markets were pricing in a meltdown scenario in Europe along with a US recession. Following positive noises out of Europe and better than feared data in the US this is now being priced out and so share markets are up sharply since early October. > The US took a lurch towards protectionism with a China currency bill passing the Senate. Hopefully this wont be supported in the lower house and if it does President Obama will probably veto it. However, populism is on the rise in the US witness plans to tax the rich and Occupy Wall Street - so the bills demise is not guaranteed. > China appears to be recognising growth is now the issue as opposed to inflation with a package of measures designed to help small enterprises that have been struggling under the impact of tighter macro policies and a sovereign fund buying bank shares. This is likely the precursor to a broader easing later this year. > Carbon pricing moved a step closer in Australia with the passage of the carbon pricing scheme through the lower house of Parliament. While one can quibble with some of the details I suspect the negative economic impact from carbon pricing will be far less than feared and in years to come we will regard it as a normal sensible part of the of the Australian economic landscape, just like the GST (which generated a similar furore).

Major global economic releases and implications


> US economic data remained consistent with continued modest growth with a slight rise in small business confidence, a rise in weekly new mortgage applications, a slight further fall in jobless claims and better than expected trade data. September quarter annualised growth is on track for 2% or slightly more. The minutes from the Feds last FOMC meeting also confirmed that the Fed considered more quantitative easing. Given the outlook continued sub-par growth we remain of the view that we will see QE3, but it probably requires another bout of softer data and low inflation beforehand. > The US September quarter profit reporting season got off to a bad start with a miss by Alcoa but a strong result from Google. So far 70% of results so far have come in better than expected. Consensus expectations are for a 14.1% rise in earnings for the year to the September quarter, but its likely to come in around 16%. > European data was a bit better than expected, with a solid gain in industrial production in August. Unfortunately more timely business conditions indicators suggest that this is unlikely to be sustained. > Japanese economic data was mixed with a strong gain in machinery orders in August, a fall in bankruptcies and a slight rise in consumer confidence but falls in general economic sentiment and bank lending and a narrowing in the current account surplus.
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> A sharp slowdown in Chinese export growth added to evidence that the global economy is slowing, and Chinese import growth slowed by even more adding to evidence of a slowing in domestic demand in China. Whats more Chinas inflation rate cooled further to 6.1% in September, supporting our view that July marked the peak in inflation and adding confidence to expectations for monetary easing ahead. We remain of the view that the Chinese economy will have a soft landing and that it will soon move to support growth by easing monetary conditions, but of course in the early stages soft landings and hard landings look the same. > Slowing exports from the Philippines and a slowdown in Indian industrial production add to evidence that Asian economies are cooling. Consistent with this Indonesia became the latest economy to cut interest rates. While India may remain a laggard, expect more rate cuts across Asia in the months ahead.

Australian economic releases and implications


> The run of better than expected Australian economic data continued over the last week with improvements in business and consumer confidence, further signs that housing finance may be bottoming and stronger than expected employment. However, the better than expected data doesnt change the need for lower interest rates. Consumer and business confidence are both low, so is housing finance and the labour market remains weak with 5000 jobs lost over the last six months and falls in job ads pointing to more weakness ahead.

Major market moves


> The rebound in share markets continued over the last week as traders had to close out their short positions as the risk of a European meltdown and US recession further receded. From their recent inter day lows US shares are up 10% (after 19% fall from earlier this year), Asian shares are up 12% (after a 27% fall), European shares are up 13% (after a 32% plunge) and Australian shares are up 9% (after a 22% fall). > Consistent with the share market rally commodity prices were mostly higher as was the euro and the $A, with the latter making it back above parity against the $US. Reflecting reduced demand for safe havens bond yields in major countries rose further.

What to watch in the week ahead?


> The focus will likely remain on Europe to gauge further progress in coming up with a durable solution to its debt problems. > The week ahead sees the release of key Chinese economic activity data for September. GDP growth is likely to have slowed further to 8.8% over the year to the September quarter. With the global backdrop having deteriorated, domestic demand growth having cooled down, inflation looking like it has peaked and mounting anecdotes that tight monetary conditions are taking their toll, Chinese authorities are likely to start easing monetary policy by year end. The key risk is that Chinese authorities are too slow to respond. > In the US, October business conditions indexes for the New York and Philadelphia regions (due Monday and Thursday respectively) are likely to improve slightly, industrial production data (Monday) is likely to see a modest rise, housing related indicators are likely to confirm a continued basing and core inflation (Wednesday) is likely to show a further rise to 2.1% over the year to September. The Feds Beige Book of anecdotal evidence on the economy is likely to show that the economy has stopped slowing but that growth remains weak. The US profit reporting season will step up pace with results due from about 150 major companies. > In Australia, the minutes from the RBAs last meeting will be scrutinized pretty closely for some guidance as to how strong its new found easing bias is. Meanwhile second order data for car sales, imports, housing starts and trade prices will be released. Expect the September trade price data due Friday to show a fall in the terms of trade from record levels as weaker commodity prices weigh on export prices.

Outlook for markets


> The bounce in share markets over the last two weeks could just be another short covering rally, of which there have been several over the last two months, albeit a big one. However, there are some reasons for cautious optimism that further volatile gains are likely into year end. Europe appears to be moving to head off a worst case Lehman style meltdown, central banks are starting to ease, the US economy appears to be avoiding recession & the month of October often sees markets bottom before shares head higher into year end. > In the short term the $A remains vulnerable to uncertainty regarding the global growth outlook. However, just as we saw after the GFC, the medium-term trend is likely to remain up as the $US remains under longterm downwards pressure, not helped by its debt woes and more quantitative easing, Chinese commodity demand will likely remain strong over the long term and Australian interest rates will remain well above US rates even if the RBA cuts rates. > Government bonds in major global countries could still rally further in the short-term and are a good diversifier. However, yields remain extremely low so expect modest medium-term returns.
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investors objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investors objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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