RBA rate cuts to lift industrials in 2013


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Transcription of Finance News Network Interview with RBS Morgans Chief Economist and Director of Strategy Michael Knox.

Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me today from RBS Morgans is Chief Economist and Director of Strategy, Michael Knox. Michael, welcome back to Sydney and to FNN.

Michael Knox: It’s wonderful to talk to you again.
Lelde Smits: The Reserve Bank of Australia [RBA] cut rates by 25 basis points at its last board meeting of this year. Do you believe it was an appropriate call?
Michael Knox: Prior to that rate cut we were saying we thought there would be two cuts of 25 basis points between then and next June[2013], although when those cuts were was of course up to the Governor[Glen Stevens]. So he delivered early on the first one and we think there’ll be another rate cut early next year.
Lelde Smits: With Australia’s key cash rate now sitting at 3 per cent, where do you see rates moving over next year?
Michael Knox: That depends very much on where inflation goes. Most of the reason we’ve been able to get these rate cuts is because we are benefiting from the European recession. Paradoxically the European recession is generating manufactured goods which are being imported to Australia and reducing inflation. And that lower than anticipated inflation is generating lower than anticipated interest rates. So it depends very much on international conditions; if Europe remains weak, other areas remain relatively soft and we get that continuing stream of cheap imported goods, then that gives us the environment for further rate cuts but we actually have to live through those inflation numbers quarter by quarter to know when the process will end.
Lelde Smits: So do you believe that equity markets are currently correctly reflecting company fundamentals?
Michael Knox: Not yet. We think that if you look at the US for example, total earnings are just below- Well,companies listed on the S&P500 are just below $100 a share, about $99.80 if you include the estimates for the fourth quarter. And at that level of earnings, the S&P500 should be trading at about 1,650. At the moment it’s trading at about 1,400 so it’s still 250 points too cheap. So there’s still plenty of upside in the US equities market. If you look at the Australian equities market, we hada pretty tough earnings seasonparticularly the second part, in the second half of this year. But even so, fair value of the ASX200 is around about 4,750, and we’re about 300 points below that at the moment so we think there’s upside in the Australian equity market as well.
Lelde Smits: The S&P/ASX 200 index started this year a little above 4,000 and is on track to finish about 4500: Where do you see the S&P/ASX 200 will trading over next year?
Michael Knox: Well we’re starting 2013 with a fair value of 4,750, if we include 2012/2013 earnings- the year we’re part-way through or halfway through - that rises to 5,200. So as those earnings become announced, fair value of the equity market rises, so we think it’ll start with fair value of about 4,750 and that fair value will rise to 5,200 so we think by the end of the year we’ll have a market well over 5,000 points.
Lelde Smits: And Michael, what do you believe will be the main market moving factors to keep an eye out next year?
Michael Knox: Well we’ve observed that the RBA has cut rates to stimulate the other part of the two speed economy- the 90 per cent that isn’t mining, so I think we’re going to have a better year in the industrial sector. I think some of those areas that have been doing it tough to provide the capital and the labour to go into mining investment; I think they’ll get a better time and I think we’ll see a better time particularly in residential construction, I think that will be much better for the economy in 2013 than it has been in 2012.
Lelde Smits: Michael Knox, thank you so much for the insights and forecast today.
Michael Knox: Thank you.