Market Review: It’s all about earnings!
Guardian Trust Funds Management managing director Anthony Quirk gives his views on the state of the markets.
Monday, November 4th 2002, 12:47PM
by Anthony Quirk
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This market summary is provided by Guardian Trust Funds Management. To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Reveiw here |
Two key drivers, corporate earnings and interest rates, combined to boost global sharemarkets in October from previously depressed levels. The result was a big rally in the US and Europe with the Dow Jones Index in mid-October having its biggest four day gain in seventy years. With an 11% rise for the month the Dow Jones also had its largest ever gain for an October month and its largest monthly rise since January 1987.
As suggested in last month’s commentary (click here to read previous article) bond markets sold off through much of October after US 10-year bond yields were down to forty-year lows in September. However, a rally in late October meant that returns from global and domestic bonds were only slightly negative for the month.
On the earnings front the majority of September quarter results are now in for US companies, with more than half beating expectations and only a small percentage falling short. This is quite a turn around from the previous two years, where most companies disappointed on the earnings front. A factor behind this outcome was companies successfully guiding analysts down to more realistic profit forecast levels. However, the good news was that the actual overall US corporate earnings growth rate from the September quarter results was the highest for over two years.
Perversely, just as company results (and global sharemarkets) are becoming more positive the economic news from the United States is starting to turn uniformly negative. While company investment levels have been depressed for some time now, US consumer confidence (and spending levels) had held up over the past year. October saw this start to erode with consumer confidence falling to a nine year low.
While there is not a perfect correlation between consumer confidence and spending levels there is increasing potential for the US to slip into recession again, the so-called “double dip” effect. This means that the consensus is the US Federal Reserve will cut interest rates on November 6, with a cut of 0.25% (to 1.50%) now factored into the markets. This boosted global sharemarkets in late October, after they seemed to be running out of steam from the rally earlier in the month.
With the potential for a “double dip” US recession growing, the risk of deflation in that country (i.e. falling prices) increases. With the Fed Funds Rate at 1.50% the US Federal Reserve does not have much more up its sleeve to stimulate the economy. In any case, Japan is a good current example of how very low interest rates and big budget deficits do not necessarily avert a deflationary economy.
Moving to Japan, in late October a watered down proposal was published by the Japanese Government to clean up the country’s financial system and, in particular, its essentially insolvent banking sector. This has been a key handbrake on the economy with most bank’s unwilling and/or unable to lend money to fund new investment.
In the Japanese Government’s original proposal it wanted to nationalise some of Japan’s biggest banks through the injection of state capital. This, and a tougher stance by the banks in allowing more corporate bankruptcies, was too radical for the ruling Liberal Democratic Party (LDP). So it now proposes to halve the bad loan ratio by 2004. Unfortunately this still smacks of too little, too late.
Looking across the Tasman, the negative impact from the drought that plagues much of Australia is starting to bite with some economists saying it could shave about 0.5% off that country’s GDP. Australia’s September monthly trade deficit was the worst in two years with export levels directly impacted by the drought. For example, the volume of wheat levels has fallen 25% with dairy exports also affected. This latter factor is partly behind the bounce in world dairy prices, which of course benefits New Zealand.
Turning to this country, we continue to be in the unusual situation of having relatively buoyant economic, currency and sharemarket levels. Consumer confidence remains strong, business confidence is rising, net immigration is high, export levels are holding up and the housing sector is robust. As a result most economists have been revising up their growth forecasts, although most warn of the downdraft New Zealand will experience if the US goes back into recession and the Japanese and European economies remain moribund.
On the housing front, New Zealand has not been alone in experiencing a strong rise in residential house prices. In the US, UK and Australia rising house prices have helped buffer consumers from the negative impacts of sharemarket declines. Some commentators are now questioning whether a price “bubble” is developing in the US residential housing market, as has occurred recently with global shares and (to a lesser extent) US bonds.
It is reassuring that, with mortgage rates in the US still at relatively low levels, the National Housing Affordability Index is around its 10-year average. However, any significant rise in mortgage rates (albeit unlikely in the short-term) would worsen the Index and once again, raise the risk of deflation in the US. After all, a rapid fall in residential house prices was a significant factor in Japan’s economic problems developing in the early 1990s.
To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Reveiw here
Anthony Quirk is the managing director of Guardian Trust Funds Management
Anthony Quirk is the managing director of Guardian Trust Funds Management.
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