Economic Update April 2017

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

March could have gone either way. We were waiting for: a big rates decision by the US Federal Reserve (“Fed”), Trump’s first bill through Congress on Obamacare; the UK actioning of “Brexit”; and the usual plethora of statistics.

March turned out much better than most expected – particularly for the Australian stock market. Janet Yellen, the Fed chair, must take most of the credit. She played the markets beautifully by talking up – well before the meeting – the number of rate hikes for 2017 and the renewed strength of the economy under Trump.

The market locked in an almost certain March hike. The market had already priced in the hike so that wasn’t taken as a negative signal when she pulled the trigger. And Yellen said at the press conference the hike showed the economy had sufficient strength – but she hosed down notions of more than the three hikes the Fed had flagged after last December’s meeting.

The net result was that markets were very happy because all the recent talk of four or more hikes had gone away. It felt like a rate cut! The United States (US) jobs data were very strong in March and inflation was just under the target rate. A great economic mix!

The Republican Party embarrassed itself by not agreeing on the changes to Obamacare (Affordable Health Care Act). There is a new faction of about 30 Republicans – including the Tea Party members from the Sarah Palin days – that have extreme right-wing views. In short, the so-called ‘Freedom Caucus’ simply disrupted.

Trump handled the defeat well. He just moved on to the next bill which is on tax reform. In some sense that has accelerated the short-term economic plan – and markets liked that too.

Is it not surprising, therefore, that the US recorded its highest consumer confidence reading in 16 years – and it was much, much stronger than the month before. The media are less than kind to Trump but the population obviously loves what he is doing.

China also impressed with a very good manufacturing number, reasonable retail sales, and a target of 6.5% economic growth for 2017. On top of that they recorded the strongest producer price inflation in nine years. That sort of inflation is very good because it measures how much businesses are earning.

The UK has now actioned ‘Article 50’ which means the Brexit must be complete by March 2019. The UK economy jogs along at a brisk pace against the predictions of the many who thought it ‘would mark the end’ for Britain.

Sydney house prices posted another strong quarter making for a very rapid rise since late 2013. However, if we go back a decade further, Sydney house prices were flat or down when compared to the CPI! At one point, the market was down nearly 15% against the CPI from late 2003. The market has just played catch-up.

It is a fact that average house prices usually go through extended periods of stagnation followed by a handful of years of rapid growth. From 2003 to today, Sydney prices have only averaged +2.5% p.a. faster than the CPI. Yes – that makes it harder for people to get into the market. But it is not the stuff of bubbles and property crashes.

In our opinion, the banks are safe from a housing crash so the ASX 200 is safe and the RBA has room to cut rates to help the sagging labour market. So why don’t they? The big banks are starting to raise rates on their own!

One should never rule out markets being side-swiped by some unpredictable event. But conditions seem very stable for the medium term. Market volatility has been unusually low through March.

Asset Classes

Australian Equities

The ASX 200 had a wonderful March gaining around 3.3% on the month including dividends. The ASX easily outperformed Wall Street and London. As such it was playing catch up.

We noted that, towards the end of the month, the ASX had strong days when the lead-in from overseas was weak. The market breached 5,900 for a few minutes on the last day of March. Our January 1 forecast for an end-of-year value of 6,000 is very much on track.

Most sectors performed well in March. The broader index was brought down by Materials, Property and Telcos.

Foreign Equities

Wall Street was flat over March. We take this behaviour as a sign of strength since Wall Street had run so hard since the November 8th election. Strong rallies often end in corrections of 5% or more. So far Wall Street has avoided a correction in this rally.

Indeed, market volatility and the VIX ‘fear’ index have been particularly low in March. We interpret these statistics as pointing to the market simply taking a ‘breather’ rather than marking the end of the ‘Trump rally’.

Bonds and Interest Rates

The market appears to be pricing in one, or possibly two more hikes by the Fed this year. We always doubted the Trump effect bringing actual economic stimulus before 2018 – although we believe it will come. It just takes time to put new policies into action.

The ECB kept rates on hold in March, as did our RBA. That has not stopped some of our banks raising home loan rates for both owner-occupiers and investors alike.

Other Assets

Iron ore prices fell from an unexpected high in February but market commentators are generally confident about prices remaining solid for the rest of the year. Oil prices also slipped but then stabilised.

The Australian dollar was flat over March but moved in a two cents range.

Regional Analysis 

Australia

The unemployment rate jumped up to 5.9% for February but retail sales came in at a respectable +0.4% for the month. We see no government or RBA action on the horizon to improve the situation.

Labor had a resounding victory in the WA elections and the government slipped further in the polls. However, the swings in popularity are not coming from better economic policies to promote growth but negativity about the incumbents’ policies.

China

China really has solidified its position as a strong economy. Some doubted its strategy a year or so ago but pessimists are relatively few and far between these days. It was particularly pleasing that its producer-price inflation was so strong.

Of course there are always political risks when the China economy is being analysed. In particular, it is not clear what Trump will try and enact and recent dealings between China and Australia were slightly destabilising.

U.S.A

The jobs data were again strong with the unemployment rate coming in at 4.7% which some Fed members consider is lower than full employment!

The main risks associated with the USA are related to Trump’s ability to get his bills through Congress. That he has moved across the aisle in an attempt to woo Democrats is essential as long as he cannot rely on his ‘Freedom Caucus’ to vote with the rest of the Republican Party.

That Trump is moving on to tax reform next is important as there is likely to be more agreement across factions on that front. Experts on US TV have put August down as a likely time for putting a tax bill before Congress. However, given the backdrop, the timing of the bill is inherently uncertain.

Europe

The Dutch decided not to vote in a party that favoured leaving the EU. On that same vein, France’s presidential election seems likely to favour the status quo.

Donald Tusk was re-elected as EU Commission president. And the ECB chair, Mario Draghi, has spoken on not needing to loosen monetary policy any further. Indeed, he spoke in terms of one day tightening!

Rest of the World

North Korea continues to be a major worry for us all. Japan wants to up its missile capabilities to counter the North Korea build up.

*Ron Bewley (PhD,FASSA) – Director, Woodhall Investment Research