Morningstar Economic Update

December 2009 / January 2010

Outlook for Investment Markets
The economic news both locally and globally has generally continued to improve (except for the unexpected news out of Dubai), and forecasts for economic growth in 2010 are being upgraded in many countries, including here at home. While markets would normally welcome these developments, investors have not been big buyers of the better news, and appear to want to wait and see what happens next before making big commitments to the prospect of better times.

Australian Cash & Fixed Interest - Review
Ninety-day bank bill yields were up 0.20 percent over the past month at 4.20 percent, reflecting the Reserve Bank of Australia's latest 0.25 percent increase in the official cash rate, which took effect from 2 December. There has been very little change at the longer end, 10-year government yields (5.60 percent), corporate bond yields (7.10 percent), and wholesale borrowing rates (the three-year swap rate 5.60 percent) all very close to month-ago levels. The $A has eased back a little against the $US (91.5 cents compared to 93 cents a month ago), and is down 1.10 percent in overall trade-weighted value, but the move is minor set against the substantial 30.30 percent rise of the past year.

Australian Cash & Fixed Interest - Outlook
In its latest statement, the Reserve Bank said that "Growth in 2010 is likely to be close to trend and inflation close to target", which means that the Bank is likely to keep up its recent moves to "lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker". Further rises in short-term interest rates are highly likely: the futures market is picking 90-day bank bills to be 4.90 percent by mid-2010, and to be 5.50 percent by the end of 2010. Government bond yields are also probably heading higher as inflation rises modestly and progressively more confident investors feel less need to hold low-yielding 'safe haven' assets. Anticipating where any currency might go is a hazardous exercise, but provided there are no more Dubai-style incidents (which tend to send global investors home and out of currencies like the $A), most of the fundamentals (commodity prices, the improving local economy, already rising interest rates and the prospect of more to come) suggest the $A could go higher.

Australian & International Property - Review
There was not much to choose between the listed property sector and the broader sharemarket over the past month, both recording small declines. The S&P/ASX200 AREITs Index was down 3.20 percent for the month. There was little corporate activity, the only item of note Mirvac's completion of its acquisition of the Mirvac Real Estate Investment Trust on modestly improved terms for its investors. Global property followed wider sharemarkets and had a subdued performance, with a small (+0.40 percent) rise over the past month in the EPRA/NAREIT Index of global shares (ex-Australia) hedged back into $A. Global property gained 2.30 percent for the past quarter, although there was a rather lopsided contribution to the overall asset class. US property shares were up eight percent, Europe (ex-UK) was flat, and most other markets went backwards to some modest extent, while Japanese property shares were weak, dropping 17.10 percent over the quarter.

Australian & International Property - Outlook
The Australian listed property sector is out of intensive care, but is still not fully healthy. Investor sentiment has improved, to the degree that existing REITs have been able to raise new capital (some A$16.0 billion to date), and new IPOs are now being considered seriously with (according to media comment) the first likely to eventuate early next year. The steadily-improving economic outlook is also a plus. But the sector is still working its way through fixing the debt-financed excesses of the pre-credit crisis days. In Mirvac's case, for example, investors were paid some 60 cents per unit, whereas the last stated net tangible asset backing was 85 cents, suggesting that there are still valuation writedowns to come. There's also the knock-on effect of debt problems: according to one estimate there are A$68.0 billion of wholesale unlisted property funds, with less access to new equity than their listed cousins but with some of the same refinancing problems, and their distress sales have the potential to weigh on property valuations.

It's much the same story for international as for domestic property: an improving economic outlook, but set against ongoing financial restructuring. Life has been a bit easier for the listed vehicles, which this year in the US alone have been able to raise US$35.0 billion of new debt and equity capital. But there's also the same theme of unlisted property funds under financial stress putting pressure on the value of property held by the listed vehicles. This is shown by the just-announced bankruptcy of Fairfield Residential, one of the largest US owners and developers of apartments, which had been unable to arrange refinancing. And while the outlook has improved for global activity in general, some countries are experiencing deflation (notably Japan), with falling property values and rentals, a difficult backdrop. This remains an asset class where the prospects depend very heavily on exactly which sectors and countries investment managers select for their funds.

Australian Equities - Review
World sharemarkets did very little over the past month, and local equities went with the trend. The S&P/ASX200 Accumulation Index was formally down 2.60 percent for the past month, but there has essentially been little overall movement for the past quarter, the index only 0.90 percent away from where it was three months ago. The Industrials were down 3.60 percent for the month, the Financials contributing a 5.50 percent fall, while Resources stocks were steady, helped by ongoing rises for world commodities (except oil and gold which fell). The Reserve Bank's index of Australian export commodity prices rose 2.10 percent in $US terms in November (though only marginally in $A terms).

Australian Equities - Outlook
While the question for many sharemarkets has been when and how strongly the economy would pull out of recession, Australia has been doing well, as shown by the Reserve Bank being one of the first central banks to start taking away the proverbial punchbowl. The question has been more about the strength of the cyclical upturn. Recent evidence has been that the upturn is turning out to be better than expected. Forecasters have been rather blindsided by the unexpected vigour of the Australian economy. For example, forecasters had expected only lacklustre employment growth in November of about 5,000 jobs, but there were 31,200 new jobs, all of them full-time, and the unemployment rate actually fell slightly (from 5.80 to 5.70 percent). Unsurprisingly, business confidence has continued to increase, the latest National Australia Bank business opinion survey commenting that "[t]he continuous climb in confidence has been remarkable, confidence the highest since May 2002". One especially encouraging detail was a significant rise in new orders, which should translate into higher economic activity down the track. The local sharemarket has been taking its cue from its counterparts overseas, and it may be that the 'wait and see' mentality prevalent recently in overseas markets will continue to shape local prospects, but latest data and forecasts have been encouraging and the improving outlook for local corporate profitability is positive for shares.

Performance periods refer to the month and three months to 15 December 2009