THE WEEK AHEAD: The savings conundrum

Change sometimes has a habit of creeping up on you. That certainly seems to be a case with consumer spending and financing trends. Most of us probably still work on the assumption that consumers put all purchases on the credit card, that they are up to their eyeballs in debt and paying off the housing loan is a really struggle.

Well a new era of conservatism is very much in force, but because analysts and some commentators still promote old stereotypes, you probably don’t know about it.

For instance, the latest consumer sentiment survey had the usual question about where consumers believe is the best place to put any extra savings. In the past, most people have said that the best place to put extra cash is either in the bank, the sharemarket or the property market.

But for the first time, paying bills and cutting debt levels is up there with the usual suspects. In the March survey almost 27% of people believe that paying debt is the best use of their funds. That was up there almost level pegging with putting the dollars in the bank and way ahead of putting the money in real estate (14%) and putting savings to work in the sharemarket (11.3%).

Not only was paying down debt almost the top choice, but it also was the highest reading since it was included in the survey almost 13 years ago.

Also remarkable is the fact that consumer sentiment actually rose in the latest month – and after the Reserve Bank announced another hike in interest rates. So it’s certainly not the case that consumers are downbeat – the consumer sentiment reading is not far off record highs.

But while consumers are confident, they still are reluctant to spend – unless it is on ‘something special’ of course. Over 2009, household disposable income rose by almost 8% – close to the fastest rate in 19 years. But real growth in consumer spending was just 2.2% – near the slowest rate in 16 years.

Even in terms of credit cards consumers are now far more conservative. The average balance on credit cards attracting an interest charge rose by just 1.3% over the past year – the slowest growth on record. And then there is the news that 70% of Commonwealth Bank home loan customers are ahead in their loan repayments – making higher repayments than they need to.

How long this new conservatism continues remains anybody’s guess. But clearly if you are in a consumer-dependent business these are trends you need to watch closely. Consumers are confident and cashed up with economic prosperity at the highest levels on record. But that doesn’t mean they have to spend to be happy.

The week ahead

Over the past fortnight investors have been bombarded with almost every key economic indicator except the inflation figures. But after the feast comes the famine – in the coming week the economic closet is largely bare.

On Monday, lending finance figures for January are released, and Reserve Bank Assistant Governor Malcolm Edey delivers a speech on Payment System Reform. The Reserve Bank is also front and centre on Tuesday with the minutes of the March 2 Board meeting to be released. New figures on dwelling starts (commencements) are released on Wednesday while data on imports is slated for release on Thursday.

Without a doubt the Reserve Bank Board minutes dominate attention. While investors know that interest rates are likely to rise over 2010, they don’t know when, and they don’t know where rates are likely to end the year – although they are in good company. While the Reserve Bank Governor provides guidance that rates are likely to lift by 50-100 basis points over 2010, the timing of the moves is certainly not pre-ordained.

Of course, a lot can change. Overseas, China may pick-up steam but the US may dip back into recession if consumers don’t spend. And then there is the uncertainty at home. Housing lending has now slid for four straight months. Both the rate hikes and withdrawal of government stimulus have played key roles in the softer lending demand. And while consumers are confident, they aren’t spending. Analysts and investors will be hoping for insights from Reserve Bank Board members on these topics as well as other ‘hot button’ topics such as the tightness of the job market, rising house prices and the growth mismatch across states.

Certainly, comparing economic calendars in Australia and the US is like comparing chalk and cheese. In the US in the coming week, not only does the Federal Reserve meet but there is a bevy of key indicators due for release.

On Monday, production and capital flows data is released while the Empire State Manufacturing index is issued. On Tuesday the Federal Reserve meets while housing starts and trade price data is issued the same day. On Wednesday producer price data is issued with consumer price figures on Thursday. And rounding off the week on Friday is the current account, leading index and Philadelphia Fed manufacturing index.

Overall, the results aren’t expected to be flash. Industrial production was probably flat in February in line with previously released manufacturing employment figures. Housing starts may have softened modestly in the month. And core rates of producer and consumer inflation (excludes food and energy) were probably flat, to only a touch higher in February. But the leading index probably rose again, up another 0.2pct, indicating that the recovery is still on track.

Apart from the economic data, there will be more interest shown in the Federal Reserve interest rate decision. The federal funds rate certainly won’t budge, but the discount rate may edge up another 25 basis points as part of the first stage of the ‘exit strategy’ – the withdrawal of monetary stimulus.

Sharemarket

The recent recovery in the sharemarket has prompted more investors to question how long it may take to get back to record highs. However the answer is not so straightforward. And it all gets back to how companies responded to the global financial crisis.

Back in 2009 when it became more difficult and more costly to borrow, listed companies decided instead to raise capital on the sharemarket. And while many were indeed successful in raising funds, the additional supply (issuance of shares) actually had the effect of keeping a lid on share prices.

So while the All Ordinaries index has lifted by around 54% from the lows of March last year, the actual capitalisation of the sharemarket (number of shares times the price) has lifted even higher, up 65% over the same period.

The interesting point is that All Ordinaries still has some way to go to hit the highs of late 2007 – in fact over 40%. But the overall sharemarket is far closer to the previous highs – just over 20% away.

But to get back to those highs, there are still some hurdles to clear. And fundamental are valuations across the sharemarket. The historic price-earnings ratio currently stands at 15.98 – not only is this above the average of 13.6 recorded over the past five years, it is also the highest level in almost four years (since May 2006). The biggest increase in PE ratios was for big stocks with the PE for the ASX 20 grouping now at 18.51 – the highest reading for at least six years. By comparison the PE for the Small Ordinaries index stands at just 13.00.

Investors need to have confidence that future earnings will keep rising to justify current prices. That confidence probably exists at present, but not if there are new hiccups in the global economic recovery.

Interest rates, currencies & commodities

Last year volatility reigned on financial markets. But so far in 2010 it’s an entirely different story. Since the start of the year, 90-day bill yields have moved just 27 basis points with 10-year bond yields fluctuating around 40 basis points. However, over the same period of 2009 both 90-day bills and 10-year bonds had moved by just under 100 basis points. Over the entire 2009 year, 10-year bond yields tracked over a 223 basis point range, but this looks less likely to be replicated this year.

Craig James is chief economist at CommSec.