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A humdrum of activity on the domestic front

August 2008

Global and domestic equity markets are at similar levels to where they were a month ago. However, in domestic news, there has been a humdrum of activity. We have seen the sharp sell-off in the Australian dollar, a weakening economic outlook for Australia, and the commencement of company reporting season. So what does all this mean?

Sharp sell-off in the Australian dollar

Looking back only four weeks ago, the Australian dollar was trading at almost 98 US cents. Great news for Australian’s planning a trip to New York! The prospect of the Australian dollar hitting parity against the US dollar (i.e. matching value dollar for dollar) was spoken of by some analysts as almost a foregone conclusion. Fast forward four weeks and our dollar is now buying only 87 US cents after a dramatic sell-off. The reason for this decline can be attributed to the following reasons.

Change in the direction of interest rates

With a weakening domestic economy the prospect of further official rate rises in the near term has essentially vanished. Instead, a potential fall in interest rates would serve to narrow the interest rate differential between Australia and other countries, thus reducing the carry trade demand for the Australian dollar.

Falling commodity prices

Australia is a large net exporter of commodities such as wheat and wine and the dollar has had a long term relationship with commodity prices. A perceived drop in demand for Australian commodities has led directly to a decrease in the demand for the Australian dollar.

A strengthening US greenback

The fall in the Australian dollar is partly due to a stronger US dollar, which has recovered recently against most world currencies. The reasons for the rally are unclear, as the outlook for US economic growth has not noticeably improved.

Moving to the domestic economy, there has been a sharp deterioration in the economic outlook...

Weakening domestic outlook

The Reserve Bank of Australia (RBA) released its eagerly awaited Statement on Monetary Policy on 11 August 2008. This quarterly insight into the RBA’s thought processes was of particular interest, with the Statement marking a noticeable shift from last quarter’s ‘inflation-fighting’ stance to a more restrained outlook.

A key comment made in the Statement was that “recent indications are that a significant moderation in domestic demand is now occurring” citing lower retail sales and a slight decline in house prices over the June quarter. In short, the RBA now believes that it has accomplished what it originally set out to achieve – a slowing in Australian spending and activity.

This has now set the stage for a sequence of rate cuts over the medium term, with most economists predicting a 0.25 per cent cut to official cash rate to occur from as early as September. Some economists are even predicting a cut of 0.50 per cent due to the speed with which consumer and business sentiment have deteriorated.

Having moved into August, company reporting season has now descended upon us…

Company reporting season

The Australian sharemarket has now entered the early stages of company reporting season which covers the financial year just gone, and also typically contains some forward looking statements by management.

Given recent market events, this period in particular represents something of an opportunity for investors and observers to see if the depressed levels that many share prices are trading at, were justified or not.

Being so early in the season, only a small number of companies have reported their earnings. Whilst there have been relatively few surprises in terms of company earnings, accompanying statements by management have given an indication that tougher conditions lie ahead.

Telstra reported a profit of $3.7 billion for the year, slightly below analyst expectations of $3.8 billion, though still up 13.5 per cent on the prior year. Telstra shares closed 4 per cent lower on the day it reported.

Commonwealth Bank’s (CBA) profit slightly beat market expectations, announcing a profit increase of seven per cent to $4.8 billion. Despite the good news, CBA closed around one per cent lower on the day it reported, though against a broader market decline of two per cent on the day.

Computershare, the world’s largest share registry company reported a 41 per cent increase in earnings per share for the year ending 30 June 2008. While in line with management guidance of around ‘40 per cent growth’ , it fell slightly short of analyst expectations of 44 per cent earnings per share growth. Highlighting the unforgiving nature of the market at the moment, the shares were sold down more than five per cent on the day.

Stockland Group, the first of the major listed Australian property trusts to report, lifted its earnings per share by five per cent over the year but indicated that it faces a tough market in the year ahead. Its share price fell six per cent on the day.

As the company reporting season unfolds, the impact of a deteriorating global economic outlook and the effect of the credit crunch on company profit margins will become clear. Going forward, a fall in the Australian dollar against the US dollar and an anticipated cut in interest rates are likely to impact the state of play.

¹ Reserve Bank of Australia, Statement on Monetary Policy, August 2008

http://www.rba.gov.au/PublicationsAndResearch/ StatementsOnMonetaryPolicy/statement_on_ monetary_0808.html

²Business Spectator, Computershare misses profit forecast, 13 August 2008,

https://www.businessspectator.com.au/bs.nsf/Article/ Computershare-FY-profit-grows-20-HG27T