Economic Update

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

Optimism pervades year end

– Collective opinion that a US recession was imminent vanishes
– US Fed firmly on hold
– Westpac gets caught up in money laundering scams

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

A TV segment aired on CNBC (November 25th) declared that the recession fears starting on August 14th had been set aside. Readers might recall that we never thought the so-called ‘yield curve inversion’ phenomenon that started this round of fear had any merit. As a result, our investment strategy has been unchanged during this three-month period while some others had to correct their thinking twice.

We, of course, know we can make the wrong call from time to time so we do not stubbornly hold on to a position. Rather, we take heightened interest in all other signals and arguments until the scare passes.

With the US Federal Reserve (“Fed”) firmly on hold for the foreseeable future, the tariff war abating, and the official US GDP growth being revised upwards from 1.9% to 2.1% for Q3, there is less to worry about into the end of the year.

We do have to keep an eye on the proposed December 15th tariff hikes flagged by Trump. The consensus is that they won’t take place at all or will be scaled back.

While we agree that Trump will get a Phase 1 deal done some time, we now don’t think he will want to do it too quickly. Rather, he might like to keep the window between a deal and the election in November short enough so as not to allow for any close scrutiny of the merits of the deal before the vote.

The US jobs data released in November were much better than expected but expectations had been set particularly low because of 46,000 GM workers being out on strike. There was no value in that data outcome but wage growth was stronger and the unemployment rate stayed close to the 50-year low.

Moreover, US housing data were strong and retail sales beat expectations. Three large retailers (Target, Lowes and Macy’s) reported earnings much better than expectations. The US consumer remains strong and the consumer accounts for about two-thirds of the US economy.

At home, some greeted our jobs data with a heavy heart. While total employment did fall for the month, the headline data is quite volatile. The official trend data was not only for jobs growth but a slight uptick in that rate of growth.

Scott Morrison flagged an acceleration of $3.8bn worth of infrastructure spending but announced no new tax cuts in the near future. The Reserve Bank is thought to be considering monetary stimulus measures including rate cuts as the Australian economy continues to experience anaemic GDP growth.

The stock market was rocked by Westpac having had 23 million breaches of the money laundering rules. All four big bank stock prices took a hit on the day and for some days to follow. Since the banks are about one third of the ASX 200, lots of investors were affected. Nevertheless, the ASX 200 came within a whisker of a record 6,900 at the end of the month.

For a change, the news from Europe was encouraging (or at least less discouraging). Germany avoided a recession and a general election in the UK was called for December 12th. The incumbent Tory party, led by Boris Johnson, is well ahead in the polls. While there is now less faith in the accuracy of polling, it looks quite possible Johnson will get an absolute majority (unlike the present government that relies on a number of Northern Ireland MPs) that might help force a conclusion to the Brexit situation.

Whether or not Brexit is a good idea, the current uncertainty about the future of the European relationship is crimping investment intentions.

With the S&P 500 and the ASX 200 recently hitting new highs, and views about future policy changes are moderating. We continue to hold our view for modest to moderate growth in both markets while interest rates will remain low for some time.

Asset Classes
Australian Equities

The ASX 200 had a strong month recording gains of around 3%. The Financials sector fell around 3% over the month because of the Westpac crisis. Most other sectors did very well indeed. We have the index only a fraction over-priced. Accordingly, we continue to maintain our focus on earnings quality and await a pullback in market index levels before we consider bailing out of this major bull-run.

Foreign Equities

The S&P 500 also had a strong November gaining around 4%. The world index grew around 3% in November. We also have the S&P 500 only a fraction over-priced.

Bonds and Interest Rates

The Fed made strong statements about future rates in the US. It claims that economic growth is moderate, jobs are strong and inflation is near its 2% target. Therefore, it will take a lot for the Fed to cut rates further. However, there seems little chance that rates will rise for a substantial period. The market is now pricing in future rates broadly in line with the US Federal Reserve.

The RBA elected to leave the cash rate unchanged at 0.75% at its last meeting for the year. However it is also considering some kind of QE (quantitative easing) program similar to what the US and Europe engaged in following the GFC but Australia avoided.

Other Assets

The prices of iron ore, copper and oil all firmed in November. Market volatility – as measured by the VIX – fell sharply over November to a below average reading indicating that markets are experiencing reasonably healthy investor support.

Regional Review
Australia

The government will report its mid-year fiscal position (MYEFO) in December – shortly after our Q3 GDP growth data are released.

There is little doubt that the Australia economy has been subdued for much of 2019 but it does not seem to be slipping further. Rather, policy settings have stabilised the economy but a boost i.e. Government spending would be welcomed. If the government indeed fast-tracks the $3.8 bn infrastructure package, and the RBA eases monetary policy, the Australia economy could be in good shape towards the end of 2020.

China

The Chinese economy did start to show signs of weakening during November. Most of the major statistics missed expectations. Perhaps the trade war is starting to bite. As a result, China might be keener to resolve the trade war than before. Also, the civil unrest in Hong Kong continues but does not appear to be escalating as it did previously. The local elections saw a significant swing to pro-democracy candidates making the leadership of Carrie Lam more problematic that previously.

US

Several key US economic indicators beat expectations in November. In particular, US GDP growth of Q3 was revised upwards from the preliminary read of 1.9% to 2.1%. Those who were predicting a US recession earlier in the year must now be questioning their views.

Moreover, a number of agencies and private banks are staring to predict 2020 and 2021 will be stronger than 2019. That is, they believe that we are now at the bottom of the cycle. We concur but we do not feel the need to predict more than 12 months ahead to prudently manage our investment strategies. We also note that just because the cycle may have bottomed, does not imply that the recovery is imminent. Observations of this current cycle are that it is very slow moving.

Bloomberg, the financial services company, has just started to produce forecasts of a possible US recession over the following 12 months. Their first estimate puts the chance of a recession at 26% which is low for any given year. We will continue to monitor this indicator in order to assess any value it might have as an input to our strategies.

Europe

The UK will elect a new government on December 12th. Polls have Boris Johnson about 10 points clear but recent votes in many countries have called into question the accuracy of such polls.
If the Conservative Tory party gets an absolute majority it might well be able to push its Brexit policy through parliament and resolve Brexit by the next (January 31st) deadline.

Business seems to be battle-weary after three years of negotiations. Any sensible resolution to Brexit might prove to be a boost to that region’s economy.

Meanwhile, Germany just avoided a recession by producing a growth +0.2% in the latest quarter.

Rest of the World

The US has now declared its support for the Hong-Kong pro-democracy movement. While that might have a negative impact on the mainland China government, it might assist to produce stability on the streets of Hong Kong.

Japan’s economy continues to limp along. The latest Q3 growth was only +0.2% and industrial output growth was sharply negative. However, investment intentions for next year received a boost in the latest survey.

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

US data shows strength
– US reporting season stronger than most expected
– US Fed cuts rate in another split decision
– RBA cuts rate to 0.75%

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

The month of October was expected by many commentators to disappoint on a number of fronts: the US reporting season was expected to show weakness; the Brexit deadline of October 31st might produce a bad ‘no deal’ outcome; and the Australian economy was expected to deteriorate.

As it turned out, October witnessed a number of positive outcomes. Broker estimates of company earnings had been pared back but Q3 reporting season produced many strong upside surprises.

As a result, the S&P 500 performed strongly over October making a new all-time high.

Market activity was justified not by earnings simply beating lower expectations but the outlook for future earnings also improved. A few big tech companies’ stock prices fell sharply. The gloss has come off the so-called’ unicorns – companies that recently listed and rapidly became massive. Such a more considered view of such companies with little or no track record of profitability might help the future stability of the market.

US GDP growth also exceeded expectations for Q3. The initial estimate for the year to Q3 was 1.9% compared to the expected 1.6%. The Q2 result of 2.0% was only a fraction higher.

The start of October’s US labour force survey produced some mixed results. The unemployment rate fell to an almost 50-year low of 3.5% from 3.7% but wages growth was a little lower than expected at 2.9%. Only 136,000 new jobs were created but that number may have been tainted by strike activity. The 46,000 GM people on strike also makes it more difficult to interpret the November 1st data release.

The US Federal Reserve (“the Fed”) met at the end of October to consider its interest rate policy. A few weeks ago, there was an estimated probability of keeping rates on hold at about 25% (using the CME Fedwatch tool that constructs such probabilities from futures contracts). The day before the October 30th statement, that probability had fallen sharply to around 2.5% – which then fell to 0% just hours before the statement.

It was no surprise, therefore, that the Fed cut rates by 0.25% to a range of 1.50% to 1.75%. There was some concern how the Fed would handle future expectations. Chairman, Jay Powell, deftly soothed the market. He made it clear the cutting cycle has ended unless the economy materially deteriorates.

He also made it clear that rates will not rise (again) until inflation becomes a problem. The stock market reacted favourably.

At home, the RBA cut rates by 0.25% to 0.75% on the first Tuesday in October and signalled more cuts might follow. But our economic data that followed in October painted a rosier picture than the RBA has been painting. Retail sales came in at 0.4% for the month and our unemployment rate fell to 5.2% on solid jobs growth.

However, Australia CPI inflation continues to stay below the RBA target band of 2% to 3%. The latest headline reading was 1.7% and the RBA’s preferred core CPI was 1.6%.

The latest saga in the Brexit negotiations seems to be a three-month delay in the deadline and a UK general election on December 12th. The early polling suggests the Labour Party has little chance of victory largely owing to the unpopularity of its leader even among the parliamentary Labour MPs! What matters, therefore, is how the minor parties rally their troops on Brexit issues. At least the hard landing scenario now seems to be on the back burner.

The IMF cut its global growth forecast to 3.0% for 2019 (from 3.7% in 2018) but it forecasts a rebound to 3.4% in 2020. In the previous month the OECD downgraded its growth forecast to 2.9% for 2019.

We believe that relevant investment conditions are as good as, or slightly better than, previously reported so we feel that no change in strategy is warranted at this point.

Asset Classes
Australian Equities

The ASX 200 largely moved sideways during October (finishing down 0.4%). We had broker forecasts of earnings and dividends gaining strength over the month. The market is more or less fairly priced.

Foreign Equities

The S&P 500 had a strong October gaining just over 2%. During the month it reached new all-time highs.

The German DAX and Japanese Nikkei had even stronger months but the London FTSE was down in anticipation of the Brexit decision. We have the S&P 500 more or less fairly priced.

Bonds and Interest Rates

Given the Fed’s position on future rates discussed in our overview, there is little prospect of a recovery in bond yields and term deposits in the foreseeable future. It is generally thought that these prospects for bonds will underpin share markets – particularly for those shares paying reasonable dividends.

Other Assets

The price of iron ore slipped about 10% during October. However, the prices of oil and copper were relatively stable.

Regional Review
Australia

After having risen from 5.2% to 5.3% in the previous month, the Australian unemployment rate decreased back to 5.2%. There were 26,200 were full-time positions while part time positions fell by 11,400 resulting in net employment growth of 14,700 new positions. Of course, replacing part-time positions with full-time jobs is a sign of strength.

The Westpac and NAB sentiment indexes for consumers and businesses underperformed. However, retail sales were reasonable at +0.4% against an expected +0.5%. Inflation continues to be weak.

China

The official manufacturing PMI fell to 49.3 from the previous month’s 49.8. The nonmanufacturing read was above the ’50 line’ at 52.8 but that too was down on the previous month.
Q3 GDP growth came in at 6.0% but, all-in-all, China data do seem to be showing some exhaustion from the trade tariffs.

It seemed that progress had been made on the trade talks with Trump talking about a ‘Phase 1 deal’ maybe being agreed to at the Santiago APEC meeting in November. However, civil unrest has caused the APEC meeting in Chile to be cancelled.

US

The US unemployment rate dropped to 3.5% which is equal to the 50-year low. Only 136,000 jobs were created when 145,000 had been expected. The GM strike involving some 46,000 workers is thought to have been influencing that and the following month’s numbers.

US Q3 GDP came in at 1.9% against expectations of 1.6%. Both the Fed Chair and JP Morgan (after its earnings results) stated that the consumer is strong.

However, there have been two consecutive quarters of negative growth in business investment. Manufacturing is now but a small part of the economy.

Europe

The continuing Brexit saga might be approaching a sensible conclusion early next year. There have been far too many twists and turns along the way to try to unravel them all but, as things stand, the UK electorate will go to the polls on December 12th. It has been reported that the polls are suggesting Boris Johnson will be re-elected and possibly with an absolute majority. Such a result might eliminate the confusion in the House.

Rest of the World

The US is claiming a victory in the ‘war against terror’ having reportedly killed the leader of ISIS. But, again, the issues are complex and outside our expertise.

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

Global share market recovers from August dip

– Australian property market appears to be stabilising
– US Fed cuts rate in split decision
– The RBA cuts again by 0.25%
– Europe returns to monetary stimulus

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

Amid largely anecdotal reports of an improving Australian property market, the private data service, Corelogic, produced hard evidence that September witnessed quite strong price growth in both Sydney and Melbourne.

While the June and July interest rate cuts from the Reserve Bank of Australia (RBA) may have been a contributory factor to house price increases, the regulator also slackened certain lending criteria. Moreover, Australian property prices typically have a strong surge every five or ten years followed by an extended period of flat or slightly falling prices. Perhaps recent price action is the initiation of the recovery after two years of declining prices.

Corelogic’s data release occurred the day before the October 1st RBA board meeting. The collective wisdom of analysts and economists was that the RBA would cut its rate to 0.75% which it did. Of course, the RBA also has its eye on our labour market, overseas interest rates and our economic growth.

Australia’s second quarter growth came in at the start of September at a weak 0.5% for the quarter or 1.4% for the year. On the other hand, the jobs market remains reasonably strong.

However, with the US and the EU cutting rates in September, the RBA is somewhat forced to keep in step to try to stop our currency appreciating.
The US Federal Reserve (the Fed) cut rates in mid-September but in a split decision. Three members voted against the cut and only seven of 17 members expect a further cut this year.

The mood around US rates materially changed over September. Gone are those predicting a near term recession based on the difference between short and long US rates.  It seems that just one more strong retail sales data release of +0.4% for the month was enough to swing opinions. We were never in that near term recession camp.

Although there should always be a nonzero probability expectation of a recession, we see no current data sufficient to raise that probability to a significant percentage.

The US jobs data were again strong with wages growth at last solid at 3.2% and the unemployment rate remaining at a near 50-year low. The consumer is underpinning the US economy.

The European Central Bank (ECB) not only cut its rate by 10 bps (0.1% point) to  0.5% but it also reintroduced quantitative easing (QE) to the tune of $20bn per month for as long as is necessary. With the new ECB president, Christine Lagarde, taking over the reins in November, she is now locked in to a strong monetary stimulus policy.

The latest EU economic growth was only +0.2% for the June quarter. The ECB forecast for the year ahead is only +1.0%.

China has just started its Golden Week celebrations as it marks the 70th anniversary of the People’s Republic of China with its biggest parade to date.
Much of the standard China data monthly releases just missed expectations during September but that month ended with the Purchasing Manager’s Index (PMI) for manufacturing beating expectations at 49.8 – which is only just short of the ‘50’ that divides contraction from expansion. The services PMI at 53.7 is well in expansionary territory.

While stock markets generally turned the corner after a volatile August, the US Democrats have started an impeachment investigation against President Trump. Since an impeachment would need a two-thirds majority in the Republican-held Senate, it is a most unlikely event. And the markets are seemingly immune from the continuing anti-Trump campaign.

Asset Classes
Australian Equities

The ASX 200 index grew by around 2% over September and volatility was quite low. Financials stocks that include the big four banks had a particularly strong month.

We have calculated that company earnings revisions have resulted in a slight softening in our predicted capital gains over the next 12 months to about the historical average rate of 5%.

Foreign Equities

The S&P 500 also gained about 2% over September. Both the ASX 200 and the S&P 500 have gained nearly 20% over the course of 2019-to-date. The S&P 500 closed the month near all-time highs.

In spite of the Brexit woes. The London FTSE and the German DAX Indices posted particularly strong gains over September.

Bonds and Interest Rates

The key “2-10 spread”, being the US 10-year bond yield minus the 2-year equivalent turned a fraction negative (a so-called yield-curve inversion i.e. the shorter maturity interest rate is higher than the longer dated maturity interest rate) towards the end of August. That spread is now again positive which is the normal state of affairs.

The Fed cut rates by 0.25% in September. The CME Fedwatch tool that prices the future course of the Fed rate has a 55% chance of rates being on hold at the next meeting on October 30th. Currently it is indicating there is a 33% chance of no more cuts this year.

With the Fed and the ECB cutting rates in September, the outlook for bond yields continues to be soft making equities relatively attractive.

Other Assets

Oil prices spiked in mid-September as a drone destroyed part of a Saudi oil installation. However, a swift reaction managed to bring stability to prices after a few days. Elsewhere, Iron ore prices strengthened.

Regional Review
Australia

The Australian unemployment rate increased one notch (0.10%) to 5.3% in the September labour survey release. Nearly 35,000 jobs were created but full-time positions fell by about 15,000 however, part-time jobs swelled by over 50,000.

The economic growth estimate was released at the start of September. GDP grew by only 0.5% for the quarter or 1.4% for the year. Retail sales were particularly weak coming in at  0.1% when an increase of +0.2% was expected.

China

China is celebrating 70 years since the founding of the People’s Republic of China (PRC). Meanwhile, the demonstrations in Hong Kong continue – but only at weekends! There appears to be no end in sight.

China trade has been affected – presumably by the tariff war. Exports fell 1.0% in the latest month while imports fell by 5.6%.

The official manufacturing PMI rose again in September but, at 49.8, it is still below the 50 cut-off that denotes expansion. The services PMI continues to be very strong at 53.7.

Trump delayed certain tariff increases by a couple of weeks so as not to detract from the PRC celebrations. There does appear to be a slight softening in the trade war and China officials are again expected in the US capital again in October.

US

The US unemployment rate stayed at 3.7% and wages growth was 3.2%. Retail sales had another strong month with a growth of 0.4%. The second revision to June quarter growth left growth unchanged at a modest 2.0%.

Nike, the sporting clothes manufacturer, posted very strong sales results. It appears that the US consumer is strong enough not to need price discounting so that gross margins have strengthened.

Europe

Boris Johnson, the UK prime minister, has been found to have illegally called the proroguing of parliament in the lead up to the Brexit deadline on October 31st. There appears to be a deadlock since the opposition won’t agree to a general election without strong conditions that are unacceptable to Johnson.

European growth remains very weak at +0.2% for the latest quarter. Official predictions are only for a 1% growth over the year but the ECB has started a new round of monetary stimulus.

Rest of the World

Japan’s industrial production slumped  1.2% in the month as an increase in sales tax from 8% to 10% is being ushered in. Japan’s core inflation came in on expectations at 0.5%.

The OECD lowered its global growth forecast to 2.9% for the year.

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

US Federal Reserve cuts rate

– US economic data strong
– Australia cuts rates too
– China data surprises on upside

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

Anyone focused on US economic data – but avoiding media coverage – could be forgiven for being shocked about the current US Federal Reserve (the Fed) move on interest rates.

The Fed had not cut rates since 2008 until July 31st and last raised rates in only December 2018. The latest GDP growth came in at 2.1% when the Fed had expected 1.8% and the markets 2.0%. The consumer component of GDP was particularly strong at +4.3% but business investment (with the uncertainty of trade war solutions) fell  5.5%.

The latest US jobs number saw 224,000 new jobs created against an expected 160,000 while unemployment (at 3.7%) was all but at historic lows. Wages growth was 3.1% and core inflation was 2.1% (the target is 2.0%).

Retail sales came in at +0.4% for the month. That made three good readings in a row after the first was initially printed as negative before being revised upwards in subsequent months. The US consumer is strong and consumers contribute about 70% to economic growth hence the importance of domestic consumption to US growth.

So why was the market pricing in a certain cut for the end of July with a material chance of a double rate cut? The day before, a CNBC survey pronounced that only 48% thought the Fed should have cut at the end of July while 95% said they thought the Fed would cut!

There was absolutely no case for a cut on past data alone. The market, and President Trump, were bullying the Fed into an easing programme for two reasons. The first was as an insurance policy against future problems flowing from the US-China trade war. The second was because of the easing bias that is sweeping central banks across the world. In a race to the bottom, the US needs to keep its policy aligned with rest of the world.

That the Fed just cut rates by one quarter of a point while flagging further future cuts has introduced a new risk. What if the US economy continues to be strong and maybe even grow stronger on the back of the rate cuts?

On the face of it, a strong US economy is great – except that the Fed would then be forced to hike rates again. Such flip-flopping would likely cause further uncertainty in the economy and introduce the chance of the Fed then tightening too quickly and too far. Over-reaction to trying to slow down a strong economy is usually the basis for causing a recession! But, in the meantime, there would likely be strong gains to be made on markets if that scenario pans out.

Either way – with a necessary monetary easing or one unnecessarily forced on the Fed – markets should continue their positive aspect with new all-time highs being reached.

At home in July, the Reserve Bank of Australia (RBA) cut rates for the second month in a row. That was after about two and a half years on hold. The new official rate of 1% is not good news for conservative investors in cash and/or term deposits as the whole interest rate structure is expected to follow suite.

Our unemployment rate was again 5.2% and, while not showing sign of material improvement, is not the stuff of recessions. On top of that the government got its $158bn tax package through parliament. Around 10,000,000 tax payers may soon get an extra $1,000 or so in rebates. Perhaps that is why the only bright light in Westpac’s consumer sentiment index was the surveyed imminent purchase of a domestic consumer durable such as a new washing machine or fridge.

Those hoping for gloomy news at first took comfort in China’s latest slightly lower economic growth statistic of 6.2%. It was bang on expectations but retail sales easily beat expectations (9.8% against 8.3%) and industrial output (5.8% against 5.5% expected) spoilt their party. China is not (yet?) showing signs of having economic problems.

With US and China economic data strong, and future Australian data supported by tax and interest rate cuts, all looks reasonably stable for investors in the months to come – and maybe for even a lot longer!

Asset Classes

Australian Equities

At last the ASX 200 closed above the previous high posted in late 2007! Of course, when dividends are included that old high was breached a long time ago.

We have the ASX 200 as being a bit overpriced, making headwinds for further price gains the short-term. However, we find the underlying earnings story sufficiently strong to propel the market even higher over the rest of 2019. However, the August reporting season for companies listed on the ASX will colour that story for the rest of 2019.

Foreign Equities

The S&P 500 breached new all-time highs in July and there doesn’t seem to be any end in sight for the rally – at the moment. At the end of July about half of US listed companies had reported their second quarter earnings. Around 75% of those companies had so far beaten expectations – the usual number because expectations are often reset when the going gets tougher. However, the underlying earnings story is still quite positive. And it’s not just the big tech companies that look promising. Consumer discretionary companies like Starbucks and MGM posted great results and their share prices jumped over 5% on the news.

Bonds and Interest Rates

The big ‘lever’ all central banks have at their disposal to attempt to meet their targets – such as price stability and full employment – is coming under question.
There is a fairly clear linkage between interest rates and unemployment. Higher rates are a disincentive to investment which in turn causes an upturn in unemployment. Lower rates stimulate investment intentions given everything else is unchanged. The direct link between rates and inflation is less clear. It is usually argued that, as unemployment rates fall, there is pressure on wages because resources become scarce. Increases in wage inflation might then reasonably be expected to flow through to increases in price inflation.

The problem is that around the world (but particularly in the US) the link between unemployment and inflation appears to be broken. Unless there is a strong and stable negative (or inverse) relationship between unemployment and inflation, central banks cannot successfully target both unemployment and inflation with only one instrument – interest rates.

The (inverse or negative) relationship between unemployment and wage inflation was first reported by Bill Phillips, a New Zealand professor at the London School of Economics, in a 1958 academic publication. At various times, the stability of this relationship has been called into question. In the 1970s the so-called Phillips curve was widely thought to be no longer relevant.

By modifying the hypothesis in various ways, scant support has been found for a modified Phillips curve in more recent times. But a relationship which only lasts for a short time before changing is of no use to policy makers. In his July 12th testimony before Congress, the Fed chair pronounced the Phillips curve is ‘dead’.

There is nothing unusual about (academic) economic hypotheses coming in and out of favour. Economics is not an exact science. However, in the case of a Phillips curve, failure of the curve means that central banks cannot reasonably meet their dual objectives.

It is not a question of changing the target band for inflation to a new lower level. A new instrument needs to be added to the central banks armoury or the inflation target needs to be dropped altogether!

Nevertheless, central banks are on a new co-ordinated round of policy easing and this does not bode well for conservative investors. Cash rates, and longer bond yields, are likely to be lower for longer. As a result, some investors are moving to, or staying with, the so-called ‘bond proxies’: stocks that produce strong reliable dividends with not necessarily any great prospect of capital growth. Many infrastructure and utilities stocks are prime examples of bond proxies.

The Fed cut as expected in July and also ended its debt drawdown two months early. At first the market reaction was neutral but then Wall Street fell by over 1% when, under questioning, Fed Chairman Powell, said that it was not necessarily the start of a trend.

The RBA also cut official cash rates but the ECB was ‘on hold’. However, the ECB president stated that it had an easing bias for future policy.

Other Assets

Oil prices have been far less volatile than one might expect given the sanction issues over Iran’s nuclear activities.

The price of iron ore rose slightly over July and it is up 66% on the year-to-date.

The price of gold was up fractionally over July but has risen 12% in $US terms since late May.

Regional Review

Australia

The Westpac consumer confidence sentiment index fell 4.1 points to 96.5 in July meaning that there are now more pessimists than optimists in Australia. Could it be that consumers, buoyed by the federal election results and the positivity on taxes that went with it, got spooked by the RBA’s rate cuts implying that our economic prospects have weakened to the point of requiring such stimulus?

With little bad economic data this year in Australia, it is difficult for many to understand how the RBA can go from ‘the next move in rates is up’ to making two consecutive cuts with more being flagged in official speeches.

There does seem to be a nascent recovery in house prices – or at least an end to the falls. APRA, the financial services regulator, has scrapped a recent rule about how much people can borrow that has eased credit. That appears to be the main reason for the house price movements. It is far too soon for the rate cuts to have had any effects – especially as not all of the RBA cuts flow through to home loan rates.

The unemployment rate stayed at 5.2% which is not great but far from causing sleepless nights for market commentators. The headline jobs number was flat but it is notoriously volatile. The more stable official trend employment data came in at 21,100 new jobs created in June which is quite acceptable.

Unsurprisingly, the Australian inflation rate came in below the RBA target range of 2% to 3% for the 14th consecutive quarter. The headline rate was 1.6% for the year or 1.4% using the RBA’s preferred core measure of inflation.

China

It should always be stressed – when considering China’s economic growth – that any economy transitioning from a low growth rural economy via a fast growth development programme to a high-powered mature economy will go through various phases. At this point of the cycle we should expect China growth to fall from the double digits of 2008 to around the trend growth rates in countries like the US at around 2% to 3% but, in an orderly fashion.

The latest Chinese economic growth report came in at 6.2% which matched expectations. If a developed country like the US or Australia came in at that level, monetary and fiscal policy would be used to slow down growth to trend rates pretty quickly. On the other hand, we might expect China’s growth rates to glide gently down to around 3%. In the last decade, China growth has dropped from around 10% to 6%. If it falls to 3% in another decade, that might be quite reasonable but the timetable should also depend on monitoring the social situation in China during this transition.

Unfortunately, some commentators do not appear to appreciate the process of the transitioning of economies such as China. They said that 6.2% being less than a recent, say, 6.5% is a worry. Not so! One only has to look at the retail sales and industrial output data released on the same day as GDP growth! Retail sales beat the expected 8.3% with 9.8% and industrial output beat forecasts of 5.3% with a report of 5.8%.

The China manufacturing PMI was a little light on at 49.7. It was the third month on the run below the 50 mark that separates expansion from contraction but it was up on the previous month and it beat expectations.

Some might have expected worse data for China with the trade war still being unresolved. However, China can and is putting its own policies in place to combat any negative trade impacts. For example, it is building much needed infrastructure and it is adjusting certain lower-tier monetary ‘levers’ such as the RRR (required reserve ratio). The RRR is the amount of capital a bank must hold on deposit against its outstanding liabilities, i.e. the lower the RRR the more money the bank is able to lend out.

US

The last US jobs report bounced back after a one-off low number for May. The latest 224,000 new jobs number is well above recent annual averages of around 180,000.

Not only have the main macro statistics been painting a strong picture for the US economy, even the more micro-based numbers are often beating expectations. The Philadelphia Fed puts out regular readings of an index which measures local manufacturing output. The market was expecting a ‘5’ but it came in at a whopping 21.1.

The debt ceiling – which can and does cause government shutdowns when it is too low – has just been lifted so that no such problems can occur for the next two years at least (a point in time after the next US presidential election).

Europe

The ECB’s president Mario Draghi is just ending his term in office and is to be replaced by Christine Lagarde – the former managing director of the IMF. Since she has no experience in central banking or qualifications in economics (she trained as a lawyer) it is difficult to predict how she will perform.

Jerome Powell, chairman of the US Fed, is also a lawyer and he made a flew blunders since his appointment by US President Trump. We recall that he put markets in a spin at the start of October 2018 with a comment that the ‘neutral’ interest rate was well above current rates. Three months later, and after a rate hike, he presented a very dovish tone and he is now on an easing bias! Perhaps Lagarde can learn from Powell’s mistakes rather than creating her own.

The ECB was ‘on hold’ in July but it has flagged there is monetary policy easing to come. Hopefully, the hierarchy of the ECB will maintain the momentum. The European Union economy is not doing well.

At last, Boris Johnson has been confirmed as head of the ruling Conservative (Tory) party and, hence, PM of the UK. His Brexit stance has been to remove the ‘Irish backstop’ or the divide between the Republic of Ireland and the UK’s Northern Ireland from future negotiations.

Johnson claims the UK will ‘Brexit’ (exit from the European Union) on October 31st come what may. That is, Britain will leave the EU with or without a new deal in place. Some sort of volatility must ensue but we see no great impact on the Australian economy or our stock market at this point in time.

Rest of the World

Iran problems continue to be unresolved. Oil tankers and navies are interacting in that region while sanctions are being imposed over Iran’s nuclear programme. Naturally there is a fall out for oil prices but, so far, oil prices have been reasonably well behaved. Perhaps the large-scale production of shale oil in the US has helped stabilise oil prices.

Also, the civil unrest in Hong Kong continues well beyond what was initially expected and the world watches on to see how Beijing authorities resolve this situation. While it persists, it is a source of uncertainty.

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.