Optima News

Welcome to the Client Update for March 2010.

Remarkably, it is almost exactly 12 months since the market hit its low at the end of the first week in March 2009, and virtually 2 1/2 years since the market high at the end of the third quarter of 2007.

It is true that there are some uncertainties in the market, particularly concerns about the growing deficit in the US and the UK, and concerns about sovereign debt and economic performance in Europe continue to prey on market confidence. On top of that, we've got rising interest rates and with the Reserve Bank of Australia (RBA) announcing another 0.25% this week the official cash rate has returned to 4%. A full 1% move, in about 6 months, from the historically low "emergency rate" of 3%. The full Statement by RBA's Governor Glenn Stevens can be read at http://www.rba.gov.au/media-releases/2010/mr-10-04.html.

So, the focus on inflation from the RBA continues. It is interesting to note that the RBA is of the view that the economy "may have already been at or close to trend for a few months" so this month's increase has been described as taking the cash rate a step closer to average. With the RBA having revised it growth and inflation forecasts upward in February, and continuing to highlight longer term expansion in the resources sector more tightening is likely to be needed to get the cash rate to average levels.

The GDP number released the day after the interest rate rise, in some ways, vindicated the decision as GDP growth surprised us coming in at 0.9% for the last quarter of 2009. While that is a pretty good headline number, it is still driven by the Government stimulus measures given the large contributions from the public sector and the one off stimulus for car sales.

Overseas last month The People's Bank of China announced that the bank's required reserve ratio will be increased to 16.5% and 14.5% for smaller banks, effective from 25th February. We view this as the Chinese authorities trying to slow the rate of their expansion, but not take it off all together. These proactive steps will most likely increase the chances of extending the recovery in China without ending it in an inflationary bust.

Also overseas, with street protests in Athens resulting from the Greek Government's measures aimed at bringing the budget back into balance, the so-called PIGS (Portugal, Ireland, Greece and Spain) lead the headlines amid fears that Greece could default on its debt.

In our view, this is a big, but simple, issue. The massive GFC-busting stimulus must eventually be paid for, and this leads to lower growth than would otherwise be the case for those countries with strained economies, including the US. Frankly, we see the huge publicity around this issue as being very healthy because Government debt can be a very insidious issue with long term harmful effects if ignored. The temptation may be for Governments to keep putting off the tough actions that they eventually must take, which will then likely require even more drastic policy action in the future. The fact that these issues are in the public domain probably is part of the cure.

Back home in Australia, we have just finished the corporate reporting season and results were mixed. Approximately twice as many companies beat expectations as those that fell short and this is as you would expect in a recovery market phase. Overall, market forecasts are up for the financial year 2010 and the market is showing a healthy increase in future earnings, particularly in 2011, with the market now trading at just under 14 times 1 year forecast earnings. In other words, it is getting closer to historic full valuations and the key driver for stock market pricing over the next year will be the ability of the market to deliver the strong earnings growth it predicts for 2011.

Those of you wanting to make smart decisions will keep close to us, particularly in the period leading up to the 30th June as we help you adapt your personal and business affairs to changing circumstances, and particularly the impact of the Federal Budget due early in May. In an election year it will be interesting to see how the Government faces a deteriorating poll position.