Market Update - 5 August 2011Global Equity MarketsOvernight we saw the most significant decline in global equity markets since February 2009. All major developed market indices fell sharply,and Emerging Market indices were also lower. Worsening economic data in the US as well as the ongoing concerns regarding the Europeanfinancial system and European sovereign debt issues resulted in a massive sell down in equities, as investors sought to further reduce exposureto risky assets and resulted in the most significant one day decline in global equity markets since February 2009.The comfort blanket that was a slow and steady US recovery now appears to be unwinding as investors are now fearing the potential of a USrecession given the weaker economic data, concerns about the ongoing European debt situation, the lack of resolve in regard to the debtceiling issue in the US, high (and sticky) unemployment, slowing consumer demand, increasing inflationary pressures, declining house prices,and the likelihood of decade long austerity measures that may further crimp economic growth.Last night, global stocks had their biggest one-day decline since March 2009. The S&P 500 Index last night fell 4.8% which is the biggest one-day drop since the March 2009. The VIX, (Chicago Board Options Exchange Volatility Index), which reflects investors’ desire to increase orintroduce ‘risk’ into a portfolio, jumped 35% to 31.7, its highest close since July 2010 and the biggest jump since February 2007 (when theindex surged 64%). Equity markets have now fallen by more than 10% from this year’s high in May. The MSCI All-Country World Index ofstocks in developed and emerging markets has declined 4.1% from its May high.In the near term, the upcoming US payroll data will be a crucial catalyst in the degree of further near term downside. We expect disappointingpayroll numbers could send the US market lower. There is speculation the Fed will start a third round of quantitative easing, or ‘QE3’, after USdata in the past week showed manufacturing grew at the weakest pace in two years, spending unexpectedly fell and service industries grew atthe slowest pace since February 2010.However, it is likely that even if a QE3 or some other form of additional stimulatory measure did go ahead, we expect that it will not be forsome time, given that the QE2 program has only just ended and secondly the effectiveness of any further fiscal program in terms of generatingsustainable economic growth and reducing unemployment remains questionable in any case given the lack of change post QE1 and QE2.The Australian Equity MarketFor investors in the local market we do expect further falls in the short term, as there is little doubt that the broader global market volatilitywill have a negative impact on the performance of the Australian market in the immediate term. At the time of writing and the opening of themarket, the S&P/ASX 200 Index is down 3.50% pointing to a challenging close to the end of the week for investors.In the week to date, the S&P/ASX 200 has already lost 3.35% and 9.88% year to date. Importantly, there have been very few sectors orindustries that have been immune to negative returns which makes protecting investment portoflios against near term volatility in the currentenviornment quite difficult.Bond MarketsWhile equity markets declined sharply, bond markets continued in moving higher. Australian bond futures surged after a drop in US stocks lastnight spurred investor demand for the safest assets. Australian three-year bond futures for September delivery climbed 0.36 to 96.22, and 10-year bond contracts jumped 0.26 to 95.53, with the yield now at a multi year low of 4.45%. Global Treasury bond markets have also ralliedextensively in recent periods. While the performance of fixed income markets has been solid, yields are now at levels not seen since 2008, andthe current macro backdrop could support yields remaining at current levels.Nevertheless, the performance of Treasury bond markets in recent periods highlights the benefits of bonds as a ‘safe haven’ investment toequity markets. It also continues to reflect the importance of diversification in managing overall portfolio risk in periods of high marketvolatility and risk aversion.Domestic Economic CommentaryWhilst recent data confirms Australia is currently experiencing a ‘two-speed economy’ with broad consumer confidence, retail sales and homebuilding approvals remaining sluggish, we remain positive on the Australian market in the medium term. Corporate and household balancesheets are in good shape after 3 years of deleveraging. Capital expenditure (capex) at major mining companies is forecast to grow in 2012 withfurther upside potential. BHP and Rio Tinto alone have signalled a combined $155bn expansion in capex over the next five years which willhave beneficial implications across the industrial sector. Unemployment remains relatively low and inflation while moving higher in recentperiods remains broadly in line with RBA longer term estimates.In regard to emerging market economies and the Asian region more broadly, we maintain that the economic growth momentum may slow inthe short term; however the overall growth rate is expected to continue to support higher commodity prices and underpin global growth.China is expected to remain the major driver for economic growth in 2011/12, with a forecast gross domestic product growth rate of 7%.While this number may be lower than in 2009/10, manufacturing and industrial production gauges still point to further expansion over time. Interms of relative investment performance, the recent returns of emerging markets continues to support our views that while these marketsmay be more volatile over shorter time frame; longer term investment opportunities and valuations remain attractive.
We continue to have a positive medium term outlook for Australian equities though we acknowledge that the near term will be a difficultperiod. We favour those companies with strong forecasted EPS growth, operational diversity/scale as well as having low gearing and longduration/well diversified debt maturity profiles, particularly given the spike in credit default swap spreads.Concluding CommentsWe expect that the recent events overnight and the ongoing volatility in financial markets is likely to continue for some time, and thereforemay further constrain investor confidence. Nevertheless, given the extent of market declines, we continue to believe that valuations are likelyto provide opportunities. Accordingly, we continue to favour growth assets over the long term as being critical in delivering positive outcomesfor investors’ in achieving longer term investment goals.Research & StrategyAdvice & Private BanksBT Financial Group5 August 2011This publication has been prepared by Westpac Banking Corporation ABN 33 007 457 141 AFSL 233714 (Westpac) and is current as at 5 August 2011. This document has been prepared for use only by advisers andclients of Magnitude Group Pty Ltd (trading as Magnitude Financial Planning) and Securitor Financial Group Ltd (“authorised users”). BT Financial Group is the wealth management arm of the Westpac group ofcompanies (“Westpac Group”).This publication is not designed for use by investors and is not intended to be, and does not constitute, financial product advice, investment advice or recommendations of any kind.This publication has been prepared without taking account of any person’s objectives, financial situation or needs, and so the reader should consider its appropriateness having regard to these factors before actingon it. Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter nor relied upon as such. Information in this publication thathas been provided by third parties has not been independently verified and Westpac is not in any way responsible for that information. It is not the intention of Westpac or any other member of the Westpac Groupthat this publication be used as the primary source of readers’ information but as an adjunct to their own resources and training. Past performance is not a reliable indicator of future performance. To the maximumextent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up to date or fit for any purpose; and (b) no member of theWestpac Group is in any way liable to any person (including for negligence) in respect of any reliance upon such information or advice (except insofar as any statutory liability cannot be excluded).