RBA Governor Mr. Stevens believes the non-mining sectors of the Australian economy may not adequately make up for the expected slowdown of the mining sector and that “monetary policy has limits” in respect to “fine-tuning” the imbalance in the short-term. Mr. Stevens sees “further confirmation that the peak in resource-sector investment is near” and believes that the A$ “seems a bit on the high side” and further comments that the RBA is “wary” of taking action on monetary policy for fear of encouraging an “asset credit buildup”. Mr Stevens remains cautious – an interest rate cut in February does not look likely, based on the current situation. (Source: Bloomberg);

The World Bank has revised its 2013 Chinese GDP forecast higher, to +8.4%, up from +8.1% previously. With the new regime taking over, Chinese data should be positive in the next year, though having said that, Chinese data should always be treated with extreme scepticism. I remain positive on China in the short term (next year), though the economy, which remains dependent on fixed asset expenditure, over emphasis on SOE’s and exports, is an unsustainable economic model in the medium to longer term. A consumption led economy has failed to materialise, in particular given the lack of a social safety net – people have to maintain a high level of savings to pay for education, health and pensions.

However, in the short term, I remain positive on China;

Japanese PM Shinzo Abe has sought an accord with BOJ to set a minimum inflation target of 2%. Pressure is being put on BOJ to boost asset purchases which some analysts believe will start as early as tomorrow;

Japanese exports in November were -4.1% lower Y/Y (though better than the -5.5% decline expected) and have declined for the 6th month, increasing the trade deficit to Yen 953.4bn ($11.3bn) in November, as compared with Yen 549bn in October and Yen 1.04tr expected, the third largest on record. Imports increased by +0.8%. Interestingly, exports to the U.S. (up +5.3% YTD), exceeded exports to China for the first time since December 2008 (YTD exports to China are -14.5% lower). Exports to the EU have declined by -20% YTD and have been down for over 1 year. Vehicle exports have received the brunt of the decline, falling 68% in November, following an 85% decline in October. Construction and mining equipment has fallen 75%. The trade deficit YTD to November increased to Yen 6.28tr (US$74Bn ), more than double the record deficit of Yen 2.6tr in 1980. Despite this, the Nikkei rose to its highest since March on the basis that economic stimulus measures will be adopted by the new government and that the Yen will weaken further. The Yen continues to weaken;

The Indian Government continues with its reforms. The Rupee has been rising and is currently at a two week high against the US$. The Sensex is also climbing on increasing optimism of positive economic reforms.

Yesterday, the Indian lower house approved a bill which increases foreign shareholders voting rights from 10% to 25%, clearly positive. The Reserve Bank is expected to issue more banking licences, also good news. However, the government has postponed plans to allow increased foreign investment in the insurance sector and, in addition, proposed legislation which would, if passed, have enabled the acquisition of land – too contentious at present.

Legislation to improve corporate governance, increase accountability of directors and auditors and make boardroom decisions more transparent was also introduced in the Companies Bill.

The reforms, started following the appointment of the new finance minister, have been positive;

The World bank reported that growth in East Asia will accelerate to +7.9% in 2013, from +7.5% this year (previously +7.2%), as China recovers, reducing the need for lower interest rates. The region accounts for approx 40% of global GDP. The World Bank believes that economies in the region are working at near full capacity, so do not need further stimulus – interesting as China clearly has significant spare capacity !!!. Risks derive from Europe, in particular, though they believe they have lessened. They expect inflation to continue to decline. Capital inflows from developed economies need to be watched to ensure that they do not result in over stimulus and/or higher exchange rates;

S&P raised Greece’s credit rating to B- with a stable outlook, up from the previous selective default rating. S&P cites the determination of the EZ to keep Greece in the EZ, as the reason. Well, OK, but stable outlook !!!

The ECB will accept Greek debt as collateral, though will be subject to a “special haircut”;

Italian October seasonally adjusted industrial orders came in flat M/M, much lower than the +1.0% expected and as compared with -4.0% in September. Italian economic data has been weaker recently.

The Italian 2013 budget has been delayed (Mr Berlusconi ?), allegedly by a few days. Mr Berlusconi is also calling for a delay in the forthcoming general elections. His party, the PDL is polling just 20% at present and he hopes that a delay will improve his chances – no hope Mr B. The Italian President urged that passage of the 2013 budget should be implemented immediately and saw no reason to delay general elections;

German December IFO business climate index came in at 102.4, slightly higher than the 102.0 expected and 101.4 in November and higher for the 2nd consecutive month. The current situation component came in at 107.1, lower than the 108.0 expected and 108.1 in November. However, the expectations component, came in at 97.9, much higher than the 96.4 in November and 95.2 in November and the highest since May. Recent views on Germany appear overly pessimistic to me. Yes Q4 GDP is likely to contract (-0.2%/-0.3% forecast) with Q1 2013 flat, though German manufacturers are increasing exports to non-EZ countries, in particular to Asia and the US; The IFO institute was positive, stating that export expectations have improved and that business over the Christmas period was going well, especially in the electronics and sporting goods sector. The Euro improved on the news and is at a 7 month high against the US$;

Fitch warns that the Dutch credit rating could come under pressure if their fiscal situation comes in worse than forecast. The Dutch 2013 budget deficit is unlikely to meet its target. Holland is one of just 4 EZ countries with a AAA rating;

The French have adopted regulation which is described as an “Ultra-Light Volcker Rule” whereby they will split the proprietary trading desks from the traditional bank activities. It will forbid banks taking positions in hedge funds, curtail high frequency trading and speculating on farm related commodities. However it allows market making functions to still remain within the main remit of the bank and only asks that the riskier trading practices be separated into separate legal units, protecting the core financing functions relating to the economy and deposits from riskier practices. The French are the first to adopt such rules for their banks in the EU. It has also been reported that France is in the process of setting up a system whereby failing banks are wound down without the need for tax payers money, i.e. bondholders and shareholders will be hit for the expense. (Source Bloomberg);

The EZ October seasonally adjusted current account came in at E3.9bn, higher than the upwardly revised E2.4bn in September – Euro positive. Demand in the EZ, in particular in the peripheral EZ countries has collapsed. The current account surpluses are expected to continue

EZ October seasonally adjusted construction output came in at -1.6% M/M, somewhat worse that the revised -1.3% in September;

Minutes from the UK’s monetary policy committee (“MPC”) of the BoE voted 8 to 1 to keep its asset purchase facility unchanged at £375bn and 9 to 1 to keep interest rates on hold. The minutes revealed that MPC members expect inflation to remain above 2.0% over the next year or so. Hmmmm. The UK economy is expected to contract in Q4, though come in broadly flat in early next year. The problems within the EZ , whilst lessening, continue to be a drag on the UK economy, with declining competitiveness impacting exports.

Fitch warned today that the UK could lose its AAA rating if extended economic weakness causes a slippage in achieving fiscal targets. I continue to believe that the is a high probability of the UK losing its AAA rating next year;

US November housing starts came in at 861k M/M, slightly lower than expectations of 872k and a revised 888k in October.

November building permits came in 899k, better than the 875k expected and the revised 868k in October.

The US residential housing sector continues to improve, a trend I expect to continue into next year. In addition, residential construction should add to GDP next year;

US oil production rose to 766k bpd, the highest in 15 years and is expected to be 6.41mn bpd this year, a 14% increase from 2011, according to the US Dept of Energy. The increasing rate of growth suggests that the US will exceed production from Saudi Arabia (November production 9.7mn bpd) by 2020. Net petroleum imports have declined by around 38% since the 2005 peak and now represent 41% of demand, down from 60%, 7 years ago. Combined with a record production of natural gas, the US should be in a hugely competitive position in coming years. Energy intensive and petro chemical industries should expand, given the locally produced and cheaper energy. I don’t believe that markets have fully appreciated the impact of this dramatic change in locally produced oil and gas – hugely positive for the US and the US$ in the medium/long term. (Source Bloomberg);

Outlook:

Asian markets closed higher, with European markets following. US futures suggest a slightly higher open, having closed over +1.0% yesterday, on improving hopes of a deal on the fiscal cliff.

Spot gold is trading at US$1667, once again lower on increased risk appetite generally. Can’t see the attractiveness of gold at present. February Brent is higher and is currently trading at US$109.71.

RSI indicators suggest that equity markets are somewhat overbought. However, I believe that the traditional positive momentum during the upcoming period should sustain markets, in particular as a deal on the fiscal cliff is agreed. On the other hand, government bond yields in respect of a number of the major developed economies (US, UK and Germany, for example) look particularly low, suggesting a sell off to little old me.

The Nikkei is trading at its highest since April this year, closing +2.4% today and above the 10,000 level. The Yen continues to weaken and is at its August 2011 low against the Euro. The BoJ meets tomorrow and is expected to increase its asset purchase programme by between Yen 5tr to Yen 10tr. I continue to be short the Yen, which continues to weaken and is currently trading at Yen 84.56 against the US$.

The Euro continues to strengthen, currently US$1.3289. The A$ is weakening, in particular against the Euro, though also against the US$, currently US$1.0487 – at long last.

I remain positive on equity markets.

Kiron Sarkar

19th December 2012

Category: Think Tank

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