Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
Support mounting for RBA rate cuts
– Popular Federal Budget
– United States (US) Federal Reserve maps out recovery phase
– China downgraded by Moody’s
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
While most market commentators are predicting no rate changes for Australia in the rest of 2017, three major houses recently re-affirmed their call for cuts.
JP Morgan and Credit-Suisse are predicting two more cuts this year which would take the RBA rate to 1%. Macquarie re-affirmed its call for three more cuts to less than 1% in this ‘cycle’ – that is, in 2017 or early 2018.
We maintain our call for two more cuts. We first identified and reported a growing problem in our full-time employment creation in April 2016. While total employment has been growing steadily, part-time jobs have been replacing lost full-time jobs.
The May Federal Budget gave some long-term hope for our economy with the infrastructure spending announced over the next ten years. The proposed tax cuts for small businesses will also help. But the increased Medicare levy and the bank tax will work against growth.
Both Moody’s and S&P re-affirmed the country’s AAA rating after the Budget.
There is no doubt that the bank tax will be passed on. No company can absorb substantial taxes by cutting costs over an extended period. The only question is whether shareholders or bank customers will bear the brunt. First-year economics teachings lead us to believe the burden will be shared.
Since the big four banks plus Macquarie form the basis of many super funds – directly or indirectly – the Australian public will have less to spend even if the banks do not raise rates to cover the tax.
On top of the bank tax, Moody’s just downgraded 23 smaller banks. The impact of this change in the ratings will be to increase the cost of funding for smaller banks. Therefore, we expect pressure on the banks to lift rates – or not reduce them by as much as any cuts made by the RBA.
The US Federal Reserve mapped out a well-received plan to ‘shrink its balance sheet’. That is, the $4.5 trillion debt amassed in quantitative easing since the GFC is to be reduced in gentle stages starting this year.
The balance sheet is to be repaired by not buying sufficient new bonds to replace all of those naturally maturing – as the Fed has been doing for years. This ‘tapering’ will have the effect of raising long-term rates. Therefore, we continue to expect that there is probably only one more hike in the US likely this year. The market has placed around an 80% chance of a rate hike in June.
At the start of the year, the Fed predicted three hikes this year and then seemingly upped that to four as Trump talked up his expansionary plans. With only one hike so far this year, the Fed again has been overly optimistic about the strength of the US economy.
China reported some very strong trade data – both imports and exports – but Moody’s downgraded China in May!
On a very positive note, Nobel Laureate Robert Shiller has said that the US stock markets could go up by another 50% and most other markets could go with it. This statement is particularly strong as Shiller’s own ‘PE ratio’, measuring whether a market is expensive or not, has been used for a couple of years or so by others to say that the US market was overpriced and about to correct!
In conclusion, we see Australia and our major trading partners’ economies making gradual improvements and the stock markets unlikely to suffer more than the usual levels of volatility.
Asset Classes
Australian Equities After three months of solid growth, the ASX 200 fell in a hole during May ( 3.4%). While there are many factors at work, the fact that we lagged behind the world indexes strongly suggests that the proposed bank tax was the major culprit. The financial sector is about 40% of the ASX 200 index.
While the ASX 200 reached a recent high of 5,957 during May – up from the 5,924 at the start – the index fell away into the close of the month. Stocks in Energy (+2.0%), Industrials (+4.7%) and Telcos (+3.4%) were up strongly in May. It was the 9.2% fall in Financials stocks that did the damage.
Of course the new bank tax might impair future dividends from the big banks but the damage should not be big enough to affect the super strategies in which many have invested.
In the coming weeks there may be some clarity on how the tax will be implemented and how the banks will deal with it. At that point we believe that bank stocks could rally because – in times of great uncertainty such as now – markets often ‘over sell’ the problem stocks.
Foreign Equities The VIX ‘fear’ index (which is considered by many to be a proxy for investors taking out insurance on downside risk in stock markets) reached twenty-year lows during May – only picking up to average levels when the Trump-FBI story peaked.
Wall Street hit new all-time highs in May with the S&P 500 breaking through the 2,400 barrier. Most other major indexes also performed very well in May.
People are mixed on whether the index can rise further since many have risen strong so far in this year. For example, the S&P 500 is up +7.7%; the London FTSE is up +5.3%; the German DAX is up 9.9%; and the Japanese Nikkei is up 2.8% (all figures year-to-date). The ASX 200 is only up
1.0% in the same time period.
1.0% in the same time period.
For the moment we stand with Shiller in that we think markets can go higher from here.
Bonds and Interest Rates
The RBA did not change rates in May and it looks very unlikely to do so in June. There has been some swing towards acknowledging our weak labour forecast data by analysts and the RBA which might encourage the RBA to cut later in the year.
The US Fed released a particularly informative minutes from its recent FOMC meeting. It outlined a clear plan to start reducing the debt amassed during the quantitative easing programmes.
Such a programme would put upward pressure on longer bonds meaning that the Fed would be ill-advised to amplify that effect with hikes in the Fed funds rate. As a result, we think our view that the Fed only has one more hike in line for the economy this year is worth holding on to.
Other Assets Iron ore prices fell further in May – by 15.5% but oil, copper and gold finished fairly flat. The OPEC meeting on May 25 helped restore some stability in oil prices.
Regional Analysis
Australia The last two months have witnessed strong growth in full-time employment after more than a year languishing in negative growth territory. The key question is whether these latest data mark the start of a recovery or a statistical artefact. Unemployment remains stubbornly high at 5.8% and wages growth came in at +1.9% for the year – which is the lowest on record. Weak wages do not usually accompany strong labour markets.
Since the proposed Federal Budget infrastructure programme and company tax cuts will take some time to work their way through the economy, the RBA would do well to cut rates once or twice this year to kick start growth in 2017. GDP growth data are due out early in June and most expect a low number – and possibly even negative growth.
In contrast to the hard data, the soft data on confidence and conditions are quite reasonable. Westpac’s consumer sentiment read stands at 98 which is just below the ‘100 level’ that separates pessimism from optimism. NAB’s business confidence came in at the highest level since before the GFC and their business conditions index is the highest since 2010.
All in all, the economic scene is mixed but not bad. A lot depends on which parts of the budget the government can get through parliament. And an accommodative RBA is important.
China
China recorded impressive import and export data in May that beat consensus forecasts. The Purchasing Managers Indexes (PMI) for both manufacturing and non-manufacturing were strong. Nevertheless, there remain some commentators that persist in talking about China slowdowns.
China is talking up a big infrastructure initiative known as ‘One Belt, One Road’ which aims to link both ends of Eurasia and well as Oceania by land and sea. This programme, together with its stated desire to relocate 200 million more citizens from the country to the cities, could ensure continued strong growth for many years to come. Nevertheless Moody’s downgraded China debt for the first time in 26 years! China was not happy about that!
China’s retail sales again grew in double digits and industrial growth was solid at 6.5%, but slightly down on the previous month’s 7.1%.
U.S.A.
The USA fell into a political hole when the debate about what Trump did and didn’t do with respect to the FBI chief and Russia got going. Cries of impeachment were heard from some corners but that is highly unlikely. Importantly, the airwaves cleared quickly as Trump set off on his first overseas trip as US President.
The response to Trump’s visits was mixed. He was well received in Saudi Arabia and Israel but he ruffled feathers in Europe and the NATO meetings.
The US nonfarm payrolls data (jobs growth) in May was particularly strong at 211,000 against an expected 190,000. The unemployment rate fell to a very low 4.4%. But, like in Australia and
elsewhere, wages growth is anaemic. After allowing for the modest levels of inflation, the so-called ‘real wage growth’ is all but zero.
The first quarter GDP growth reading was revised up from 0.7% to 1.2% (annualised). The first quarter results are often buffeted by weather factors so this result is not yet considered to be a problem. However, it will limit the Fed’s enthusiasm to hike rates or speed up the shrinking of its balance sheet.
Europe
Macron won the French presidency – as expected. That brought stability to markets in that region. The UK goes to the polls on June 8th in what PM, Theresa May, hopes will be a ticket for her to lead the exit from the EU. However, the early polling is not going well for May. The only real upside for her is that her opposite number, Jeremy Corbyn, does not have much support from Labour politicians. In the UK, the non-parliamentarian members of the Labour Party have a major say in who leads the party.
The Manchester bombing was yet another reminder of the constant source of instability terrorists can wreak on communities. After initially fearing further attacks from the same group, the security level in the UK has since been downgraded by one notch.
But when we focus solely on the economy, Europe continues to strengthen. It is now running ahead of trend growth!
Rest of the World
North Korea launched a missile that reached an altitude of 120 km! The US, and the rest of the world, is increasingly concerned about the proliferation of tests in that part of the world.
*Ron Bewley (PhD,FASSA) – Director, Woodhall Investment Research