The Big Picture

We were calling for a rate cut in the last update on two grounds – full-time jobs (f/t) growth had stalled and inflation was low. We don’t get another read on inflation for a couple of months but May’s jobs report showed that the last three months had experienced cuts to trend f/t employment. That is worrying. The question is, will the RBA’s cut in May be enough?

No one else seems to be talking about this stall in f/t jobs which makes it even more worrying. The argument seems to be that 5.7% unemployment is good enough, but what has been happening is that f/t jobs are being replaced by part-time jobs (p/t). Since the official data just adds the two types of employment together for total employment, they are missing the point. An average p/t job is about 10 hrs/week, while it is around 40 hrs/week for a f/t position. And that’s why some of our consumer data isn’t as good as we would like.

The last GDP growth number was out of the box but that was largely driven by net exports. The domestic economy is not as strong. So we think we need at least a couple more rate cuts and the sooner the better. But what about the impact of the Budget? We think it isn’t likely to do much for the health of the economy in the short term. The main changes seem to be cuts to some company taxes and changes to superannuation regulations.

Around the globe, countries are trying to get debt under control rather than implement expansionary and costly fiscal programmes. We are no different and so we are reliant on our RBA.

In the US, their Federal Reserve (Fed) has been dragging its feet on enacting its second rate hike since the GFC. It promised four for 2016 last December when it made its first hike but now they are only predicting two this year. Markets don’t believe them. The Fed keeps saying each meeting is “live”, meaning that rates could go up at any time, but their accompanying language doesn’t back that.

In a recent speech at Harvard, the Fed Chair, Janet Yellen, used words like ‘probably raise rates’, ‘in coming months’, and ‘if economic data improve’. Not exactly positive wording! US jobs data in May were a bit on the weak side and US GDP growth was revised up from +0.5% for the year to only +0.6% when trend growth is closer to 3.0%. These data do not seem strong enough to warrant a rate hike now and it may be many months or more before they are.

Data in China has been a little bit lighter than expected, but oil and iron ore prices seem to have stabilised after extreme volatility at the start of 2016.

Japan’s economy continues to struggle. It planned a staged increase in sales tax when Prime Minister Abe came to power a few years ago, but he has just postponed the second hike for a second time! Increases in taxation are contractionary and their economy, like ours, needs the opposite.

The UK is facing up to its referendum on whether to leave the European Union on June 23rd. The enigmatic Boris Johnson is leading the exit campaign while the PM is for staying in. Polling does suggest that Britain will remain in the EU. An exit would cause great market instability.

Asset Classes

Australian Equities

Gains were made on the ASX 200 for the third consecutive month. The gains of +2.4% in May were not evenly spread across sectors. Healthcare made particularly impressive gains of +9.4% with three other sectors posting very strong gains: Consumer Discretionary (+5.8%); IT (+6.5%); and Telecommunications (+5.0%).

Of course there have to be underperformers. Energy (???1.8%) and Materials (???3.3%) actually lost ground in May.

High yield sectors have lost ground in the year to date, but when dividends are included, they have just held their ground.

The prospects for earnings growth over future years have been growing to the extent that we still think the ASX 200 might finish the year around 5,850 from an end of May level of 5,379.

Market volatility is back to normal levels after a taxing first quarter. We have the index only slightly overpriced, with a current fundamental level of 5,300.

Foreign Equities

The S&P 500 also gained in May but by less than the ASX 200. The World index was almost flat at +0.2%.

The VIX index, which purportedly measures ‘fear’ on Wall Street, has reached quite low levels when compared to historical values. Markets are no longer feeling stretched.

We also see good gains in Wall Street over the rest of 2016 growing, at an annualised rate of over +15% pa.

Bonds and Interest Rates

The RBA cut our rate from 2.0% to 1.75% in May. There are strong calls for more cuts, this year from most quarters. Macquarie was the first to predict at least three cuts in the foreseeable future. Morgan Stanley joined that camp later in May. We see no advantage to Australia in not cutting at least twice – and soon.

The Fed keeps stating the rates may soon go up, but they never seem to do anything! And they would be silly if they hiked, and then had to reverse the policy anytime soon. We are of the opinion a hike is unlikely before December. However, the market seems prepared to accept a hike when it does happen. We do not expect any excess volatility when the next hike arrives.

Other Assets

Iron ore prices and oil prices have stabilised after a torrid start to the year. Oil supply has been restricted from the Canadian forest fires and the Nigerian terrorist attacks.

Our dollar fell from $US0.76 to $US0.72 over the month of May.

Regional Analysis

Australia

It looked like there was going to be a landslide victory for the Turnbull government a short while ago. Recent polling is now close with possibly Labor ahead at times. The repeated policy ideas and reversals by the Coalition in recent months seem to have taken their toll. And the changes to super have possibly frightened people – including those unaffected by this round of changes. Whether or not you subscribe to whether the changes are technically retrospective, what walks like a duck …

The RBA inflation forecasts from the Statement of Monetary Policy have taken the range down from 2-3% to 1-2%, but GDP forecasts were unchanged. While we had +10,800 new jobs in May, that growth was entirely due to a big increase in p/t jobs and a big fall in f/t jobs.

Building Approvals grew at +3% when ???3% was expected by the market. Net exports were very strong and GDP growth came in at +1.1% for the quarter, but much of that was from very strong net exports, and not activity at home.

China

The China Purchasing Managers’ Index (PMI) for manufacturing continues to come in at just above the 50 level that signals expanding growth. The services industry PMI continues to be stronger as the consumer side of the economy takes an increasingly important role.

Retail Sales growth came in at 10.1% and Fixed Asset Investment grew at 10.5%. Industrial Production was a more modest 6.0%.

Inflation was a little bit softer than in recent times but China gets a solid tick for its continued economic strength.

U.S.A

It seems that few like either of the major Presidential candidates – Trump and Clinton. Indeed they seem so short on popularity that it is easy to imagine a last minute candidate to take control. Apparently it is possible.

Unemployment is stable at 5.0%, and wages grew a creditable 2.5% over the year. But that behaviour is more like showing ‘signs of life’ rather than pure strength. However, new home sales came in at an eight-year high.

Europe

Germany posted a quite strong growth figure of +0.8% for quarter one. France’s unemployment dipped back into single digits for the first time in a while.

Greece was struggling with its economy and debt repayments but the so-called ‘troika’ have just restructured their debt. We were writing about this in the European crises of 2011 and 2012. No one could then afford to give in to Greece without some ‘tough love’ first. But now that Greece seems to be trying to reform, it is easier to make some concessions.

Rest of the World

Nigeria has lost about half of its oil production due to terrorist activity which, with the production loss from the massive Canadian forest fires, helped restore oil price stability.

The Japanese government is moving a little further away from the ‘big end of town’ in an attempt to restore some economic growth. They also pushed back their scheduled sales tax hike by a couple of years.

India has overtaken China in terms of growth rates. The latest quarter, the economic growth read for India was +7.9%, the same quarter in the previous year, compared to +6.7% for China. India grew at +7.2% in the last quarter of 2015.

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

The Big Picture

If you feel confused by recent events in financial markets, you are certainly not alone. But, as we tried to convey in recent Economic Updates, some people deliberately put out bad news to grab headlines; some are manipulating markets behind the scenes in short-selling and the like; and calm, informed analysts and commentators get crowded out by the other two groups.

Now that the Quarter One (Q1) ‘volatility cluster’ is behind us we can say we saw what happened. At the time, we could not be certain but – as they say in courts of law – for us it was beyond reasonable doubt.

Whatever was the catalyst – probably the United States (US) Fed rate hike in December or it was just ‘the time was right for a correction’ – commodity prices nose-dived to unsustainable levels in Q1.

When the price of oil got down to the mid 20’s some big houses were calling $10 and $20. But prices jumped to around $40 and stabilised. Iron ore prices also plummeted and bounced back as hard. In fact, on March 8th, the price of iron ore had its best day ever – up +19% in one day!

The calls for a hard landing in China and a recession in the US have come and gone. They will come back again one day and someone will listen – but not us unless there are sound reasons for such calls.

The moral of the story is simple. Events like these happen from time to time so long-term investors should be positioning their portfolios before such events, and then sit tight. The whole point of these ‘squeezes’ is what we call ‘shaking the tree’ in the industry. You shake the tree so some fruit falls and someone picks it up to their benefit. In finance – some force prices down to get people to sell in fear and panic so that they can buy cheaply.

So where is the world heading? It’s fine but not great – just as it was late last year. We discuss the details in the ‘Regional Section’ below. Let’s just focus on the big game in town here.

The Prime Minister got the new Senate voting procedures through both Houses and then flagged a possible election and double dissolution for July 2nd. As we wrote in 2013 the voting procedures needed to change and now they have. People will now get the people they vote for and not those that did backroom deals with almost no first preferences. It was never to Australia’s advantage (whoever won majority) that a clutch of micro parties had to be placated to get any business done in parliament. We are back on track.

But the budget is now to be on May 3rd and the election looks like July 2nd. That means the Reserve Bank is unlikely to change rates at those times. In fact, it now looks like there can be no rate cut until around August/September.

On top of that the US Fed’s talk and US data have pushed back previously expected rate hikes probably to December if not later. These interest rate scenarios amount to a massive change in policy just since last month’s Economic Update! We think this means that the Australian economy will be a little more sluggish than we previously expected it to be.

In summation it is important to understand your investments in good times so that you don’t have to sell in bad. Unless you are a trader it is best to be calm when headlines get gloomy.

Asset Classes

Australian Equities

The ASX 200 had a bumper month as it gained +4.1% in March. But that was not enough to put the market in the black for the year-to-date. We are still down ???4.0% while Wall Street is up.

Despite the big sell-off near the end of the month for the big banks, that sector led performance over the whole month at +6.3%. The resource sectors also did well with +5.3% for Energy and +5.5% for Materials. At the other end of the spectrum the normally robust Healthcare sector fell by ???0.5%.

Importantly, volatility has subsided to normal levels. Given that we estimate that the market fundamentals strengthened over March but that we have the market a little underpriced, April could also be good for investors.

Foreign Equities

The S&P 500 gained an impressive +6.6% over March but the Shanghai Composite (China) index led the way with a gain of +11.8%.

The VIX ‘fear’ index for Wall Street has fallen to below average levels suggesting that investors are quite relaxed about the future direction of that market.

Bonds and Interest Rates

The Reserve Bank of New Zealand cut rates again by 0.25% in March. But, at 2.25%, New Zealand still has the highest rate in the developed world. We are next at 2%!

At home, the chance of a rate cut by June has been priced down by the markets. The market now has a cut at 30% compared to 60% a month ago. Political considerations make the next move unlikely before the mooted July election.

The US Federal Reserve changed its rate outlook at the March meeting. Last December, when it first hiked in nearly a decade, its ‘dot plot’ representation to the media suggested four hikes this year totalling 1.0%. The March version now has only two hikes for 2016 but again the market thinks that is optimistic. The market consensus has just one hike in December if any at all this year.

Other Assets

Iron ore prices are up +12% over the month and seemingly stable. The power play by the big miners to squeeze out smaller miners seems largely over.

Oil prices too have stabilised and Brent oil is up +12.5% on the month. OPEC is scheduled to meet again on April 17th with Iran to thrash out deals to stabilise prices further.

The price of gold was flat but our dollar appreciated +7.2% against the US dollar in March.

Regional Analysis

Australia

Trend unemployment continues to improve but at a very slow rate and trend employment growth has been strong and steady. But here, as around the world, improving labour markets are not resulting in wage or price inflation.

Our overall economic growth – measured by the growth in Gross Domestic Product – came in unexpectedly high at 3.0% for 2015. But digging deeper, the headline number was a little above trend but some of the components were less robust.

Our score card is the same as it has been for months. A rate cut or two would help. A budget that paves the way for solving the long-run problems we face would also really help. There is no impending cliff from which to fall – nor is there a simple solution to our current situation. We will probably jog along at this pace for the rest of the year.

China

It seems that the China doomsayers have retreated into the shadows but they can easily return unless data get really strong. So far China is much stronger than most thought a month or two ago. Indeed the March Purchasing Managers’ Index (PMI) came in at 50.2, or expansionary territory easily beating expectations of 49.3 and following February’s read of 49.0.

The China policy makers have set a range of 6.5% to 7.0% for growth over the next five years. China is also making overtures in the form of stimulus. China says there is no hard landing and we can’t find any evidence of one. At last, the China economy looks pretty safe.

U.S.A

The US jobs data reported in March were very strong. There were 242,000 new jobs when only 19,000-195,000 were expected. But, importantly, 242,000 jobs were not big enough to make an interest rate hike likely any time soon.

The Fed Chair, Dr Janet Yellen, has taken two of the four mooted rate hikes from last December off the table. And then she may have even taken another off in a speech later in March.

Europe

Obviously the Brussels’ bombings dominated March news in Europe and around the world. Sadly these incidents will not go away any time soon but, fortunately, they do not seem to dent market performance and economic conditions.

The so-called ‘Brexit’ referendum slated for June 23rd looks line ball when the UK will determine whether or not it should stay in the EU. Migration issues are front and centre – as we wrote about last year when Germany’s Chancellor, Angela Merkel, wanted to embrace all immigrants. Now countries are reportedly planning to send back 80% of immigrants because they are not ‘proper’ refugees. There is a lot to sort out in that part of the world.

The UK sugar tax caused some interest. In their recent budget they stated they are to tax sugar content in drinks and food in a bid to help health. They just happen to get a nice tax haul as a bonus!

Rest of the World

After a very poor run for nine months into the end of January, Emerging Markets have bounced back strongly. Indeed, the markets’ index grew +8.2% in March.