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Aug 30

Simple Economic Update

The month of July saw the return of strong sharemarkets both in Australia and overseas with the first positive monthly performance for four months. This return of confidence was largely due to investors reacting positively to the European Banking stress tests where 92% of European banks tested passed. Alongside of the good sharemarket performance was higher oil prices and a stronger Australian dollar. Whilst July was a good month for the riskier asset classes, at the start of August the Reserve Bank of Australia decided to leave interest rates on hold as their expectations of inflation and economic growth were in line with long term averages and the global outlook continued to show significant uncertainty.

During August, sharemarkets returned to being quite volatile as talk about the US entering a recession in the second half of this year gained momentum. With the removal of US government stimulus programs under way, continued high unemployment, and a weak housing market, the US consumer continues to save more and spend less thus increasing risks of deflation. Deflation can be quite a destructive force on an economy because if the consumer expects prices to be lower tomorrow they will not spend today. This prospect of deflation has also resulted in strong demand in US Treasury Bonds and, at the time of writing, a 10 year US Government currently yields only 2.5% which is the lowest since January 2009 near the height of the GFC. The upside to this is an expectation of strong international bond returns for investors.

In Australia, the August company reporting season produced mixed results with the only consistent outcome being an outlook of caution. This added to local sharemarket volatility and like the US, investors appeared to move their money from shares to the safer Australian bond market where yields have dropped significantly.

Looking forward the outlook remains the same as it has for a long time…an expectation of continued sharemarket volatility which may produce buying opportunities. Unfortunately for all asset classes, whether shares, property, or bonds, expected returns over the next several years are expected to be low but if high returns are required then the acceptance and purchase of high risk assets will also be required.

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