With very high levels of uncertainty at present causing investment markets to retreat, one pleasing aspect has been the verification of a strategy we have been implementing for Guidance Financial Services clients.  Our thinking for some time has been that the recent high Australian dollar has been fuelled by a combination of high commodity prices and a weak US dollar.  We have felt that in the event of market turmoil, commodity prices would probably fall, and the US dollar was likely to gain popularity as a safe haven.  The combined effect of these moves would be for the Aussie dollar to fall against the USD.

Through buying investments in the US (our preference has been exchange traded funds (ETF’s) such as iShares), any drop in the AUD will result in an increased value in our international assets when converted back into Australian dollars, providing a natural cushion in the event of a market fall.  For this reason we have been working hard to gain our clients unhedged international share exposure over past months.  Thus in all of the market turmoil currently being experienced with the problems in Libya, the Middle East, and now of course the earthquake and nuclear worries in Japan, the Aussie dollar has indeed fallen, and the value of our clients portfolio’s have to some extent at least been protected.  As they used to say on the A-Team “I love it when a plan comes together”.

The Australian Bureau of Statistics released data yesterday on businesses initial estimates for private capital expenditure in 2011-12.  Mining companies advised they planned to increase spending by a massive 55%, leading to total investment expenditure of $133billion for the Australian economy overall, a rise of 30%.

It is important to caution that these are estimates of intentions, however the magnitude of these plans cannot be ignored.  Demand for services such as engineering, equipment, and the skilled workers needed to physically get the work done, will no doubt be in short supply, with costs inevitably rising.  This is what the Reserve Bank of Australia is worried about.  Will the wages pressure that flows from these plans lead to inflation?

The report found the resources sector was on track to account for about 57% of total private capital expenditure based on the 2001-12 estimates.

Overnight US markets reached there highest levels in over two and a half years on a mix of positive news.  Worries of a US double dip recession have now evaporated.  With the US back into a growth phase, the developing world performing well, the European mainstays of Germany and France posting solid economic numbers, and even Japan showing positive signs, the outlook for 2011 is looking increasingly positive for investors.

Yesterday NAB released their business confidence survey which reported a third month of decline.  Also released yesterday was data on new home starts for the September quarter which dropped 13.2%, its biggest decline in 2 years.  At the same time construction work in the public sector declined 60% as the government stimulus package wound down.

It seems that whilst the resources sector continues to power along, may other sectors of the economy are doing it tough.  Retail in particular has been identified as a sector that is struggling.  The RBA’s seven rate rises in a little over a year, plus what the banks have put on top, seem to have really taken the wind out of the sails of many Australian consumers and businesses.  The high Australian dollar has also had a role to play in making exporters less competitive, and those suppliers to the domestic market increasingly exposed to competition from imports.

NAB have reduced their expectations for Australia’s economic growth for this year by 0.5%, and many are now questioning the RBA’s growth estimate of 3.5% with the Financial Review reporting that economists now expect growth to be less than 3% this year.

The RBA rate rises have in part been implemented on the expectation of significant investment by mining companies in 2011.  Let’s hope that investment comes to pass because it appears other businesses are feeling the hurt and it would be disappointing if that pain proved to be unnecessary.

It’s been a busy 24 hours in economic data.  Yesterday the Australian Bureau of Statistics reported that the economy grew by 0.2% in the September quarter, the slowest rate of growth in 2 years.  Even this growth could prove illusionary, as it was the farming sector that pushed the result into the positive.  Agricultural output was an estimate based largely on good rain falls across the Eastern seaboard in the September quarter leading to solid upward revision of farming production.  We now know that those rains have continued to the point where crops are reportedly being damaged.  So it could be that those estimates for agricultural production are overly generous, with a downgrade occurring with the next set of numbers.

Beyond our shores however the news has been good.  A private sector estimate of jobs growth in the US during November indicated 93,000 jobs were created. For some time we have been saying that the signs are good for the US economy but until we start seeing the unemployment rate decline, we wont get the full buy-in of the investing public to give the market some good positive momentum.  We got a taste of this last night with US markets gaining 2% following the jobs report.  Official unemployment data is out on Friday US time.  Lets hope that data provides further confirmation of an economy on the road to recovery.

Elsewhere reports from China on their manufacturing sector showed strength and resilience.  Ongoing economic strength in China is important to commodity producing countries such as Australia, since they represent a major customer.

European markets also gained overnight as concerns about government finances eased somewhat.  The European Central Bank suggested it may do more to calm markets there.

We have recently revised the risk factors for our 3 year economic outlook, our estimate of the likelihood of a series of economic outcomes.

This outlook graph forms part of the annual review material Guidance Financial Services provides its clients.  Does your financial planner provide this type of analysis?  Why not talk to us to explore whether Guidance Financial Services should become your financial planning partner?  Phone 9870 6544 or send us an email here.

After a volatile period on investment markets over the past year, there appears to finally be some positive momentum.  The Australian market has gained 10% over the past 2 months, whilst US markets have gained 16%, to be at their highest point in 2 years.

So what is driving these gains?  There are several reasons, but Australia’s domestic economic settings don’t seem to be particularly significant.  I’d assess the drivers, in order of importance as:

1. Some optimism in the US – there is growing confidence that the US economy will not experience a double dip recession.
2. Federal Reserve have made it quite clear that they will print as much money as necessary to create some inflation and get things moving.  This action has the potential to underwrite share prices, since if their is more money around, chasing the same number of stocks, then it stands to reason that share prices should rise.
3. China confirmed its economy was on track by raising interest rates last month.  This move can be seen as a vote of confidence in the global economy, and it led to significant rises in many commodities prices (which has been very helpful for BHP and RIO).
4. Political change in the US which markets see as positive.
5. Recent corporate profits have largely meet expectations – i.e., no nasty surprises.

The one missing piece of the economic puzzle is progress on unemployment.  Unemployment in the US is stuck at 9.6%, and is worse in many European countries, and thus far, despite modest economic growth, these levels of joblessness have not improved.  On this issue, it seems the approach required is a bit like that of the coach of a football team.  Our leaders can’t make employers employ more people, just as the football coach can’t go out onto the field and kick the goals.  All they can do is get the settings right and keep people positive, and have confidence that in laying these foundations, success will flow.

The Reserve Bank of Australia (RBA) surprised most market forecasters by raising rates yesterday by 0.25%.  The CBA was quick to lift their rates, and the other’s will no doubt be soon to follow. 

Rates have been on hold for some time.  The RBA has flagged concerns about inflation and capacity constraints, but has held off on raising rates, primarily it seems, due to worries about the global economy.

In raising rates this month they have indicated a greater confidence in the global economy, and Australia’s consequent prospects.  In the governor’s statement:

“…concerns about the possibility of a larger than expected slowing in Chinese growth have lessened recently and most commodity prices have firmed…  The prices most important to Australia remain at very high levels, with the result that the terms of trade are at their highest since the early 1950s.  The turmoil in financial markets earlier in the year has abated, though sentiment remains fragile.”

For those of us who are borrowers, higher rates are no fun, but would you rather have a strong economy like Australia’s, where most people who want a job have one, or be in the the United States or Europe where unemployment ranges between 9% and 18%.  Sure, interest rates are low, but that’s not much good to you if you are unemployed.

The Australian Financial Review reports today that “the $18.6billion export education industry is struggling to find new revenue as the rising dollar deters foreign students…”.  Elsewhere it is reported Fosters faces a $30million hit from the strong Australian dollar.  Prepare for plenty more reports along these lines.

A strong dollar is seen by some as a source of national pride, with many in the media portraying our exchange rate as something of a score board – when it goes up we are winners, and down we are losers.  Yet for many in the economy the high Australian dollar is extremely detrimental.

Firstly, lets consider why the value of the Australian dollar has risen compared to the US dollar in particular. In truth this is more a story of USD weakness, although our dollar has also gained against the Euro in recent months.

There is an increasing expectation that the US will work their way out of their economic woes through printing money. By creating inflation, the debt they owe the rest of the world is reduced in value, asset prices such as real estate rise, and consumers are given an incentive to spend now, rather than put things off, because in a world of rising prices, delaying a purchase means paying more.

Of course if you print money, then it means each US dollar is worth a little less compared to other assets, such as gold, where we have seen record prices fetched, and other currencies, such as the Australian dollar.

With one Australian dollar currently buying around 98 US cents, we are a long way for our long term average of around 75 US cents. At this moment however it is difficult to see what will change current sentiment.

So who are the winners from a high dollar?  Well simply, they are the importers.  Imported electrical equipment, cars, industrial machinery, etc.  The high Australian dollar makes buying things overseas cheaper. The airlines for instance have reported that the higher AUD will be very favourable for them, as it reduces their fuel bills, and it encourages Australians to travel overseas.

It follows then that the losers will be our exporters.  It makes it harder for Holden to sell locally produced cars into the US, our agricultural exports become less competitive, and our services businesses, such as IT become more expensive relative to other competing countries.

Whilst both Importing and Exporting industries produce employment and economic wealth for Australia, on balance it is reasonable to assume that our export industries generate a greater benefit to the nation, given the clear link to employment.  So with a higher Australian dollar damaging our exporters, our current strong currency will likely lead to a slow down in Australia’s economic growth over the medium term.  Given the RBA is currently talking about raising interest rates to slow down the economy, perhaps this is no bad thing.  I worry though that some of our exporters will go out of business, and the dollar will remain high for an extended period due to high commodity prices.  Over time our mining sector will tick over nicely, while other industries die.  Then one day, when China doesn’t need so much of our resources, and commodity prices drop back to more normal levels, our economy will look like the Royal Melbourne Show with only one old ride that no one wants to pay for any more.

Our attempt to assess the likelihood of a range of economic outcomes with a 3 year view.