The average trend of Australian GDP growth over time is considered to be 3.25%. Throughout 2009, as it became more and more apparent that Australia would not suffer a GFC-inspired recession and that stimulated Chinese growth was a major reason why not, the RBA updated its expectations month by month to first suggest the Australian economy would stabilise, then that it would grow timidly, then that it would begin to head towards trend and finally, last week, that growth was already close to trend.
That's why we've had four interest rate rises in six months from the “emergency” low of 3.00%, set in April last, to 4.00% this month. In the fourth quarter 2009 we registered GDP growth of 0.9% - the fastest rate of growth in almost two years – up from 0.3% in the third quarter. GDP growth for 2009 netted 2.7% but another four quarters of 0.9% would give us 3.6% - above trend.
It's thus no wonder the RBA fears inflation will again creep out of the 2-3% comfort zone, and why more interest rate rises are expected by economists – perhaps up to 5.00% by year-end. Currently the RBA expects GDP growth to exceed 3% in 2010 and rise to 3.5%, above trend, in 2011 and 2012.
But the RBA has now found itself at the low end of expectations. The economists at GSJB Were were previously forecasting GDP growth to average 3.5% in 2011 but also in 2010. This morning, however, they upped those numbers to 3.75% for both 2010 and 2011.
To appreciate why, one must first appreciate that the most fundamental impact on Australian GDP presently comes from the export of two commodities alone – coal and iron ore. One reason Australia didn't slip into recession late 2008 and early 2009 (post Lehman) was because Australia's bulk commodity exporters were still trailing 2008 annual contract prices in both commodities, which were the highest in history. By the time prices were reset lower after the first quarter, the sheer volume of fresh buying of iron ore from China had ensured Australia was already on its way to recovery after a mere economic stumble.
And coal demand has returned with a vengeance as well. On Monday BHP Billiton (BHP) reported it had set a quarterly contract met coal price with Japan at a 55% increase over the 2009 price, not far from the prevailing spot price. Analysts expect subsequent quarters to see further coal price increases, and also expect iron ore price increases of 60% or more on 2009 as well. By settling on quarterly rather than annual contracts, BHP has left room to capture this upside.
[See Big Win For BHP Coal, Iron Ore Next? published earlier this week]
GSJB Were is expecting a 60% iron ore price increase, which it notes would take the Asian price of Pilbara ore fines to US$96/t (freight-on-board). The previous peak in 2008 was US$90/t ,but this was when hot rolled coil (HRC) steel was selling for US$1000/t. Presently it is only selling for about US$630/t.
It is these increases in 2010 price expectations for coal and iron ore which have pushed Weres' GDP growth forecasts from 3.5% to 3.75%. The economists note that these price increases are of such an order of magnitude that they alone can add $38.5bn or a “staggering” 2.75% of nominal GDP in 2010-11. (Note that the 3.75% growth number is “real”, meaning adjusted for inflation. Nominal numbers do not adjust for inflation.)
One suspects the RBA won't take too long to yet again ratchet its own GDP forecasts, at least once 2010 iron ore price settings are clear (some analysts have price increase forecasts up to 80%). The next obvious step is for the RBA to push its cash rate higher once more, towards that 5% expectation.
GFC? What GFC? Speaking at the Citi London Conference on Australia now underway, in which major Aussie corporates are invited to speak, the CEO of mineral sands specialist Iluka implied we can hardly be in any sort of trouble while waiting to see whether iron ore prices will be 60% or 80% higher this year. A fair point.
Indeed, Citi reporters noted that all Day One presenters maintained a common theme, being the GFC has now faded into history. So quickly did Aussie corporates pay down debt and recapitalise as a response to the 2008 scare that some are now simply over-capitalised. Credit costs have pulled back, cashflows are returning to allow a revival of dividend payments and profits are turning around as well.
But that isn't to say Aussie corporates are not now once bitten, twice shy. A lesson learned means a new conservatism, and presenting companies echoed no desire to rush headlong into hasty acquisitions, but rather a comfort in maintaining strong balance sheets for the time being at the expense of short term return on equity.
The theme from Citi's own presenters was that while 2009 provided a macro recovery for global stocks, 2010 will be more a case of company specific success or lack thereof. This means Australian investors will need to be smarter and more selective than they needed to be in the general bounce-back of 2009.
It also means there are unlikely to be any clear and consistent trends evident in the Australian stock market in the near term, according to local stockbroker Patersons' Monthly Strategic Outlook for March. It may be a case of stock-picking amongst local listings, but Patersons warns offshore influences will still play a major part.
The apparent Greek bail-out is a short term positive for the market, but Patersons' Andrew Quinn suggests the Greek Tragedy and its implications will be a drag on European growth in the longer term. A weak euro is preventing a weak US dollar despite near-zero interest rates in the US. Rates will need to be kept low in the US for a “considerable” time, says Quinn, to counter high unemployment, a still nervous housing market and the pending withdrawal of monetary and fiscal stimulus measures.
While Australia may have flown out of a brief and shallow dive, not so the rest of the world. China may be our saviour but ongoing sovereign risks in major economies cannot be ignored and will continue to impact on local stock market pricing. Quinn notes the ASX 200 has been range trading for the past six months now and will probably do so for another six months. Patersons' strategists have every sector weighting at “neutral”, or market-weight, with the exception of materials (which includes the bulks) for which it has an overweight recommendation.
Moving out of the big end of the market cap weightings, JP Morgan has been looking at the performance of so-called small caps – those stocks outside the ASX 100 which are not real estate investment trusts (REIT).
The reporting season just gone proved to be a bit of a fizzer for this usually more volatile segment of the market, notes JPM, with only 15% of stocks sparking any significant share price upside and 20% any significant downside. In terms of earnings expectations per se, the JPM analysts found half of the small caps in their coverage universe beat their forecasts and half missed.
So the big end's not offering much more than range trading and the small end lacks any spice as well, it would seem. Nevertheless, JPM has singled out some small caps for specific mention.
In cyclicals the analysts like the resource sector service names Ausenco ((AAX)), Boart Longyear ((BLY)) and Monadelphous ((MND)). In defensives they like communication solutions provider Salmat ((SLM)) and health insurer NIB Holdings ((NHF)).
Stocks that are trading on undeserved discounts to valuation at present, according to JPM, are internet service provider iiNet ((IIN)) and budget airline Virgin Blue ((VBA)). Stocks that are trading on deserved premiums, and should continue to provide positive surprises, are the multi-faceted Campbell Bros ((CPB)) and online real estate advertiser REA Group ((REA)).
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