THE BIG PICTURE: Why the US continues to set the tone for Australian shares and growth

Is there one particular theme or issue that dominates the radar screen? Unfortunately it is never that easy. There are always a few balls in the air and that is certainly the case at present.

Probably the biggest issue is whether the US economy is headed for a double-dip downturn. Everyone seems to have their views on the topic, including renowned investor Warren Buffett. At present all the economic data indicates that the US is merely consolidating after a ‘V-shaped’ recovery in late 2009/early 2010. But clearly the issue is a watching brief given that unemployment is still high and the housing market remains over-supplied with stock.

Certainly the issue of a ‘double-dip’ will be in focus in the coming week with the US Federal Reserve policy-making committee to assess the state of the economy and determine if more stimulus is required. Some analysts are betting on more ‘quantitative easing’ – buying government bonds to inject cash in the economy – and that speculation is putting downward pressure on the US dollar.

A weaker greenback is good news for the US economy, serving to stimulate the export sector. And a weaker US dollar also tends to lead to higher commodity prices as it improves purchasing power for European and Asian buyers. But the opposite side of the equation – strength in other currencies – may pose problems for other countries. The Aussie dollar has certainly soared over the past week, putting pressure on tourism, exporters and manufacturers.

There are also a number of other issues to watch. One is that listed companies are paying more attention to dividends. In the latest profit-reporting season in Australia, CommSec calculated that 83% of companies paid a dividend with 40% lifting dividends compared with a year ago. Companies have high cash reserves at present, and if they remain reluctant to put them to work, there may be more recourse to issuing share buy-backs, lifting dividends or paying special dividends. In the US, Cisco Systems will pay a dividend for the first time and Microsoft has announced that it will borrow to fund a higher dividend payment.

And one other event to keep a watch on is the US mid-term elections, held on November 2. Analysts believe that this could actually be good for stocks, calculating that the S&P 500 has risen on average by 13% during the year after mid-term elections. And if gridlock eventuates this could be even more positive for stocks. Gridlock is where one party has control of the White House and another has control of Congress, creating the risk that little in the way of new legislation gets advanced.

The week ahead

A quiet week is in prospect on the Australian economic calendar with housing data to dominate in the US. In addition the US Federal Reserve holds its latest interest rate setting meeting with the jury still out on prospects for a double-dip recession.

In Australia, the Reserve Bank Governor is scheduled to deliver a speech on Monday with minutes of the last Reserve Bank Board meeting to be released on Tuesday. Also on Tuesday, the Government’s main commodity forecaster, ABARE, will release its quarterly Australian Commodities publication containing the latest commodity price forecasts. And on Friday the Financial Accounts will be released.

Whenever the Reserve Bank Governor speaks, investors and analysts stand to attention. But few are expecting any hints on interest rate settings. The Reserve Bank will probably wait until the next inflation data at the end of October before deciding its next move. Certainly domestic economic data remains very patchy and the same can be said for the global environment with China in strong shape, the US stagnating and European countries taking different growth paths.

The Reserve Bank Board minutes will probably come to the same conclusions and the commentary is unlikely to signal any urgency in changing the stance of policy.

The commodity price forecasts will be keenly awaited by those investors focussed on prospects for the resources sector. But the Government will also be a keen observer as each time ABARE changes its forecasts, it seems to trigger changes in the expected tax take of the proposed mineral resource rent tax.

The data release of note in the coming week is the Financial Accounts. This publication will reveal statistics like the cash holdings of superannuation funds, the proportion of listed shares held by foreigners and the financial wealth held by Aussie households.

In the US, the focus is squarely on the health of the housing sector, although we use the term ‘health’ quite lightly. The latest housing starts data is released on Tuesday with existing home sales on Thursday and new home sales figures are slated for release on Friday.

Apart from the housing market data, the Federal Reserve hands down its interest rate decision on Tuesday with the leading index slated for release on Thursday and durable goods orders on Friday.

Overall economists expect slightly more positive results for the housing market in August after dreadful results in July. Admittedly the home buyer tax credit adversely affected these July figures, but it is clear that housing activity remains depressed.

Housing starts probably lifted 1.5% in August. Interestingly, with inventories already so high, a bigger lift in starts may appear encouraging but it wouldn’t be sustainable. In addition, existing home sales are tipped to have risen by over 7% in the month, but this follows a fall of over 27% in July. And new homes sales are expected to have lifted 7.5% from record lows.

The Federal Reserve meeting should prove an interesting event given the mixed views that currently exist. But the Fed is unlikely to be in a rush to inject any more stimuli into the economy. The best thing it can do is to leave current policy settings in place and focus on the positive aspects of the economic recovery.

Sharemarket

You could hardly call the Australian sharemarket “cheap” at present. Currently the historic price-earnings ratio (PE ratio) stands at 15.95, above the long-term average of around 15.00. Going back a year ago after the profit-reporting season, the PE ratio hovered in the 13-14 range. It was in a similar range after the earnings season in 2007. And in the intervening year of 2008, the sharemarket was even cheaper with a PE ratio of 10-11 times – admittedly it became even cheaper as investors were focussed on the earnings outlook rather than history.

With the PE ratio slightly above average at present and companies reluctant to provide guidance on earnings, the Aussie sharemarket will continue to find it hard to make forward progress in the short term. What is needed is a more upbeat view on recoveries in the US and Europe. Our end year forecast for the ASX 200 remains at 4800.

Interest rates, currencies & commodities

There is currently a lot of focus on the Aussie dollar, but how strong is it really? CommSec has assessed 120 currencies and found that the Aussie is the 13th strongest against the greenback since the start of the year. The Colombian peso is on top with gains of 12%, followed by the Malaysian ringgit (up 9.5%) and Japanese yen (up 9%). The Aussie dollar has actually made modest gains of around 4% since the start of the year. At the other end of the spectrum, African and eastern European currencies have recorded the biggest losses against the US dollar over 2010, but the Euro is also one of the biggest losers, down 12%.

Australian motorists are certainly one of the beneficiaries of the high-flying Aussie dollar. Not only has the Aussie lifted from US88 cents to US 94 cents in recently weeks, but the oil price has retreated over the past month or so from just above US$80 a barrel. As a result, the average retail price of petrol has fallen to an 11-month low with motorists saving around $17 a month compared with three months ago.

Craig James is chief economist at CommSec.