Infocus

The Big Picture

After a great July in markets, many stomachs understandably churned as fingers were pointed at China’s stock market during August.

We listened to and watched well-dressed people with sincere faces likening the China stock market falls to the Lehman Brothers collapse in 2008. Nothing could be further from the truth. Lehman’s was a massive investment bank and the main problem was that no one knew who held the complex web of Lehman’s massive debt – so credit markets locked up.

China is transitioning from a poorly run Communist country to a world powerhouse – while remaining Communist. That is a difficult task, but China has been doing tremendously well. The China authorities know that every good capitalist country has a well-functioning stock market to allow for secondary trading in companies.

The so-called Shanghai Composite Index is a measure of a China market in its infancy. Unlike, say, Australia, there is very little institutional investing there. In Australia, we have the likes of BT, Colonial First State and many, many other sophisticated investment houses researching and trading in the relevant companies. We even have a substantial overseas investment in our market.

The Composite is dominated by mum and dad investors. The vast majority of mums and dads do not invest in the market and those that do mostly rely on property and gold for their main investments.

So a year or so ago, China encouraged more activity in the Composite and provided cheap loans for margin lending to promote involvement. The market rose more than 150% in less than a year so, even after the recent falls; the capital gain over the last 12 months has been mammoth! The point is, share market activity has little to do with economic activity in China.

So when global investors got caught up with the obvious overselling of mature markets, the China market continued to fall while mature markets surged from the bottom. Of course China did some good work in adjusting monetary policy that helped matters but – basically – our market was simply oversold.

A few other events disturbed thinking at the same time – the China dock explosions and deaths; the Bangkok bombings and deaths; ruminations in the US as to when the Fed will eventually hike rates; etc., etc.

It is often the case that when a lot of adverse news bombards markets, people sell first and ask questions later. Of course, these are the times when professional traders can make a killing.

While all of this was noise going on, the USA reported some spectacular growth data and reasonable labour market data. Our labour market data was also just fine.

So, in the next few weeks we expect markets to start to look far more settled and growing. And investors might even be looking for a Santa rally.

But one thing is bothering. There are almost constant news reports on the BBC of immigrants flooding into Europe from Africa and the Middle East. While some people are genuinely fleeing war and oppression, lots being interviewed just want a better economic life. While it would be great to accommodate all of these people in Europe, there are obviously even more people who will follow as ‘family’ and/or other illegal immigrants to the point where European standards of living would fall measurably. The problem must be solved – and soon.

Asset Classes

Australian Equities

Our market suffered a major downturn in August losing ???8.6% on the month. However, most other major international markets took a similar hit and our market started a recovery at the end of the month.

The Energy and Industrials sectors took much of the brunt of the fall on our market and no sector was spared. We have fair value for our market to be 5,750 making the end-of-August level of 5,207 quite underpriced.

Reporting season in August was not strong enough to dominate market movements but more than half of the companies that reported beat consensus estimates, which is about normal.

Foreign Equities

The VIX index is a measure of volatility, which many use as a ‘fear’ index for Wall Street, spiked a week before the end of the month but it too started to settle by the end of August.

Most major overseas markets are down on year-to-date, by around ???4% to ???5%. Since we have these markets also under-priced, we see most markets to be up by the end of the 2015 calendar year.

Bonds and Interest Rates

As September approached, more and more analysts were coming to the view that September is too early for the Fed to raise rates in the US. Fed member William Dudley has all but ruled out September. October is also less likely since there is no scheduled press conference to follow the Fed meeting.

We maintain our view that the first hike could be as late as 2016 as there is little to gain by going earlier. We also think it is quite likely that the first hike might be less than the traditional 0.25%.

China cut rates by 0.25% for the fifth time since November last year. It also cut the amount that banks have to hold against their lending.

The Reserve Bank of Australia (RBA) kept rates on hold in August and again on September 1. Perhaps the recent gyrations in markets might force its hand soon – one more cut is still possible this year.

Other Assets

Iron ore prices seem to have stabilised at moderate levels. Oil prices, that were plummeting, surged +10% in one day near the end of August. Oil prices rose a massive +27% in a three-day fight back. Russia and OPEC countries must be hurting, but oil importing countries are benefitting from lower prices.

The Aussie dollar continued to be volatile. It started the year well into the 80s but is now in the very low 70s.

Australian employment improved, albeit marginally, by +38,500 new jobs. Unemployment came in at 6.3% but, importantly, the official trend measure is still stable at 6.1%. The 6.3% number is most likely higher through statistical sampling errors.

The RBA left rates unchanged in August and at its 1st September meeting.

Various economic statistics continue to be mixed. It seems the political process is stuck in a rut and that is not helping the economy grow.

China

The China “perma-bears” had a field day when the Shanghai Composite index went into freefall again. But, as always, the authorities came to the rescue.

They devalued their currency, cut rates, reduced capital requirements for the banks, injected money into the system and deregulated pension holdings. Quite a lot for one month but that is why we are confident China will continue to manage its economy well.

On the real side of the China economy, the Purchasing Managers’ Index for Manufacturing slipped below the key 50 level to come in at a three-year low of 49.7. Of course, the latest rate cut has not yet had a chance to work but it is worth continuing to watch activity in the world’s second-largest economy.

China now has built an array of man-made islands in the South China Seas – complete with military installations. Clearly China not only wants to keep a hold over any oil and gas explorations in the region, but it also wants to have a strategic hold over shipping activity in the Singapore Straits.

U.S.A.

The Federal Reserve may be in a quandary as what to do about rate hikes, but there is in no doubt that the economy is booming. With Q2 growth at +3.7%, it looks like a no-brainer for the first hike soon but the Fed might not want to rock the boat with all of the market volatility that went on in August.

US jobs were a little soft this month – just +215,000 new jobs when recent averages have been more like 240,000. But unemployment is still steady at a low 5.3%.

We still think caution will prevail and a very small cut later this year or at the start of next will be the go. We doubt whether it will have much effect on us.

Europe

European news is dominated about how the European Union (EU) can deal with the immigration issue. People smugglers are taking so many would-be immigrants to places that just can’t cope with the influx. Sadly, tragedies abound as smugglers push the limits.

The Greek Prime Minister, Alexis Tsipras, called a snap election. A caretaker PM is now in place, but the election will be soon. Since one-third of his party did not vote with him in the bailout negotiations, the snap election is an attempt to rid his party of that element and leave a functioning parliament in its place. That will further stabilise the European economies.

In the UK, the race for the leadership of the Labour Party is taking on pantomime proportions. The claim by Labour is that non-Labour people have been signing up to vote for the leadership so that the outsiders can elect someone that has no chance of ever becoming Prime Minister! Given the rise in the Scottish National Party after last year’s referendum, it is possible the current structure means that Labour has little chance anyway in the near future.

Rest of the World 

Russia’s GDP came in at ???4.6% on the back of the slump in oil prices and the Ukraine-related sanctions. Other oil-exporting countries like Venezuela and Saudi Arabia are also feeling it.

Venezuela and Colombia are having their immigration difficulties too, but Venezuela is just shipping illegal immigrants back in droves.

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

** Australian Bureau of Statistics 

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.

Short-term volatility always makes investors nervous. Importantly, for advisers and your clients it’s about talking through with clients the reasons why they are invested and relating this back to their advice goals and objectives. It’s vital to remember that inevitably short-term volatility is experienced in markets, and the longer the timeframe to achieve clients’ goals and objectives the more likely market ‘ups and downs’ will be experienced.

The fact is…
Market Update: Dr Ron Bewley, Woodhall Investment Research

No one can deny that markets have sold off heavily in the last little while, but why?

Markets are driven by investors who do not know the true value of the constituent companies and use all of the signals they can find to adjust their views. September has been a big month on the calendar for the whole of 2015. That is when most analysts expected the US Federal Reserve to make their first interest rate hike since the GFC struck.

The US

Quantitative Easing – the programme of expanding the money supply – ended nearly a year ago in the US without any tears. The current official interest rate setting is a band from 0.00% – 0.25%. Traditionally the Fed moves like us in multiples of 0.25% changes in rates. However, the Fed recently flagged that it is prepared to move in smaller amounts in the first instance.

Rates in the US, here and most developed countries, are currently so low that even a 1% hike would still leave us all at lower than emergency settings – so why would anyone be worried about a hike of 0.25% or less? The answer is simple. It has nothing to do with the cost of borrowing. It is all to do with what we believe the Fed is thinking in terms of its confidence in its own economy. If it hikes, the Fed thinks the economy is strong enough to take it. If it doesn’t hike then the Fed will be perceived as being negative on the economy.

To complicate matters, The Fed moved too soon in the Great Depression and arguably prolonged it. So it has a bias towards not hiking too soon. Moreover, the costs to the economy of not hiking when it could against hiking too soon are so, so small. We have argued for some time that the Fed does not need to, and may not hike before 2016 but Fed watchers had pencilled in September.

Now that September is all but here, and the Fed is vacillating, analysts are getting spooked about the strength of the US economy. However, the all-important jobs data keep coming in comfortably above 200,000 new jobs per month and unemployment is at much lower than anyone expected a year or two go. True, wages growth has not been strong but that has been a worldwide problem.

When interest rates return to normal levels in say a few years, the stock market will not look quite as attractive relative to the yields on safer assets. Of course, markets often did well when rates used to be at normal levels but some investors always want to be the first out.

So in terms of long-run investing, we always maintained that rate hike would increase market volatility – and we have certainly seen high levels of volatility – but is it time to do something about it?

If the fundamentals remain strong as we expect, volatility will pass and markets will climb back up. Since there is no obvious sign that the fundamentals have weakened there is no point in selling. Indeed, such investors could be locking in losses. It is true that the US August reporting season was a little softer than expected but many companies beat expectations.

China

China is always a possible worry but its stock market – the Shanghai Composite Index – should not be. The recent sell-off is a little like the Reserve Bank of Australia (RBA) getting worried because there was a bad run on pokie machines in Australia. The Composite is dominated by mum and dad type investors and not institutions like ours and those in the USA. What is important is China’s ability to regulate and control the market. It did a good job in the middle of the year but in the round 2 sell-off they are being perceived as being less successful.

At the weekend, China announced that pension funds could now hold up to 30% in China equities – up from 0%. The fact that it had no impact on day one should not surprise. If you had never been able to buy shares and someone gives you the green light, how long does it take to work out what you want to buy and when? China also has an enormous amount of wiggle room in terms of cutting interest rates and reducing the Reserve Requirements Ratio for banks.

We would be very surprised if China cannot cope with smoothing out the ripples in its stock market. But what about its real economy?

When the ‘flash’ Purchasing Managers Index (PMI) came out last week, it shook some investors as, at 47.1 it was not just below the 50 level that separates improving growth from weakening, it was below expectations and at a six-year plus low. However, this flash read recently taken over from HSBC sponsorship is based on a much smaller sample than the official read and the flash read is only based on small companies. The flash read is often much less the official read which has been at 50 or above for quite some time. The next official read is due on September 1st.

Europe and the EU

Turning to Europe, except for migration issues from Africa and the Middle East, its economy looks stronger than in a long time. The India economy is starting to grow in a meaningful way and lower oil prices help economies that are net importers of oil.

In conclusion

To us, the recent behaviour looks like a ‘shaking-the-tree’ exercise where the weak run for cover and the seasoned investors buy up cheap. Of course this could change but for the foreseeable future this all looks like what has been an overdue correction in the US. We all caught the cold but after a few ‘sick days off we could so easily be back to growth quite quickly.

Yours faithfully,

Ron Bewley PhD, FASSA
Director
Woodhall Investment Research

^{Important information}

^{This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.}

The Big Picture

July was a bumper month for news that affected stock markets. The Greece debt crisis dominated the first half of the month. Greece started July by going into arrears on a $1.7bn loan to the IMF. But having the Finance Minister resign and immediately hop onto his motorbike wearing a leather jacket and a matt black helmet with a pretty blonde sans helmet on the pillion seemed to be the tops – but then the replacement Finance Minister (also a Marxist and former academic) was so relaxed he didn’t bother to take written comments to the big Brussels meeting as he was requested to do – the dog apparently ate his homework and he asked for an extension. He got more than what he bargained for.

As a result, Greece finished up with a far worse deal than they voted against in June. But for the rest of us the Greece issue has probably gone away for quite some time. As we always thought, there would be no long-run fall-out on us – and, as it turned out – there wasn’t that much short-term volatility either.

In an unrelated crisis, the mainland China stock exchange seemingly went into meltdown. Unlike our market that is dominated by big fund managers making big calls, the so-called Shanghai Composite Index is dominated by “mum and dad” investors that border on having a gambling mentality – people that the China government was encouraging to borrow to get into the market. When the index fell by around one third in a couple of weeks in June-July it seemed bad until one realised that the index had gone up by about 150% in the previous 12-months.

The China Government stepped in and rapidly brought back order into the market. The index gained over 10% in a few days – another problem solved, but some volatility remains in that market!

Because iron ore was apparently being used for collateral on the China market, its price also took a nose-dive from just under $60 / tonne to a 10-year low of $44.59 before finishing the month at over $55.

Iran has almost struck a deal with six major powers to maintain its nuclear power programme without the weapons part. If, or is that when, the US Congress ratifies the deal, trade sanctions should be lifted and more oil will flow into an already over-crowded market. Oil prices are unlikely to rise anytime soon.

But there was also lots of good news. The UK got its best result since 2001 on household disposable income growth – after taking inflation into account.

US employment data and economic growth data were good without being great and our employment data points to last October (2014) as having been the peak for our unemployment. Every month since has marked a slight decrease. And the Governor of the Reserve Bank recently joined the chorus that unemployment may have peaked.

Nevertheless, our official interest rate looks set to fall at least once more this year. The cost – measured in terms of risk – is so small for another cut compared to a no-change or rate-hike decision, it’s almost a win-win for us (unless you are on a pension in cash).

And our Reserve Bank Governor has come out and said perhaps we should accept that trend economic growth going forward will be lower than what we were once used to.

Whatever the pundits might be saying, we still see new record highs on Wall Street in the remainder of the year and the ASX 200 breaching 6,000 sometime soon. In the meantime, there is a more likely chance of some sideways movement until all of the jangled nerves have settled down and our August reporting season to the ASX has been digested.

Asset Classes

Regional Analysis

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

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.