The Big Picture

The NAB business confidence survey came in at the best since August 2014, and the previous month, the Westpac consumer confidence index was the best since February 2014. On top of that, the Household Savings ratio is at last coming down to more reasonable levels reinforcing the confidence story. Don’t worry – we are still saving well but not hoarding in fear as we were.

On top of that, the official trend unemployment rate series for Australia – the preferred official index – peaked at 6.17% in December 2014 and has gradually improved each month since – to sneak to just under 6.0% for May!

Our GDP growth came in at 0.9% for Q1, 2015 and the number of jobs created again easily beat forecasts. The Reserve Bank kept rates on hold and the government got the pensions bill through parliament with the support of the Greens – within hours of Labor stating it would oppose it. At last our economy is starting to get going again.

China cut its official interest rate for the fourth time since November 2014 and removed its import duty on luxury goods. The main measure of manufacturing activity – the Purchasing Manager Index (PMI) – remains above 50 which indicates a slight rate of expansion.

Japan threw in a big revision to Q1 GDP growth – up from 2.4% to 3.9% on an annual basis. The UK delivered growth in pay of 2.7% on the year and ???0.1% on inflation – so people’s wages are better off (before tax) by 2.8% on the year.

The US posted a big +1.2% increase for the month on Retail Sales but some other data were a bit mixed. The June date for the US Fed to hike rates for the first time since the GFC came and went with no action – that’s not what most expected last year.

Indeed Fed rate official forecasts for the end of 2016 and 2017 have fallen to 1.75% and 2.75%, respectively. In other words, when rates do start to rise they are expected to do so very slowly. Some commentators think the first hike will be in September – and some even expect two hikes this year. But as the Fed keeps reminding us, the data must be strong enough first. We maintain that we expect that the first hike is more likely to happen next year. But that’s not bad. Indeed, it would reflect prudent policy if the data turn out to be not strong enough.

Even Europe gets some plaudits. There was a release of some bumper PMIs for some European countries in late June. But of course there is Greece!

It is exhausting following the Greek crisis. They have a Finance Minister (who held a position in Marxist Economics in university) negotiating – or rather not negotiating – with the IMF and various European governments and policy centres.

Europe and Greece both want Greece to stay in Europe but the price of membership is that Greece must agree to get its house in order. Portugal, Ireland and Spain all started in a similar position in 2010 but those so-called ‘PIGS’ countries took their medicine and successfully exited the bailout program last year.

Without being too harsh, the conditions needed to get the next bailout required Greece to accept the sort of conditions that most of us in the Developed World – such as Australia – live in. Don’t avoid your taxes; lift the retirement age up to 65; pay GST in the Greek islands as well as the mainland, etc. And their top marginal tax rate is well less than ours! I suspect that whatever happens will have almost no long-run impact on our economy and markets.

Asset Classes

Australian Equities

The ASX 200 had a shocking month (down ???5.5%) and no sector was spared. Of course the sell-off at the end of June over the Greek situation exacerbated the situation but May and June together have taken us down from nearly 6,000 momentarily to under 5,400 – a 10% correction!

We see this dip as short-term volatility. The financial year starting today is likely to be really good. Our forecast for next June 30th is 6,200 – so that’s up 14% in 2015/16! On top of that we can expect about a 4.7% dividends plus franking credits.

The year 2014/15 that just finished was nearly flat at +1.2% but the returns including dividends were +5.7% which was a lot better than cash – and franking credits would take that return to about 7%.

And different sectors performed very differently over the financial year. Health was up +29.2% and Telecommunications was close by at +25.8% – both including dividends. At the other end of the spectrum, the Energy sector lost ???20.2% on the back of the falling oil prices.

Although we have the market very underpriced, high volatility might continue for a few months due to Greece and the US Fed deliberations.

Foreign Equities

Wall Street outperformed our market over June (???2.1% against our ???5.5%) but London’s FTSE (???6.6%) was even worse than the ASX 200.

While most markets have had big sell-offs in recent weeks, the S&P 500 is only ???3.2% off its all-time high.

Bonds

The bond markets are currently more volatile because of the Greek crisis and the talk from the US Fed about starting to make its first move in raising rates.

What is surprising is that the Fitch (a major rating agency like S&P or Moody’s) estimated one-year probability of default is only 1.02% for Western Europe. It started 2015 at 1.43% and reached as high as 4% during the GFC. Markets aren’t really that worried about Greece.

Interest Rates

Neither the Fed nor the Reserve Bank made any move on rates in June.  The Fed stressed that when it starts raising rates, it will be at a snail’s pace. Of course increasing the rate from 0% to 0.25% should have no impact on doing business but markets like to react to things that move – particularly when they are just coming out of hibernation!

There is no real consensus about whether we will get any more cuts at home this year, but any hike is a very long way off. There is a reasonable chance of another cut in a few months but it isn’t anything to bank on. A lot will depend on unemployment and inflation data over coming months.

Consumer and business confidence indexes are starting to look very good. Perhaps a rate cut would boost confidence even further. But nobody should be investing in a new business that critically depends upon one more cut. On the other hand, it will be interesting to see what the impact of the small business package from the May budget is.

Other Assets

Iron ore prices moved largely sideways in June but dipped below $60 / tonne for the first time in five weeks today.

Brent oil prices were relatively unchanged over the month, but they did dip a little at one point.

Perhaps surprisingly, the price of gold has been stable in the face the Greek crisis. It was actually down ???$US11 on the month.

Regional Analysis

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in today at 50.2 for the second month in a row. A number above 50 signals growing economic growth.

Like Greece, the China story will not go away for a very long time. The media feeds on stories and if there is no big news around it needs to find some. India is currently growing a little faster than China’s 7% target. And with ‘small’ China cities having more than 10 million citizens, there has to be a story to be found.

The PBOC (People’s Bank of China) just cut its main interest rate by 0.25% and its reserve ratio (the amount banks hold against loans) by 0.5%. China also removed import taxes from luxury goods. China is managing its economic destiny very well indeed.

Any prudent government changes tax rules and interest rates to glide an economy to where it needs. Think of Australia and what we are discussing about budgets and rates at the moment. China is no different. They are not panicking with massive or even big tweaks to policy. These changes would also look normal in Australia in recent times.

Yes, the first big wave of investment in China has ended, but much of China is still rural and poor. There will be more bursts of investment cycles to follow – after China has digested the impact of this last wave.

U.S.A.

After a very poor jobs number for March (+85,000 new jobs) the April data were quite strong with +223,000 jobs created and a 5.4% unemployment rate. The May number released at the start of June came in at a bumper +280,000 but unemployment slipped one tick to 5.5%. Only 225,000 new jobs were expected.

But the Fed is not happy with these numbers. The new jobs are still predominantly lower paying ones. Such employees typically spend all of their income on basics. They need wages growth to spread the gains across the economy.

The ???0.7% Q1 GDP growth figure (due to bad weather) was revised up to ???0.2% (both annualised) but everyone expected that. The US is sadly lacking productivity gains like so many other countries.

Europe

Europe ex-Greece is starting to do well – and in some places very well. Think back to 2010 when it looked like the eurozone might break up! That problem has gone away. Think of the start of 2014 when some talked of a recession in Germany. That problem too has gone.

Many mid-month preliminary PMIs were strong across Europe. Even Spain – with its 20%+ unemployment posted a number in the mid-fifties. Unemployment typically lags behind business expectations.

The Europe statistics are starting to look pretty damn good – even if you don’t include the UK. The UK growth in the first quarter of 2015 was just revised up to 2.9% over the year. Real (adjusted for inflation) household income was up a massive +4.9% in the quarter, and interest rates increase’s there are starting to be talked about.

Since midnight on June 30 has passed and Greece did not make its payment to the IMF, the bailout programme has officially ended. The referendum on Sunday is apparently worded as requesting a vote on continuing the bailout package – which no longer exists. Do they have the time to print new ballot papers and ship them out to the islands?

Sadly there is now talk of humanitarian aid being needed for Greece. Drug companies are owed more than a billion dollar’s but they have said they will continue to send drugs to Greece for now.

Rest of World Europe

Just when we thought Greece was enough of a handful, Puerto Rico announced at the end of June it had no chance of repaying its $72 billion debt. No doubt the US – with its very close ties – will bail them out. After all, you wouldn’t notice an extra $72 billion added to the $4.5 trillion US government debt!

The Iran nuclear talks are important. Depending on how they go, oil prices could move strongly either way on supply issues. Flip a coin.

*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.

By Ron Bewley*. Brought to you by Infocus

The Big Picture

On May 12th we got the Budget we ‘had to have’. While the previous Budget was a big step in the right direction – to set Australia on course for a stable future – it was so unpopular that the Government had to soften its stance this time around. Of course people will always be able to find something to gripe about because it is simply not possible to make everyone better off in a budget. Budgets redistribute wealth and income.

The Westpac – Melbourne Institute Consumer Confidence index jumped up a big +6.4% after this Budget. Normally this index falls after a budget. This latest number took confidence back up to above where it was even before the 2014 Budget!

Also, the Government came back in polling – level-pegging with Labor in the latest read. The main focus in the latest Budget was Small Business – with tax reductions and accelerated depreciations. As so many, many people are involved in small business, it is no surprise that the economy will get some sort of a lift – it is just a question of how much.

It was Peter Martin’s turn to be the ‘favoured journalist of the month’ to pre-empt the RBA cut in its rate from 2.25% to 2.00% on May 5th. While a cut – such as that made in February – would normally be expected to give economic indicators a boost, the fact that the RBA removed its ‘easing bias’ statement from it accompanying notes failed to excite pundits. Indeed, the Bank also cut its economic (GDP) growth forecast by  0.5% to the range 2% – 3% for 2015/16. The Treasury forecast is a fraction more optimistic. However, the Bank would (or is that should?) not have known what was in the Budget when it reduced its growth forecast.

The latest Budget is meant to be ‘all about jobs’ rather than the ‘debt and deficit repair’ of last year. The latest estimate is that the Budget will return to surplus by 2019/20 but, of course, debt is accumulating in the interim.

Both the Standard & Poor’s and Moody’s ratings agencies confirmed their AAA credit ratings for Australian debt after the Budget.

The official Australia Bureau of Statistics (ABS) trend estimate of unemployment for April – published in May – actually fell from 6.2% to 6.1%. Only  2,900 jobs were lost over the month. But the full-time jobs’ fall was  21,900 – with part-time hires negating much of that that loss.

And there were some bright signs from overseas. China’s trade data was poor but China cut its lending rate for the third time this year and announced an additional $300bn spending on new projects. It’s Purchasing Managers’ Index (PMI) for manufacturing improved slightly over the month.

The ECB  (European  Central Bank) is set to lift its rate of stimulus in Europe for the next two months; Greece seems to be coming to some sort of agreement with its creditors but nobody can really keep up with the dialogue; and the EU (European Union) growth is forecast to be a modest +1.6% for the year. Fitch’s credit rating for Europe has improved further on this round of Greece negotiations.

The US Federal Reserve caused a little concern with its announcements on when it will start to raise rates. However, Chair Janet Yellen stated clearly that it could be years before the Fed Funds Rate gets back to ‘normalised’ levels.

Asset Classes

Australian Equities

The ASX 200 finished flat over the month but Industrial stocks surged +5.5%. Consumer Staples (e.g. Woolworths) and Financials (e.g. the big banks) went sharply backwards.

In my opinion, the four high yield sectors went into a bubble after the February rate cut which was then burst by the lack of guidance about future cuts in the May RBA statement. These sectors are just back to where they were in January.

On the 1st July 2014, we were predicting this financial year to end at 5,900 on this coming June 30th. Stock markets are inherently volatile but the recent rally from a low of 5,610 keeps 5,900 on the radar. We think 6,300 is on the cards for mid-2016.

Foreign Equities

Wall Street keeps surging to new levels but largely in a sideways fashion. Most major markets were pretty flat in May. Emerging markets slipped a couple of percent.

There seems to have been no repeat of the ‘taper tantrums’ of 2013 as the US Fed is about to hike rates. Bond markets have been a bit volatile but equities seem to be strong.

Bonds

The Fed’s comments certainly put some volatility into bond markets around the world. But there hasn’t been much of a flow-on to equities. Our 10 year yield is firmly below 3% so – after tax and inflation – most such bond owners are going backwards.

Interest Rates

The RBA cut its rate to 2.00% in May. The market is divided over whether there will be any more cuts. We suspect there will be one more cut in a few months unless the Budget really sets the economy alight.

The US Fed has all but given up on a June rate hike for fear of going too soon. The first quarter was so bad in the US economy – largely because of weather and the dock strikes on the West Coast. The initial growth estimate for Q1 was only +0.2% and many were expecting that estimate to be revised downwards in subsequent months – and the  0.7% first revision confirmed that view. US Jobs data did jump back after a terrible March figure.

Other Assets

Iron ore prices recovered from their end-of-April slip to gain nearly 10% on the month. Brent oil prices have been relatively stable at above $60 / barrel.

Regional Analysis

Australia

It was not only the Westpac Consumer Confidence index that jumped up after the Budget, the average of the three post-budget ANZ – Roy Morgan indexes was also quite strong.

Retail Sales – measured before the Budget – came in at +0.3% which was fractionally down on the expected +0.4%.

But the big problem in forecasting the Australian economy at the moment is so much of the 2014 Budget has not yet passed through Parliament – and what from this Budget will pass?

It did look a bit like an election budget so there is a realistic chance Tony Abbott will use some bill not passing through the Senate to call a double dissolution before the 2016 Budget.

If Australia follows the UK’s lead in voting in a party that has the mechanism to truly lead, it might be a simple matter to get the economy ticking along quite nicely.

At the end of May, the CAPEX (Capital Expenditure) data for business forecasts was released. Expected 2015/16 expenditure is  24% down on that in the current financial year. Markets didn’t like that but, as we switch from heavy industry to clever industry, we probably don’t need quite as much CAPEX to support the same job growth.

But on Tuesday 2nd June we get the next RBA rate decision, followed by GDP growth on Wednesday 3rd. A rate change is highly unlikely and a soft GDP read looks likely on the cards.

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in today at 50.2 – a fraction up from the 50.1 in the previous month – but slightly down on expectations. A number above 50 signals growing economic growth.

China’s reaction to some weaker economic data with both a monetary and a fiscal injection proves they are serious about managing to hold on to a respectable growth target of 7% p.a. for 2015.

It is a little disturbing that China is building some man-made islands in the South China Sea – in the vicinity of the islands disputed with Japan and others for sovereignty over the last few years. It is more disturbing to read that China plans to place military infrastructure on these islands! And there is an awful lot of oil and gas in the neighbourhood. This news is starting to read like a James Bond movie script!

U.S.A.

The particularly poor US nonfarm payrolls (jobs increase) figure reported at the start of April of +126,000 jobs for March, was revised downwards to +85,000 – a truly miserable number.

However, the latest data were quite strong with +223,000 jobs and a 5.4% unemployment rate. Even average wage growth at +2.2% over the year was promising. This coming Friday’s numbers will tell the real tale. Was the March read just a blip that can be written off?

The preliminary GDP growth for Q1 was +0.2% and that was revised over the weekend down to  0.7% (but this was widely expected). Most serious analysts are predicting a much stronger second half for 2015 (around 2% for Q2 and 3% for Q3) but the Fed won’t want to pre-empt that with a rate hike just in case.

Europe

Greece is sailing close to the wind in regard to its debt repayments but the end of May witnessed some optimism regarding the negotiations. But whichever way it goes, people are so over Greece that the outcome doesn’t really matter anymore – unless you happen to live in Greece.

David Cameron’s UK Conservative Party was elected with a majority meaning that it does not need support from a coalition nor cross benchers to go forward for the next five years. And with a House of Lords rather than an elected Senate, Cameron will have no excuses if he fails to deliver. The UK is facing deflation – albeit only a  0.1% fall in the CPI for Q1 – for the first time since 1960!

Rest of World

Japan’s economic growth was a little better than expected. But the big news in the rest of the world is the magnitude of the alleged corruption in awarding various countries the right to host the football (soccer) World Cup. Everyone smelt a rat when Qatar won a bid to host the 2022 Cup in temperatures of over 40C but even the long-gone South Africa bid seems to be getting embroiled in the investigation.

It seems Qatar has already spent $200bn on the Cup preparations – or 10 times the amount Russia has spent on the 2018 Cup. Qatar will have serious egg on face if it gets the Cup taken away from it.

Recall England got bundled out of the 2018 bid with only two votes. Australia didn’t fare much better for the 2022 bid – and both countries spent a lot of money on their bids – and lost big time from the benefits flowing from any successful bid.

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

**Australian Bureau of Statistics