Investment Commentary - August 2010

Quick Overview

Economic data out of the United States was consistently weaker than expected during August. This caused market participants to focus on the risk that a double-dip recession may occur in the US, which would cause a contraction in overall global growth. As a result, riskier investments that tend to perform well during periods of economic expansion were sold in favour of investments with defensive and stable characteristics. Global share markets, high yield corporate bonds, and the Australian dollar ended the month weaker, while gold prices and government bond markets performed well.

Key Developments

Australian economic data releases were a mixed bag.  On the positive side, retail sales rose in June and July; and employment grew by 23,500 in July.  The unemployment rate nudged up to 5.3% from 5.1% owing to an increase in the number of people actively seeking work.  The trade balance rose to a larger than expected surplus in June, and the overall contribution of net exports (exports minus imports) gave a better than expected boost to June quarter GDP growth. On the negative side, business inventory growth and private capital spending fell in the June quarter, which was expected to be a drag on GDP growth for the June quarter.  The GDP report, released in early September, did in fact show that inventories and business investment detracted from growth.  Importantly, however, the report showed that the Australian economy expanded by a better than expected 1.2% over the quarter, and 3.3% over the year.

The Reserve Bank (RBA) kept the official cash rate steady at 4.50% for the third consecutive month.  It is likely that steady interest rates have had a significant positive impact on consumer confidence which has recovered 17% in the last two months and is roughly at the same level as the beginning of 2010.

Australian government bonds delivered strong performance in August.  Yields fell aggressively, mainly due to deteriorating sentiment about US growth prospects, which also led to sharp declines in US government bond yields.  With underlying inflation appearing to decelerate, interest rate markets are lowering their expectations for the cash rate.  Australian 10 year government bond yields are now only slightly higher (by 25 basis points) than the official cash rate.

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