Downgrade adds to market volatility

In this column last week, I wrote that the Australian reporting season was upon us and it was time to start having a close look at the fundamentals of the companies on the ASX.

This thought was derailed almost as quickly as it went to print as fresh issues inside Europe surfaced, this time focusing on the larger economies of Spain and Italy.

Despite raising the debt ceiling, the issues within the United States are also far from solved as poor economic data has continued to flow, led recently by a slump in manufacturing and lower than expected growth in second quarter GDP.

The US non-farm payroll numbers on Friday night beat expectations but this uptick was quickly squashed when ratings agency Standard and Poor’s downgraded the US’ credit rating from AAA to AA for the first time in history.

The cut of the US credit rating was not unexpected, as commentators had flagged it as a possibility during the debt ceiling debate, but as always the result was not fully priced into the market until it occurred.

The timing is the interesting part, because the markets were already in a spin prior to the downgrade announcement, so this event simply added to the volatility that has seen the Australian market down 19 per cent since the highs in April.

It is now obvious that both European and US governments and central banks are running out of bullets in their stimulus guns.

The European Central Bank fired another shot over the weekend by announcing it was buying Italian and Spanish bonds in an attempt to prevent these larger economies from following Greece into a destructive debt cycle.

One can only speculate from here, but it wouldn’t be too surprising if both Europe and the US seriously considered another round of stimulus (that is, printing money) in the wake of the events of the last week.

Back on the local market, reporting season has begun with Rio Tinto posting a record first-half profit, up 35 per cent to $US7.8 billion for the six months ending June.

Despite being a record, the profit missed analysts’ expectations of US$8 billion and Rio Tinto has since fallen over $11 from its pre-report close of $80.05.

Still, there was a lot to like about the Rio Tinto report.

The company is continuing to ride high on record iron ore prices (iron ore earnings accounted for 78 per cent of the company’s profit) and it sweetened the deal for shareholders by announcing a $2 billion increase to the current $5 billion share buyback program.

As expected, Rio did show some signs of the cost pressures that were sweeping over the industry.

However, like major international rivals Anglo-American and Xstrata, the high commodity prices were masking the true effect on the bottom line at this point in time.

Rio Tinto also boosted its interim dividend to US54 cents per share, from US45c a year earlier.

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