Market Review: Is a day of reckoning coming for the US Dollar?
It was more the same for August as it was in July, but less so. Guardian Trust Funds Management managing director Anthony Quirk gives his views on the state of the markets.
Thursday, September 4th 2003, 2:54PM
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This market summary is provided by Guardian Trust Funds Management. To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here |
It was more the same for August as it was in July, but less so.
That is, government bonds continued their sell-off, but at a lesser rate than the previous month, while global equities continued their rise. The global equity index (the unhedged MSCI) is now up for six straight months, its best run since mid-1998. Two reasons for this occurring are:
1. Sheer momentum. Many institutional investors around the globe have scrambled out of their cash or bond positions into shares while many retail investors started to once again consider equity investments, after being burnt by previous "false" rallies of the past 2-3 years.
2. Consistently strong economic data from the US. Whereas 2-3 months ago the data was mixed (indicative of a turning point) virtually all economic data released in August was strong. There is no doubt that the US economic recovery is underway; the only issues being how high will growth go, for how long will it continue and what will be its impact on corporate earnings and interest rates?
In terms of these questions, many economists have been busily upgrading US growth forecasts for the rest of 2003 and into 2004. Moreover, already strong corporate earnings rises from analysts are at least being maintained and, in some cases, upgraded. The markets are also starting to suggest (and price in) the possibility of interest rate rises from Central Banks around the world some time in 2004; well ahead of previous market expectations.
However, we see a "black cloud" on the horizon in the form of global trade imbalances. This was illustrated by the balance of payments releases from the US, Australia and New Zealand during August. All three countries look pretty poor with the potential it will get worse from here.
The Australian current account deficit was particularly ugly, being a record 6.7% of that country's gross domestic product (GDP). The hope is that the stronger world economy will help lift Australia's exports but its deficit is now at levels which may cause investor concern and possibly currency weakness. New Zealand is not as bad but threatens to breach 5% of GDP in the September quarter numbers.
The US has a double whammy, with not only a current account deficit of almost 5% of GDP but also a projected 2004 fiscal deficit of over 4%. This means that the US is increasingly becoming a creditor nation, reliant on overseas investment to fund the gap between what it spends and what it earns.
In contrast many Asian countries have very large trade surpluses; for example China's now stands at US$100 billion. Part of this is currency related, particularly for China (which pegs its currency to the US dollar) and Japan (which has a Central Bank actively trying to sell down the Yen to keep its exporters competitive). However, in the case of China it is simply more competitive in terms of its cost of production, particularly labour costs, and this seems likely to remain the case for some time.
Given these surpluses have to be invested somewhere (and Japan has such low interest rates) Asian country purchases of US government bonds are helping to prop up the US dollar. Moreover, the stronger US sharemarket is also helping to attract more overseas investment. It has not got to the same stage as 3-4 years ago when the vast majority of global investment was going into the US, but it is still significant.
The issue we see is that at some stage the sheer scale of the US dollar purchases required to fund their twin deficits will see a significant sell off in the US currency; with potential negative flow-on effects to US stocks and bonds. We don't see this happening any time soon but the risk remains significant if a loss in confidence snowballs in the US dollar.
Looking back on the actual numbers for August it was another strong month for offshore share markets. This was particularly true for Japan, which was up over 8% (Nikkei 225) on the back of economists revising up that country's growth forecasts. The US was also up slightly with the S&P 500 up 1.8%, with the NASDAQ up 4.4% for the month and 35% higher since the end of March.
European sharemarkets were less buoyant with Germany (DAX) and the UK (FTSE 100) basically flat. France (CAC 40) was an exception, up 3.2%.
The strong performance of the New Zealand sharemarket continued with it being up 3.2% (NZSX50) for the month on the back of very strong company earnings results.
In contrast NZ bonds under performed global bonds with the former down 0.5% for the month (CSFB Government Stock Index), compared with a positive 0.3% return from the latter (Lehman Global Aggregate Hedged Index).
On the currency side investors finally got some respite from the Kiwi's strength against the US dollar, with a slight fall helping unhedged equity investors. The biggest move for the Kiwi was its 3.6% fall against the Yen but it is still over 20% higher than 12 months ago.
In summary, we do see a "judgement day" coming for the US dollar (and therefore possibly for bond and equity markets as well) but that is probably a story for next year. For now the direction in markets may continue, or at least result in consolidation at current levels for shares and bonds.
To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Anthony Quirk is the managing director of Guardian Trust Funds Management Special Offers
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