July Market Commentary

July Market Commentary

Monthly Economic & Investment Market Commentary

July 2012

There is a fierce debate happening in many parts of the world about the appropriate role of government, including the types of activities and their scale. Of course it is a debate that is impossible to have without discussing the funds that governments use to complete their activities, and that is the taxes they levy on individuals and companies. Many argue that much of what the government spends is wasted and that the free market would be capable of providing the same services, and would do so more efficiently.

A year ago our commentary included the following quote, which remains as self-evident now:

In reality, we need more spending on some programs and less spending on others, and we need more good regulations and fewer bad ones. Analytical expertise is needed to accomplish this, to make government more effective and efficient. Skilled analytical thinking should not be drowned out by mistaken, ideologically driven views that more is always better or less is always better.(2)

As we return to earth (some might say with a bit of a thud), our role is to interpret the landscape where our politicians unfortunately all too often refuse to compromise on their ideologically driven views. We need real leadership to address the range of serious problems in the world, and so far the attempted solutions have been piecemeal at best. The world awaits the financial equivalent of landing a rover vehicle on Mars, but until we see this we will continue to recommend a defensive stance in your portfolio.


Last year a bi-partisan committee was set the task of developing a plan to address the budget and deficit problems of the United States by identifying both spending cuts and tax increases. To ensure members of the committee were sufficiently motivated to find such a solution there were automatic spending cuts and lower tax rates to be withdrawn should they fail in their endeavour. You will likely not be surprised to hear that in fact no such plan was agreed, and as a result the US is just a few months away from the start of $1.2 trillion in spending cuts. These cuts will be spread over the next 10 years, with half taken from Defence and half from other spending programs. In addition, lower tax rates that were passed under the previous administration will expire at the end of this year, leaving households with less money.

The popular term in the media has been that the US economy is approaching a “fiscal cliff” though the reality is more likely to be a fiscal slope.(3) Whether it happens suddenly or gradually, without further policy action from the political leaders there will be a contractionary effect to an economy already struggling to keep momentum in it’s recovery.

Some political analysts are currently assessing the value of “going over the cliff” as a means to bring about their parties desired policies. We should pause here to note that this is what currently passes for sound stewardship of the world’s largest economy.

The problems and issues that led to the Global Financial Crisis have not been remedied. The “too big to fail” banks have only become bigger, there has been little effective regulatory response to the crisis, asset and income inequality has become more pronounced and unemployment remains high and looks like staying that way. Corporate profits rebounded strongly after the financial crisis, though more recent signs indicate that some slowing is emerging, which we expect over time would lead to a reversion to lower longer term trend growth rates.


As we wrote last week, expectations were high that the European Central Bank would announce comprehensive measures to ensure that interest rates on Spanish and Italian bonds were contained within a level that ECB President Mario Draghi deemed necessary to ensure monetary policy was effective in the euro zone. The reality of the subsequent statement from the ECB initially left investment markets underwhelmed, though on further reflection there is a more encouraging view forming.

This view has it that much like his American counterpart Ben Bernanke, Draghi is frustrated with the lack of progress from the politicians, and hence his bold speech in London was an attempt to coerce action from the respective European governments, and most importantly the Germans.

“While it gave lip service to the discussion of “policy options” to address the “high risk premia” observed in Spanish and Italian debt costs, the ECB was holding the politicians feet to the fire to enact policy reforms, i.e. fiscal consolidation, structural reform and European institution building. Translation: we’ll play ball as long as you proceed with greater economic integration and the kinds of structural reforms outlined in Draghi’s Grand Plan earlier this year.”(4)

We have a critical milestone coming up next month when the German Constitutional Court decides whether or not to grant an injunction against the laws required to establish the permanent bailout fund, the European Stability Mechanism. On September 12 when the decision is known, a major impediment to greater integration in Europe may well be removed, and that will be significant. Assuming that it is, we must not lose sight of the fact that on September 13 the problems will not have gone away, and even an optimistic scenario in Europe involves a long process of reform.


When we turn to China, a one party state, they also are not without their political machinations. Later this year the once a decade transition of power will see Hu Jintao and Wen Jiabao hand over power to Xi Jinping and Li Kejiang as President and Premier respectively. Of greater note to investors around the world will be the continuing transition within the Chinese economy, specifically the shift from investment led growth to domestic consumption.

In recent months the Chinese have shown a willingness to use policy to support their economy, via interest rate cuts and reducing the reserve requirements in the banking system. This has led some analysts to predict a stronger second half of 2012 for the Chinese economy. There are also plans to continue investing in infrastructure, though care needs to be taken that this is done in a productive manner. Long term the goal is for the Chinese to continue to support urbanisation and growth in their middle class, thus increasing the importance of domestic markets for goods and services, and reducing reliance on the international markets for their exports, the United States and Europe in particular.


We note that the recent rate cuts from the Reserve Bank in May and June of a combined 0.75% may be starting to have an impact. The Bureau of Statistics reports that department store spending was up 3.4% in June, following on from a 1.2% rise in May. There was also the small matter of the Government making transfer payments to households in May and June of $2.85 billion, ahead of the introduction of the carbon tax on July 1.

One month into the new financial year, Australians are starting to see that dire predictions from the Opposition of our own “carbon cliff” are overstated. In addition, with interest rates low, but not without scope for the Reserve Bank to provide additional support, the “crisis of confidence” that we have been writing about in sectors of the Australian economy outside mining, may also start to dissipate.

When we write to you next month we will have the benefit of the updates from the Australian company reporting season which is just about to commence, and will focus on the more positive outlook for both Asia and Emerging Markets and our own local economy.


DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of CHPW Financial Pty Ltd AFSL 280201) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.

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.