May Market Commentary

May Market Commentary

Monthly Economic & Investment Market Commentary

May 2012

British philosopher Bertrand Russell passed away more than four decades ago, yet the following quote of his can readily be applied to so many of the problems that the global economy and investment markets currently face, and also to many of the people tasked with resolving these problems.

One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.

We don’t profess to know how the European situation will resolve itself, and frankly anyone who does is more than likely a member of the first category of people about which Russell spoke. Managing your investment portfolio is not about evaluating binary outcomes, there are just not a lot of black and white decisions to be made. 


Whereas something used to just be popular, in the current day the true test of popularity is whether something has gone viral on the internet, most commonly a video clip on YouTube. However, for those of us inclined that way, it can also apply to a research report, maybe a simple chart, or in this case a speech by George Soros delivered to the Festival of Economics in Italy. In it, Soros addresses the problems in Europe, and says

it is impossible to predict  the eventual outcome,

thus identifying himself as having imagination and understanding by Russell’s definition. Let us avoid the temptation to consider exactly what transpires at a Festival of Economics, and move to the key quote from the speech.

But the likelihood is that the euro will survive because a breakup would be  devastating  not only for the periphery but also for Germany. It would leave Germany with large unenforceable claims against the periphery countries…  And a return to the Deutschemark would likely price Germany out of its export markets – not to mention the political consequences. So Germany is likely to do what is necessary to preserve the euro – but nothing more. That would result in a Eurozone dominated by Germany in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer payments.(1)

The process of trying to keep Europe together is going to be extraordinarily difficult, and one that will be punctuated with panic and crises and involve hardship for millions of Europeans. Yet, the alternative of breaking up is likely to be worse. Last year we wrote that the options facing Europe were abandoning integration or embracing integration, and that remains the choice today.

What that means in a practical sense is best illustrated by a comparison of Spain to Florida. Both had large bubbles in their housing markets as a result of lax lending standards, buyer speculation and too much   supply. Economist Paul Krugman writes   that  

between falling tax payments without any corresponding fall in federal benefits, plus safety-net aid… Florida received what amounted to an annual transfer from Washington of $31 billion plus, or more than 4% of state GDP. That’s a transfer, not a loan. And it’s very big.2

He finishes with the obvious conclusion that aid on that scale is inconceivable with Europe in its current form, and right now the United States of Europe still seems a long way away. We will watch progress closely, particularly for any contagion effect to our region and our major trading partners.


We have written before of how the incredibly short attention span in investment markets and the financial media leads to an increase in volatility, as one day’s weaker data is followed by tomorrow’s positive surprise – and so yesterday the market was down, and today the market recovers. Most often, the reality is that not a lot has actually changed, and the monthly data releases when considered as part of the longer term trend are invariably more reliable and informative.

A weak number on jobs growth in the United States combined with GDP for the March quarter being revised down to 1.9% from 2.2%, were two of the reasons for a 9.1% drop in the US share market over the last month. Balancing that were more signs that a bottom in the housing market looks to be forming, as shown by lower inventories and supported by higher refinancing activity and record low mortgage rates. Historically the housing sector has been a key driver of growth in a recovering economy, however simply stabilising and hence eliminating the drag on the economy will be a welcome and positive development in the US.

All of the above is consistent with our forecast for economic growth in the United States, and our view that whilst the recovery is continuing it is likely to remain at a sluggish pace. Fed Chairman Bernanke has again indicated that the US central bank is “prepared to take action as needed,” but the key risk remains in Washington and the likelihood that US politicians are unable to come together and enact long term fiscal reform.

As we head into the final six months of the seemingly never ending election cycle, this still looks to be a prospect for which there can be little hope. House Speaker John Boehner has indicated that he plans another showdown on increasing the debt ceiling, either later this year or early next. Increasing the debt ceiling simply means that Congress agrees to issue more debt, so that the US can pay for spending already approved by Congress. Last year the very same fight led to the first ever downgrade in the US credit rating, and repeating the same plan this year has mildly been described as irresponsible, and perhaps more accurately as an “act of economic sabotage”.3

We expect the sluggish growth to continue for the short to medium term, not least because it looks unlikely that a serious effort at long term reform will even be attempted in that period. There will come a time when the US Government is no longer able to borrow money for 10 years at 1.5%, but hopefully well before then the politicians will have come to their senses.


As expected China has announced support for their slowing economy, in early June a more direct approach was taken with interest rate cuts, as compared with the more recent and subtle stimulus activity of reducing the amount of reserves that banks are required to maintain. The Chinese authorities are likely to use a broad range of supportive measures, as they manage the growth in their economy back towards the target range of 7.5%, particularly given the leadership transition later this year.


Confidence in the Australian economy has been buoyed by two recent positive data releases. The National Accounts figures showed that GDP grew by 4.3% over the year ending March 2012, well ahead of the consensus expectations. Whilst commentators have suggested that the current quarter is likely to be slower, it was still a remarkable result, and importantly the growth was quite broad based. The largest contributor was still the mining sector, but good growth was also shown in other parts of the economy.

Employment data for May was also positive, with a net addition of 39,000 jobs in May. Whilst being conscious of our earlier comments about caution being required when interpreting a one month result, the composition of the number was encouraging as temporary jobs actually declined by 7,000 and full time jobs increased by 46,000. One interesting comparison is to adjust the result to account for the population difference between Australia and the United States, giving an equivalent number for job creation in the US of 525,000. The Americans only managed to add 69,000 jobs in May, which is below the level required to accommodate new entrants to their workforce.

Our Treasurer did indeed announce that we would return to surplus in the financial year starting in a few weeks’ time, requiring the largest one year turn around in our budget. It would seem fair to suggest many are skeptical the result will come in as announced, as there are simply far too many items beyond the control of the government that could tip the balance either way.

Our key concern was the impact to our economy of the government sector contracting by more than $45 billion the space of 12 months, from a deficit of $44 billion to a surplus of $1.4 billion.

The encouraging news is that our initial assessment of the actual impact being much less than the 4% figure is supported by more recent analysis. After allowing for what will likely be optimistic assumptions about revenue growth, and also expenditure cuts to items such as Defence spending which have limited impact on the domestic economy, an impact of around 1% seems to be the consensus.

With an economy currently growing at 4.3% per year, a 1% budgetary impact is certainly manageable and is already being offset by accommodative moves to cut interest rates from the Reserve Bank. The prospects for the Australian economy look sound, and we remain comfortable heading towards an overweight target for this asset class in your portfolio.


Tipping Points May


1.    George Soros, Remarks at the Festival of Economics, Trento, Italy. 2-Jun-12.

2.    Paul Krugman, Florida Versus Spain. New York Times. 2-Jun-12.

3.    Betsey Stevenson & Justin Wolfers, Debt-Ceiling Deja Vu Could Sink Economy. Bloomberg. 28-May-12.


Reuben Zelwer


About Reuben Zelwer


Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.