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Economic Update – July 2019

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe. Central banks go soft on monetary policy:

  1. Australia cuts its benchmark rate
  2. US Fed holds off on a cut but flags a couple are on the way
  3. The US consumer still displaying confidence!

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

After nearly three years of keeping interest rates on hold, the Reserve Bank of Australia (RBA) cut its benchmark Cash rate from 1.5% to 1.25% on June 4th, and again on July 2nd. These cuts were widely anticipated as the easing cycle had been flagged in various speeches by senior RBA personnel. The big question is, of course, what next? For long term investors, there is no need to be overly concerned by every cash rate adjustment by the RBA.

We just need to know that monetary policy is managed responsibly – and that the government is acting on the promised tax breaks. Our unemployment rate again came in at 5.2% p.a. and the first NAB business surveys of business confidence taken after the election were mildly positive. The US Federal Reserve (Fed) did not cut rates, as was widely expected, but it did remove the word ‘patient’ with respect to its policy stance from its press release. US Official rates look set to be on the move back down after last being increased in December 2018. In the previous meeting of the US Federal Open Markets Committee (FOMC) held in March 2019, 11 committee members predicted rates to be on hold for 2019 with four members predicting one hike and another four predicting two hikes in the remainder of 2019. This time around one member even voted for a cut on the day and eight predicted cuts during 2019. The market is predicting a good chance of more than two cuts this year.

We feel that outcome is unlikely because there are no clear signs of problems. The proposed cuts are seen as being more pre-emptive than reactive. The European Central Bank (ECB) and the Bank of England have also kept official rates on hold but the Reserve Bank of India (RBI) made its third cut in rates in 2019. However, the RBI interest rate stands at 5.75%! Central banks around the world are moving to an accommodative stance which is one half of the equation. The G-20 meeting held at the end of June in Osaka canvassed the need for some coordinated fiscal response – the other half required – to complete the economic management picture. The G-20 was set up just after the onset of the GFC to coordinate global economic management. In recent times, the G-20 has been behaving more like a G-2 with 18 spectators. The main focus of all is on the US-China trade negotiations. US President Trump and Chinese Premier Xi, in a lunch immediately after the G-20, agreed to resume negotiations and no new tariffs are planned. Trump was quoted as saying, “We are back on track”. The US economic data released in June were a bit mixed. On the positive side, retail sales grew by +0.5% for May and the April figure – initially reported as 0.2% – was revised upwards to +0.3%. The US new jobs data for May came in well below the expectations of 180,000 at 75,000. Those numbers do get revised and also jump around so that alone does not worry us necessarily. On top of that, the unemployment rate remained at a very low 3.6% and the wage growth rate was a creditable 3.1%. Since Trump has begun his re-election campaign there are bound to be flurries of negativity from his opponents. We focus on the facts – and facts in context.

There are no reasonable grounds to state that US economic data are pointing to a major slowdown. Of course, times can change so we will continue to monitor any material economic data output. Data points from China were also a bit mixed. Retail sales data impressed to the upside but its industrial output figure missed expectations. A very good financial year for share markets has just ended and the next is set to start smoothly.

Asset Classes Australian Equities

The ASX 200 posted its sixth successive monthly gain for 2019 in June. The capital gain was +3.5% for June and +6.8% for the financial year (FY19). Materials was the standout sector in June with a gain of +6.3%. The Consumer Discretionary sector was the only one that went backwards in June.

We have the broader index moderately over-priced and that brings down our forecast for gains in FY20 to about the historical average. Fundamental earnings remain resilient and supportive of prices generally. Given that the RBA has indicated its easing cycle – and the government is on the case with proposed tax breaks to enact, any poor economic data in the coming months is less likely to have a big negative impact on our market. Indeed, the shifts in monetary policy of central banks around the world is likely to continue to be supportive of stock markets.

Foreign Equities

The Dow Jones index experienced its best June gain since 1938. However, that did follow a poor result in May that we did not share in Australia. Although different countries have different end points for their financial years, we can impute that the ASX 200 and the S&P 500 behaved similarly over our FY19 and well ahead of the UK, Germany and Japan. Emerging Markets went backwards over FY19.

Bonds and Interest Rates

The change in emphasis in monetary policy around the world is putting further downward pressure on bond yields. The cuts in the official cash rate by the RBA is not good news for those investing in term deposits. The 90-day bill rate is only 1.21% and the 10-year bond yield is now at 1.35%. Both are below current levels of inflation meaning that the so-called real (inflation adjusted) interest rates are negative in Australia. On the other hand, the expected yield on the ASX 200 over the next 12 months is 4.4% excluding franking credits. The search for yield will likely underpin our share market. The Fed could possibly cut its reference (official) interest rate at the end of July with another cut to come later in the year. Some market participants are factoring in three and four cuts in rapid succession. We think the US Fed will act more conservatively i.e. not cut interest rates so quickly to avoid the need to reverse its easing monetary policy stance if the US economy happens to prove more resilient than expected during the remainder of 2019. While some continue to talk of recession in the US, the fact that 2020 is an election year there is the prospect that President Trump could deploy additional spending. This could be a further reason the US Fed may be less inclined to embark on an aggressive rate cutting program without clear evidence of fundamental weakness in the US economy.

Other Assets

June was a very strong month for iron ore as prices responded to supply shortages. Gold and Oil prices rallied during the month spurred on by rising political tension in the Middle East as the US and Iran engage in tit for tat engagement in relation to Iran talk of re-starting its nuclear program and attacks on oil tankers in the Persian Gulf.

Regional Review Australia

There was some fear that our economy will continue to slow based on the last reported GDP growth being the lowest since the onset of the GFC. However, the Australian jobs report for May was positive. The unemployment rate stayed at 5.2% and the creation of 42,300 new jobs were reported.

Also, on the bright side, the two NAB business confidence surveys – collected after the election – were mildly encouraging. Given that the government is going to try hard to launch some fiscal stimulus, in terms of tax cuts and rebates, our economic future seems to have been somewhat stabilised in the near term. The next quarter’s economic growth figure ended on June 30th so when June quarter growth is reported (on September 4th), it will be from the ‘old regime’. We remain hopeful that there will be some promising signs reported towards the end of this year in response to monetary and fiscal stimuli. Although a second rate cut from the RBA is most likely, we expect a pause before the next one is implemented to avert the appearance of the RBA panicking. China China’s retail sales came in at 8.6% (against an expected 7.1%) for the year but that number should be read in conjunction with the softer 5.0% industrial output reading that missed expectations by 0.5% points. After half a year of the new tariffs imposed by the US, the Chinese economy is holding up much better than many expected. Infrastructure spending over the coming period (on the belt and road initiative) is expected to help support economic growth in China.

US

The last US jobs report was mixed but that was not of a material concern for the moment. The key figures of the unemployment rate and wages growth were more positive. However, we will soon have the next jobs number and that might well overshadow the unexpectedly low number reported at the beginning of June. It was the retail sales data that really impressed – because so much gloom surrounded the reading released in May. That 0.2% April growth was revised upwards to +0.3% and the new May growth was reported at a solid +0.5% for the month – or +3.2% for the year.

Europe

 The ECB announced it was extending its low interest rate policy for longer and also it is revisiting its bond buying programme. After ending the so-called Quantitative Easing (QE) policy in December 2018 it is considering reinstituting that policy, clearly a sign that growth in the region remains anaemic. The German auto industry is suffering from Trump’s tariffs and it is not anticipated that growth will be returning in the near to medium term. In summary it appears the EU is in economic limbo. When the new UK prime minister is selected, it seems that he will move to exit Europe by October 31st even if no deal is done. That may cause some volatility in markets but in reality it should have limited impact on Australia and its major trading partners.

Economic Update – June 2019

Too much talk of recessions!

  • Does anyone have a strong track record in predicting recessions?
  • US and China ready to act
  • Australia likely to cut rate and give a fiscal boost

The Big Picture

Most of the market volatility in recent times has been due to fears of an impending recession – in the US, in Australia, in Europe. Let’s put this nervousness in context.

Paul Samuelson, the 1970 winner of the Nobel Prize in Economics, once quipped that the stock market predicted 11 of the last five recessions!

Two and a half years ago – when Trump was about to start his first term as President – Bloomberg reported that “a pack of Nobel Laureates” gave Trump’s economic policy the “thumbs down” and one even predicted a severe recession as a result. The US has had two and a half years of very strong growth and the unemployment rate has dipped to 50 years lows.

But, perhaps, the best comment on recessions was made by an anchor on CNBC last week. He likened recession calling to badger watching in England. To paraphrase, “Badgers are rarely seen in the English countryside (they are nocturnal and live in very long inter-twined underground burrows). But we know they exist because, from time to time, we see one on the side of the road after having collided with a car.” 

In short, recessions are almost impossible to predict by any economist but we know they exist and one will occasionally happen with almost no warning!
Some headline-seeking commentators are suggesting the fact that a short-term interest rate (say 90-day rate) is greater than a long rate (say the 10 year) is symptomatic of an impending recession. 

In the past, central banks have sometimes forced the short-term rate higher (above the long rate) to slow down a booming economy and have gone too hard. This time the short rate has not been pumped up but the long rate has fallen on inflation expectations. There is no reasonable evidence that this phenomenon precedes recessions! Of course, we acknowledge the past possible impact of over-zealous central banks.

If Trump forces tariffs too high with China, he could cause a recession. But Trump cannot afford the US economy to stop booming before the November 2020 presidential elections. From past experience we know that China will not stand by and let its economy stumble. Both will do something – and it does not matter what – to prevent a recession or even a significant economic slow-down.

Before our Federal election, our Reserve Bank (RBA) looked reticent to cut rates and we were facing the prospect of higher capital gains tax; restrictions on negative gearing; and restrictions on franking credits. Whatever one’s shade of politics, we now face none of these four factors. The RBA has stated (with almost certainty) that it will cut rates on June 4th (and probably again a few months later) and the three tax policies are not shared by those in government.

Markets had priced in those four factors and must now unwind those expectations. Our labour market and economic growth were fine (but not great) and, on top of that, there are now to be tax rebates of more than a thousand dollars in July/August for a whole swathe of tax payers. Even if our economy wobbles for a couple of months, it looks set to bounce back in the second half of the year.

Analysing monthly data on our stock market since 1893, we note there has only been one instance (in around 1,500 months) when the market fell more than 15% in one month (the ’87 crash) and the prior month in that case fell nearly 15% as a warning. Importantly, the market then had more than doubled in just more than one year before the crash! In less than 1% of cases did the market fall more than 10% in one month.

Our thesis is simple. If we sell too early, we could miss out on big gains. And if we had sold before the peak, what would then induce us to buy back in while the market continued to climb? We would have been waiting at least 30 years after the last recession in Australia (while the US had three) from 1990 to the next! We believe it is better not to try and predict the top but to wait for it to become self-evident. The potentially small loss from a (then) previous high is likely to be small compared to the gains from the previous big lows or premature sale date!

Recessions and deceased badgers alike will, unfortunately, come and go. Investing needs strong, thorough analysis, a proven philosophy and prudent application. 

Asset Classes
Australian Equities

While most major markets around the world finished May firmly in the red, the ASX 200 kept its head above water. The 5.9% surge in Financials stocks on the day after the election results of obviously helped but Materials, Health and Telcos also put in better returns than Financials over the month.
Since we have the ASX 200 only modestly overpriced with strong earnings growth prospects, we see these factors as being supportive of the share market over the second half of the year.

Foreign Equities

The May sell-off on foreign stock exchanges comes after four very strong months of gains in most cases. We now have Wall Street rated as fairly valued with positive prospects for earnings growth with the potential for further gains should concerns over the tariff war subsides.

Bonds and Interest Rates

The CME Fedwatch tool for pricing possible rate changes by the US Fed this year continues to be volatile in its predictions. The latest data identifies one cut this year as the most likely scenario followed by two cuts and then no cuts. Even three cuts have a 10% chance!

The Fed pretends to be standing firm but the market does not agree.

With the drop in 10-year bond yields, the short-term interest rates are above those at the longer end. While this behaviour has concerned some recession watchers, we do not agree with their analysis. 

With the Fed Funds interest rate range at 2.25% to 2.5%, we cannot agree that there is currently tight monetary policy – the phenomenon which arguably caused some previous recessions when short term rates were higher than longer term rates (an inverted yield curve).

The RBA has stated that it is all but certain to cut its benchmark cash rate on June 4th. Another is then likely in the second half of the year. That means our benchmark cash rate may well end the year at only 1% (and possibly below that next year).With bond rates so low, growth assets such as equities, property and infrastructure are offering comparatively attractive yields. 

Other Assets

Iron ore prices shot through the roof after the Brazilian mine crisis. Oil prices have been a little volatile due to the Iran sanctions but the prices of both major commodities remain firm. 

Regional Analysis
Australia

The federal election gave a surprise, slender majority to the incumbent coalition parties. Many speculate on the reasons for the upset but, for investors, the result means no increased capital gains tax, loss of franking credit refunds or removal of negative gearing. In addition, they will also implement tax rebates of approximately $1000 to a large group of middle-income earners.

While the government will not also have a majority in the senate, it will likely have fewer cross benchers to woo to get its policies through. We look forward with anticipation to a stable government for coming three years.

On the employment front the labour force data were not strong. The unemployment rate rose to 5.2%, up from 5.1% the month before and from 4.9% the month before that. With imminent rate cuts from the RBA and a lowering of borrowing requirements for home loans from the regulator, any dip in economic fortunes should be quite short lived.

Wages grew by 2.3% over the year and the minimum wage rate was just increased by 3% to $740 per week. Price inflation is below 2%.
Just prior to the election we lost one of our truly great leaders in Bob Hawke, aged 89. Along with Paul Keating, he internationalised our economy to make it the great one we all enjoy today. Vale Mr Hawke.

China 

Unusually all of the main Chinese data released in May missed expectations. However, based on past experience, we expect its government to be working at stimulus programmes that will avert any meaningful slowdown.

Owing to the nature of a one-party government. Its policies can afford to be long term with less interest in shorter-term wobbles.

President Xi has dug in his heels over certain aspects of its alleged violations of Intellectual Property law. He will meet US president Trump at the end of June in the Tokyo G-20 summit but we are no longer hopeful of a quick resolution to ongoing trade tension between the world’s two largest economies. On the other hand, President Trump cannot afford a global or US slowdown so some sort of deal must be cobbled together this year.

US

The US increased tariffs on many imported goods from 10% to 25% as they had foreshadowed. However, President Trump made a last-minute decision to hold off on the auto tariffs’ increases for six months as they would really have hurt Japan and Europe.

The unemployment rate came in at the lowest since December 1969. At just 3.6%, anyone predicting a recession anytime soon must have a very different crystal ball! US wages were up 3.2% which is well above its price inflation rate. There is fat in the economy to shed long before any real problems can emerge.

President Trump needs a strong economy going into the November 2020 elections. Four years of strong growth – against popular opinion in 2016 – will promote his chances of a second term in office. Since a sitting president cannot be tried in the federal courts, Trump has an extra incentive to win next year!

Europe

At last, UK prime minister Theresa May has fallen on her sword. She was gifted the unenviable task of negotiating Brexit. In the recent European Union elections Nigel Farage, one of the architects of the Brexit movement and now leader of the Brexit party, polled very strongly in the UK indicating gaining substantial grass roots support from UK voters. 

Indeed, in the rest of the European elections there was a significant move to parties leaning towards breaking up the union. A so-called hard-Brexit (meaning the UK leaving without a deal on October 31st) is now more probably given the results of the EU elections.

UK economic growth was the best since 2017 at 0.5% for the quarter. After Trump visits in the first week of June to meet with departing Prime Minister May and the Queen, Theresa May will leave office on June 7th.

Rest of the World

The Ukrainian comedian who swept into office a few weeks ago has already called a snap election to get out quick and return to his TV career.
India posted an impressive rate of inflation at 2.9% while its prime minister, Narenda Modi, was re-elected in a landslide.

Economic Update – May 2019

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe. 

Markets hit record highs

– US strong economic data
– China data impress
– Australian jobs hold up

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 our team.

The Big Picture

In March, Wall Street’s S&P 500 reached all-time highs and our ASX 200 reached an 11-year high. To keep these results in perspective, both indexes are only just ahead of the 2018 September highs. 

The US reported some positive economic data in March. In particular, economic growth came in at 3.2% when trend growth is only about 2%. The market was only expecting 2.3%. Given the longest government shutdown occurred during this quarter one (Q1) – and the weather was quite bad – this result is one in the face for the recession merchants! 

In mid last year a significant number of commentators were calling for a recession starting with negative growth in Q1. In spite of the ‘unexpected’ economic strength, the Fed’s preferred inflation measure – the so-called core PCE – came in at 1.6% which is comfortably below the Fed’s target of 2%.

The US jobs data were also stronger than expected with 196,000 new jobs created in March and the unemployment rate is at 3.8%. Wage growth was a creditable 3.2% which is well above price inflation. If that wasn’t enough, US retail sales came in at a big 1.6%.

China too beat market forecasts for economic growth. GDP came in at 6.4% and retail sales, industrial output and fixed asset investment also beat expectations. Exports came in at +14.2% growth over the year.

With the US and China firing on all cylinders, global growth is not under threat – even if Europe isn’t doing well.

At home, the Reserve Bank of Australia (RBA) signalled that it will cut rates if the unemployment rate starts to trend upwards. The latest rate was 5.0% and it has been steady for some months.

A fair haul of new jobs were created in March; 25,700 in total and full-time jobs were at +48,300 swamping the part-time loss of  22,600.

So why are we all now worried about the Australian economy? The official data do not distinguish between food-delivery cyclists (and the like) seemingly growing exponentially and traditional jobs – and this switch also has an impact for average wage growth.

Moreover, our strong immigration numbers inflate job gains and economic growth. When per capita data are analysed our situation is more problematic.
The recent Federal Budget – if it all gets passed in parliament – is mildly stimulatory – and two RBA cuts if implemented, will provide a back-up monetary policy easing. Both parties are offering reasonably stimulatory policies going into the May 18th election.

In short, at last our economy may be getting the policy support it needs. That support can help our stock market especially as resources demand is supported by a strong China. There is also every chance of a compromise trade deal between China and the US being nutted out in May and presented in early June.

But the recent CPI data at home caused a stark reminder of what might happen if economic policies do not get through parliament and the RBA sits on its hands. Our latest inflation read was actually zero! When highly variable components are extracted to get the RBA-preferred number, inflation jumps only to 0.3% for the quarter, or 1.6% for the year. That growth is well below the 2% to 3% target of the RBA.

But, on a lighter note, maybe we should follow the Ukraine in voting in a TV comedian as the new president with a landslide victory. We doubt if anyone thinks he can do well but it is confirmation that people right across the globe are fed up with the current style of politics on all sides in all countries.

Asset Classes
Australian Equities

The ASX 200 posted a fourth straight month (+2.3%) of positive gains in April making a gain of +12.0% over 2019 to date. There was great disparity among the gains across sectors. Consumer Staples (+7.3%) and IT (+7.3%) were the very big winners with Materials ( 2.1%), Property ( 2.6%) and Utilities ( 0.5%) going backwards.

By our own measurements, we see the end-of-year forecast for this market to be stronger than we did at the beginning of the year. We have the market only mildly overpriced and so that does not seem to be a headwind for markets. 

While there maybe heightened market volatility around the May 18th election, if so we expect this to be a short term event.

Foreign Equities

Many have suggested there would be an ‘earnings recession’ in the US – a recently thought-up concept to suggest two negative quarters of earnings growth. The current Q1 earnings are well below the bumper Q4 results but Q1 earnings growth is strongly positive which no doubt played a large part in propelling the market to new highs.

In spite of global doubts by some and the strong run-up in markets since the start of the year, there have been some amazing gains on international markets. The S&P 500 posted +3.9% for April but Japan’s Nikkei came in at 5.0% and the German Dax at +7.1%! 

Bonds and Interest Rates

The CME Fedwatch tool for pricing possible rate changes by the Fed this year keeps changing on the slightest news. There is little or no credence being given to a rate hike this year and the probability of no change is varying between 30% and 40%. The real movements are in the possible number of rate cuts this year. The latest strong GDP data brought one cut to be a little more dominant than in recent times. Indeed, one cut currently has a much higher probability than no changes this year.

At home there is a 50% chance being priced in for a cut in May by the RBA. Given the proximity of the Federal election, May seems unlikely to us as that might be used to signal an unwelcome comment on past economic management. But two cuts this year seems almost a certainty. 

Other Assets

Oil prices were the biggest movers of the major commodities. They were up over 5% in April. Part of this move is due to Trump’s sanctions on Iran but Trump has also encouraged the Saudis to play their part in stabilising prices.

Regional Review
Australia

The general election is rapidly approaching and both sides are offering the usual sweeteners to voters. Either way, there is likely to be some stimulus coming our way soon. However, as with previous elections, there is unlikely to be a majority for one party in both houses so deal making will have to happen to get the bills through.

With inflation remaining well below the target range there is every chance of rate cuts that might help stabilise the housing markets.

Jobs data remains quite strong but we believe the basic statistics mask some of the changes that are going on within this – and other – economies. Technology improvements and home delivery services are changing the balances. It is difficult to assess what the real situation is. The weak wages growth supports the notion that all is not well in the labour market. Nevertheless, the latest monthly data shows that 48,300 new full-time jobs were created in March.

China

The latest economic growth data did not disappoint the People’s Republic forecasts made in the previous month. A 6.4% outcome for Q1 against an expectation of 6.3% supports the notion that China’s stimulus policies are working.

All of the other major partial economic indicators beat expectations – except for the latest manufacturing index that came in at 50.1 when 50.5 had been expected. Nevertheless, 50.1 is above the 50 level that divides expected growth from expected contraction.

US

A bumper economic growth figure of 3.2% boosted Trump’s economic management message. The negative commentators whose expectations have not come to fruition are now looking for reasons why the next number will be lower. The Boeing crisis is now being estimated to take 0.1% to 0.4% off Q2 growth.
With trend economic growth at about 2% there is a lot of wiggle room before published data suggest a real slowdown.

It is hard to watch any of the overseas business TV channels without being inundated with claims and policies from a long list of would-be Democratic nominees for the 2020 election.  

The problem when so many candidates are in the running is that policies have to become wilder and wilder to get the attention of the media. Hopefully, candidates will start to drop off soon due to lack of funding so that a sensible debate about how the US should be run can emerge.

Europe

The Brexit deadline seems to have been moved back to Halloween (with a hurdle or two before) so that Brexit is less of a distraction for markets.
In further moves to political instability around the globe, Spain just voted back in a socialist government but ‘with a far-right breakthrough’.

Economic conditions in Germany are far from great and the car industry is suffering from US trade policy.

Rest of the World

It is difficult to ‘top’ the report that the Ukraine voted in a comedian to be its president (he actually plays the part of a comedian who becomes president in his new series). But, after the recent failure of the Trump-Kim nuclear talks, it is interesting to see Putin and Kim are getting their knees together under the table.

Economic Update – April 2019

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

Markets remaining bullish!
Global recession fears not abating
US Fed on hold for 2019

RBA acknowledges rates may go down in Australia

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 us/

The Big Picture

After two very strong months on global stock markets, which completed the recovery from the correction in the December quarter of 2018, markets were flat to positive in March. That behaviour was inevitable but the narrative surrounding the end of the recovery was somewhat of an over-reaction, in our opinion.

The US Federal Reserve (Fed) last raised cash rates in December 2018 and then forecast two more hikes for 2019. At the March 2019 meeting, the Fed signalled no more hikes in 2019 and the markets started pricing in the possibility of cuts. There was heightened talk about a global slow-down causing this change in stance.

Possibly precipitated by the Fed policy, ‘the US yield curve became inverted’ on March 23rd. Usually, the short-term interest rate – such as the 90-day-bill rate – is below the rate at the long end – say the 10- year bond rate. When the short rate is above the long rate, the so-called yield curve is said to be inverted.

Inverted yield curves are rare and are often associated with an impending recession. The last time the US yield curve was inverted was in mid- 2006 before the GFC but we think the 2019 version is different.

An inverted yield curve is usually caused by the central bank jacking up its short-term rate while the interest rates on longer term instruments such as Government bonds moves less because they are tied to inflation expectations. That’s what happened in 2006 but not in 2019.

The current US cash rate is about half of what it was in 2006. This time, it was the interest rate on longer term instruments which fell on the news that the Fed had stopped increasing the cash rate as inflation was not, in their view, a current issue!

No one is suggesting that there is a causal link between yield curve inversion and recession. Rather, both are usually caused by common factors. At the end of March, the final estimate for US economic growth in 2018 came in at 2.9% which is comfortably above even moderate levels.

At home, our central bank, the RBA, kept the official cash rate on hold. But the economic growth figure for the December quarter of 2018 (Q4) came in at only +0.2% only days after the RBA interest rate announcement. The RBA’s expectation was for +0.6% for Q4 and 3.0% for 2019. The market too predicted +0.6% for Q4 a few days before the data release but cut that forecast to +0.3% the day before. RBA Governor, Philip Lowe, stated that “it’s hard to see a case for a rate hike this year”.

The situation was not helped when the US jobs data was particularly soft. Only 20,000 new jobs were reported in the month of February but that month’s employment was affected by the partial government shutdown caused by Congress’ failure to agree on spending. The jobs’ report was delayed in its release because the data collection agency was also affected by the shutdown. This data announcement might well be revised upwards. The new reported unemployment rate was down to 3.8% from 4.0% and wages growth came in at 4.3% which is the highest since the GFC. Consequently, we are not in the naysayer’s camp as these economic data announcements are continuing to confirm robust growth in the US.

Naturally China played a big role in shaping the broader views of economic prospects. The official China growth forecast for 2019 is in the range of 6.0% p.a. to 6.5% p.a., a fraction down on the 2018 outcome. But in an attempt to stimulate the economy Chinese authorities have cut the (GST-equivalent) value added tax (VAT) rate to 13% from 16%.

The China-US trade talks resumed at the end of March. There appears to be widespread hope of some sort of resolution to the impasse – but just not yet.

The Brexit negotiations are now outdoing even the best of the Monty Python sketches. The UK PM took the same bill back to the UK parliament for a third vote after it had failed twice. She had offered to stand aside if that last vote had been successful and stay if it failed!

We still think the fundamentals of the ASX 200 and Wall Street are strong but all eyes will be on the latter’s Q1 reporting season that starts in a couple of weeks.

Asset Classes

Australian Equities

The ASX 200 climbed +0.2% in March after two great months (+3.9% in Jan. and +5.2% in Feb.). While the more defensive listed property sector lead the ASX 200 in March rising +6%, the index was negatively impacted by Energy (-4.7%) and Financials (-2.8%).

We assess the local market as being about fairly-priced at the moment. With the next reporting season four months away, the market will be more reliant on the macro and political picture than company news at least in the interim.

The Australian Federal Budget, due on April 2nd, could well provide some fiscal stimulus that will help both the economy and the market. With the Federal election looming (forecasts are for May 11 or May 18), the government may well wish to announce some electoral sweeteners to kick off the full election campaign.

Foreign Equities

The S&P 500 posted a gain of +1.8% in March making it three strong months in a row – and the best opening quarter since 1998! We have that market fairly to fully priced but their next (quarterly) reporting season is only two weeks away and will provide more insight on longer term valuation.

With some investors and commentators focusing on a possible recession in the US, the company outlook statements will be key to the medium-term future of US shares.

In spite of the failing Brexit negotiations, UK equities posted a strong March (+2.9%) but the German DAX struggled with a +0.1% gain on a slowing economy.

Bonds and Interest Rates

The Chicago Mercantile Exchange (CME) Fedwatch tool for pricing possible rate changes in the US is now set at about 34% probability for no change in the US cash rate in 2019 and 41% chance for one cut in the cash rate, 20% for two cuts and 5% for three cuts! There is even a slight chance (0.6%) given to their being four cuts in the rest of this year! This distribution represents a significant change to the down side in expectations for US cash rates from expectations in February.

In Australia, the RBA official cash interest rate was ‘on hold’ at 1.5% in March but we think the RBA could cut the rate a couple of times in 2019. With the Budget in April and the election in May, it may have to wait until June for its first opportunity to make the first cut. If this were to occur, we expect the second in rapid succession.

In Europe the European Central Bank (ECB) has further delayed its plan for a rate rise. The softness in the key German economy being a contributing factor.

Other Assets

The price changes for the major commodities were quite mixed: oil was up 3% while copper was down by a similar amount. Iron ore was flat and gold was down nearly 2%.

Regional Review

Australia

The jobs report in March revealed a modest jobs’ gain of +4,600 but there were +20,600 new jobs in the ‘official trend data’. The unemployment rate did fall from 5.0% to 4.9% but the trend rate was flat at 5.0%.

The Q4 GDP reading came in at +0.2% making economic growth for a second half of the year at a modest +1.0%. However, a strong start to 2018 produced an acceptable +2.3% for the year. In 2019 it could be a different story if the moderating trend continues.

The Westpac’s consumer sentiment measure dropped sharply below the 100 level to 98.8 from 103.8.

If the RBA does cut the official cash rate twice this year and the April Budget produces a reasonable fiscal boost, the risk of a recession in Australia this year at least is substantially mitigated. However, if both monetary and fiscal policy fail to address the current moderating economic situation then our economic prospects will be more subdued.

China

The People’s Congress published an economic growth forecast range of 6% to 6.5% for 2019. The Congress usually gets what it wants!

It is planning to promote growth through a cut in indirect taxes and an increase to infrastructure spending. China’s trade data were again out of line with expectations but this variance is quite likely due to both new and possible tariffs and the ongoing trade negotiations with the US.

China’s increase in soybeans and auto imports from the US helped produce the biggest cut in the US trade deficit for 10 months hence it appears some changes in trading patterns are underway. The trade talks with the US resumed at the end of March.

The manufacturing PMI (Purchasing Manager’s Index – a measure of confidence and demand of companies) jumped 1.3 pts to 50.5 after three months operating below the 50 mark. A reading below 50 indicates a contraction a reading above 50 indicates expansion.

US

Delayed US growth data produced a first revision for the previous Q4 (December 2018) release to 2.6% at the start of March but this was brought back to 2.2% for the final Q4 read at the end of March. The figure for 2018 as a whole was 2.9%, just below President Trump’s forecast of 3%. The US Federal Reserve chair, Jerome Powell, now predicts 2.1% for 2019 from his December forecast for 2019 of 2.3%.

US core inflation was +0.1% for the month and 2.1% for the year – just on the Fed’s target. The broader inflation reading that does not exclude highly variable components came in at +0.2% for the month and +1.5% for the year. US inflation is currently not an issue and the Fed has stated that it would even be happy if inflation did come in a little higher before it felt the need to hike rates.

The Mueller report concluded that US President Trump did nothing illegal in the widely-discussed Russian attempt to influence the US 2016 election outcome. Trump cannot be impeached on that but the Democrats are still looking for angles to discredit the president.

US retail sales came in at 2.3% for the year. All in all – when data glitches are accounted for – the US economy is not heading for recession in 2019 – in our opinion!

Europe

Unlike in the US, European growth is slowing and it needs some stimulus – as does Australia – to avoid a bleaker future. Some of the growth problems emanate from Trump’s tariffs on German cars. It is not just China that is in the cross-hairs of US trade policy.

The Brexit saga should have ended by now. It was all due to be resolved by last Friday, March 29th but a short extension to April 12th was granted. The UK Prime Minister, Theresa May, continues to try to get a resolution but it is appearing to be bordering on the impossible. A number of choices were put before parliament but all were rejected!

A major stumbling block is the treatment of the Eire – Northern Ireland border as the southern Irish Republic will stay in the EU. Moreover, UK Prime Minister May’s government relies on the support of the Northern Ireland conservatives in her coalition majority. After decades (and centuries) of disharmony that was resolved at the Good Friday (1998) Agreement no one wants to return to the bad old days of disunity in Ireland.

Rest of the World

Turkey continues to be embroiled in economic and political crises. In the last week of March, the swap rate for the lira (an interest rate for borrowing the currency overnight) touched 1,000%. At least our economic problems are manageable!

Economic Update – March 2019

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe. 

Markets keep on roaring!

  • Trump makes progress on several fronts
  • RBA changes its monetary policy stance
  • China delays coal imports

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 us.

The Big Picture

For the second straight month, major stock markets around the world made impressive gains. While some express the opinion that this rate of growth is unsustainable, we are of the opinion that nearly all of these recent gains just take us back to September – before the US Federal Reserve (the “Fed”) chair made comments that sent markets into a tailspin. 

Since we have markets once again about fairly priced, we believe that the ASX 200 and the S&P 500 can continue to grow from here – but at a more modest pace – as if the October-February period had never happened. 

Of course, Trump’s dealings over trade with China, his “Wall”, and the US government shutdown contributed in part to market volatility. The shutdown is now behind us as Trump compromised on the level of funding – only to lodge an emergency order for the rest. 

While there are social issues concerning the Wall, there should be no major economic impact for Australian investors from here over its possible construction or funding.

China has agreed with making some changes on trade with the US. Trump removed the March 1 scheduled uplift in tariffs from 10% to 25%. A meeting between Trump and Xi in Florida is mooted for late March.

It is unlikely that Trump will get all he wants anytime soon but a start will be seen as a win for both sides. There have been issues with intellectual property (IP) and IT for decades so that won’t get sorted quickly. China has agreed to certain policy moves on its currency and increases in agricultural imports from the US.

The US jobs data were again particularly strong but some other data were weaker. There are major statistical issues in trying to interpret a vast array of data on a monthly basis. For example, Retail Sales for December were a major miss on expectations. But the massive retailer, Walmart, blitzed the market with its latest quarterly report released in the same month. Go figure!

The Fed has been very careful in managing expectations in recent times. It has even downplayed its moves on reducing debt levels. It seems unlikely that investors have anything to fear from the Fed in 2019.

The RBA kept rates on hold in Australia but, importantly, acknowledged that the next move in rates is as likely down as up. For two years it has been arguing that “the only way is up”.

We have argued over this same period that cuts would be beneficial and now we think we at last should get two this year – and the first one pretty soon (now that the RBA has softened us up!).

The Royal Commission into Financial Services largely left the banking structure intact. Mortgage brokers and some insurance businesses were, however, affected.
Our jobs report was also quite strong – more than 65,000 new full-time jobs were created in January. The real problems are not yet self-evident. We believe that future growth in Australia will be limited by the running down of household savings. Our savings ratio is close to pre-GFC lows and so we must pull in the purse strings.

In Europe, the UK is taking a line which might result in a delay to Brexit or, indeed, a second referendum in an attempt to forget the whole exit process. Both the Bank of England and the EU have downgraded their economic growth forecasts for 2019 but both are still comfortably above 1% pa.

We conclude that the political and economic backdrops are more conducive to market growth than they have been for many months.

Asset Classes
Australian Equities

The ASX 200 put in a strong month in January at +3.9% and backed that up with a +5.2% in February. Given that the long-run average capital gains in this market are about 5% pa, these numbers are big. But when the index falls in the fourth quarter of 2018 are taken into account, we are just back to around September levels.
The bank stocks did particularly well after the Royal Commission ended without any major impost on the banking structure.

The defensive Consumer Staples sector ( 2.3%) was the only one from 11 of the key industrial sectors to go backwards in February. The market is looking for risk and growth again! The 2018/19 y-t-d is well back in the black (+2.6%) when dividends are included.

Foreign Equities

All the major indexes put in a strong February and the ASX 200 was at the head of the pack – possibly because of the bounce in banks after the end of the Royal Commission.

Despite the massive gains on the S&P 500 since Christmas Eve, we have that market currently about fairly priced. 

Bonds and Interest Rates

The CME Fedwatch tool for pricing possible rate changes in the US is now set at about 6% for a cut in 2019, 4% for a hike and 90% on hold. Sentiment can and does move quickly.

The RBA was on hold in February but we think it is likely to cut a couple of times in 2019 after Governor Lowe’s statements flagging a softening of the hiking stance. Westpac has also publicly stated a forecast of two cuts in 2019.

Other Assets

The prices of copper and oil received a big boost in February. The prices of gold and iron ore were flat.

Regional Review
Australia

The jobs report in February was one out of the box. In recent times, expectations are usually for around 10,000-20,000 new jobs to be created each month. After a strong report in January, 65,400 full-time jobs were created in January. This was offset by a fall of  26,300 part-time jobs but who wouldn’t trade full for part time if that’s what the employee wants.

Wages growth did miss at +0.5% for the quarter compared to an expected +0.6%. Wage increases are barely beating inflation.

As the general election nears, the polls are changing rapidly. While there are many important issues at stake, it does appear that the Labour party’s policy of reducing franking credits and increasing capital gains tax are not popular. While we take a neutral position on politics, changes to how we should invest are inevitable if the status quo no longer applies.

China

China has been forced to the table over trade and IP protection. Whatever people think about Trump – the man – the President of the US has made inroads into the problems that are at hand.

The issues are immense. Not just trade and IP, but ‘owning’ the South China Seas and more are critical for a strong future for the world order. If the West does nothing, the position might deteriorate. But if the West tries to move too quickly, old folk know only too well what life could then be like. Just remember the public fear surrounding the ‘Bay of Pigs’ showdown in 1962 (Kennedy v Cuba) to know that we never want to witness such situations again. 

China is agreeing to some changes and that is why Trump did not impose round two of the tariff hikes scheduled for March 1. The China Purchasing Managers Index (PMI) a measure of changes in industrial demand stands at 49.2 from the previous month’s 49.5. It is below 50 but, as an expectations survey, it is likely to be affected by the US-China trade talks discussions.

US

The US government shutdown ended with a compromise on the “Wall” funding. The March 1 tariff hike was averted and Trump went to Vietnam to have a summit with the North Korea leader, Kim Jong Un. 

Some say that Trump has achieved nothing on this front but we wrote 15 months ago or more that Kim was trying to fire missiles over Japan – and the only good thing was they failed to get out of his territory. There have been no tests in the 15 months since that dialogue started. The problems, as with China, cannot be resolved overnight but the groundwork is being laid.

Trump did walk out on the Hanoi summit which was applauded by both sides of the aisle in the US Congress. Trump is not being bullied into a “bad deal” just to get a deal signed. The US Secretary of State has since confirmed negotiations are continuing. 

We still think the US economic slowdown is still being oversold. GDP growth of 4.2% for Q2 was a high but a recession is not expected any time soon. The latest GDP growth for Q4 was 2.6% which exceeded the market expectations of 2.2%. This growth equated to 3.1% for 2018.

Europe

The Brexit debate has taken a turn with the UK PM, Theresa May, going back to parliament to renegotiate. The March 29 deadline is so close that some are wobbling at the knees. We do not pretend to know how the process will end but it does look like, as we always expected, that some sort of common sense will prevail.

The Bank of England cut its growth forecast from 1.9% to 1.3% for the current year. The EU cut its forecast from 1.7% to 1.2%.

Rest of the World

Since the Radcliffe line was hastily instituted in 1947 to split “British India” into Pakistan and India, the peace has never been settled. Towards the end of February, both sides were shooting down each other’s military planes. At this stage the fall out to markets seems limited but all international conflicts must be taken seriously.
On a more frivolous note, Fox (US) TV was commentating on the (then) impending summit between Trump and Kim. The anchor stated that Trump had to fly half way round the world for the meeting but Kim “just had a couple of hours train ride” to make!

As the crow flies, North Korea is more than 3,000km from Hanoi so it seems like a train would take much longer to get there that a plane for Trump from the US!

Economic Update – February 2019

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

Markets roar back to life!

Federal Reserve clarifies its position

China data were weaker than expected

Australian rate cuts on the horizon

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
We reported last month that we had the Australian and US stocks markets as being meaningfully under-valued. Well they are much less so now after a very strong rally during January.

The turn-around in markets started straight after Christmas and gained momentum throughout January as the US Federal Reserve (“The Fed”) made increasingly dovish tones – so much so that the chance of a rate hike this year is now estimated by the market to be minimal. A chance of a cut this year now has gained some support among the analyst community.

The end of January Fed meeting produced a no-change result on rates and the chairman emphasised the word “patience” in his press conference about the timing of future moves. The accent is once again firmly on “data driven” policy changes rather than following a pre-set course.

The US-China trade stoush took a few more twists and turns. The threat of more tariff increases looms large but could well be averted. The China economy is clearly in need of avoiding that situation and so some solution may come soon. China did offer to reduce the trade balance with the US to zero over the next 6 years, however, more needs to be done to address what is characterised as the rampant abuse of intellectual property rights.

US employment data series were particularly strong. A much bigger than expected 312,000 new jobs were created. Unemployment came in at 3.9% pa and, importantly, wage growth was a far more respectable 3.2% pa. The weakness in the US economy mooted by some does not seem to be showing through in the data – at least not yet.

China inflation data – both consumer and producer variants – came in weaker than expected. GDP growth was 6.6% for the year – which was on expectations – but import and export data were weaker.

The weakness in China data is nowhere near as bad as some are making out. There is a natural progression from the double-digit growth of a decade ago to more moderate levels as any country matures. The Chinese government is putting in place policies to combat any slowdown so we do not see modest softness in GDP growth becoming a problem unless Trump brings the next round of tariff hikes into play.

At home, the biggest change has been the attitude towards possible rate cuts by the RBA. This was almost unheard of a month or so ago but the muttering has become louder. Indeed, one leading analyst reported a 36% chance of a rate cut this year.

One reason for a cut is that the NAB and ING just finished the out-of-cycle home loan rate increases. The second is that our CPI inflation data has been persistently lower than the target band of 2% to 3%. The latest reading was 1.8% making it 15 out of the last 17 quarters that the rate has been below the target range.

The RBA has a dual mandate. First it must try and keep full employment. At the current 5% that could be said to be have been fulfilled as there is no prescribed number. The second is to keep inflation within the target band. The RBA has failed in that regard – even in any ‘average over the cycle’ sense.

Our employment data was quite strong again this month but, as always, our immigration numbers helps underpin that and more generally economic growth.

In short, the US Fed has learnt its lessons from making last October’s ill-advised comments. If Trump can be a little more compliant, the US does not seem to be an issue – and neither then would China. And if/when we get a rate cut (or two) from the RBA, we’ll be doing better too. We reiterate our view that Australian and US stock markets barring any unforeseen events are forecast to have an average year of returns in 2019 – with the balance of risk to the upside.

Asset Classes
Australian Equities

The ASX 200 put in a strong month in January at +3.9% with Energy stocks (+11.5%) leading the way. However, the Financials sector, under the weight of the Royal Commission, produced a capital loss of 0.2%.

We have the index only slightly under-priced at this point but our forecast of capital gains for the next 12 months has risen slightly as the February reporting season approaches. Brokers have been modestly increasing their earnings forecasts.

We do not see a return to the 2018 peak through the forecast period but all being well it is not out of the question that we could see it by the end of the year.

Foreign Equities

All the major indexes put in a strong January with Wall Street’s S&P 500 gaining +7.9%. Even Emerging Markets put in over 6%.

In contrast to the ASX 200, we have the S&P 500 sufficiently under-priced to continue the January rally for a little while longer.

Our 12-month capital gains forecasts for the S&P 500 (based on broker forecasts of earnings and dividends) did start to slip a little into the end of 2018 as a pall of gloom started to collect over Wall Street. However, the Q4 reporting season, which is still underway, has given brokers the confidence to reverse some of those calls. As a result, our index forecast strengthened a little – and has stabilised.

Bonds and Interest Rates

The Fed has started 2019 on a clear path to maintain patience over any rate changes and that has pleased markets. A reasonable chance of a cut this year is now being priced in however important to note that any rate adjustment will be data dependent. But noteworthy that the attitude of the US Fed has softened somewhat and they now look to economic data to guide rate policy.

There is now also a significantly greater chance of a rate cut this year in Australia. Such a cut would act to offset the big four banks out of cycle rate hikes of recent times and possibly help promote inflation into the 2% to 3% band.

Other Assets

The prices of iron ore and oil surged by more than 15% each in January. Those increases helped support the January rallies in resources stocks.
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Regional Review
Australia

Australia is inching towards its next general election and with the May budget looking like returning a small surplus both sides are offering sweeteners to the electorate. It is not clear that such expenditures are in the best interest of the economy’s long-run growth path.

There were 21,600 new jobs reported in the last Labour Force Survey which is strong. However, all of these jobs and more were part-time. Full-time jobs shrank by 3,000.

If the RBA does cut the official cash rate soon, that could give a small boost to housing sentiment and the economy in general.

Interestingly, in the days before the Royal Commission hands down its findings, a new bank, Volt, has been given a full banking licence. With the increasing tendency towards internet-based payments systems, the big four’s customer base is at risk of being eroded over time.

We again emphasise that the economy is not ‘in trouble’. Rather, it is just not performing as it could. That said, we do not see a recession on the horizon in 2019.

China

China’s economy is rapidly approaching the size of that for the US – and the US is not happy about that. With economic size comes political power. It is, therefore, important that the global powers assist China in transitioning to the number one slot without upsetting world order.

Trump is trying to do his bit with trade policies. They may not be fashioned in the best way but it is a start to getting China to respect intellectual property rights and also behave in a way that fits in within a cohesive World Trade Organisation (WTO) type framework.

The near misses on the economic data front are not a major issue. It is not possible to guide any economy in a perfect trajectory. We see the Chinese government acting in appropriate ways over 2019 to ensure a stable outcome. That is, of course, unless Trump takes the tariff war too far.

US

The stand-off between Trump and the US Congress did not make any significant gains during January. The partial shutdown of the US government is due to switch back in quite soon and the debt ceiling debate will loom large in about six months.

Whatever we think about the US political process, the hard-economic data are quite good. GDP growth has been strong and jobs growth has been even better.

It is not possible to predict what Trump will do next but he does not have a free hand – especially with this new split Congress. Some compromise on the ‘wall’, and a ‘fig leaf’ from China on trade could have a big positive impact on economic prospects for 2019.

Companies reporting quarter four 2018 earnings at the moment have been a little mixed but there have been lots of very strong results – hence the positive stock market reaction.

Europe

The Brexit issue rolls on and on. It now seems quite likely that, in effect, the March 29, 2019 deadline for the Brexit might be pushed back until later in the year.

The German economy has spluttered a bit in recent months. German car manufacturers are suffering from the US trade tariffs but the impact on Australia is muted.

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